Bessemer Trust Company and Ogden Phipps as Trustee (1957 Trust) v. Minister of National Revenue, [1972] CTC 473, 72 DTC 6404

Collier, J:— This is an appeal by a non-resident trust against an assessment by the Minister which seeks to add back into the taxable income of the trust for the year 1969 capital cost deductions previously allowed to the trust. The trust had owned real property in Vancouver, BC, which earned rental income. The property was sold in 1969. The full amount of the previous capital cost deductions or allowances is in issue: $156,777.

The parties have filed an agreed statement of facts, which I set out:

1. The Appellant is a Trust. The Trustees of the Trust are the Bessemer Trust Company and Ogden Phipps, both of whom are residents of the United States of America. The beneficiaries of the Trust are residents of Great Britain.

2. Prior to 1969 part of the Trust property was rental property situated in the City of Vancouver, in the Province of British Columbia.

3. For the 1965 and 1969 taxation years the Trust elected to file returns on the basis as set forth in Section 110(1) of the Income Tax Act, in respect of the property described in paragraph 2 above, and was assessed accordingly with respect to the said returns.

4. In 1969, the property referred to in paragraph 2 above was sold.

5. By Notice of Re-Assessment the Minister of National Revenue reassessed the Appellant by purporting to tax recapture in the amount of $156,777.00 arising out of the said sale of the rental property.

By way of further explanation, I understand the appellant, in the years 1966, 1967 and 1968, did not elect to file under subsection 110(1) of the Income Tax Act, RSC 1952, c 148 and amendments, but paid tax on the rental income under paragraph 106(1 )(d).

To appreciate the submissions made, it is necessary to set out section 110 in full:

110. (1) Where an amount has been paid during a taxation year to a non-resident person 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 I, thereupon be liable, in lieu of paying tax under this Part on that amount, to pay tax under Part I [and tax under Part IB] for that taxation year as though

(a) he were a person resident in Canada and were not exempt from tax under section 62,

(b) his interest in real property in Canada or timber limits in Canada were his only source of income, and

(c) he were not entitled to any deduction from income to determine taxable income.

(2) Where a non-resident person has filed a return of income under Part I as permitted by this section, the amount deducted under this Part from rent payments to him or from timber royalties paid to him and remitted to the Receiver General of Canada shall be deemed to have been paid on account of tax under this section and any portion of the amount so remitted to the Receiver General of Canada in a taxation year in excess of the tax under this section for the year shall be refunded to him.

(3) Part I is applicable mutatis mutandis to payment of tax under this section.

(4) Where a non-resident person has filed with the Minister an undertaking in prescribed form to file a return of income under Part I for a taxation year as permitted by this section but within 6 months from the end of the taxation year, a person who is otherwise required by subsection (3) of section 109 to remit in the year an amount to the Receiver General of Canada in payment of tax on rent on real property or in payment of tax on a timber royalty may elect, by virtue of this section, not to remit under that subsection but if he does so elect

(a) he shall, when any amount is available out of the rent or royalty received for remittance to the non-resident person, deduct therefrom 15% thereof and remit the amount deducted to the Receiver General of Canada on behalf of the non-resident person on account of the tax under this Part, and

(b) he shall, if the non-resident person

(i) does not file a return for the taxation year in accordance with the undertaking filed by him with the Minister, or

(ii) does not pay the tax he is liable to pay for the taxation year under this section within the time limited for payment,

pay to the Receiver General of Canada, upon the expiration of the time for filing or payment, as the case may be, the full amount that he would otherwise have been required to remit in the year minus the amounts that he has remitted in the year under paragraph (a).

(5) Where a non-resident person has filed a return of income under Part I for a taxation year as permitted by this section and has, in computing his income under Part I for that year, deducted an amount under paragraph (a) of subsection (1) of section 11 in respect of real property in Canada or a timber limit in Canada, he shall, within the time prescribed by section 44 for filing a return of income under Part I, file a return of income under Part I, in the form prescribed for a person resident in Canada, for any subsequent taxation year in which that real property or timber limit or any interest therein is disposed of, within the meaning of section 20, by him, and he shall, without affecting his liability for tax otherwise payable under Part I, thereupon be liable, in lieu of paying tax under this Part on any amount paid to him or deemed by this Part to have been paid to him in that subsequent taxation year in respect of any interest of that person in real property in Canada or timber limits in Canada, to pay tax under Part I [and tax under Part IB] for that subsequent taxation year as though

(a) he were a person resident in Canada,

(b) his interest in real property in Canada or timber limits in Canada were his only source of income, and

(c) he were not entitled to any deduction from income in computing his taxable income.

(6) Subsection (5) does not apply to require a non-resident person to file a return of income under Part I for a taxation year unless, by filing that return, there would be included in computing his income under Part I for that year an amount by virtue of subsection (1) of section 20.

(7) Where, by virtue of subsection (5), a non-resident person is liable to pay tax under Part I for a taxation year, no election may be made by that person under subsection (1) of section 43 unless that person has, within the time prescribed by subsection (1) for filing a return of income under Part I, filed a return of income under Part I, in the form prescribed for a person resident in Canada, for each of the 5 taxation years immediately preceding the taxation year, in which latter case he shall be deemed, for the purposes of section 43, to have been resident in Canada or to have carried on business in Canada, as the case may be, during each of those 5 years immediately preceding the taxation year.

I point out that subsections (5)-(7) were added to section 110 in 1955. Prior to 1955, and particularly as of January 1, 1951 (the effective date of Article XIIIA 2 of the Canada-US Tax Convention) the predecessor section of the Act was section 99, and I set it out:

99. (1) Where an amount has been paid during a taxation year to a nonresident person as rent on real property in Canada, 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 the taxation year and he shall, without affecting his liability for tax otherwise payable under Part I, thereupon be liable in lieu of paying tax under this Part on that amount, to pay tax under Part I as though

(a) he were a person resident in Canada,

(b) the real property were his only source of income, and

(c) he were not entitled to any deduction from income to determine taxable income.

(2) Where a non-resident person has filed a return under subsection (1), the amount deducted under this Part from rent payments to him and remitted to the Receiver General of Canada shall be deemed to have been paid on account of tax under this section and any portion of the amount so remitted to the Receiver General of Canada in a taxation year in excess of the tax under this section for the year shall be refunded to him.

(3) Part I is applicable mutatis mutandis to payment of tax under this section.

(4) If a non-resident person has filed with the Minister an undertaking in prescribed form to file a return of income for a taxation year as permitted by this section, a person who is otherwise required by subsection

(3) of section 98 to remit in the year an amount to the Receiver General of Canada in payment of tax on rent on real property may elect, by virtue of this section, not to remit under that subsection but, if he does so elect,

(a) he shall, when any amount is available out of the rents received for remittance to the non-resident person, deduct therefrom 15% thereof and remit the amount deducted to the Receiver General of Canada on behalf of the non-resident person on account of the tax under this Part,

and

(b) he shall, if the non-resident person

(i) does not file a return for the taxation year as and when permitted, or

(ii) does not pay the tax he is liable to pay for the taxation year under this section within the time limited for payment,

pay to the Receiver General of Canada, upon the expiration of the time for filing or payment, as the case may be, the full amount that he would otherwise have been required to remit in the year minus the amounts that he has remitted in the year under paragraph (a).

As can be seen subsections 99(1) and 110(1) are, but for minor differences in wording, the same. Section 99, however, did not have a “recapture” provision similar to subsection (5) of section 110.

In 1951, there were “recapture” provisions in section 20 of the Act substantially the same as those in section 20 of the Act as it stood in 1969.

It is necessary to set out Article XIIIA 2 of the Convention:* [1]

ARTICLE XIII A

1. . . .

2. Rentals from real property derived from sources within Canada by an individual or corporation resident in the United States of America shall receive tax treatment by Canada not less favorable than that accorded under Section 99, The Income Tax Act, as in effect on the date on which this Article goes into effect.

The appellant concedes that if subsections (5) and (6) of section 110 are applicable in this case, then the assessment is correct. Counsel submits, however, that one must look at the true nature of the dollars in question here. The appellant says they are, in essence, income from rent not previously taxed. If that is so, then, as there was no “recapture” provision in section 99 in 1951 (the effective date of Article XIIIA 2), the appellant contends there is no authority for the Minister to make the assessment he did.

I deal first with the contention that the amount in question here is, in essence, rental income. The word “recapture” nowhere appears in subsection 110(5), nor for that matter, in section 20. It has become a convenient label to describe what those sections appear to do. After consideration of those sections along with paragraph 11(1)(a) and section 1100 of the Income Tax Regulations, I agree with counsel for the appellant that the so-called “recapture” provisions are fundamentally adjustments to income of previous years, and do not create, in the year of disposal of the asset, some new form or source of income, described by the respondent as income from the sale of depreciated property. Paragraph 11(1 )(a) refers to a deduction in the computation of the taxpayer’s income of an amount in respect of the capital cost of property. Subsection 1100(1) of the regulations provides that in computing his income, a taxpayer is allowed certain deductions and what is loosely called the capital cost allowances are set forth.

Applying that concept to the facts here, this is in my view what occurred. The appellant had real property in Canada and derived rents from that source. Obviously, the rent was income. When the appellant elected to file under Part I of the Act, it was allowed to deduct from that income, certain amounts, called capital cost allowances.

These allowances are, I think, not depreciation in the true accounting sense, but an artificial depreciation system which may not accord with the ultimate economic facts in a particular case. Here, the allowances were made in respect to real property from which the income came, but to my mind they merely reduced the amount of income taxable in the particular year. They did not, in my view, create a potential new source of income when the asset was disposed of at a price greater than the “undepreciated capital cost”.* [2] As I see it, the recapture provisions amount to this in this case: the reduction of your rental income in previous years, by reason of these artificially calculated allowances, has turned out to be too great and the excess reductions will be added back in to your rental income, now that you have disposed of that asset.

I find support for this view in two decisions of the Tax Appeal Board,* [3] although the cases are not directly in point. In the Pioneer case the taxpayer had carried on a farming business and a printing business. It sold the printing business and some $70,000 of recaptured capital cost allowance was added to its income by virtue of subsection 20(1)- The taxpayer sought to deduct its farming losses for previous years from this amount, contending it was not income derived from its three main sources of income, but was “statutory income”. The argument was not accepted. The Chairman said at pages 226-227 [17]:

Counsel for the Minister submitted that the appellant’s argument that its various activities constituted one business was not in accord with the decision in the Eastern Textile Products case where it was held that losses sustained in a textile business carried on by that appellant could not be written off against profits from another phase of the company’s operations. It was pointed out that Section 13 contemplated the division of income from various sources and that section allowed the deduction of only one-half of farm losses from income derived from another source. Capital cost allowance granted to the appellant in respect of assets of the printing business related to the computation of the appellant’s income from that business and, when recovered, this allowance also related to the printing business and farm losses were not deductible from the amount recaptured.

As to the appellant’s argument that its farming losses should be deductible from what it termed “statutory income” it would be well to examine the wording of Section 27(1 )(e) under which this deduction is claimed. That section provides for the deduction of business losses of previous years from “the taxpayer’s income for the taxation year from the business in which the loss was sustained”. It does not state that a loss may be deducted from “income for the taxation year from any source”. Despite the appellant’s novel argument that the amount of recaptured capital cost allowance was not income from any particular phase of its operations but was instead “statutory income” it must be remembered that this amount would not be included in its 1956 income if the company had not sold its printing business in its 1956 fiscal year. While the printing business did not produce this amount of income in its usual operations, nevertheless it would be fanciful to attribute this amount to any other source than the said printing business . . . .

In my opinion, the source of the recaptured capital cost allowances in this case was the rental income derived from real property.

In the Powell case the Minister had taken the position taken here: that the recaptured capital cost allowance moneys represented the proceeds of the sale of certain capital assets and were not profits reasonably attributable to the production of prime metal from the taxpayer’s mine. The Minister’s argument did not succeed. The Board said at pages 286-287 [404]:

From the last-mentioned case above, the present appellant argued that, since the income derived by it in past years from the operation of its gold mine was taken into account for taxation purposes, even although it may have been reduced by deductions in respect of capital cost allowance, it should follow that, when the amounts represented by that capital cost allowance had been recaptured and were brought into income for taxation purposes, the appellant herein should be entitled to obtain a depletion deduction in respect thereof, that is, the converse of the Sheep Creek Gold Mines case should be applicable in the present instance.

It has long been held by the Courts that a taxpayer cannot be held liable for tax merely on a bookkeeping entry. I do not need to cite cases to this effect. In my opinion, the appellant should succeed in its appeal in the circumstances of the present case. In years prior to 1956, a portion of the income which it had derived from the operation of a gold mine was permitted to be deducted in respect of a capital cost allowance deduction for the purposes of arriving at the taxable income of the appellant company, and each of the amounts so deducted over the years was recorded in a bookkeeping entry designated as “Capital Cost Allowance Account’’. When, in the year 1956, the appellant company happened to sell some of its assets at a figure in excess of the undepreciated capital cost of those assets on its books at the time of the sale, and was thus required to bring into income the amount of this excess up to but not exceeding the total amount of the capital cost allowance deductions written off on those assets in its books for income tax purposes, it is my opinion that the source of this income should be recognized as having been, originally, the appellant’s activities in respect of its gold mine, and the income itself as having been, as the Income Tax Regulations state, “reasonably attributable to the production of prime metal’’.

I find the reasoning persuasive.

I proceed to the next step: Were these moneys “rentals from real property derived from sources within Canada”? (Article XIIIA 2 of the Convention). The only problem is the meaning to be given to “derived” and I think that is resolved by adopting the construction given to that word by the Supreme Court of Canada in MNR v Hollinger North Shore Exploration Co Ltd, [1963] SCR 131 at 134; [1963] CTC 51 at 54; 63 DTC 1031 at 1033, as “arising or accruing” rather than “received”. On that interpretation, there arises the connotation of source or origin of the income rather than the connotation of mere receipt.

Counsel for the respondent submitted an alternative argument to his contention that these recaptured moneys were not rent within the meaning of either subsection 99(1) or 110(1). The appellant, it is said, by electing to file under subsection 99(1) brought into play section 20, and is therefore taxable on these “recaptured” moneys under that section. In my opinion, to give effect to that submission would render meaningless the addition of subsections (5) and (6) to section 110 in 1955. Until that year the concept of recapture arose only under Part I of the Act. Part ill, dealing with non-residents such as the appellant here, was silent. There was, in my view, a gap, in the sense that non-residents, electing to file under section 99, were not subject to section 20, and Parliament intended to close the gap by enacting the two subsections referred to earlier.

This brings me to the final point which is whether the Article of the Convention prevents the application of subsection 110(5) to this case. While the words “. . . shall receive tax treatment by Canada not less favorable than that accorded under Section 99 . . .” are quite general, I am unable to construe them in any other way, and I hold the Article does so prevent.

The appellant here is entitled to have its rental income taxed according to section 99. To apply subsection (5) of section 110 would, in my view, be less favourable treatment.

The appeal is therefore allowed with costs and the assessment referred back to the Minister accordingly.