The Queen v. Gelber, 83 DTC 5385, [1983] CTC 381 (FCA)

Le Dain, J:—This is an appeal from a judgment of the Trial Division allowing the respondent’s appeal from an income tax reassessment in respect of his 1972 taxation year.

The issue is whether a deduction from the respondent’s income of capital cost allowance in respect of a part of the purchase price of a share in a film should be disallowed on the ground that it would unduly or artificially reduce the respondent’s income within the meaning of subsection 245(1) of the Income Tax Act, RSC 1952, c 148, as amended by SC 1970-71-72, c 63, which reads:

245. (1) In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

The respondent, who is a lawyer, entered into an agreement in 1972, on the recommendation of one of his partners, for the purchase from Intercontinental Leisure Industries Ltd (“Intercontinental”) of a 4 / per cent interest in a feature film entitled “Mother’s Day” and the leaseback of the film to Intercontinental for a period of 15 years at a rental of 4 / per cent of 92 per cent of the gross revenues from the exploitation of the film. The offer to purchase provided that the price of the respondent’s share of the film was $38,333.33, of which $8,333.33 was payable upon acceptance of the offer, and the balance of $30,000 was payable within seven days of the pledge by Intercontinental of Government of Canada bonds having a market value of at least $31,583.33 to secure the guarantee under the lease of a minimum rental revenue of $30,000 over a period of eleven years. The contract provided alternatively that the bonds could be hypothecated to secure a bank loan to finance the purchase price. The purchaser had the right to retain the interest on the bonds as additional rental revenue, not to be applied in reduction of the rental guarantee. For each $1,000 of rental revenue received by the respondent from the gross revenues of the film he was to return to Intercontinental $1,000 worth, at market value, of the bonds.

In his testimony the respondent said that he looked at this investment in terms of what he referred to as “the risk reward ratio”. He was risking some $38,000 against an assured minimum return over eleven years which he estimated to be about $48,000, consisting of the guaranteed rental revenue of $30,000 and the interest on the bonds. As he put it, his “risk was minimal, on the down side”. According to him, this was the aspect of the proposed investment which chiefly concerned him and which induced him to enter into the arrangement. He said he was also aware of the tax implications. The tax advantage of the 60 per cent rate of capital cost allowance on films was noted in the “Film Purchase Proposal” which had been submitted to him. It was also reflected in the calculations of his partner, who recommended the investment to him. His partner noted, however, that the tax saving realized by the capital cost allowance would be largely offset by the tax payable on the rental revenue, and in a memorandum to the respondent he said: “To understand this film deal properly, I think you have to look at it as an investment and not strictly as a tax shelter”. In his testimony concerning the relative importance of the tax advantages of the investment as an inducement for making it, the respondent said he could not be sure how significant the tax advantages would be, depending on how successful the film was, and that they would not have been sufficient by themselves to induce him to make the investment.

The total price of $38,333.33 was paid by the respondent to Intercontinental. The bonds were pledged by Intercontinental, and the respondent received the interest on them. As it turned out, the film was not successful, and there was a very small amount paid as rental from the gross revenues of the film. The balance owing under the minimum rental guarantee will be payable on December 31, 1983.

In his return for his 1972 taxation year the respondent showed a loss of $23,000 on his investment in the film, which resulted from taking capital cost allowance in this amount, calculated at the rate of 60 per cent on the total purchase price of $38,333.33 for his share of the film. In his reassessment the Minister of National Revenue disallowed $18,000 of the capital cost allowance on the ground that the capital cost to the respondent of his share of the film was $8,333.33, the amount payable on acceptance of the offer to purchase, and that capital cost allowance on the balance of $30,000 payable under the contract would unduly or artificially reduce the respondent’s income within the meaning of section 245(1) of the Act. The Trial Division allowed the appeal from the Minister’s reassessment, holding that the capital cost of the respondent’s share of the film was $38,333.33 and that capital cost allowance on the amount of $30,000 did not fall within subsection 245(1). The Trial Division also allowed appeals, involving the same issue, from reassessments in respect of the respondent’s 1973 and 1974 taxation years. The three appeals were heard together on common evidence. The judgment of the Trial Division with respect to the reassessments for the respondent’s 1973 and 1974 taxation years is the subject of separate appeals in this Court in Court numbers A-791-80 and A-792-80.

The essential submission of the Crown was that the $30,000 should not be considered as part of the capital cost because it was not at risk in view of the conditions of the contract providing for an assured return in the form of guaranteed rental and interest on the bonds. There were other submissions but this, as I understood it, was the heart of the appellant’s case. That this is so is indicated by the statement in paragraph 6 of the statement of defence that the sum of $8,333.33 payable on acceptance of the offer to purchase was the only amount which the respondent “had in fact invested and put at risk”. It is also indicated by the statements in the appellant’s memorandum of fact and law that the $8,333.33 “is the only sum put at risk by the Respondent in respect of the acquisition of the film” and that “the capital cost allowance claimed in the first year would be almost triple the capital put at risk”. It was not contended that the transaction was a sham or other than it purported to be. In one of his submissions counsel for the appellant went so far as to contend that all that was acquired by the payment of the $30,000 was the “usufruct” of the bonds, but that is in my opinion clearly untenable in view of the disproportion between the $30,000 and the amount of the interest to be earned on the bonds. The appellant argued that the agreement provided, in effect, for a return or exchange of capital, but I think the guaranteed rental and the additional rental in the form of the interest on the bonds cannot be regarded as other than income. Although the right to retain the interest on the bonds is a departure from the general rule in the case of pledge, it cannot be seriously contended that the respondent had a right of ownership in the bonds rather than a mere right of security. The appellant also submitted that the tax advantages, in the form of the capital cost allowance, was the respondent’s principal motive for entering into the transaction. That is not supported by the evidence, but in any event it would not by itself be sufficient to justify the application of subsection 245(1). The high rate of capital cost allowance was established to encourage investment in films. It would have to be shown that the $30,000 was included in the purchase price solely to permit the taking of additional capital cost allowance, and that it bore no real relationship to the value of the share of the film purchased by the respondent. That has not been shown.

I turn, then, to the submission that because of the assured rental revenue under the lease, including the interest on the bonds, the $30,000 should be considered not to have been invested in the film because it was not at risk. In my opinion, the fact that a purchaser of property provides, as a condition of the purchase, for a leaseback under which he is assured of a revenue that will cover the amount of his investment and some return on it does not make the purchase price any less the true capital cost of the property. The degree to which an investment is at risk is not, in the absence of a provision in the Act or the regulations to that effect, a valid criterion as to what is capital cost.

Subsection 245(1) permits the disallowance of a deduction, which is based on what is otherwise a genuine transaction, if it would unduly or artificially reduce the taxpayer’s income. In my opinion there is no basis in the conditions of the contract or in the evidence for treating the $30,000 in issue as resulting in an unduly large or artificial capital cost, and the section should not, therefore, be applied to disallow the capital cost allowance in respect of that amount. I would accordingly dismiss the appeal.