Pandju Merali v. Her Majesty the Queen, [1986] 1 CTC 521, 86 DTC 6261

Denault, J.:—This is an appeal by way of an action pursuant to subsection 172(2) of the Income Tax Act, R.S.C. 1952, c. 148, as am. by S.C. 1970-71-72,

c. 63, from an income tax reassessment made by the Minister of National Revenue respecting plaintiff’s 1981 taxation year.

In computing his 1981 income tax, the plaintiff deducted from his income non-capital losses in the amount of $212,013. This deduction was disallowed by the Minister on the ground that the plaintiff was not entitled to claim a non-capital loss in the amount of $212,013 as the said loss was reported by the plaintiff in accordance with provisions of section 216 of the Income Tax Act and could not therefore be used to reduce the tax otherwise payable by the plaintiff pursuant to Part I of the Act in 1981 when the plaintiff was a resident of Canada.

The litigants have provided the Court with an agreed statement of facts which is hereinafter reproduced:

AGREED STATEMENT OF FACTS

The parties hereto, by their respective solicitors, hereby admit the facts and documents hereinafter specified provided that:

(a) the admissions are made for the purposes of this action only and may not

be used against either party by any other person or on any other occasion;

(b) the parties hereto reserve the right to object to the relevancy of any of the said facts and documents; and

(c) either party may adduce further and other evidence relevant to the action and not inconsistent with this agreement.

1. In the 1978, 1979 and 1980 taxation years, the Plaintiff was a resident of the United States and the owner of an undivided interest in real property (herein called the “Property”) situated in the Municipality of Richmond, in the Province of British Columbia.

2. In the 1978, 1979 and 1980 taxation years, the Plaintiff computed his liabilty for tax in Canada in respect of rents received on the Property in accordance with the provisions of subsection 216(1) of the Income Tax Act.

3. The Plaintiff incurred losses in respect of the Property in the amounts of $103,445 and $108,568 in the 1978 and 1979 taxation years, respectively, which amounts the Plaintiff reported in filing his returns of income for the 1978 and 1979 taxation years.

4. In the 1980 taxation year, the Plaintiff earned no net income from the Property, for the reason that the aggregate of expenses and capital cost allowance was equal to the Plaintiff’s share of rental revenue from the Property.

5. In or about the month of June, 1981, the Plaintiff became a resident of Canada.

6. In computing his taxable income for that portion of the 1981 taxation year during which he was a resident of Canada, the Plaintiff deducted the sum of $212,013 comprised of the sums of $103,445 and $108,568, referred to in paragraph 3 hereof, on the basis that such amounts were non-capital losses of the Plaintiff deductible in computing taxable income pursuant to the provisions of paragraph 111(1)(a) of the Income Tax Act.

7. By reassessment, notice of which was dated April 6, 1983, the Minister of National Revenue assessed the Plaintiff to disallow the deduction of non-capital losses in the amount of $212,013.

8. The Plaintiff filed a notice of objection to the assessment and by reassessment dated February 6, 1984, the Minister of National Revenue reassessed the Plaintiff to allow an additional deduction of $167,708 in respect of an income averaging annuity contract purchased by the Plaintiff in the 1981 taxation year, which amount had not been previously deducted by the Plaintiff, but confirmed the disallowance of the deduction of any portion of the sum of $212,013.

The general rule is that a non-resident, not carrying on a business in Canada, is subject to the withholding tax provisions of Part XIII of the Act in respect of rental income from property. As an alternative to this general rule, he may use the method permitted under subsection 216(1) of the Act, which allows a non-resident to elect to be taxed under Part I of the Act, on his net rental income, as if he were a Canadian resident. His net rental income derived from property in Canada is thus determined in the same manner as that of a Canadian resident: from gross rental income received, he may deduct actual expenses incurred to earn the income, including capital cost allowance, but no Division “C” deductions such as personal ex- eruptions, medical or charitable outlays or non-capital losses may be claimed. Subsection 216(1) is now reproduced:

216. (1) Where an amount has been paid during a taxation year to a non-resident person, or to a partnership of which he was a member, as, on account or in lieu of payment of, or in satisfaction of, rent on real property in Canada or a timber royalty, he may, within 2 years from the end of the taxation year, file a return of income under Part I in the form prescribed for a person resident in Canada for that taxation year and he shall, without affecting his liability for tax otherwise payable under Part 1, thereupon be liable, in lieu of paying tax under this Part on that amount, to pay tax under Part I for that taxation year as though

(a) he were a person resident in Canada and were not exempt from tax under section 149,

(b) his income from his interest in real property in Canada, timber resource properties and timber limits in Canada and his share of the income of a partnership of which he was a member from its interest in real property in Canada, timber resource properties and timber limits in Canada were his only income,

and

(c) he were not entitled to any deduction from income for the purpose of computing taxable income.

If the election is made under section 216, the non-resident is put in the position where he treats himself as if he were a Canadian resident and his only income for the purpose of computing his tax liability under Part I is the liability attributable to the rental income. Of course, the non-resident is not entitled to any deductions in computing his taxable income and no such deductions were claimed in the 1978, 1979 and 1980 taxation years.

Now in 1981, the non-resident plaintiff became a Canadian resident. The effect of this change of status has enabled the plaintiff to use the deductions contained in Division “C” (see subsection 2(2)). One of those deductions is non-capital losses for which the statutory authority to carry over and deduct such losses is contained in paragraph 111(1)(a) of the Act:

111. (1) For the purpose of computing the taxable income of a taxpayer for a taxation year, there may be deducted from the income for the year such of the following amounts as are applicable:

(a) non-capital losses for the 5 taxation years immediately preceding and the axation year immediately following the taxation year, but no amount is deductible in respect of non-capital losses from the income of any year except to the extent of the taxpayer’s income for the year minus any amount deductible under subsection 138(6) and all deductions permitted by the provisions of this Division other than this paragraph, paragraph (b) or section 109;

The definition of non-capital losses is set out in paragraph 111(8)(b) of the Act:

(b) “‘non-capital loss” of a taxpayer for a taxation year means the amount, if any, by which

(i) the aggregate of all amounts each of which is the taxpayer’s loss for the year from an office, employment, business or property, his allowable business investment loss for the year, and all amounts deductible under section 112 or subsection 113(1) or 138(6) from the taxpayer’s income for the year

exceeds

(ii) the amount determined under paragraph 3(c)

Thus the appeal turns on the question of whether or not losses sustained by the plaintiff while he was a non-resident can be carried forward and deducted as non-capital losses in a year in which he became a resident.

The plaintiff had the burden of showing that the defendant’s reassessment is unjustified and, to discharge himself of that task, he submitted the following arguments.

In 1978 and 1979, the plaintiff elected to file tax returns as though he was a Canadian resident pursuant to section 216 of the Act. His liability for tax was thus determined by Part XIII of the Act and he was not entitled to deduct from his rental income losses from other years. But in 1981, he became a resident and his liability for tax was therefore determined in accordance with subsections 2(1) and 2(2) of the Act. Those subsections specifically gave him access to Division “C’’ deductions which of course include the non-capital losses carry forward provisions. The plaintiff submitted. that there is nothing in the relevant provisions of the Act, i.e. 111(1)(a), 111(8)(b) and 216, which prevents him from deducting the non-capital losses he sustained in previous years while he was a non-resident. He concluded by saying that it would be necessary for the defendant to point to some specific wording in the Act which would prohibit the deduction when on every point the plaintiff falls within the non-capital provision contained in section 111.

The gist of the defendant’s argument is that the non-resident can only sustain losses if he carried on a business in Canada and, because such was not the case in the 1978, 1979 and 1980 taxation years, the plaintiff is precluded from any deduction from income for the purpose of computing his taxable income. In other words, the defendant contended that the plaintiff did sustain losses when computing his net rental income, but those losses cannot be termed as non-capital losses since he has no access to Division “C” deductions and in particular to non-capital losses provisions. The losses simply did not exist and the plaintiff cannot retroactively breathe life into those “losses” to carry them over to offset income earned in a year in which he became a resident.

I do not agree with the defendant on this point because he seems to forget that when the plaintiff in 1978 and 1979, then as a non-resident, made the election under section 216, he was not entitled to any deduction and his only income for the purposes of computing his tax liability under Part I of the Act was the liability attributable to the rental income; while when he became a resident in 1981, he was to be considered as such. In order to gain access to the deductions afforded by Division “C”, a taxpayer must be liable for taxes under subsections 2(1) and 2(2) of the Act. Clearly in 1981, the plaintiff was a resident and thus liable for taxes pursuant to the above subsections. It now remains to determine whether losses incurred by the plaintiff while a non-resident can be termed as non-capital losses and carried forward to offset income earned in a subsequent taxation year in which the plaintiff became a resident.

The plaintiff computed in the 1978, 1979 and 1980 taxation years his income from property in accordance with section 9 of the Act. The net rental income thus calculated turned out to be negative and losses were incurred. It is such losses that cannot be applied against income for the year [as determined under paragraph 3(c)] that become non-capital losses. The plaintiff is statutorily precluded from carrying over those losses during the period he is a non-resident [paragraph 216(1)(c)]. From my reading and interpretation of the relevant provisions of the Act, he is not barred from sustaining losses. Those losses exist, but they cannot be used until the taxpayer becomes a resident. Clearly the losses incurred in the 1978 and 1979 taxation years fall within the ambit of paragraph 111 (8)(b) which defines the non-capital losses. The statutory authority to carry over those non-capital losses is conferred by paragraph 111(1)(a), but paragraph 216(1)(c) is specifically designed to prevent their carry over. Paragraph 216(1)(c) does not, however, go as far as saying that a non-resident taxpayer is precluded from computing losses on income earning property held by him in Canada.

For the above reasons, I would allow the appeal, vacate the reassessment made by the Minister of National Revenue, and refer the matter back to the Minister for reconsideration.

Appeal allowed.