Hope R. Gaynor v. Minister of National Revenue, [1987] 1 CTC 2359, 87 DTC 279

Sarchuk, T.C.J.:—The appeals of Hope R. Gaynor from reassessments of tax with respect to her 1979, 1980, 1981 and 1982 taxation years were heard in Vancouver on Wednesday the 19th day of November, 1986. At the commencement of the hearing counsel informed the Court that there was agreement between the parties as to most of the facts in issue and the following agreed statement of facts was filed:

1. The Appellant is a citizen of the United States of America who has been ordinarily resident in Canada since June 21, 1971.

2. The Appellant filed a return of income in Canada for each of the years under appeal as a Canadian resident.

3. The Appellant owns a portfolio of securities (“the Portfolio”) managed by the United States Trust Company of New York, of 45 Wall Street, New York, New York, United States of America, under Account No. 627-072.

4. The Portfolio was owned by the Appellant at the time she moved from the United States of America to Canada.

5. The Portfolio consists of United States securities (the “Securities").

6. The Securities were purchased and sold in the currency of the United States of America.

7. In her 1979 and 1980 taxation years the Appellant sold those Securities listed on pages (i) and (v) of schedule A* [1] attached to this Agreed Statement of Facts (Schedule “A").

8. The number of Securities sold, the date of acquisition, and the date of sale is set out in columns 1, 2, and 3 respectively of Schedule A.

9. The Securities were purchased for the amounts set out in column 4 of Schedule A.

10. None of the Securities described in Schedule A were purchased by converting Canadian dollars to United States currency.

11. The Securities were sold for the amounts set out in column 6 of Schedule A.

12. In computing the gain or loss realized on the disposition of the Securities, the Appellant calculated the adjusted cost base and proceeds of disposition of the Securities in Canadian dollars at the average exchange rate prevailing in the year in which the Securities were sold.

13. The average exchange rate adopted by the Appellant was that published by the Department of National Revenue for each of the years in which the Securities were sold.

14. The proceeds of disposition, adjusted cost base and gain or loss realized on the disposition of the Securities as computed by the Appellant for the 1980 taxation year is set forth in schedule Bt [2] attached to the Agreed Statement of Facts (Schedule B).

15. In assessing the Appellant to tax for each of the years under appeal, the Minister of National Revenue computed the gain realized by the Appellant on the disposition of the Securities on the basis that the adjusted cost base and the proceeds of disposition of the Securities should be calculated in Canadian dollars at the exchange rate prevailing at the time of acquisition and time of disposition respectively.

16. The adjusted cost base, proceeds of disposition and gain or loss realized on the disposition of the Securities as computed by the Minister of National Revenue is set out in columns 5, 7, and 8 respectively of Schedule A.

In addition to the foregoing the Court heard evidence from the appellant and her accountant. Mrs. Gaynor testified that upon her taking up residence in Canada in 1971 she retained assets in the United States and in particular an investment portfolio of U.S. securities consisting principally of stocks and bonds. In the event that any stock or bond was sold the proceeds from those sales were put into a cash account until such time as the funds were required to purchase additional stocks or bonds. The cash account was an account kept in the United States in U.S. currency. At no time did Mrs. Gaynor ever convert any Canadian currency into U.S. currency for the purpose of contributing to that account.

Mr. William Barclay, a chartered accountant, stated that he had been responsible for the preparation of the appellant’s tax returns since approximately 1974. He computed the gains Mrs. Gaynor realized on the disposition of her U.S. securities in the manner set out in paragraph 12 of the statement of agreed facts a method which was followed consistently by him since the preparation of the 1973 tax return. Mr. Barclay was also able to confirm that Mrs. Gaynor's 1972 return of income tax which was not prepared by him, was prepared on the same basis.

The basic facts of this case are not in dispute. The appellant reported capital gains and losses with respect to her portfolio of U.S. securities in her income tax return. During the 1979 and 1980 taxation years securities belonging to her were purchased and sold on her behalf. In computing her gains from these dispositions the appellant calculated the adjusted cost base and proceeds of disposition by converting the United States costs into Can- adian dollars at the average exchange rate prevailing in the year in which the securities were sold. In reassessing the appellant to tax for each of the years under appeal the respondent computed her gains on the disposition of these securities on the basis that the adjusted cost base and the proceeds of disposition should be calculated in Canadian dollars at the exchange rate prevailing at the time of acquisition and time of disposition respectively.

The relevant provisions of the Income Tax Act are contained in paragraphs 54(a) and 54 (h) of the Income Tax Act. They define “adjusted cost base” and "proceeds of disposition” as follows:

Section 54: In this subdivision,

(a): adjusted cost base to a taxpayer of any property at any time means, except as otherwise provided,

(i) where the property is depreciable property of the taxpayer, the capital cost to him of the property as of that time, and

(ii) in any other case, the cost to the taxpayer of the property adjusted, as of that time, in accordance with section 53,

(h): proceeds of disposition of property includes,

(i) the sale price of property that has been sold, . . .”

The appellant contends that the respondent's method of computing the adjusted cost base was wrong and submits that the cost to the appellant is properly calculated using the exchange rate in effect on the date of disposition.

Mr. Heinrich, counsel for the appellant, submitted that there had never been a Canadian cost to the taxpayer since at no time had she ever converted her U.S. currency assets. He noted that at the time of taking up residency in Canada the appellant had a pool of assets which contained both United States securities and United States currency. All subsequent purchases and sales of securities were effected in United States currency. The funds realized by these transactions were then reinvested in United States securities. This made the appellant’s position somewhat unusual in that she was using her pool of U.S. currency to purchase United States securities. He submitted that her situation is to be distinguished from the usual case where a taxpayer must convert Canadian currency into United States currency prior to purchasing United States securities. In her case "there was no Canadian cost to her of those securities” at the time of their acquisition. He went on to say:

However, we say that the only gain realized by the taxpayer is a gain in U.S. currency. She had U.S. dollars when she bought it, she realized U.S. dollars when she sold it, therefore the only proper method of in effect measuring her gain on the disposition of that hard asset is the U.S. currency applied to that gain at the exchange rate prevalent at the time the gain was realized.

Mr Heinrich contended that the method of computing gain adopted by the respondent is wrong in principle because the respondent was trying to measure the gain or loss of a United States asset by attaching notional values to its cost and its proceeds of disposition. In his words:

We say that is wrong because we really never realized any economic profit on the sale of the hard asset. There may be a built-in, inherent profit in the U.S. currency that we have in our possession, and that profit would be taxed or should be taxed down the road if that currency is ever converted, but it cannot be taxed as part of the disposition of the hard asset itself.

Counsel for the respondent submitted that the appellant was required to convert all transactions in foreign currency into Canadian currency at the prevailing rate of exchange on the date of each transaction, when calculating capital gains and losses to be reported as required by the Income Tax Act in her returns for the 1979 and 1980 taxation years. Counsel further submitted that the cost within the meaning of subparagraph 54(a)(ii) of the Act to the appellant of the United States securities was the cost in United States dollars converted to Canadian dollars at the exchange rate prevailing at the dates the securities were acquired and that accordingly the respondent properly determined the amount of the capital gains and losses realized by the appellant on the disposition of United States securities in the years in issue.

In support of her position counsel for the appellant referred to Pattison v. Marine Midland Ltd., [1984] 1 A.C. 362 (H.L.); Greig (Inspector of Taxes) v. Ashton, [1956] 3 All E.R. 123; [1956] 1 W.L.R. 1056 (Ch.D.) and The Queen v. The Bank of Nova Scotia, [1981] C.T.C. 162; 81 D.T.C. 5115 (F.C.A.). The Pattison decision was relied on to support the proposition that the respondent was utilizing a notional method for computing gain and that this method was wrong in principle. In Pattison the taxpayer company, which was incorporated in England was a subsidiary of an American bank and carried on a banking business providing short-term and medium-term financing mainly in U.S. dollars. Immediately after incorporation the company issued $15 million U.S. of subordinated unsecured loan stock to two U.S. subsidiaries of the parent bank. As intended the whole of the $15 million received was used in making dollar loans and deposits in the ordinary course of its business without being converted into sterling. In 1976 the company purchased the whole of the loans stock, repaying the $15 million from its existing dollar funds. Apart from interest, the company made no profit on the dollar loans it made, but there was a yearly notional sterling profit on them, owing to the depreciation of sterling as against assessments of corporation tax on the notional profits. The House of Lords held, dismissing the appeal, that the company realized no actual exchange profits since it made no relevant currency conversion and that, accordingly, it made no taxable profit from the lending and repayment of the $15 million save for the difference between the interest received from its customers and the interest paid to its loan stockholders.

Counsel for the appellant submitted that the method of taxing notional profits in the Pattison case which was rejected by the House of Lords was indistinguishable from the respondent's notional method for computing gain in the case at bar.

I do not agree. In the Pattison case moneys were borrowed and repaid. These moneys were the asset, this asset was borrowed by the taxpayer corporation and in due course returned. In the interim it had increased in value. The Inspector of Taxes assessed corporation tax on the increase as a notional profit. The House of Lords appears to have accepted submissions by counsel for the taxpayer corporation to the effect that the return to a debtor of the specific subject matter of a loan can never give rise to a profit to the borrower notwithstanding the change in value of the subject matter of the borrowing.

The conclusions in Pattison cannot in my view be applied to the facts before me. Taxation in the case at bar is dependent upon the determination of capital gains or losses which are by statutory definition the difference between the adjusted cost base and the proceeds of disposition. In the Pattison case there were no dispositions, there were no sales or purchases. The asset was simply borrowed and increased in value while the borrower had the asset. That is not the case here where assets were sold and gains and losses were incurred.

The Greig and The Bank of Nova Scotia decisions were relied upon by counsel for the appellant in support of the position that a tax liability should not be assessed based on fluctuations in the currency rate. He submitted that would be the result if the appellant were precluded from determining the cost of the securities by converting the U.S. cost into Canadian dollars using the exchange rate on the date of disposition. Both of these cases concern the calculation of foreign tax credits where the taxes were not payable until a much later date. In both cases the courts held that the foreign exchange rate to be applied was that in effect when the tax liability arose.

Mr. Heinrich made specific reference to The Bank of Nova Scotia decision wherein the Federal Court of Appeal summarized the Minister of National Revenue's position in the following words at 165 (D.T.C. 5117):

Counsel for the appellant submits first, that the learned trial judge erred in failing to hold that, pursuant to paragraph 126(2)(a), the right to the tax credit conferred thereby, only arises upon actual payment of the foreign business income tax and in failing to hold that such tax credit should be computed on the basis of the rate of exchange prevailing at the date of actual payment.

Mr Justice Heald speaking for the Court dealt with this submission in the following words at 166 (D.T.C. 5117):

. . . I am unable to agree with his view of this matter. It is my opinion that the respondent's liability for U.K. income taxes for the 1972 taxation year arose in 1972 since that is the year when the income creating the liability was earned, even though by U.K. law, the tax was not required to be paid until some fourteen months later. I consider that the liability for the U.K. tax attached to the respondent at fiscal year-end, namely October 31, 1972

If the appellant is correct, the amount of U.K. tax credit would have changed almost daily during the period from October 31, 1972 to January 1, 1974, depending on when the U.K. tax was paid. I do not believe that Parliament intended such a result — namely, that the amount of tax credit should be affected by variations in the rate of foreign exchange.

I do not share counsel's view that this decision supports the appellant’s position. If anything it and the Greig decision support the respondent's submission that it is the historical cost which must be considered and not an arbitrary fluctuating cost determined by the exchange rate in effect on the date of disposition.

Counsel for the respondent relied upon the decision in Cockshutt Farm Equipment of Canada Ltd. v. M.N.R., 41 Tax A.B.C. 386; 66 D.T.C. 544. In that case the appellant company purchased depreciable assets on February 1, 1962. On the date of purchase the capital cost of these assets was set up in the appellant's books by adding to each item in the purchase agreement the amount of exchange necessary to convert from U.S. to Canadian funds, the U.S. dollar on that date being worth approximately $1.05 Canadian. At the end of its 1962 taxation year the appellant adjusted the capital cost of the depreciable assets acquired during the year to take into account the increase in the premium on U.S. funds, the U.S. dollar at that time being worth about $1.08 Canadian. Capital cost allowances were claimed by the appellant on the capital cost established at the year-end. The respondent granted capital cost allowances on the capital cost determined on the date of purchase. It was argued on behalf of the appellant company that it was proper for the company to adjust the capital cost on December 31, 1962 in order to reflect what the depreciable assets would have cost in terms of Canadian dollars as of the end of the taxation year.

The Tax Appeal Board held that the basis used by the respondent in granting capital cost allowances to the appellant was the proper one. A careful study of various provisions of the Act and Regulations led the Board to the conclusion that the expression “capital cost to the taxpayer’’, as used in paragraph 11 (1)(a) of the Act, refers to the actual, factual or historical cost to the taxpayer of the depreciable property when acquired. The Board further held that the rule established by the jurisprudence with respect to foreign exchange gains or losses on inventory items had no application.

Counsel for the respondent quite correctly pointed out that the Cock- shutt case dealt with the cost of depreciable property whereas the case at bar does not. However, Mr. Van Iperen urged the Court to find that there is no essential difference in the determination of cost as between depreciable and non-depreciable property. I agree.

The nub of the appellant’s argument is that the U.S. dollar cost should not be converted into Canadian dollars at the exchange rate in effect on the date of acquisition because the appellant was at that time in possession of U.S. funds and paid for the security in those funds with the result that there was never any conversion. In my view this argument cannot be accepted. Income is assessed under the Income Tax Act in terms of Canadian dollars. Any reference to valuation contained therein refers to value in Canadian dollars unless the Act specifically provides otherwise. It is therefore clear that in the definition of "adjusted cost base” in paragraph 54(a)(ii) the reference to “the cost to the taxpayer" must mean the Canadian cost to the taxpayer. It would be illogical to assume otherwise. In a paper entitled "The Meaning of Cost in Canadian Income Tax”, by D. Keith McNair, one finds the following comment at page 109:

Where a depreciable property is acquired in a transaction requiring payment of a foreign currency, the capital cost of that property is the Canadian dollar equivalent of the foreign currency amount, calculated at the rate of exchange prevailing at the time of the transactions. Fluctuations in the exchange rate resulting in the eventual payment of more or less than the capital cost amount do not affect that capital cost. This position reflects the decision of the Tax Appeal Board in Cock- shutt Farm Equipment, where it was held that the phrase “capital cost to the taxpayer” refers to “the actual, factual, or historical cost to the appellant of the depreciable property when acquired/’ without adjustment for subsequent events.

I have concluded that the Minister of National Revenue was correct in reassessing the appellant as he did. Accordingly the appeals with respect to the 1979, 1980 and 1982 years are dismissed.

Because the appellant failed to file a notice of objection in respect of the reassessment of her 1981 taxation year as required by section 169 of the Income Tax Act this Court has no jurisdiction to hear an appeal from that assessment. An order will go quashing the purported appeal for the 1981 taxation year.

Appeals dismissed.

Schedule B

HOPE R. GAYNOR

SUMMARY OF DISPOSITIONS OF CAPITAL PROPERTY IN 1980 — SCHEDULE 2

(CONVERTED @ U.S.: $1.1690 CDN.)