Royal Trust Co. v. The Queen, docket 97-3757-IT-G

Date: 20001204

Dockets: 97-3757-IT-G; 97-3758-IT-G; 97-3759-IT-G

BETWEEN:

THE ROYAL TRUST COMPANY, ROYAL TRUST CORPORATION OF CANADA,

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent,

Reasons for Judgment

Sarchuk J.T.C.C.

[1] At the commencement of the trial the parties to these appeals filed the following Statement of Agreed Facts:

A. BACKGROUND INFORMATION RELATING TO THE APPELLANTS

1. Each Appellant is and was, at all material times relevant to the appeals, a "financial institution" as defined in subsection 181(1) of the Income Tax Act, R.S.C. 1985, c.1 (the "Act").

2. For purposes of the appeals, the relevant taxation year of each Appellant was ended on December 31st.

3. Neither of the Appellants is or was, at any material time relevant to the appeals, an "insurance corporation" as defined in subsection 248(1) of the Act.

4. Each Appellant was, at all material times relevant to the appeals, a member of the Royal Trust Leasing Partnership (the "Partnership").

5. The interest of RTCC and RTC in the Partnership was approximately 96% and 4% respectively.

6. The fiscal period of the Partnership, for purposes of the appeals, ended on December 31.

B. DIRECT FINANCING LEASING TRANSACTIONS AND THE LESSEES

7. Each Appellant or the Partnership entered into lease agreements (collectively, the "Leases") as lessor, with the following corporations (collectively, the "Lessees") on the following dates noted in brackets with respect to the following types of property (collectively referred to as the "Assets"):

(a) Potash Corporation of Saskatchewan Mining Limited (December 16, 1983) (the "Potash No. 1 Lease") (Mining equipment)

(b) British Columbia Railway Company (December 30, 1983) (the "Railway Lease") (Railway locomotives)

(c) Potash Corporation of Saskatchewan Mining Limited (August 23, 1984) (the "Potash No. 2 Lease") (Mining equipment)

(d) British Columbia Forest Products Limited (October 16, 1984) (the "Forest Products Lease") (Mill equipment)

(e) British Columbia Transit (December 14, 1984) (the "Transit Lease") (Advanced Light Rapid Transit Vehicles)

(f) Pacific Western Airlines (May 1, 1985) (the "PWA Lease") (Airplane)

(g) Canarctic Shipping Company Limited (May 10, 1985) (the "Canarctic Lease") (Ship)

(h) Electric Furnace Products Limited (June 15, 1987) (the "EFP Lease") (Ethylene oxide/glycol manufacturing equipment)

(i) Air Canada (November 2, 1987) (the "Air Canada Lease") (Airplane)

(Copies of the Leases are attached hereto as Exhibits 1 to 9 respectively).

8. Pursuant to the terms of the Leases, the Lessees paid each Appellant or the Partnership amounts in respect of the use of the Assets by the Lessees.

9. The Appellants do not know, and did not know during the 1990 to 1992 taxation years, of the geographic location of the use of the Assets by the Lessees.

C. THE APPELLANTS' BALANCE SHEETS AND FINANCIAL STATEMENTS – GENERAL COMMENTS

10. For the 1990-92 taxation years each Appellant prepared audited financial statements, including balance sheets (the "Balance Sheets") in accordance with generally accepted accounting principles ("GAAP"). The Balance Sheets are attached hereto as Exhibits 10 to 18.

11. In the course of preparing financial statements and accounting for the Leases, each Appellant and the Partnership relied upon, inter alia, the information set out in the documents set out below:

The Royal Trust Company ('RTC') – Reconciliation of Lease Accounts to Financial Statement (1990, 1991, 1992) (attached as Exhibit 19)

Royal Trust Corporation of Canada ('RTCC') – Reconciliation of Lease Accounts to Financial Statement (1990, 1991, 1992) (attached as Exhibit 20)

RTC – Detailed General Ledger Based Balance Sheets and Grouping Schedules (1990, 1991, 1992) (attached as Exhibit 21)

RTCC – Detailed General Ledger Based Balance Sheets and Grouping Schedules (1990, 1991, 1992) (attached as Exhibit 22)

Royal Trust [RTC, RTCC and Royal Trust Leasing Partnership ('RTLP')] – Reconciliation of Amortization Schedules to Lease Accounts (1990, 1991, 1992) (attached as Exhibit 23)

Breakdown of Lease Components (RTC, RTCC and RTLP) – Summary (1990, 1991, 1992) (attached as Exhibit 24)

Breakdown of Lease Components (RTC, RTCC and RTLP) –1990 (attached as Exhibit 25)

Breakdown of Lease Components (RTC, RTCC and RTLP) –1991 (attached as Exhibit 26)

Breakdown of Lease Components (RTC, RTCC and RTLP) –1992 (attached as Exhibit 27)

Royal Trust (RTC, RTCC and RTLP) Lease Continuity Schedule for the year ended December 31, 1990 (attached as Exhibit 28)

Royal Trust (RTC, RTCC) Lease Continuity Schedule for the year ended December 31, 1991 (attached as Exhibit 29)

Royal Trust (RTC, RTCC and RTLP) Revised Lease Continuity Schedule for the year ended December 31, 1992 (attached as Exhibit 30)

BC Ferries Partnership – Continuity Schedule from December 31, 1991 to July 6, 1994 (attached as Exhibit 31)

12. The financial statements of each Appellant and the Partnership were audited in accordance with GAAP, based on a review, inter alia, of the information set out in the documents listed in paragraph 11 above.

13. The Balance Sheets were presented to the shareholders of each Appellant and the members of the Partnership.

14. The Balance Sheets did not use either the equity or consolidation methods of accounting.

15. Each Appellant and the Partnership followed the recommendations and guidelines in the CICA Handbook, specifically those in section 3065, to account for the Leases when preparing its audited Balance Sheets in accordance with GAAP.

16. In preparing its Balance Sheets each Appellant and the Partnership classified the Leases as "direct financing leases". This treatment was in accordance with GAAP.

17. For accounting purposes each Appellant and the Partnership treated the Assets as having been disposed of and the Leases as having resulted in long-term receivables.

18. The Appellants' and Partnership's accounting characterization of the Leases as giving rise to lease receivables (the "Lease Receivables") and the characterization of the Lease Receivables as "Other Loans and Investments" or "Loans and Investments" or "Investment in Equipment Leases" on their Balance Sheets was in accordance with GAAP and specifically in accordance with section 3065 or the CICA Handbook.

19. The Balance Sheets were accepted by Office of the Superintendent of Financial Institutions (OSFI).

D. THE APPELLANTS' BALANCE SHEETS AND FINANCIAL STATEMENTS – SPECIFIC COMMENTS

20. Each Appellant's 1990 Balance Sheet contained an entry entitled "Other Loans and Investments" and included in this entry was the amount of the Lease Receivables.

21. Each Appellant's 1991 and 1992 Balance Sheet contained an entry entitled "Loans and Investments" and included in this entry was the amount of the Lease Receivables.

22. Each Appellant's inclusion of the amount of the Lease Receivables in the categories of "Other Loans and Investments" and "Loans and Investments" in the 1990 and 1991-92 Balance Sheets, respectively, was in accordance with GAAP.

23. The Partnership's 1990 Balance Sheet contained an entry called "Investments in Equipment Leases". Included in this entry was the amount of the Lease Receivables.

24. The Partnership's in 1991 and 1992 Balance Sheets each contained an entry entitled "Net Investment in Equipment Leases". Included in this entry was the amount of the Lease Receivables.

25. The Partnership's inclusion of the amount of the Lease Receivables in the categories of "Investment in Equipment Leases" and "Net Investment in Equipment Leases" in the 1990 and 1991-92 Balance Sheets, respectively, was in accordance with GAAP.

26. The amount of the Lease Receivables included on the Appellants' and Partnership's Balance Sheets was calculated in the manner set out in the documents entitled "Breakdown of Lease Components" and attached hereto as Exhibits 32 to 35.

27. The Lease Receivables were not tangible property for the purposes of Part I.3 of the Act.

28. The Leases themselves were not tangible property for the purposes of Part I.3 of the Act.

29. Each Appellant and the Partnership presented the Lease Receivables as intangible assets on the Balance Sheets, in accordance with GAAP.

30. The only property shown on the Balance Sheets as tangible property were land, buildings and certain equipment owned by each Appellant or the Partnership.

31. The Balance Sheets did not show as assets the Assets or any other tangible property owned by each of the Appellants and the Partnership and leased to the Lessees.

32. The assets subject to the Leases were not shown in the notes to the Balance Sheets and such disclosure was not required by GAAP.

33. Land, buildings and equipment are tangible property for the purposes of Part I.3 of the Act.

34. The carrying value of the Appellant's land, buildings and equipment was shown on the Balance Sheets at net book value; namely, the cost less accumulated depreciation in the case of fixed assets or the cost in the case of non-depreciable assets.

35. Each Appellant and the Partnership calculated the carrying value of its "Loans and Investments" or similar categories on the Balance Sheets on a different basis from that used to determine the carrying value of their land, buildings and equipment.

36. For the purpose of the appeals, the issues relating to the 1990 to 1992 taxation years of each Appellant are uniform. Further, there are no procedural irregularities in issue.

E. PART I.3 RETURNS

37. Each Appellant duly filed its Part I.3 Tax Return for each of the 1990-92 taxation years. Copies of those returns are attached as Exhibits 36 to 41.

38. The Appellant RTCC did not include any amount in respect of the Assets or in respect of its interest in the Assets carried in the Partnership in its "taxable capital employed in Canada" (as defined in subsection 181.3(1) of the Act) for the purpose of computing its Large Corporations Tax ("LCT") liability for its 1990-92 taxation years under Part I.3 of the Act.

39. The Appellant RTC did not include any amount in respect of the Assets or in respect of its interest in the Assets carried in the Partnership in its taxable capital employed in Canada for the purpose of computing its LCT liability for the 1990 and 1991 taxation years under Part I.3 of the Act but did (erroneously in the opinion of RTC) include amounts in respect of the Assets in its taxable capital employed in Canada for its 1992 taxation year. RTC subsequently objected to and is appealing the inclusion of the amounts in respect of the Assets for its 1992 taxation year.

F. PART I RETURNS

40. In filing their T-2 Corporate Income Tax Returns for the purposes of Part I of the Act only each Appellant claimed capital cost allowance ("CCA") on its Assets as a deduction in computing its tax payable under Part I of the Act. Attached hereto as Exhibit 42 are schedules setting out the amounts of CCA claimed by the Appellants and the amounts thereof allowed by the Minister in respect of the Assets in the 1990 to 1992 taxation years.

G. RTC REASSESSMENTS

41. The Minister of National Revenue (the "Minister") issued a Notice of Reassessment in respect of each of RTC's 1990 to 1992 taxation years bearing the following dates:

Year Date

1990 March 7, 1996

1991 March 7, 1996

1992 May 21, 1996

42. The Minister included an additional $177,055,023, $148,719,751 and $133,576,709 in RTC's "taxable capital employed in Canada" for the purposes of calculating its liability for LCT in respect of its 1990, 1991 and 1992 taxation years respectively and reassessed LCT of $711,821, $789,270 and $697,916.

H. RTCC REASSESSMENTS

43. The Minister issued a Notice of Reassessment in respect of each of RTCC's 1990-1992 taxation years bearing the following dates:

Year Date

1990 February 15, 1996

1991 November 22, 1996

1992 March 24, 1997

44. The Minister included an additional $67,487,313, $86,181,632 and $79,531,142 in RTCC's "taxable capital employed in Canada" for the purposes of calculating its liability for LCT in respect of its 1990, 1991 and 1992 taxation years respectively and reassessed LCT of $1,893,084, $2,260,434 and $1,934,869.

I. BASIS FOR REASSESSMENTS BY THE MINISTER

45. The Minister reassessed each Appellant for additional LCT on the basis that the Assets were tangible property of the Appellants or Partnership and were used in Canada and that the carrying value of the Assets was the amount of the Lease Receivables included on each Appellant's Balance Sheets in respect of the Leases, including the amounts of each Appellant's interest in the Partnership's Lease Receivables. He therefore included those amounts in each Appellant's "taxable capital employed in Canada".

46. In reassessing each Appellant's LCT liability for the 1990-92 taxation years and determining each Appellant's "taxable capital employed in Canada", the Minister:

(a) Reviewed the Lease Receivables component of the entries on the Appellants' and the Partnership's Balance Sheets for "Other Loans and Investments" or "Loans and Investments" or "Investment in Equipment Leases" to determine whether there was any tangible property used in Canada associated with the Lease Receivables. Further, to determine that there was tangible property used in Canada, the Minister examined each Appellant's and the Partnership's T2S(8) Capital Cost Allowance Schedules, prepared for the purposes of Part I of the Act, and the Balance Sheet working papers and other accounting documents of each Appellant.

(b) treated the Assets, which were included in each Appellant's T2S(8) Capital Cost Allowance Schedules prepared for the purposes of Part I of the Act, as tangible property owned by the Appellants for the purposes of Part I.3 of the Act;

(c) used the amounts included by the Appellants and the Partnership as Lease Receivables in entries on their Balance Sheets as the carrying value of the Assets for purposes of Part I.3 of the Act.

(d) did not consider section 3065 of the CICA Handbook or any other principle under GAAP relevant for determining the proper characterization of the Assets for the purpose of Part I.3 of the Act;

(e) considered the Lease Receivables and the Assets to be different assets;

(f) considered each Appellant's and the Partnership's characterization of the Assets as Lease Receivables in entries on the Balance Sheets to be irrelevant for the purposes of calculating each Appellant's LCT liability, notwithstanding that the Balance Sheets were prepared in accordance with GAAP;

(g) considered the following assets on the Balance Sheets not to be tangible property for the purposes of Part I.3 of the Act:

(i) cash and short term deposits;

(ii) securities;

(iii) mortgage loans;

(iv) equipment leases (although he considered the leased equipment, i.e. the Assets, to be tangible property for the purposes of Part I.3);

(v) accounts receivable and prepaid expenses;

(vi) deferred pension charges;

(vii) income taxes recoverable; and

(viii) "other loans and investments" or "loans and investments";

(h) determined the amount of each Appellant's and Partnership's 1990 and 1991 Lease Receivables from each of the Appellant's and the Partnership's 1990 and 1991 OSFI filings;

(i) determined the amount of the Appellant's and Partnership's 1992 Lease Receivables from each of the Appellant's and the Partnership's 1992 OSFI filings, as well as from their 1992 lease continuity schedules and deferred tax models;

(j) assumed the phrase "used in Canada" in subsection 181.1(3) of the Act referred to "use" by the Lessees;

(k) assumed the Lessees were using the Assets in Canada on the basis that the Lessees and the Appellants and the Partnership were Canadian entities;

(l) did not verify whether the Lessees used the Assets in Canada;

(m) in the course of the audit did not review the Leases;

(n) relied upon, inter alia, each Appellant's;

(i) Part I.3 Tax Returns;

(ii) Balance Sheets;

(iii) Balance Sheet Working Papers;

(iv) T2S(8) Capital Allowance Schedules;

(v) general ledgers;

(vi) amortization schedules; and

(vii) lease continuity schedules;

(o) for accounting purposes considered the Leases as direct financing Leases and financial instruments;

(p) did not rely upon RTC's 1992 Part I.3 filings in which RTC included amounts in respect of the Assets in its taxable capital employed in Canada for its 1992 taxation year;

(q) made the assumptions set out in the Replies to Amended Notices of Appeal in these appeals.

J. RTC'S OBJECTION & MINISTER'S CONFIRMATION

47. RTC duly filed Notices of Objection bearing the following dates in respect of each of the Notices of Reassessment for its 1990-1992 taxation year:

Year Date

1990 March 18, 1996

1991 March 18, 1996

1992 June 20, 1996

48. The Minister issued a Notification of Confirmation, date December 10, 1997, in respect of RTC's Notices of Objection on the basis that the amounts referred to in paragraph 44 were properly included in RTC's "taxable capital employed in Canada" in each of its taxation years.

K. RTCC'S OBJECTION & MINISTER'S CONFIRMATION

49. RTCC duly filed Notices of Objection bearing the following dates in respect of each of the Notices of Reassessment for its 1990-1992 taxation years:

Year Date

1990 March 18, 1996

1991 December 17, 1996

1992 June 9, 1997

50. The Minister issued Notification of Confirmation, date October 22, 1997 and December 10, 1997, in respect of the Appellant's 1990-91 and 1992 Notices of Objection, respectively, on the basis that the amounts referred to in paragraph 44 were properly included in the Appellant's "taxable capital employed in Canada" in each of its taxation years.

L. CONCESSION BY MINISTER

51. The amounts included by the Minister in the Appellants' taxable capital employed in Canada as set out in paragraph 44 above exceeded the actual amount of the Lease Receivables included on the Appellants' and Partnership's Balance Sheets by the following amounts, and the Minister is prepared to concede that the Appellants' taxable capital employed in Canada should be reduced by these amounts:

RTC RTCC

1990 $76,023 $2,009,313

1991 $0 $1,496,632

1992 $0 $0

[2] In addition to the foregoing agreed facts, the Appellants introduced the expert opinion of Philip D. Arthur, F.C.A. relating to the accounting for certain lease contracts in the audited balance sheets included within the audited financial statements of the Appellants for the taxation years in issue.[1]

[3] In his report, Arthur set out the questions asked and his opinions with respect thereto as follows:

1.1 You asked for my opinion on questions relating to the accounting for certain lease contracts, listed in Appendix A (the "Lease Contracts"), in the audited balance sheets of The Royal Trust Company (RTC) and Royal Trust Corporation of Canada (RTCC), (the "Balance Sheets") included within the audited financial statements of RTC and RTCC for the fiscal and taxation years ending December 31, 1990, 1991 and 1992 included in Appendix B. These Balance Sheets were audited by Ernst & Young, whose opinion on the Balance Sheets was that they "present fairly in accordance with generally accepted accounting principles".

1.2 Specifically, you have asked for my opinions on the following:

(a) What was the accounting treatment for direct financing leases under Generally Accepted Accounting Principles in Canada ("GAAP") during the 1990, 1991 and 1992 taxation years of RTC and RTCC?

(b) What was the accounting treatment for operating leases under GAAP during the 1990, 1991 and 1992 taxation years of RTC and RTCC?

(c) How were the Lease Contracts accounted for under GAAP by RTC and RTCC during their 1990, 1991 and 1992 taxation years?

(d) Can the direct financing lease receivables on the Balance Sheets of RTC and RTCC relating to the Lease Contracts be considered for accounting purposes and based on accounting terminology to comprise part of the carrying value of tangible property reflected in the Balance Sheets?

(e) What is the meaning of "tangible property", "carrying value" and "reflected" in the context of GAAP and based on the use of such terminology by members of the accounting profession and the business community?

(f) What constitutes the "carrying value" of tangible property on the Balance Sheets?

(g) How are assets subject to the Lease Contracts, or other assets collateralizing other types of loan agreements, accounted for once repossessed by RTC or RTCC?

1.3 For the purposes of rendering these opinions, among other things:

(a) I relied on the audit opinion of Ernst & Young referred to in paragraph 1.1 to establish that the Lease Contracts have the characteristics of direct financing leases as defined by GAAP and that the Lease Contracts were properly recorded under GAAP as direct financing leases on the Balance Sheets;

(b) I read the Lease Contracts and certain of the supporting accounting records of RTC and RTCC and determined that each company recorded the Lease Contracts in the Balance Sheets as "Lease Receivables" under the caption "Loans and investments" or "Other loans and investments";

(c) I read certain supporting accounting records of Royal Trust Leasing Partnership ("RTLP") and determined that RTLP recorded the lease contract to which it was party in its unaudited balance sheets for the fiscal and taxation years ending December 31, 1990, 1991 and 1992, included in the financial statements of RTLP within Appendix B, under the caption "Net investment in equipment leases". I assumed that the lease contract was correctly classified as a direct financing lease and that it was properly recorded as a direct financing lease under GAAP on RTLP's unaudited balance sheets;

(d) I considered how the Lease Contracts were accounted for and characterized under GAAP as it was applied during 1990 to 1992; and

(e) I reviewed the Handbook of the Canadian Institute of Chartered Accountants (the "CICA Handbook") and other authoritative accounting texts applicable to the 1990, 1991 and 1992 taxation years of RTC and RTCC.

1.4 My opinions accord with my understanding and experience of the ordinary commercial meanings and usage of the terms noted above, based upon my twenty five years of experience auditing financial institutions and over twenty years of experience auditing lease transactions.

[4] Arthur summarized his opinion as follows:

2.1 The treatment of direct financing leases under GAAP results in the characterization of the Lease Contracts as an interest-bearing investment. This investment is considered an investment in a long-term receivable (i.e. "Lease Receivable"). This treatment under GAAP removes the asset subject to the lease immediately upon the execution of the Lease Contract from the affected company's Balance Sheets.

2.2 The "carrying value" of the Lease Contracts for accounting purposes is the amount recorded in the financial statements with respect to the Lease Contracts. Accountants would understand that the amount "reflected" under GAAP with respect to the Lease Contracts would refer to the amount that has been recorded or shown in financial statements with respect to the Lease Contracts. GAAP indicates and accountants understand that the Lease Contracts and the Lease Receivables are considered financial assets. The Lease Contracts and Lease Receivables are not considered tangible non-financial or capital assets and cannot be considered tangible property. The "tangible property" on the Balance Sheets consists only of the "Land, buildings and equipment" included in Other Assets. Both the unguaranteed and guaranteed residual values of the Lease Contracts are regarded as a component of the lessor's net investment in the lease and are not "tangible property" under GAAP. "Land, buildings and equipment" are considered "tangible property" under GAAP. Neither the Lease Contracts nor the Lease Receivables are part of the "Land, buildings and equipment" included in Other Assets reflected in the Balance Sheets.

2.3 No amount recorded in the Balance Sheets with respect to the Lease Contracts can be considered to comprise part of the carrying value of "tangible property" reflected in the Balance Sheets under GAAP. The determination of the carrying value cannot occur without characterizing the asset under GAAP. It is not possible to determine the carrying value of an asset for accounting purposes without first determining the asset's accounting characterization. If the Lease Contracts or the assets subject to the Lease Contracts were not considered financial assets, but rather as tangible property, the treatment of the assets subject to the Lease Contracts would be determined much differently than the treatment of the Lease Receivables (e.g. Other loans and investments) shown on the Balance Sheets.

2.4 On repossession, the lessor would replace the carrying value of its net investment in the lease on its balance sheet with a tangible capital asset carried at the amount equal to the lesser of the net realizable value of the asset repossessed or the carrying value of its net investment in the lease. The net realizable value is a different amount and results from a different calculation than what is used for direct financing leases when the assets subject to lease remain in the possession of the lessee. Net realizable value is defined by Terminology for Accountants as "Estimated selling price in the ordinary course of business less estimated costs of completion and sale". Net realizable value to the lessor upon repossession could be equal to the net present value of the lease payment stream expected to be received from a new lease contract if the lessor were to release the repossessed asset to another lessee or could be equal to the net proceeds that the lessor expects to receive from the sale of the asset.

Issue

[5] The Minister of National Revenue (Minister) included an additional $67,487,313, $86,181,632 and $79,531,142 in the Appellants' "taxable capital employed in Canada" for purposes of calculating liability for Large Corporations Tax (LCT) for the 1990, 1991 and 1992 taxation years, respectively, and assessed LCT of $1,893,084, $2,260,434 and $1,934,869. It is in the calculation of the Appellants' taxable capital employed in Canada that the issue in these appeals arises.

Appellants' Position

[6] The Appellants contend that the carrying value of the Lease Receivables should not be included in their respective "taxable capital employed in Canada" for the purposes of determining LCT liability for the 1990-1992 taxation years. The basis of each Appellants' legal position is that:

(a) For the purposes of paragraphs 181.3(1)(a) and (b) of the Act, "tangible property" must be interpreted in accordance with its accounting characterization because corresponding carrying values are derived from accounting concepts under GAAP. Lease Receivables or Loans and Investments are not "tangible property" for the purposes of subsection 181.3(1);

(b) The carrying value of the Lease Receivables does not reflect the "carrying value of an asset that is tangible property";

(c) Paragraphs 181.3(1)(a) and (b) only apply to tangible assets physically used in Canada by a taxpayer. The lease of the Assets by each Appellant and the Partnership involves possession and physical use of the Assets by the Lessees and not by each Appellant and the Partnership;

(d) Each Appellant's interpretation of the undefined terms "reflected" and "tangible property" in Part I.3 of the Act is consistent with the modern principles of statutory interpretation and the words-in-context approach adopted by the Canadian Courts. It is inappropriate to give a plain meaning to the undefined terms "reflected" and "tangible property" because Part I.3 of the Act uses a series of accounting concepts and, in particular, taxes each Appellant on the basis of carrying values reflected in balance sheets prepared in accordance with GAAP. These carrying values cannot be determined without first determining, for accounting purposes, the appropriate characterization of the items in the Balance Sheets;

(e) Each Appellant's position is also consistent with the scheme and structure of Part I.3 of the Act. The omission of the Lease Receivables' carrying value from each Appellant's capital tax base avoids double taxation under Part I.3 of the Act and in congruent with the treatment of other financing arrangements under Part I.3 of the Act.

Respondent's Position

[7] The Respondent does not contest that the accounting for the leases on the Appellants' balance sheets was done in accordance with GAAP and that for accounting purposes, the Appellants are considered to have disposed of the leased property to the lessees and have retained only a right to receive the payments provided for under the leases. The Respondent, however, argues that "the GAAP treatment and the balance sheet description of the lease transactions as Lease Receivables disregards the legal relationship between the Appellants and the lessees (which is that of lessor/lessee and not vendor/purchaser) and substitutes an accounting view of the economic substance of the lease transactions". According to the Respondent there has been no disposition of property, thus it would be improper to disregard the legal character of the leases for the purpose of determining the Appellants' "taxable capital employed in Canada". Given this legal relationship the amounts included on each of the balance sheets properly reflect the carrying value of a net asset of each Appellant that was tangible property used in Canada.

[8] The foregoing conclusion is based on the proposition that GAAP is to be relied upon only for the purpose of determining "the carrying value of a corporation's assets" or "any other amount" required by other provisions of Part I.3 to be used in calculating the capital tax base of a taxpayer. According to the Respondent GAAP is relevant only because subsection 181(3) of the Act provides that for the purpose of determining the carrying value of an asset, the amount "reflected in the balance sheet" shall be used. However, while the balance sheet should be used for the purpose of determining the carrying value of a corporation's assets the description or characterization accorded by GAAP to a specific balance sheet item is not necessarily determinative for all purposes of Part I.3. Parliament has determined what items are to be included in the calculation of the capital base under Part I.3 and the question whether a particular item falls within the words used by it to describe those items is a question of law rather than of accounting practice. Counsel for the Respondent submitted that:

"an ambiguity arises in this case out of the wording of subsections 181(3) and 181.3(1)(a) of the Act.The latter provision requires inclusion of the carrying value of the financial institution's tangible assets used in Canada, and the former gives the means of determining the carrying value of those assets. For accounting purposes the Assets, which are tangible property of the Appellants used in Canada, are not represented on the balance sheets. Instead, the Appellants' investment in those Assets is included in the balance sheets as Lease Receivables which are intangible property".

It is the Respondent's position that the fact the Appellants' investment in the Assets is described for accounting purposes as intangible property does not preclude the inclusion of the amount in the calculation of the Appellants' taxable capital employed in Canada.

[9] This is so, according to counsel for the Respondent, because subsection 181(3) utilizes the expressions "carrying value of a corporation's Assets" and "the amounts reflected in the balance sheets" of the corporation which may readily be taken to mean that Parliament intended to have taxpayers use amounts that do not appear directly on the balance sheets. The object and purpose of Part I.3 as a whole is to raise revenue to reduce the deficit and to do so, intended to include the Assets in the Appellants' taxable capital.[2] This purpose is apparent from the wording of subsection 181.3(1) as well as from the technical notes which accompanied the introduction of the LCT. Since Parliament clearly referred to the inclusion of tangible property of a taxpayer in its taxable capital, a narrow interpretation of "carrying value" of the tangible property "reflected in the balance sheets" would result in the exclusion of the value of that property from the calculation of taxable capital and defeat the inclusion of the value of the property in the capital base. It follows, according to the Respondent, that this Court should construe the wording of subsection 181(3) in a liberal manner in order to achieve the intention of Parliament and to achieve harmony with the wording of Part I.3.[3]

[10] The Respondent further contends that the Minister was correct in recognizing the lease receivable amounts on the Appellants' balance sheets as being the carrying value of the Assets for the purposes of Part I.3 of the Act. This is premised on the testimony of Arthur to the effect that:

"at the beginning of the lease, when, for accounting purposes, the Appellants are considered to have disposed of the leased Assets, the cost of those Assets to the Appellants is recorded as the net investment in the lease, the lease receivable amount."

This lease receivable, according to the Respondent, is a representation of the capital investment of the Appellants in the Assets which underlie the leases. Thus the Appellants' investment in the lease as it is presented on the balance sheet is a function of the cost or fair market value of the leased assets at that particular time and:

"from that point the accounting treatment reduces the amount of the lease receivable, that is the principal amount of this notional loan, by the amount of the notional principal received each year. So that at the end of the year the lease receivable amount is a reduced form of the original recording on the balance sheet of the cost of the asset to the Appellants. Each year it is reduced by the amount of notional principal received to reduce that notional principal laid out originally".

Counsel submitted that there is a direct correlation between the cost of the Assets to the Appellants and the amounts of Lease Receivables shown on the balance sheet sufficient to permit that these amounts can be accepted as the carrying value of the Assets themselves. Counsel further submitted that given the intention of Parliament to include the carrying value of tangible assets of a financial institution in the taxable capital employed in Canada, it is appropriate to:

"read into the phrase reflected in the balance sheets a carrying value for the purpose of an inclusion in taxable capital employed in Canada of the Lease Receivables".

[11] The Respondent further takes the position that the Minister was correct in assessing on the basis that the Assets reflected tangible property used in Canada. Counsel submitted that there is nothing in the context of paragraph 181.3(1)(a) to indicate that use of the tangible property must be actual physical use by the owner. The term used is of broad import and covers the use of the Assets by the Appellants through leasing to another party. Nothing in the provisions of the relevant sections of the Act appears to restrict the scope of the word use and there is no indication of an intention by Parliament to so restrict it.

Analysis

[12] Subsection 181(3) is fundamental to the calculation of a financial institution's LCT liability. The relevant parts of this subsection read:

181(3) For the purposes of determining the carrying value of a corporation's assets or any other amount under this Part in respect of a corporation's capital, investment allowance, taxable capital or taxable capital employed in Canada for a taxation year or in respect of a partnership in which a corporation has an interest,

(a) the equity and consolidation methods of accounting shall not be used; and

(b) subject to paragraph (a) ... the amounts reflected in the balance sheets

(i) presented to the shareholders of the corporation (in the case of a corporation that is neither an insurance corporation to which subparagraph (ii) applies nor a bank) or the members of the partnership, as the case may be, or, where such a balance sheet was not prepared in accordance with generally accepted accounting principles or no such balance sheet was prepared, the amounts that would be reflected if such a balance sheet had been prepared in accordance with generally accepted accounting principles, or

(ii) accepted by the Superintendent of Financial Institutions, in the case of a bank or an insurance corporation that is required by law to report to the Superintendent, ...

shall be used.

Subsection 181.1(1) is the charging provision for LCT. For each Appellant's 1991 and 1992 taxation years, it provided that:

181.1(1) Every corporation shall pay a tax under this Part for each taxation year equal to 0.2% of the amount, if any, by which

(a) its taxable capital employed in Canada for the year

exceeds

(b) its capital deduction for the year.

For each Appellant's 1990 taxation year, the rate had been set at 0.175%.

[13] Each of the Appellants is a financial institution as that term is defined in subsection 181(1) and accordingly is taxed under Part I.3 of the Act. Specifically, subsection 181.3(1) required the inclusion of three principal elements of a financial institution's balance sheet in the capital tax base of the institution. These elements are drawn from both the asset and liability sides of the balance sheet. The portion of subsection 181.3(1) relevant to these appeals states:

181.3(1) The taxable capital employed in Canada of a financial institution for a taxation year is the aggregate of

(a) the total of all amounts each of which is the carrying value at the end of the year of an asset of the financial institution (other than property held by the institution primarily for the purpose of resale that was acquired by the financial institution, in the year or the preceding year, as a consequence of another person's default, or anticipated default, in respect of a debt owed to the institution) that is tangible property used in Canada ...

(b) the aggregate of all amounts each of which is an amount in respect of a partnership in which the financial institution has an interest at the end of the year equal to that proportion of

(i) the aggregate of all amounts each of which is the carrying value of an asset of the partnership, at the end of its last fiscal period ending at or before the end of the year, that is tangible property used in Canada

that

(ii) the financial institution's share of the partnership's income or loss for that period

is of

(iii) the partnership's income or loss for that period, and

(c) an amount that is equal to

(i) in the case of a financial institution ... that proportion of its taxable capital for the year that its Canadian assets at the end of the year is of its total assets at the end of the year, ...

[14] Each appeal involves a dispute regarding the amount of each Appellants' LCT liability under Part I.3 of the Act. Each Appellant's taxation year ended in 1990, 1991 and 1992 on December 31 and each was a member of a leasing partnership, the fiscal period of which also ended on December 31 in those years. Part I.3 is separate and distinct from Part I of the Act. Part I has its own specific charging provisions for tax on income and taxable capital gains. Part I.3 of the Act also has its own charging provisions and it levies an annual tax on a corporation's capital tax base, i.e. on its "taxable capital employed in Canada" in excess of $10 million.

[15] Under Part I.3 of the Act, paragraph 181.3(1)(a) requires the inclusion in the Appellants' capital tax base the "carrying value of an asset" ... "that is tangible property used in Canada". For its part, subsection 181(3) of the Act provides the means for determining the carrying value for those assets. It mandates that the amounts reflected in a corporation's unconsolidated balance sheet prepared in accordance with GAAP and presented to its shareholders are to be used for that purpose. The amount of each Appellant's LCT liability for its 1990-1992 taxation years is in dispute because the parties disagree regarding the inclusion of certain amounts in each Appellant's "taxable capital employed in Canada". Specifically, the parties disagree on whether the amounts described variously on the balance sheets as "Other Loans and Investments" or "Loans and Investments" or "Investment in Equipment Leases" reflect the "carrying value ... of an asset" of each Appellant "that is tangible property used in Canada". It is conceded that there is no dispute between the parties as to the legal rights and obligations of the Appellants regarding the leases nor is there a dispute between the parties regarding any other component of each Appellant's capital tax base or about any other aspect of Part I.3 of the Act.

[16] The primary issue in these appeals is the interpretation to be given to the relevant sections of Part I.3 of the Act and in particular, the role of GAAP in the interpretation of the undefined terms "tangible property" and "reflected" for the purposes of paragraphs 181.3(a) and (b). The Appellants submit that undefined elements of Part I.3 of the Act are to be interpreted in the context of their accounting usage. The Respondent's position on the other hand is that while GAAP does play a role in the interpretation of the relevant provisions, it is not the exclusive means by which all terms in Part I.3 of the Act should be interpreted. More specifically, counsel for the Respondent takes the position that a GAAP interpretation should prevail only where the terms are intended to be used in a technical sense, such as with reference to the term "carrying value", but GAAP should not prevail in the case of the terms "reflected" and "tangible property". Rather, these terms should be read and interpreted in context harmoniously with the object and purpose and the intention of Parliament.

[17] I am unable to agree with the Respondent's position. In Canfor Limited v. Minister of Finance,[4] the Supreme Court of Canada held that undefined elements in the Corporation Capital Tax Act, R.S.B.C. 1973, c.24 take their meaning and effect from accounting principles. The Supreme Court adopted in full the British Columbia Supreme Court's reasons for judgment to that effect. In those reasons, Fulton J. speaking for the British Columbia Supreme Court observed:

It appears clear from the cases that where a word or expression used in a taxing statute is not expressly defined or interpreted in that statute, then if that word or expression has an accepted meaning or application in accordance with ordinary commercial or accounting principles, that meaning or application is to be given to the word or expression in applying the statute (Dominion Taxicab Assoc. v. Minister, [1954] S.C.R. 82; Can. General Electric Co. v. Minister, [1962] S.C.R. 3).

[18] In Upper Lakes Shipping Ltd. v. Ontario (Minister of Finance),[5]the Ontario Court of Appeal has also ruled that accounting meanings apply in interpreting the Ontario provincial capital tax rules. In that case, the Court was considering whether certain government grants should be included in the taxpayer's "earned, capital and any other surplus", an undefined phrase, for the purposes of the capital tax rules in Part 3 of the provincial Corporation's Tax Act. At trial, the Court rejected the taxpayer's assertion that the words used in the undefined phrase were commercial words that should be interpreted according to GAAP. On appeal, the Court observed at page 6265:

... There is no doubt that GAAP do not govern the result. ... This does not detract from the fact that, in the absence of a statutory definition for "earned, capital and any other surplus", resort must be had to ordinary commercial principles to attribute any meaning to the phrase.

In this context, the plain and ordinary meaning of these words should be taken from the language accountants speak, not that of persons who are not involved with corporate balance sheets. The tax assessors know accounting language, as do the accountants who certify the corporation's financial statements. The accountants, applying GAAP, do not include a government grant as an item of capital surplus in the year of surplus. Rather, the grant is treated as an item of retained earnings or "earned surplus" over time as the asset is used in the operations of the business. In our view, the statute should be interpreted in accordance with this approach.

It should be observed that, as contrasted to the present appeals, the legislation in issue in Canfor and Upper Lakes Shipping did not contain a specific reference to the application of GAAP. Notwithstanding that fact, it was clearly expressed by both Courts that the provisions in issue should be interpreted in accordance with the rationale that "the plain and ordinary meaning of the words in the statute should be taken from the language accountants speak, not that of persons who are not involved with the corporate balance sheets".

[19] That was the approach taken by Archambault J. in Oerlikon, supra. In that case, the taxpayer received certain amounts as advance payments for goods to be provided and services to be rendered. For tax purposes, it included the amounts in its income under paragraph 12(1)(a) of the Act and claimed a reserve under paragraph 20(1)(m) of the Act. Pursuant to GAAP, the amounts were "advances" and the taxpayer recorded them as such on its balance sheets. The taxpayer, however, did not include those amounts in its "taxable capital employed in Canada", taking the position that they were "reserves" for the purposes of Part I.3 of the Act and, therefore, were excluded from its "capital" under paragraph 181.2(3)(b). The Minister assessed on the basis that the amounts were "advances" in the accounting sense and, therefore, included in capital under paragraph 181.2(3)(c) of the Act. Archambault J. agreed with the Minister's position and held that the nature and meaning of elements referred to in Part I.3 of the Act must be determined in accordance with their accounting meanings. In reaching this conclusion, he stated at page 968:

Part I.3 of the Act levies a tax on large corporations computed on the basis of their "taxable capital", one of the significant components of which is "capital". Subsection 181.2(3) of the Act describes the component parts of capital. All the relevant information for computing capital is generally found in a corporation's balance sheet. It is therefore not surprising to note that Parliament provides in subparagraph 181(3)(b)(i) of the Act that the amounts to be used to determine the carrying value of each of the components of a corporation's capital are those reflected in the "balance sheet presented to the shareholders of the corporation ... in accordance with generally accepted accounting principles". It therefore goes without saying that the terminology used in the Act to identify the component parts of capital is that used by accountants in preparing a balance sheet. I therefore find it entirely appropriate to use accounting dictionaries to define the scope of the components listed in subsection 181.2(3) of the Act for which the Act provides no definition.

(Italics in original)

And at page 970:

I do not share this view of counsel for OA. Rather, I am of the opinion that the accounting sense of the terms "reserves" and "provisions" in subsection 181(1) of the Act should be adopted, and there are a number of reasons for this. First of all, as stated above, subparagraph 181(3)(b)(i) of the Act states that the carrying value of the various assets that constitute capital is that appearing in the balance sheet presented to the shareholders of the corporation. Unlike counsel for OA, I believe that accounting principles must be used to determine not only the value, but also the nature of the elements set out in subsection 181.2(3) of the Act. The value appearing in a balance sheet has meaning only when it is linked to a specific heading.

[20] In The Manufacturers Life Insurance Company v. The Queen,[6]O'Connor J. also held that accounting meanings are to be used in determining the meaning and nature of elements found in Part I.3 of the Act. At issue in this case was whether certain amounts shown in the taxpayer's balance sheets were "reserves" or "any other surpluses" for the purposes of that Part of the Act. O'Connor J. held that the amounts in issue did not form part of the taxpayer's "taxable capital employed in Canada". The terms "reserves" and "surpluses" were undefined terms and the terminology in Part I.3 of the Act was generally to be interpreted with accounting principles. The amounts were not "reserves" or "surpluses" in the accounting sense. Therefore, the amounts were not "reserves" or "any other surplus" for the purposes of Part I.3 of the Act.

[21] In the present appeals, the evidence was that accountants who prepare balance sheets characterize "tangible property" in a particular way. Under GAAP, "tangible property" for balance sheet purposes only consists of land, buildings and equipment included in the category "Fixed Assets" or "Other Assets" on the balance sheet. The Assets in issue were not included in this category nor were the leases or the lease receivables part of "land, buildings and equipment" included in "Other Assets" on the balance sheets. Furthermore, Arthur's testimony was that upon execution of the leases each Appellant and the Partnership is treated as having disposed of the Assets to the Lessees for accounting purposes under GAAP. Accordingly, each Appellant and the Partnership removed the Assets from its balance sheets and the Assets were no longer characterized under GAAP as tangible property. The Assets once leased to the Lessees were owned by the latter under GAAP and the Lessees recorded an amount in respect of the carrying value of the Assets as tangible property on their balance sheets. As a result of this, the Assets leased, for accounting purposes, are considered to no longer exist for the lessor and have no carrying value on the lessor's balance sheets.[7]

[22] I am satisfied that the appropriate characterization to be given to the undefined term "tangible property" is dependent upon the context of the surrounding text and upon Part I.3 of the Act as a whole. This part of the Act relies on balance sheets and GAAP in the determination of a corporation's "taxable capital employed in Canada". It seems only reasonable to conclude that the technical terms referable to the balance sheet ought to be defined and characterized for the purposes of Part I.3 of the Act by reference to accounting terminology. Accordingly, the Appellants were correct in not including the carrying values of the Assets in their respective "taxable capital employed in Canada" because each Appellant had no "tangible property" for the purposes of subsection 181.3(1).

[23] I am also unable to accept the Respondent's submission with respect to the carrying value of the Assets. In his report, Arthur observed that under GAAP, the nature of the asset is first determined. In this case, the rights and obligations of the lessor and lessee under the lease contract are analyzed to determine whether substantially all of the rights and risks of ownership of the leased property are conveyed to the lessee. When this condition is met, the lessor is considered to own an investment in a direct financing lease rather than the underlying leased property itself. The carrying value of the direct financing lease is then determined in accordance with its characterization as a financial asset. The carrying value is calculated as the present value of all future minimum payments under the lease in keeping with its nature as a financial asset, plus any unguaranteed residual value of the leased property accruing to the lessor. This method of determining carrying value is in sharp contrast with the method for determining the carrying value for fixed assets, being original cost less an allowance for depreciation. Furthermore, according to Arthur, the Lease Receivables reflect a carrying value of the leases and the long-term receivables resulting from them. The Lease Receivables do not reflect a carrying value of the Assets which are determined on a completely different basis under GAAP if the Assets are owned by the Appellants. Under subsection 181(3) an asset carrying value is the amount in respect of that asset reflected in the balance sheet prepared in accordance with GAAP. If no amount is reflected in the balance sheet in respect of that asset, then its carrying value is nil. The term "reflected" is also undefined and is to be interpreted in accordance with the principles of statutory interpretation applied previously to the term "tangible property". Arthur observed that the term "reflected" is used by accountants to mean how a transaction has been recorded or shown on financial statements. It is also used as a synonym for "recorded", "included in" and "accounted for". Furthermore, according to Arthur no amount was reflected or recorded in respect of the Assets because the carrying value of the Assets was removed from the balance sheets and the Assets no longer existed for each Appellant and the Partnership. Therefore, the carrying value of the Assets was nil.[8]

[24] Parliament deliberately selected commercial or financial terms with specific meanings for accounting purposes in using the terms "carrying value", "tangible property" and "reflected" in Part I.3. The Respondent, on the basis that the language used in subsection 181(3) and paragraph 181.2(3)(a) was ambiguous, urged the Court to look to the object and purpose of the provisions in question. I find no guidance to interpreting these specific provisions in the Respondent's submission that the object and purpose of Part I.3 of the Act is to raise revenue to reduce the deficit. Rather, I look to the fact that Part I.3 specifically relies on balance sheets and GAAP in the determination of a corporation's "taxable capital employed in Canada". In my view, the interpretation of the undefined terms "tangible property" and "reflected" in accordance with their accounting meanings accords with Parliament's use of accounting-based concepts throughout the entire scheme of Part I.3 of the Act. As was observed by Archambault J. in Oerlikon, supra, "All the relevant information for computing capital is generally found in a corporation's balance sheet. ... It therefore goes without saying that the terminology used in the Act to identify component parts of capital is that used by accountants in preparing a balance sheet".

[25] For the foregoing reasons, the appeals are allowed, with costs, and the assessments are referred back to the Minister for reconsideration and reassessment on the basis that the amounts added by the Minister to the Appellants' taxable capital as set out in paragraphs 42 and 44 of the Agreed Statement of Facts were not properly included in the Appellants' taxable capital employed in Canada in each of their respective taxation years.

Signed at Toronto, Ontario, this 4th day of December, 2000.

"A.A. Sarchuk"

J.T.C.C.

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