North Pacific Towing and Salvage Limited v. Minister of National Revenue, [1976] CTC 2053

A J Frost (orally: October 3, 1975):—These are income tax appeals in respect of the appellant’s 1967, 1969, 1970 and 1971 taxation years. The appeal in respect of the 1967 taxation year was abandoned by the appellant on the grounds that there is no right of appeal from a nil assessment. This last contention being in agreement with the latest case law on this subject, the appeal for the 1967 taxation year is hereby quashed accordingly. _.

In reassessing the appellant for the 1969, 1970 and 1971 taxation years, the Minister of National Revenue confirmed the original assessments on the ground that the losses sustained by the taxpayer in 1966 and 1967 were not deductible from the income of the subsequent 1969, 1970 and 1971 taxation years by virtue of subsection 27(5) of the Income Tax Act, RSC 1952, c 148 as amended.

At the commencement of the 1967 taxation year, the appeilant company owned and operated the tug “Polaris”. The “Polaris” was Originally a British Admiralty tug with a steel hull, built in 1918 or 1919. The appellant bought the tug in the mid-1960’s and completely refitted it at a total cost of $594,875 which included the cost of the hull. For capital cost allowance purposes, this asset was considered to fall into the following categories: Class 7—$20,875 and special class subject to straight-line depreciation $574,000, making a total of $594,875. The cost of this item was shown on the balance sheet of the company as at December 31, 1966, as follows:

Boat at cost, first mortgage held by Finning Tractor Company Limited; second mortgage held by May Marine Electric Company—$594,875.

On November 11, 1967, the first mortgagee, Finning Tractor Company Limited (hereinafter referred to as “Finning”) foreclosed on the appellant pursuant to the terms of its mortgage agreement, and almost immediately sold the vessel for $325,000 in order to recover principal and interest owing under the terms of the mortgage. The amount of loss sustained was $269,875.

As there were a number of outstanding claims, including customs duties on foreign repairs, the excess of the selling price over secured and preferred claims could not be determined until January 1968. A letter from Finning, dated January 17, 1968, Exhibit A-6, indicates that an amount of $14,561 was owing to the appellant, out of which Finning retained a reserve of $7,500 to protect itself against further claims.

The amount of $14,561 is shown as a receivable on the interim balance sheet of the appellant as at February 29, 1968. In September, or possibly October, of 1968, the appellant company was acquired by Harken Towing Company Limited of Port Coquitlam, British Columbia, for $20,000. Under new shareholder ownership, the appellant company acquired, on November 29, 1968, the sailing vessel BT-84 from Spartan Investments Limited for the sum of $50,000.

The questions at issue in this appeal are: Did the appellant dispose of all of its Class 7 assets, and acquire no more during its 1967 taxation year? Secondly, for purposes of the Income Tax Act, did the appellant company, during its 1969, 1970 and 1971 taxation years, carry on the business in which the 1967 loss or, as counsel for the appellant contends, the 1968 loss, of $269,875 was sustained?

To decide the first question as to whether there was a terminal loss in 1967, it is necessary to determine if there was a disposition within the meaning of paragraphs 20(5)(b) and (c) of the Act, which provide that the disposition of property includes any transaction which entitles the taxpayer to the proceeds of the disposition of the property. They then go on to state what is included in the proceeds of disposition.

In the case at bar, the selling price of $325,000 constitutes a credit to the “Polaris” vessel account on the books of the appellant and a debit to the mortgage liability account of Finning to the extent of $269,350, thereby reducing the liability of the taxpayer to Finning, leaving a balance of $28,640 available for the settlement of other outstanding claims and leaving any final surplus to the account of the appellant.

The main point is that the appellant became entitled to this credit of exactly $325,000 prior to the 1967 year end. This amount is the only figure needed to establish a terminal loss in 1967. It is the total amount to be credited to the assets in Class 7. Nothing was unknown or unascertained at the 1967 year end which would affect the amount of the terminal loss. The $325,000 credit, plus the $269,875 loss, total the amount at which the “Polaris” was capitalized.

The unascertained items do not affect any depreciated capital cost balances. The fact that the taxpayer became entitled to a credit of $325,000, being the proceeds of disposition, does not, however, necessarily resolve the question of whether there was a terminal loss in 1967. Before one can claim a terminal loss, all the assets of a class must be exhausted or sold. A terminal loss only exists when no assets remain at the end of a taxation year and a debit balance remains in the class after the proceeds of disposition have been deducted.

When the “Polaris” was seized, the only productive asset in Class 7 was taken out of production and no new asset was acquired before the end of the 1967 taxation year for the purpose of continuing the business operations of the appellant company. From a production viewpoint, the appellant company had no property of Class 7 which could generate income. The fact that part of the cost of the “Polaris” tug fell into a special class makes no difference to the outcome of this appeal.

The acquisition of a sunken tug, scow or barge, which had been acquired on the advice of the appellant’s accountant, cannot be deemed to have kept the class alive, as it was not a depreciable asset within the scope of Class 7. It was a wreck and therefore was not acquired for the purpose of producing or earning income. It was purchased sight unseen, and its inclusion in the balance sheet of the company as at February 29, 1968, is in my view improper financial reporting. Presenting this acquisition as one adding to the assets within Class 7 gives this transaction the characteristic of a sham. The tenets of accounting theory require a meaningful measure of income entailing a matching of revenues against cost allocations. Books of account should, as far as possible, reflect the facts of business life and not merely contain figures for tax purposes.

With respect to the second question, did the appellant company, during its 1969, 1970 and 1971 taxation years, carry on the business in which the 1967, or, if you prefer, the 1968 loss of $269,875 was sustained? Again I refer to the interim balance sheet of the appellant company as at February 29, 1968 (Exhibit 12). Here we have a company with $10 in the bank to meet the following liabilities:

A company with $10 in the bank, no equipment and virtually no working capital to meet liabilities of over $200,000 is not a financially viable operation.

The appellant’s balance sheet as of February 29, 1968, reflects a worthless condition to which no value can be attached other than that which might be attached to a tax loss situation.

To establish that the appellant company did in fact become viable in later years, that is, in 1969, 1970 and 1971, and did carry on the business in which the earlier loss occurred, would require a preponderance of relevant evidence. Since no such evidence is before me the Board has no alternative but to dismiss the appeals.

Appeals dismissed.