Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
(1) Whether a terminal loss of $XXXXXXXXXX resulting from the disposition of its mining assets by an amalgamated corporation should be disallowed in computing its income for the purposes of the Act.
(2) Whether such loss should reduce its resource profits for the purposes of the Regulations.
Position:
(1) The terminal loss resulting from the disposition of the machinery (mining equipment) by XXXXXXXXXX (the amalgamated corporation) could be allowed as a deduction in computing its income by virtue of subsection 20(16) of the Act, even though XXXXXXXXXX did not have any mining operations during the period after the amalgamation and before the disposition.
(2) The terminal loss should reduce resource profits for the purposes of section 1204 of the Regulations subject to the proration under the transitional rules.
Reasons:
(1) Based upon the Supreme Court case of Hickman Motors, it is our view that the machinery should not be precluded from including as depreciable property in a prescribed class of XXXXXXXXXX upon the amalgamation of XXXXXXXXXX. It is also our view that XXXXXXXXXX met the requirements for the deduction of the terminal loss under subsection 20(16) of the Act.
(2) In light of the broad scope of the definition of "resource activity" in subsection 1206(1) of the Regulations, it is our view that notwithstanding the mining operations ceased in XXXXXXXXXX, the disposal of the machinery by XXXXXXXXXX would be considered as "activities that the taxpayer undertakes as a consequence of" the mine production/processing. Accordingly, the terminal loss would not be precluded from the deductions from XXXXXXXXXX resource profits by virtue of subparagraphs 1204(1.1)(a)(iv) and (v) of the Regulations.
July 17, 1997
Calgary Tax Services Office Resource Industries
Graham Hoard Section
Acting Assistant Director Peter Lee
Verification & Enforcement (613) 957-8977
Attention: Doug Reeh
Large File Case Manager
7-970054
XXXXXXXXXX
Terminal Loss and Resource Allowance
This is in reply to your memorandum of January 2, 1997 wherein you requested our opinion on whether a terminal loss of $XXXXXXXXXX resulting from the disposition of its mining assets by the corporation formed in an amalgamation of XXXXXXXXXX, should be disallowed in computing the amalgamated corporation's income under the Income Tax Act (the "Act"). You also requested our opinion on whether such loss should reduce its resource profits for the purposes of the Income Tax Regulations (the "Regulations").
Facts
XXXXXXXXXX
Taxpayer's Views
6.Even though the Terminal Loss was deducted in computing its income for XXXXXXXXXX for the purposes of the Act, XXXXXXXXXX excluded the Terminal Loss from the resource profits calculation under section 1204 of the Regulations for the following reasons:
(a) the provision of the Regulations does not make any direct reference to the expression "terminal loss";
(b) the Machinery would not be able to earn "resource profits" within the meaning of the expression under the Regulations as XXXXXXXXXX does not have any mining rights and interests after the amalgamation;
(c) it is questionable as to whether the Terminal Loss resulting from the idle Machinery previously used for mining may reasonably "be regarded as applicable to a source referred to in paragraphs 1204(1)(b) and (b.1)" of the Regulations;
(d) because the Machinery relate to a separate business - mining business, that is no longer carried on by XXXXXXXXXX, the Terminal Loss from its mining business should not affect the resource income from its other business - oil and gas business;
(e) if the disposal of the Machinery was made by XXXXXXXXXX, prior to the amalgamation, this would not be an issue because the Terminal Loss would have no impact to XXXXXXXXXX as it would have resulted in negative resource profits; and
(f) XXXXXXXXXX had no mining operations nor mining revenue (a source) in the year in which the Terminal Loss was claimed and the Machinery is not related to a source (i.e., a business of production and/or processing) for the purposes of subsection 1204(1.1) of the Regulations.
7.As an alternative argument, the taxpayer has argued that there was a change in use of the Machinery when the mining operations ceased. This change in use would trigger the Terminal Loss in the predecessor company - XXXXXXXXXX, resulting in realization of a non-capital loss that would flow to the successor company - XXXXXXXXXX, on amalgamation.
Industry Specialist's Views
8.In the view of the Department's oil and gas specialist, one of the purposes of the changes to section 1204 of the Regulations, effective July 23, 1992, was to clarify the meaning of "reasonably attributable". It is the specialist's view that a terminal loss is reasonably attributable to a resource activity, including the inactive mining operations, and therefore it should grind resource profits.
Your Views
9.You indicated that there are two alternatives to resolve this matter:
(a) if the Machinery are non-resource assets to XXXXXXXXXX, it is arguable that the Machinery have no potential of earning income from business or property by XXXXXXXXXX. Accordingly, the Machinery are precluded from inclusion in a prescribed class in Schedule II under the Regulations immediately subsequent to the amalgamation. As a result, any loss on disposal of the Machinery would be disallowed under paragraph 18(1)(a) of the Act - the Terminal Loss would be disallowed in computing XXXXXXXXXX income, and there would be no impact to the resource allowance calculation; and
(b) the Terminal Loss grinds the resource profits because it is reasonably attributable to resource activity resulting in a reduction of resource allowance equal to $XXXXXXXXXX.
10.It is our view that the Terminal Loss resulting from the disposition of the Machinery (mining equipment) by XXXXXXXXXX could be allowed as a deduction in computing its income by virtue of subsection 20(16) of the Act and should reduce resource profits for the purposes of section 1204 of the Regulations subject to the proration referred to in 20 below. Our rationale of these views is provided in the following paragraphs.
11.With respect to the taxpayer's change-in-use argument referred to in 7 above, we do not agree with it. In order to apply the change-in-use rule under paragraph 13(7)(a) of the Act to the case at hand, it is our view that the Machinery must be used at some point in time for a purpose other than gaining or producing income (e.g., for personal use). However, you have informed us that the Machinery was idle, was simply held for sale and that the Machinery was not used for any other purposes. Accordingly, it is our view that paragraph 13(7)(a) of the Act does not apply to the Machinery. This view is consistent with the Department's comments in paragraph 8 of Interpretation Bulletin IT-478R.
12.One might argue that when XXXXXXXXXX ceased its mining operations in XXXXXXXXXX, its mining business also ceased and the subsequent disposal of the Machinery would have nothing to do with this mining business. However, by analogy to the cases of Selig, 55 DTC 46 (TAB), and Poulin, 94 DTC 1674 (TCC) (which was reversed by the Federal Court of Appeal (96 DTC 6477) on different ground), it is our view that the disposal of the Machinery is related and attributable to this mining business, even though such business was inactive and there were no mining operations. (See also the case of Powell Rouyn Gold Mines Limited, 59 DTC 401 (TAB), in which the Board concluded that as a practical matter, notwithstanding that the gold mining operations were suspended, the recapture of capital cost allowance would constitute profits reasonably attributable to the production of prime metal and was therefore an amount eligible for depletion allowance for the purposes of sections 1200 and 1201 of the Regulations.) In the case of Poulin at page 1678, the Tax Court of Canada differentiated this case from the case of Emerson, 86 DTC 6184 (FCA), and quoted with approval the comments of Member Fisher in the case of Selig as follows:
Every dealer in scrap metals runs the risk, in the ordinary conduct of his business, of purchasing in good faith metals which may ultimately turn out to have been stolen property, with the result that the dealer will be held liable for their value less the amount which he paid for them... the appellant happens to be no longer actively engaged personally, as a sole proprietor, in the operation of the scrap dealing business in the year 1952... The liability was incurred personally by the appellant herein as sole proprietor of the business. It was not assumed by the limited company when it took over the business in 1947 for the simple reason that it was not even known to exist at that time. Nevertheless the court, in 1952, has found that the appellant, personally, was liable to make the payment of the $7,000 as a result of his personal business transactions. To the extent that he was so liable, it would appear that he was still in business until his business liabilities had all been settled once and for all.
In the case of Poulin, 96 DTC 6477 (FCA), the Federal Court of Appeal reversed the decision of the Tax Court of Canada on the ground that the $385,802 payment by the taxpayer did not correspond with any risk which the taxpayer had been required to assume in his capacity as a real estate agent, and therefore, the payment was not deductible (not a permissible deduction) by virtue of paragraph 18(1)(a) of the Act. However, the Federal Court of Appeal agreed with the observation of the Tax Court of Canada that the taxpayer, although no longer carrying on business and could no longer act on behalf of clients as a licensed real estate agent in 1987, was still occupied during 1987 with the activities as a broker as long as he was engaged in completing the things he had done in carrying on his profession. The surrender of his licence, therefore, did not preclude the taxpayer from complying with the provisions of paragraph 18(1)(a) relating to an otherwise permissible deduction from income.
13.With respect to your reassessment alternative referred to in 9(a) above, we considered whether the Terminal Loss could be disallowed by virtue of subsection 20(16) of the Act, not paragraph 18(1)(a) of the Act, on the basis that the Machinery is not "depreciable property of a particular class" to XXXXXXXXXX.
Pursuant to subsection 20(16) of the Act, notwithstanding paragraphs 18(1)(a), (b) and (h) of the Act, at the end of a taxation year a taxpayer can deduct a terminal loss in respect of a "depreciable property of a particular class" in computing the taxpayer's income in the year provided that the requirements under this subsection are met.
The expression "depreciable property" is defined in subsection 13(21) of the Act as:
... property acquired by the taxpayer in respect of which the taxpayer has been allowed, or would, if the taxpayer owned the property at the end of the year and this Act were read without reference to subsection (26), be entitled to, a deduction under paragraph 20(1)(a) in computing income for that year or a preceding taxation year...
Pursuant to paragraph 1102(1)(c) of the Regulations, for the purposes of paragraph 20(1)(a) of the Act, the classes of property described in Part XI and Schedule II of the Regulations would be deemed not to include property:
... that was not acquired by the taxpayer for the purpose of gaining or producing income...
In the case of Hickman Motors Limited, 95 DTC 5575 (FCA), the Federal Court of Appeal concluded that because after the winding-up of a subsidiary of Hickman Motors under subsection 88(1) of the Act, Hickman Motors did not acquire the assets from its subsidiary for the purpose of gaining or producing income, it was not entitled to a capital cost allowance deduction under paragraph 20(1)(a) nor a terminal-loss deduction under subsection 20(16) of the Act. In the Hickman Motors case, Hugessen, J.A. commented at pages 5578 and 5579:
... section 88 does not create for the appellant an independent right to claim capital cost allowance on the property which it acquired on the winding-up of its subsidiary "Equipment". Such a claim can only succeed if the appellant can demonstrate that it otherwise meets the requirements of the Act and Regulations.
... the test to be applied in determining whether property has been acquired for the purpose of gaining or producing income is similar to that which was authoritatively settled by the Supreme Court of Canada (Moldowan v. The Queen, 77 DTC 5213) for determining the analogous question as to whether a taxpayer is carrying on a business with a reasonable expectation of profit... In particular, "Equipment's" experience in past years was one of substantial losses; "Motors" was not in the business of leasing heavy equipment; and the intended course of action of the appellant, at the time the assets of "Equipment" were acquired by it, was admittedly to turn such assets over to "Equipment (1985)" within five days time... the fact that this taxpayer held the property here in issue only over the period of a long holiday week-end is surely indicative of the fact that it had no intention of actually earning income from the property... In sum therefore, I am of the view, that the trial judge's finding of fact to the effect that the appellant did not acquire the property of "Equipment" for the purpose of gaining or producing income is concordant with the applicable principles of law and is solidly based in the evidence.
... the effect of subsection 1102(1) is that the appellant did not own any property of the relevant class as of December 31, it equally did not own it on December 28... the text (under the provisions of subsection 20(16) of the Act) makes it abundantly plain that the taxpayer must, at some previous time, have owned property of the relevant class; no other meaning can be attributed to the use by the Parliament of the words "no longer owns".
Based upon the Federal Court of Appeal's decision in the case of Hickman Motors, one might argue that in the case at hand, there would be no "depreciable property of a particular class" in respect of the Machinery after the amalgamation by virtue of paragraph 1102(1)(c) of the Regulations because there was no expectation of profit by XXXXXXXXXX in the acquisition of the Machinery. The result would be no deduction in respect of the Terminal Loss to XXXXXXXXXX in computing its income under subsection 20(16) of the Act. However, the Machinery would fall within the definition of "capital property" under section 54 of the Act, with the result that the loss of $XXXXXXXXXX arising from the disposal of the Machinery would be treated as a capital loss to XXXXXXXXXX.
14.The above-noted comments and conclusion of Hugessen, J.A. are based on the majority decision of the Federal Court of Appeal in another similar case dealing with inventory instead of depreciable property, Mara Properties Limited, 95 DTC 5168 (FCA). (See the comments of Hugessen, J.A. in the case of Hickman Motors at page 5577.) However, the Supreme Court of Canada (96 DTC 6309) subsequently reversed this majority decision and simply indicated in its oral decision as follows:
We agree with the conclusions reached by the Tax Court and Mr. Justice MacDonald, the dissenting judge in the Court of Appeal. In our view, in the circumstance of this case, the property retained its character as inventory in the hands of the appellant.
It appears that this conclusion of "retainment of the property's character" is in conflict with the decision of the Federal Court of Appeal in the case of Hickman Motors. Unfortunately, the Supreme Court of Canada in Mara Properties did not provide its own rationale for the conclusion nor comment on whether it would agree with the rationale of the lower Courts. In particular, the Supreme Court of Canada did not address the important issue as to whether the property distributed to the parent company from its subsidiary company under subsection 88(1) of the Act (or any other roll-over provision of the Act) would automatically retain its character or whether such retainment would depend on the facts of a particular situation. Furthermore, the Supreme Court of Canada did not address the issue of the "reasonable-expectation-of-profit test" which was rejected and commented on by Mr. Justice MacDonald, the dissenting judge in the Federal Court of Appeal, at page 5174:
... the appellant's argument is that since the purpose of respondent's purchase of Fraserview was not to gain or produce income and because the purchase had no reasonable expectation of profit, the land did not create a source of income and it therefore cannot constitute inventory in the respondent's business. In essence, the appellant's claim that the sale of Fraserview to the respondent fails to meet a "business purpose test"... I find that subsection 9(1) of the Act does not block the inclusion of the respondent's loss on the sale of the inventory in the calculation of business income.
There are a number of roll-over provisions under the Act, including section 87 and subsections 88(1). Given that the purpose of a roll-over is generally to defer the incidence of tax, it is arguable that property transferred on a roll-over should retain its pre-roll-over character. While the Federal Court of Appeal in the case of Hickman Motors was prepared to accept this view of the purpose and intent of subsection 88(1) of the Act as argued by the taxpayer (see page 5577 of the case), it rejected the taxpayer's arguments regarding the consequences of this view. The Court noted that subsection 88(1) of the Act does not, in and of itself, create rights to any deductions. Pursuant to paragraph 1102(14)(d) of the Regulations, it is arguable that property acquired in an amalgamation or winding-up would be deemed to be property of the same prescribed class or separate prescribed class, as the case may be, as that of the property before the amalgamation or winding-up. However, the Federal Court of Appeal in the case of Hickman Motors rejected this argument at page 5578 as follows:
Subsection 1102(14) does not have the reach contended for it. It does not say that it operates notwithstanding the general rule set out in subsection 1102(1) or the underlying principle enshrined in paragraph 18(1)(a). The purpose of subsection 1102(14) is manifestly to prevent the acquirer of depreciable property, in the circumstances described in the various paragraphs thereof, from switching such property from one class to another.
15.On June 26, 1997, the Supreme Court of Canada rendered its decision in the case of Hickman Motors (Court File #24994). The Supreme Court concluded that subsection 88(1) of the Act does not, in and of itself, create any right to claim capital cost allowance, and that such deduction may only be taken if the requirements under subsection 20(1) of the Act are met. The majority of the Supreme Court concluded that based on the facts of the case, there was evidence that Hickman Motors had a single source of business income from the GM cars and trucks dealership and the John Deere heavy equipment dealership. Accordingly, the preamble of subsection 20(1) of the Act was met. Furthermore, the majority of the Supreme Court reversed the concurrent finding of the trial judge and of the Federal Court of Appeal that the assets transferred on wind-up were not used for the purpose of gaining or producing income from the parent's business. The majority of the Supreme Court concluded that the taxpayer was entitled to capital cost allowance because it also met the requirement of paragraph 1102(1)(c) of the Regulations (the property was acquired for the purpose of gaining or producing income from the business). According to the majority of this majority (McLachlin, La Forest and Major JJ.), this requirement was met by virtue of the deeming provision of paragraph 1102(14)(c) of the Regulations (repealed in December of 1989, although presumably paragraph 1102(14)(d) of the Regulations would now cover the same ground) - where the property (before the winding-up) was property of a prescribed class the property (after the winding-up) shall be deemed to be the property of that same class, and by virtue of the fact that the taxpayer did not commence to use the property for some purpose other than the production of income (paragraph 13(7)(a) of the Act). According to the minority of this majority (L'Heureux-Dubé J.), this requirement was met by virtue of the fact that the assets in question produced income.
The dissenting judges (Iacobucci, Sopinka and Cory JJ.) acknowledged that, during oral argument, the Crown counsel had conceded that, by virtue of subsection 88(1) of the Act, when Hickman Motors assumed ownership of its subsidiary's heavy equipment assets, it acquired depreciable property of a prescribed class (i.e., this departed from the line of argument pursued by the Crown in the lower courts), and that the Crown did not base its opposition to the appellant's claim on anything contained in the Regulations. Rather, the dispute revolved entirely around the opening words of subsection 20(1) of the Act - whether the capital cost allowance in question was applicable to a business source of income. Accordingly, the dissenting judges did not address the issue in respect of the Regulations in the case.
16.In light of the decision of the Supreme Court of Canada in Hickman Motors in respect of subsection 1102(14) and paragraph 1102(1)(c) of the Regulations, the Machinery should not be precluded from being included in depreciable property in a prescribed class of XXXXXXXXXX upon the amalgamation of XXXXXXXXXX. Accordingly, the Terminal Loss resulting from the disposition of the Machinery by XXXXXXXXXX could be allowed as a deduction in computing its income by virtue of subsection 20(16) of the Act, even though XXXXXXXXXX did not have any mining operations during the period after the amalgamation and before the disposition.
17.Pursuant to paragraph 1204(1)(f) of the Regulations, deductions could be made in calculating "gross resource profits" as follows:
... any other deductions for the year that can reasonably be regarded as applicable to the sources of income described in paragraph (b) or (b.1), other than a deduction under paragraph 20(1)(ss) or (tt) of the Act or section 1201 or subsection 1202(2), 1203(1), 1207(1) or 1212(1).
Pursuant to subsection 1204(1.1) of the Regulations, "resource profits" of a taxpayer for a taxation year means the amount, if any, by which the taxpayer's gross resource profits for the year exceeds the total of:
(a) all amounts deducted in computing the taxpayer's income for the year other than (i) an amount deducted in computing the taxpayer's gross resource profits for the year... (iv) an amount deducted in computing the taxpayer's income for the year from a business, or other source, that does not include any resource activity of the taxpayer, and (v) an amount deducted in computing the taxpayer's income for the year, to the extent that the amount (A) relates to an activity (I) that is not a resource activity of the taxpayer, and (II)... and (B) does not relate to a resource activity of the taxpayer...
Pursuant to subsection 1206(1) of the Regulations, "resource activity" of a taxpayer means:
... for the purposes of this definition... (g) the production or the processing, or the production and processing, of a substance by a taxpayer includes activities performed by the taxpayer that are ancillary to, or in support of, the production or the processing, or the production and processing, of that substance by the taxpayer... (i) the production or the processing, or the production and processing, of a substance by a taxpayer includes activities that the taxpayer undertakes as a consequence of the production or the processing, or the production and processing, of that substance, whether or not the production, the processing or the production and processing of the substance has ceased...
18.As discussed in 12 above, the disposal of the Machinery would be considered as related and attributable to the mining business for the purposes of section 9 and paragraph 18(1)(a) of the Act, even though such business was inactive and there were no mining operations. However, by analogy to the cases of Gulf Canada, 92 DTC 6123 (FCA), and Gulf Canada Resources, 96 DTC 6065 (FCA), it is our view that after the mining operations ceased in XXXXXXXXXX, the source of income from mine production/processing for XXXXXXXXXX also ceased for the purposes of paragraphs 1204(1)(b) and (b.1) of the Regulations. Accordingly, the Terminal Loss would not have to be deducted from XXXXXXXXXX resource profits under paragraph 1204(1)(f) of the Regulations.
19.In light of the broad scope of the definition of "resource activity" in subsection 1206(1) of the Regulations as referred to in 17 above, it is our view that notwithstanding the mining operations ceased in XXXXXXXXXX, the disposal of the Machinery by XXXXXXXXXX would be considered as "activities that the taxpayer undertakes as a consequence of" the mine production/processing. Accordingly, the Terminal Loss could not be precluded from the deductions from XXXXXXXXXX resource profits by virtue of subparagraphs 1204(1.1)(a)(iv) and (v) of the Regulations. As a result, we do not agree with the taxpayer's argument referred to in 6(a), (b), (d) and (f) above.
20.New subsection 1204(1.1) of the Regulations is effective for taxation years that begin after July 23, 1992. For taxation years that begin after December 20, 1991 and before July 24, 1992, as in the case at hand, the amount determined under paragraph 1204(1.1)(a) of the Regulations for XXXXXXXXXX would have to be determined by a prescribed formula.
21.With respect to the taxpayer's argument referred to in 6(e) above, we agree that if the disposal of the Machinery was made by XXXXXXXXXX, prior to the amalgamation, whether the terminal loss would grind resource profits would not be an issue because the terminal loss would have no impact to XXXXXXXXXX as it would have resulted in negative resource profits. There is no requirement that this negative resource profits of XXXXXXXXXX must be offset against any resource profits of XXXXXXXXXX under the Regulations. Furthermore, new paragraph 12(1)(z.5) of the Act would also not apply to XXXXXXXXXX for the relevant period. However, by analogy to the case of Bronfman Trust, 87 DTC 5059 (SCC), it is our view that one must deal with what the taxpayer actually did, not what he might have done.
We hope that our comments are helpful to you. If you have any further queries, please contact the writer.
Acting Chief
Resource Industries Section
Resources, Partnerships and Trusts Division
Income Tax Rulings and Interpretation Directorate
Policy and Legislation Branch
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