Odyssey Industries Inc. v. R., [1996] 2 CTC 2401, 97 DTC 498

Sarchuk J.T.C.C.: - This is an appeal by Odyssey Industries Incorporated from an assessment of tax with respect to its 1985 taxation year.

The parties admit the following facts:

1. The Appellant is a corporation formed on December 20, 1984 by the amalgamation of Odyssey Industries Incorporated and Associated Freezers of Canada Ltd. and, at all material times, carried on the business of providing freezer processing and warehousing facilities.

2. In its 1985 taxation year, the Appellant disposed of certain assets (the Assets) used in the freezer processing and warehousing business.

3. A number of Assets were depreciable property of a prescribed class, as that term is used in the Income Tax Act (Canada) (the Act), which assets are referred to herein as the Subject Assets.

4. Pursuant to the agreements to sell the Assets, a portion of the sale proceeds were [sic] not due until a day that was more than two years after the day on which the Assets were sold and after the end of the 1985 taxation year.

5. The sale proceeds and the gain on disposition of the Assets in the 1985 taxation year as per Exhibit “A” were as follows:

	Proceeds	Gain
Land	$ 4,226,512.00	$ 2.229,935.00
Buildings	46,243,388,00	20,228.215.
Total	$50,469,900.00	22,458,150,00

6. Of the total proceeds of $50,469,900.00 the sum of $30,993,729.00 was not due until the day mentioned in paragraph 4 hereof.

7. In the income tax return filed for its 1985 taxation year the Appellant reported recaptured depreciation in the amount of $21,196,677.00 and a taxable Capital Gain of $5,276,356.00 after having deducted $12,627,867.00 as a reserve under subparagraph 40( 1 )(a)(iii) of the Act as shown in Exhibits “B”, “C”, “D” and “E”.

8. The Appellant claimed a deduction under paragraph 20(1 )(n) of the Act in the computation of its income for the 1985 taxation year for a reasonable reserve in respect of that portion of the proceeds not due on the sale of the Subject Assets which may reasonably be regarded as relating to the profit from the sale. The amount of the reserve claimed was $9,653,200.00 as per Exhibit “F’.

9. In a Notice of Reassessment dated October 5, 1992, the Minister of National Revenue reassessed to tax the Appellant by disallowing the deduction claimed under paragraph 20(1 )(n) of the Act and by a Notice of Appeal dated December 29, 1992, the Appellant appealed this reassessment. [1]

Evidence was also adduced on behalf of the Appellant from Maria V. Casano, (Casano), a chartered accountant. She was qualified as an expert, without objection, to express an opinion concerning generally accepted accounting principles. Counsel for the Appellant placed the following two propositions before her:

1. Under generally accepted accounting principles, on disposal of a capital asset, the difference between the net proceeds on disposition and the net carrying amount of the asset disposed of is recognized in income in the fiscal period. The net carrying amount is equal to the original cost of the asset less accumulated depreciation.

2. All timing differences between the measurement of the total income for purposes of the Income Tax Act for all fiscal periods and the total income under generally accepted accounting principles for all the fiscal periods, will, over the life of the business, offset one another and will result in these amounts being equal, subject only to permanent differences.

In her opinion, these propositions were correct and in accordance with specific generally accepted accounting principles as set out in the CICA Handbook. [2]

Appellant’s Position

Paragraph 20(1 )(n) of the Act permits a taxpayer to claim a deduction for a reserve in respect of amounts which are taxable as income but not due until a later year. Three preconditions must be met under paragraph 20(1 )(n) in order for the Appellant to deduct a reserve under this paragraph. First, an amount must be included in computing the taxpayer’s income from the business for the year. The Appellant contends that recaptured depreciation has the same character as income from which the capital cost allowance (CCA) was deducted and given that the CCA was deducted through the course of the Appellant’s business, the amount of the recapture should also be income from the business. Minister of National Revenue v. Bessemer Trust Co., [1973] C.T.C. 12, 73 D.T.C. 5045 at page 16 (D.T.C. 5048) (F.C.A.); Arnos v. R., [1981] C.T.C. 176, 81 D.T.C. 5126, at pages 177-79 (D.T.C. 5127) (F.C.T.D.); IT-73R4, paragraph 6.

With respect to the second precondition, i.e. the amount which was included in income must be in respect of property sold in the course of the business. The relevant statutory words, i.e. “in the course of the business” must be examined “in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act and the intention of Parliament”. Stubart Investments Ltd. v. R. (sub nom. Stubart Investments Ltd. v. The Queen), [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305 at pages 577-79 (C.T.C. 315-16, D.T.C. 6323). The Appellant contends that phrases such as “regular course of the business” and “in the ordinary course of business” [3] have a narrower meaning than “in the course of the business” and that had Parliament meant to limit the availability of paragraph 20(1 )(n) to such common and ordinary transactions, it could have done so by employing the phrase “in the ordinary course of the business”, which refers to transactions which are “part of the undistinguished common flow of the company’s business as carried on calling for no remark and arising out of no special situations”. B.C. Telephone Co. v. Minister of National Revenue, [1986] 1 C.T.C. 2410, 86 D.T.C. 1286, at pages 2415-16 (D.T.C. 1290) (T.C.C.).

The Appellant contends that given the grammatical and ordinary meaning of the words “in the course of the business” and provided the business had not terminated prior to the sale of the assets or even if the sale was coincident with the cessation of the business, such sale must have been in the course of the business. Andreychuk v. Minister of National Revenue, [1983] C.T.C. 2052, 83 D.T.C. 20, at pages 2058-59 (D.T.C. 25-26). Accordingly, the second precondition to paragraph 20(1 )(n) has been satisfied.

The third precondition is that the amount included in income or some part of that amount must be due on a day that is more than two years after the day on which the property was sold and after the end of the taxation year. This precondition has also been met since a portion of the sale proceeds of the subject assets was not due until a day that was more than two years after the day on which they were sold and after the end of the 1985 taxation year.

The requirements of paragraph 20(1 )(n) having been satisfied, the next step according to the Appellant, is to determine what portion of the amount included in income may reasonably be regarded as “a portion of the profit from the sale”. Since profit is not defined in the Act, it must be determined using ordinary commercial principles. Under GAAP, profit is a synonym for income and is the excess of proceeds of sale of an asset over its book value. Under GAAP, on the disposition of a capital asset, the difference between the net proceeds on disposal and the net carrying amount is recognized in income in the period in which it is disposed of and for this purpose, the net carrying amount is equal to the original cost of the asset, less accumulated depreciation. In determining income for the purposes of the Act, the system of depreciation of capital assets which is used for financial statement purposes is replaced by the CCA system; both of these systems have as their purpose the deduction of the cost of capital assets computing income of the enterprise over a period of time (Bessemer Trust Co., supra.) The income tax equivalent of the financial accounting concept of net carrying amount of a prescribed class of assets is the undepreciated capital cost of that class; undepreciated capital cost is the basis for the measurement of recaptured depreciation and it is submitted by the Appellant that undepreciated capital cost is the appropriate base from which to measure profit on the sale of depreciable property.

The Appellant’s position is that it has established its entitlement to the reserve under paragraph 20(1 )(n) of the Act. Since the recaptured depreciation is a component of the profit from the sale of the assets for this purpose, it is submitted that the amount of the reserve claimed may reasonably be regarded as a portion of the profit from the sale. Thus the method of calculation of the amount of the reserve claimed under paragraph 20(1 )(n) of the Act was correctly done in accordance with the policies accepted and published by the Minister of National Revenue. [4]

Respondent’s position:

The Respondent’s position is that the reserve provisions of paragraph 20(1 )(n) do not apply to the recaptured depreciation when the sale has not been made “in the course of a business”, as it is only in such case that a reserve is permitted by that paragraph. Avril Holdings Ltd. v. Minister of National Revenue, [1970] C.T.C. 572, 70 D.T.C. 6366 (S.C.C.), at page 575-76 (D.T.C. 6369). The assets in issue were not sold in the course of the Appellant’s business.

The context of the Income Tax Act in which paragraph 20(1 )(n) appears is important because the Act separates the taxation of income and the taxation of capital gains and in the present appeal, a reserve for the capital gains portion was in fact allowed. The Act defines the term “depreciable property” to mean assets for which a taxpayer is entitled to capital cost allowance. [5] Depreciable property by definition is capital property. [6] According to the CICA Handbook, the definition of a capital asset is that which is not sold in the course of business. [7] The Respondent contends that the Income Tax Act recognizes the distinction between capital and noncapital property, the common example of the latter being inventory. Furthermore, the phrase “in the course of business” in paragraph 20(1 )(n) of the Act is a reference to a sale which is a sale of inventory in a general sense and not the sale of a capital asset. The word “profit” is generally associated with non-capital property while the word “gain” is used with respect to capital property. The “property” contemplated by paragraph 20(1 )(n) of the Act is not a reference to capital property.

The Respondent further contends that recaptured depreciation is not “profit from the sale”, it is merely the calculated accumulation of an unwarranted charge made by the taxpayer. “Profit from the sale” would be the difference between the cost of the property sold and the amount for which it was sold, not the difference between the net depreciation value and the amount of the sale. The profit is the capital gain on the sale of the asset, unless it is established that the taxpayer in question was in the business of buying and selling such assets. The fact that the excess is brought into income by virtue of subsection 13(1) of the Act does not turn it into a “profit” for the purposes of paragraph 20(1 )(n) of the Act (Andreychuk, supra, at pages 2059-60 (D.T.C. 26)).

Last, it is the Respondent’s position that GAAP has no application in the present case. If this were a question of quantum then such expert accounting evidence is relevant. It is however not relevant and of no assistance to the Court in determining the essential nature of the recapture and GAAP is not relevant in determining whether a receipt or expense is on revenue or capital account.

Conclusion:

The Appellant, a corporation carrying on the business of providing freezer processing and warehousing facilities disposed of depreciable property of a prescribed class in its 1985 taxation year. The proceeds of disposition from the sale of the property exceeded both the adjusted cost basis (ACB) and the undepreciated capital cost (UCC) of the property. Accordingly, there was a capital gain from the dispositions which the Appellant reported after having deducted a reserve under subparagraph 40(1 )(a)(iii) of the Act. The reserve claimed was allowed by the Minister. There was also a recapture of depreciation which the Appellant included in computing its income by virtue of subsection 13(1) of the Act and with respect to which it claimed a reserve pursuant to paragraph 20(1 )(n) of the Act. The Minister disallowed the reserve on the recaptured depreciation.

The issue to be determined is whether the Appellant is entitled to claim the amount of $9,653,200 as a reserve pursuant to paragraph 20(1 )(n) of the Act with respect to the recaptured depreciation taken into income under subsection 13(1) of the Act.

The relevant statutory provisions are subsection 13(1) and paragraph 20(1 )(n) of the Act. Subsection 13(1), which deals with recaptured depreciation, provides that:

Where, at the end of a taxation year, the aggregate of all amounts determined under subparagraphs (21)(f)(iii) to (viii) in respect of depreciable property of a particular prescribed class of a taxpayer exceeds the aggregate of all amounts determined under subparagraphs (21)(f)(i) to (11.1) in respect of depreciable property of that class of the taxpayer, the excess shall be included in computing the income of the taxpayer for that taxation year.

Paragraph 20(1 )(n) reads:

Notwithstanding paragraphs 18(l)(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(n) where an amount has been included in computing the taxpayer’s income from the business for the year or for a previous year in respect of property sold in the course of the business and that amount or a part thereof is not due,

(i) where the property sold is property other than land, until a day that is

(A) more than 2 years after the day on which the property was sold,

and

(B) after the end of the taxation year, or

a reasonable amount as a reserve in respect of such part of the amount so included in computing the income as may reasonably be regarded as a portion of the profit from the sale;

The Appellant’s position is based on the proposition that recaptured depreciation is an element of profit for income tax purposes just as the gain on disposition of the same assets is an element of profit for financial statement purposes, even though the timing of recognition of the two amounts may differ due to differing methods of computation. It is in this context that the Appellant relied most heavily on the testimony of the expert witness, Casano.

I am not satisfied that the testimony of Casano is, or should be, determinative of the question which in this case is whether the excess recaptured depreciation brought into income by virtue of subsection 13(1) of the Act is profit for the purpose of paragraph 20(1 )(n) of the Act. In my view, this question is ultimately one of law for the Court. Canadian General Electric Co. v. Minister of National Revenue, [1962] S.C.R. 3, [1961] C.T.C. 512, 61 D.T.C. 1300, per Martand J. at page 12 (C.T.C. 519-20, D.T.C. 1304). Bowman J. made the following comments with respect to the use of GAAP when the issue before the Court involved the questions of law: Ikea Ltd. v. R. (sub nom. Ikea Ltd. v. Canada), [1994] 1 C.T.C. 2140, 94 D.T.C. 1112 (T.C.C.):

It is important that the set of rules sanctioned by the Canadian Institute of Chartered Accountants for the presentation of the financial results of a business, and known as “generally accepted accounting principles” (GAAP) be assigned their proper role in the calculation of income for the purposes of the Income Tax Act. One needs only to read the one and one-half page explanation of the meaning of “generally accepted accounting principles” in the CICA Handbook to realize that to found a system of fiscal law upon practices and policies based upon subjective professional accounting judgment would quickly lead to a state of uncertainty and confusion. It is not surprising that courts have been reluctant to place reliance upon GAAP in the determination of income for income tax purposes. GAAP is not relevant in determining whether a receipt or expense is on revenue or capital account. It is not relevant in determining whether an item of revenue is to be recognized in the year of receipt or in a later year. (Burrard Yarrows Corporation v. The Queen, 86 D.T.C. 6459, affirmed 88 D.T.C. 6352 (F.C.A.).) The relevancy of GAAP in determining the timing of a deduction is highly questionable: Oxford Shopping Centres Ltd. v. R., 79 D.T.C. 5458 (affirmed 81 D.T.C. 5065); cf Minister of National Revenue v. Tower Investment Inc., 72 D.T.C. 6161. GAAP may be relevant in determining the manner in which a reserve that is sanctioned by statute is to be calculated (Coppley Noyes & Randall Limited v. R., 91 D.T.C. 5291). GAAP was decisively rejected as a basis for inventory valuation in Minister of National Revenue v. Anaconda American Brass Ltd., [1956] A.C. 85. It may have an extremely circumscribed subordinate function within the framework of principles of law enunciated by the courts as “ordinary commercial principles”. It cannot supersede those principles.

I am unable to accept the proposition advanced by the Appellant since the relevant language and in particular the word “excess” found in subsection 13(1) of the Act and the word “profit” in paragraph 20(1 )(n) of the Act are not synonymous. They are terms that are used in the Act to achieve a specific legislative purpose. Subsection 13(1) of the Act was considered by D.E. Taylor, a Member of the Tax Review Board, (as he then was) in Andreychuk, supra. He said at page 2060 (D.T.C. 26):

The critical word in subsection 13(1) (which brings the amount into income) is “excess”, in the final phrase, “the excess shall be included in computing the income...” The corresponding critical word in paragraph 20(1 )(n) under which the taxpayer seeks relief is “profit”, found in the last phrase “profit from the sale”. In my analysis of the situation, the “recaptured depreciation” is not profit from the sale, it is not profit in any sense of the word — it is simply the calculated accumulation of an unwarranted charge made by the taxpayer, the quantity of which always existed but was determined only by virtue of the sale. But it is not “profit from the sale”. In fact, it has nothing to do with the sale of the property, other than that the sale provides a number required in making the calculation for the excess depreciation charged. The “profit from the sale” would be the difference between the cost of the property sold and the amount for which it was sold, not the difference between the net depreciated value and the amount of the sale. Simply put, the profit is the capital gain on the sale of the asset, unless it is established that the taxpayer in question was in the business of buying and selling such assets. The fact that the “excess” is brought into income by virtue of subsection 13(1) of the Act does not turn it into a “profit” for purposes of paragraph 20(1 )(n) of the Act. They are simply not interchangeable terms under these circumstances as would be necessary in order for the appellant to succeed. As I see it, therefore, the bar to the utilization of paragraph 20(1 )(n) with respect to recaptured depreciation taken into income under subsection 13(1) of the Act may not arise out of the juxtaposition and comparative definitions of “going out of business” and “in the course of the business”, nor out of the mere logic of such a disallowance, but rather out of the precise terminology used by the legislators in those two sections, particularly the words “excess” and “profit”.

Notwithstanding the forceful submissions of counsel for the Appellant, I have not been convinced that the Judgment in Andreychuk was wrong. The reasons advanced therein constitute a clear and correct interpretation of the provisions of the Act in issue before me and I propose to adopt them. In my view, the recapture of the excess is merely a counterbalance to what are considered to have been excessive deductions of capital cost allowance on the asset in question that were made in computing the taxpayer’s income for previous years. While there is substantial logic in the legislators’ intent to require the inclusion of such amounts back into a taxpayer’s income, it does not follow that these amounts constitute a “profit from the sale” for the purpose of paragraph 20( 1 )(n) of the Act.

For the foregoing reasons, the appeal is dismissed with costs to the Respondent.

Appeal dismissed.