Courier Trading & Enterprises LTD v. Her Majesty the Queen, [1977] CTC 346

Smith, DJ:—In this action the plaintiff is appealing the reassessment of its income for the taxation year 1971, by which the Minister of National Revenue assessed its income for tax purposes at $30,000 more than the amount shown on its income tax return for that year. The Minister’s reassessment was objected to by the plaintiff, which appealed unsuccessfully to the Tax Review Board.

The relevant facts may be stated as follows:

In 1969 Northland Fisheries Ltd, which used aircraft to some extent in its fisheries operations, caused the plaintiff to be incorporated for the purpose of buying and selling used aircraft and handling mortgages on aircraft and collecting money due thereon. The plaintiff was then and still is a subsidiary of Northland Fisheries Ltd, which in these reasons is hereafter designated as Northland. Peter Lazarenko is president of both companies.

In August 1969 the plaintiff acquired, in an arm’s length transaction, a Mallard aircraft and a Beech aircraft in exchange for a Grumman Goose aircraft, the Goose on the one hand and the Mallard and Beech on the other being valued at $100,000.

On May 1, 1970, in its opening inventory balance, the plaintiff placed a value on the Mallard of $60,000 and a value on the Beech of $25,000, indicating a total value $15,000 (15%) less than that at the time of purchase a little more than eight months before.

On July 21, 1970 the plaintiff sold the Beech aircraft, in an arm’s length transaction, for $34,500, showing a profit on the sale of $9,500, which amount was shown as income on its income tax return for that year.

On or about March 12, 1971 the plaintiff, in an arm’s length transaction, purchased a Cessna aircraft for $15,000.

In April, 1971 the plaintiff sold both the Mallard and Cessna, in a non-arm’s length transaction to its controlling company, Northland, for a total consideration of $45,000. On the evidence of Mr Lazarenko this sale was made because it had been decided to wind up the affairs of the plaintiff.

The price, according to Mr McFarlane, a chartered accountant and auditor for both Northland and the plaintiff, was arrived at by deducting from their cost valuation of $75,000, 40% or $30,000. Mr McFarlane and Mr Lazarenko both indicated that no sales of Mallard aircraft had occurred (Mr Lazarenko said three, in addition to their one had been on the market), and as a result they were unable to establish a market price. McFarlane said Lazarenko thought $60,000 was too high for the Mallard, and at McFarlane’s suggestion 40% was deducted being what McFarlane said would have been allowed for income tax purposes if the aircraft had been depreciable assets which they were not in the hands of the plaintiff.

In the hands of the plaintiff they were merchandise for sale, or inventory. The $30,000 was in fact all deducted from the cost value of the Mallard as shown on the May 1, 1970 inventory balance, $60,000. The deduction was, therefore, 50%, not 40%. No deduction was made from the cost price of the Cessna, purchased only a month before for $15,000. In point of fact the Cessna was sold by Northland in June 1971 for $16,500, at which price, after allowing $1,500 for floats installed during the couple of months it was owned by Northland, there was neither profit nor loss on the Cessna transaction.

The plaintiff had been trying to sell the Mallard and did succeed in finding two prospective buyers. Mr Lazarenko was hazy about the dates when these prospective buyers showed interest in purchasing the aircraft, except that they were close in point of time and that it was before April 1971 and probably in 1970.

The plaintiff offered to sell the Mallard to the first of these interested parties for $80,000. This company sent an engineer named Gaburi to examine the aircraft. He did so and reported that a number of things required to be repaired and replaced, and particularly that an 800 hour (flying) check was required, which alone would entail about 2,000 man hours of work. The evidence concerning this report is not very satisfactory. Mr Gaburi was not called as a witness and the report itself was not filed. Mr Lazarenko’s evidence concerning it is hearsay. The only written evidence about it is a letter (Exhibit D-3) dated January 30, 1973 from Gaburi to Lazarenko, which states that a carbon copy of his inspection report is enclosed, and contains some comments about its contents. Nothing further developed after Gaburi’s inspection.

The second display of some interest in the Mallard was made by Georgian Bay Airways Ltd on behalf of Mr John David Eaton. According to a letter (Exhibit D-2) dated August 1, 1972 from Georgian Bay Airways to Lazarenko, this occurred in May of 1971, which would indicate that Mr Lazarenko’s memory was faulty as to the date. Exhibit D-2 indicates that on May 25, 1971 Lazarenko wrote Mr Powell, president of Georgian Bay, offering to sell the Mallard for $70,000. The letter goes on to state that during the summer, after considerable negotiations, Lazarenko was prepared to accept $60,000 for the aircraft, including the spare engine, or $55,000 without the extra engine. Finally

the letter states: “We probably would have purchased the aircraft if we had been able to obtain an engineer’s report which, as you know, was promised but was never forthcoming from your competition.” Nothing further developed.

As already stated, Northland sold the Cessna in June 1971, without either loss or profit. In October 1971 Northland sold the Mallard in an arm’s length transaction for $75,000, realizing only $60,000 on the sale because it had been listed with the agent at a price of $60,000 net to Northland. The sale was to Palm Tree Airways, a Bahamian company.

The only other sale of a Mallard in Canada during the latter part of 1970 or in 1971, of which we have any evidence, is recorded in a bill of sale, of which a carbon copy was filed (Exhibit D-4), which is dated at Winnipeg, September 28, 1971. The sale was by Midwest Airlines Ltd, of which Mr Lazarenko was also president, to Chalk’s International Airlines, of Miami, Florida. The price was $68,000. We have no evidence of this aircraft’s condition at the time of the sale. Mr Jack Falk, an airworthiness inspector with the Department of Transport, was questioned about Exhibit D-4 and noted it contained no requirement for an 800-hour inspection. On cross-examination by counsel for the plaintiff, he said that neither he nor the Department was aware of any manufacturer’s check regulations for the Mallard, adding that if there were any the Department would be aware of it.

One further fact about the Mallard aircraft with which we are concerned is that it had, both in 1970 and 1971, a certificate of airworthiness (C of A) issued by the Department of Transport. Mr Falk had examined both of them. He stated that the certificate for 1970 was dated June 8, 1970 and that for 1971 was dated June 6, 1971. The total hours of flying logged up to June 8, 1970 were 6,677, and up to June 6, 1971 were 6,678, only one hour having been logged during the year, that one hour having been flown during the test preceding issue of the certificate.

Mr Lazarenko gave evidence about the market for aircraft (other than those of the large airlines). He said the market price fluctuates greatly, depending on demand. Thus the price may rise or fall sharply. As one example he said the Cessna when new was sold at about $35,000 but that now it was worth $70,000. A second example he gave was that of the Beaver aircraft, which he said had risen in price during the last few years from about $40,000 to $75,000, but that recently the United States government had put a lot of them on the market, creating a glut. As a result, he said a Beaver might be bought right now for as low a price as five years ago.

Mr Lazarenko stated that the Mallard is an amphibious aircraft, being able to take off and land on both land and water. It is an executive type aircraft, designed for passenger traffic, but can be converted into a carrier of goods or equipment by stripping out the seats. As an amphibious aircraft it has an advantage over other types for flying in the north, more particularly in summer. In his evidence he said there were only about ten, perhaps fewer, Mallards in Canada, and that when, as was the case during much of 1970 and 1971, there were four being offered for sale, the market was depressed. As Mr McFarlane put it, there were no buyers at the time the non-arm’s length sale was made by the plaintiff to Northland.

Counsel for the plaintiff submitted that the offer by Lazarenko in May 1971 to sell the Mallard to the agent for John David Eaton for $55,000, which might have been accepted if an engineer’s certificate had been produced, could fairly be taken as a starting point. From this sum he argued that some $20,000 or $25,000 should be deducted, being the cost of repairs and replacements and the 800-hour check listed in Gaburi’s report. This would bring the final price to about $30,000, the amount at which it was valued in the non-arm’s length sale.

I am unable to agree with this submission. As stated above, the evidence concerning Gaburi’s report is not such as to warrant giving it much weight. There were no arm’s length sales of Mallards in Canada of which the Court has any evidence, in the last half of 1970 or in 1971 prior to September. If, as Lazarenko testified, there were four of them being offered for sale during this period, I can only conclude either that there were no buyers of Mallards to be found or that the parties could not agree on a price or terms. This suggests strongly that owners who might have sold were unwilling to sell at prices lower than they thought they should realize. Then on September 28, 1971 one Mallard was sold for $68,000 and in October the one owned by Northland was sold for $75,000 gross and $60,000 net to Northland.

On a careful consideration of all the evidence my finding is that the plaintiff has not discharged the onus of proving, on a balance of probabilities, that the Minister’s reassessment of $60,000 for the Mallard was wrong. In my view, the weight of evidence is to the opposite effect.

The plaintiff, at the trial, argued strongly that the Minister’s assumption concerning the effect of subsection 17(2) of the Income Tax Act was in error, and that by reason of the provisions of subsections 17(7) and 20(4) of that Act, subsection 17(2) does not apply to this transaction at all. The provisions of these subsections are as follows:

17. (2) Where a taxpayer carrying on business in Canada has sold anything to a person with whom he was not dealing at arm’s length at a price less than the fair market value, the fair market value thereof shall, for the purpose of computing the taxpayer’s income from the business, be deemed to have been received or to be receivable therefor.

(7) Where depreciable property of a taxpayer as defined for the purpose of section 20 has been disposed of under such circumstances that subsection

(4) of section 20 is applicable to determine, for the purpose of paragraph (a) of subsection (1) of section 11, the capital cost of the property to the person by whom the property was acquired, subsections (2), (5) and (6) are not applicable in respect of the disposition.

20. (4) Where depreciable property did, at any time after the commencement of 1949, belong to a person (hereinafter referred to as the original owner) and has, by one or more transactions between persons not dealing at arm’s length, become vested in a taxpayer, the following rules are, notwithstanding section 17, applicable for the purposes of this section and regulations made under paragraph (a) of subsection (1) of section 11:

(a) the capital cost of the property to the taxpayer shall be deemed to be the amount that was the capital cost of the property to the original owner;

(b) where the capital cost of the property to the original owner exceeds the actual capital cost of the property to the taxpayer, the excess shall be deemed to have been allowed to the taxpayer in respect of the property under regulations made under paragraph (a) of subsection (1) of section 11 in computing income for taxation years before the acquisition thereof by the taxpayer.

Paragraph 11(1)(a) referred to in paragraph (4)(b) of section 20 is the paragraph which permits the deduction from income of capital cost allowances (depreciation) on property in accordance with regulations. Property, real or personal, which is intended to be retained or used by the taxpayer in the operation of his business is depreciable at rates established by the regulations. On the other hand, where the taxpayer is a dealer, ie a buyer and seller of things, items of property which he buys for resale in the course of his business are not depreciable. They are merchandise or items in his inventory of things for sale.

The plaintiff, Courier Trading & Enterprises Ltd, non-active since the sale of its two aircrafts to the plaintiff in April 1971, is a dealer in used aircraft. Its business is not transportation. Thus aircraft purchased by it are inventory and are not depreciable property in its hands. On the other hand Northland, its parent company, is engaged in the fisheries business. It uses aircraft to some extent in that business for carrying people and sometimes for carrying cargo. Its business, at least after it had incorporated the plaintiff, did not include the buying and selling of aircraft. Thus aircraft owned and used by it were depreciable property in its hands.

The meaning of subsection 17(2) of the Income Tax Act is quite clear and if it stood alone there would be no basis on which the argument advanced by counsel for the plaintiff could have been made. The only question would be what was the fair market value of the Mallard aircraft in April 1971, when it was sold by the plaintiff to Northland in a transaction not at arm’s length.

Subsection 17(7) establishes an exception to what is provided in subsection (2). That exception applies only where “depreciable property of a taxpayer", as defined for the purpose of section 20 has been disposed of under circumstances to which subsection 20(4) is applicable to determine, for the purpose of paragraph (a) of subsection (1) of section 11, the capital cost of the property to the person by whom the property was acquired. Under such circumstances subsection 17(2) does not apply in respect of the disposition.

I note here that the only disposition of property with which this action is directly concerned is the sale by the plaintiff to Northland of the Mallard aircraft in April 1971. The taxpayer referred to in subsection

(7) of section 17 can only be the plaintiff in this case. The only other party referred to in the subsection is “the person by whom the property was acquired’’, which, for this case, clearly means Northland.

Subsection 20(4) likewise refers only to depreciable property but does not contain the words “of a taxpayer”. It provides that where such property did belong to a person (referred to as the original owner) and has by one or more non-arm’s length transactions become vested in a taxpayer, the rules in paragraphs (a) and (b) of the subsections apply, notwithstanding section 17.

Here I note that the taxpayer referred to in this subsection can only be, for the purposes of this action, if the subsection applies at all, Northland. Similarly, on the facts of this case, the person referred to as the original owner can only be the plaintiff.

Paragraph (a) of subsection (4) of section 20 would not help the plaintiff, since the capital cost of the Mallard to the original owner (the plaintiff) was, as shown on its inventory balance of May 1, 1970 and not disputed by the defendant, $60 000, the same figure as that stated in the Minister’s reassessment.

Paragraph (b) of said subsection provides that where the capital cost to the original owner exceeds the actual capital cost to the taxpayer (Northland), the excess shall be deemed to have been allowed to the taxpayer (Northland) in computing income for taxation years before the acquisition thereof by the taxpayer.

Counsel for the plaintiff submits that subsection (7) of section 17 and Subsection (4) of section 20 both apply to the facts of this case and that consequently subsection (2) of section 17 is not applicable in respect of the disposition with which this action is concerned. He further submits that the rule that subsection (2) of section 17 is not applicable in respect of the disposition must apply to both parties to the disposition, and that anything else would be completely improper.

Subsection (2) of section 17 is concerned with a sale of anything by a taxpayer in a non-arm’s length situation at a price below fair market value and the effect that such a transaction is to have on the taxpayer’s income. On the other hand, subsection (4) of section 20 is concerned with a situation where depreciable property belonging to one person has by one or more non-arm’s length transactions become vested in a taxpayer, and the effect such circumstances are to have on the capital cost of the property to the taxpayer. Subsection (2) of section 17 Is clearly designed to prevent a non-arm’s length sale at a price below fair market value being effective to reduce the seller’s (taxpayer’s) income by the difference between the price obtained and the fair market price that could have been obtained. If such an effect were not prevented, the taxpayer’s income tax would be reduced improperly. Subsection (4) of section 20 is clearly designed to prevent a non-arm’s length sale of depreciable property at a price above fair market value from being used to establish an improperly high capital cost base on which allowable depreciation would be calculated.

I find it hard to believe that Parliament, in establishing a rule to prevent a buyer from becoming entitled to excessive depreciation allowances, by means of a fictitiously high capital cost, would intend to make inapplicable a rule to prevent a seller from reducing his income tax by means of a loss on a sale at an unreasonably low price. In the present case, if the Minister’s reassessment is correct (and I have already held the contrary has not been proved) we are dealing with the latter type of situation.

A conclusion as to whether subsection (7) of section 17 and subsection (4) of section 20 have any application in this case has occasioned some difficulty.

Caine Lumber Company Limited v MNR, [1959] SCR 556; [1959] CTC 221; 59 DTC 1123, is a decision of the Supreme Court of Canada. Briefly stated, the relevant facts were as follows: Martin Caine was a saw and planing mill operator who in 1949 purchased a timber limit for $250. He then incorporated the appellant company to take over his business. In 1951 he sold the limit to the company for $15,000, in what the parties agreed was a non-arm’s length transaction. The appellant cut timber and became entitled to claim a capital cost allowance, for depletion of capital assets, things which Caine himself had never done or claimed. The appellant claimed capital cost allowance, calculated on the full price paid to Caine. The Minister allowed the claim but based on a purchase price of $2,928.60 being the $250 paid by Caine for the limit plus the amount expended on it while it was his property. He was thus applying subsection (2), now (4), to the transaction.

Subsection (2) of section 20 of the Income Tax Act at that time was in exactly the same words as subsection (4) today, and subsection (3) at that time, which gives a definition of “depreciable property of a taxpayer’’, is the same as paragraph (a) of subsection (5) today, except that in the present definition the quotation marks enclose only the two words “depreciable property’’. Paragraph (a) of subsection (5) reads:

(a) “depreciable property’’ of a taxpayer as of any time in a taxation year means property in respect of which the taxpayer has been allowed, or is entitled to, a deduction under regulations made under paragraph (a) of subsection (1) of section 11 in computing income for that or a previous taxation year:

In the Caine case the appellant claimed that as Caine had never cut any timber from the limit and was never allowed and never became entitled to a deduction under the regulations, the limit had not been depreciable property of a taxpayer until the plaintiff began to cut timber. The Minister, he submitted, had improperly applied subsection (2), now (4), of the Act, and should have applied subsection (1) of section 17. The Supreme Court dismissed the appeal, holding that the statutory definition of “depreciable property of a taxpayer’’ could not be held to be the definition of “depreciable property” in subsection (2). It was held that those two words clearly refer to property such as a timber limit, the value of which depreciates as the timber is cut. Section 17 was therefore excluded and the assessment was properly made.

Martland, J (Cartwright, J, as he then was, concurring) agreed with Locke, J and the other judges, but added, at pages 561-2 [226, 1125]:

I agree with the conclusions of my brother Locke and merely wish to add that, in my opinion, the result of this appeal would be the same even if the definition of “depreciable property of a taxpayer” in subsection (3) [now (5)] of Section 20 of the Income Tax Act were to be applied in construing the meaning of the words ‘‘depreciable property” in subsection (2) [now (4)] of that section. It seems to me that subsection (2) applies if the property in question constitutes depreciable property vested in the taxpayer who claims the allowance provided under Section 11 (1 )(b), irrespective of whether or not the property was “depreciable property” in the hands of the person from whom the taxpayer acquired it by a transaction not at arm’s length.

The Caine decision is authoritative in the circumstances of that case. It was a case of a buyer claiming deductions based on the capital cost to him of property of which he was at that time the owner. This is exactly the situation to which subsection (4) would apply today. All that subsection does is lay down rules for determining capital cost in the circumstances described in it.

The situation in the present case is quite different. Here the appellant is not asking for a capital cost allowance. Its claim has nothing to do with capital cost. It is claiming the right to take into revenue only the $30,000 received on its non-arm’s length sale of the Mallard aircraft, not the $60,000 which the Minister assessed as the fair market value. Further the plaintiff was not at the time its claim was made and is not now the owner of that aircraft. It was never depreciable property while owned by the plaintiff.

Ryan v MNR, [1967] CTC 484; 67 DTC 5325, was another case of a plaintiff’ claiming deductions from income by way of capital cost allowances. The property in question was a gravel pit. Thurlow, J, in the Exchequer Court of Canada, rejected an argument that subsection 20(4) does not apply unless the property in question was “depreciable property” when owned by the transferor. He said, at page 490 [5329]:

. . . there is, in my opinion, nothing in the wording of Section 20(4) which requires that the property referred to be “depreciable property” while owned by the transferor. The subject matter with which the subsection is concerned is the capital cost of depreciable property of a taxpayer who has acquired it through a non-arm’s length transaction and what the subsection does is to prescribe what is to be taken as the capital cost of the property to that taxpayer.

At page 491 [5329] Thurlow, J quoted the opinion of Martland, J in the Caine Lumber case, which has been quoted supra, and spoke of it as being conclusive on the point.

On the basis of the foregoing two cases, and after reading all the other cases cited to me by counsel for both parties, I agree with Thurlow, J’s opinion that subsection (4) applies to cases where the question to be resolved is the capital cost of depreciable property of a taxpayer who has acquired it through a non-arm’s length transaction, and that what the subsection does is to prescribe what is to be taken as the capital cost of the property to that taxpayer.

That is not at all the situation in this case. We are not dealing with a purchaser taxpayer and the capital cost of property to that taxpayer. We are dealing with the vendor of the property and the question to be determined is whether that vendor, in a non-arm’s length transaction, received the fair market value of the property.

In my view subsection (4) of section 20 has no application to the circumstances in this case. Therefore subsection (2) of section 17 is not rendered inapplicable by subsection (7) of that section.

As stated earlier in this judgment, in my opinion the plaintiff has not discharged the onus of proving the Minister’s assessment of the fair market value of the Mallard in question at $60,000 to be wrong.

The action is accordingly dismissed with costs.