Subsection 13(21) - Definitions

A private company (“SherWeb”), which provided, to paying customers, the use of software developed by it, transferred its software for creditor-proofing reasons a newly-formed sister company (“501”) at a gain (with such software licensed back to it for continued use in its software services business).

The Court found that although the acquired software was depreciable property to 501, it had not been depreciable property to SherWeb because SherWeb, rather than claiming capital cost allowance respecting the software, had treated its software development expenses as deductible SR&ED expenses, so that the software had been excluded from treatment in its hands as depreciable property pursuant to the Quebec equivalent of Reg. 1102(1)(d) (which excludes, from depreciable property, any property that was acquired by expenditures in respect of which the taxpayer was allowed a deduction under s. 37). Accordingly, Taxation Act s. 99 (equivalent to the ½ step-up rule in ITA s. 13(7)(e)) did not apply to reduce the capital cost to 501 of the acquired software.

The Court further stated (at paras. 28, 32, TaxInterpretations translation):

Depreciable property is property in respect of which a depreciation allowance has been allowed, or “would have.” The fact that a deduction, in the abstract, could have been allowed in respect of a property cannot, however, permit that property to be characterized as a purely depreciable property to SherWeb, when the evidence demonstrated that it had lost that character by reason of the various expenditures on programmers' salaries, and the SR&ED credits that were accorded to it year after year. …

One cannot escape the fact that, to SherWeb, the Software has never been treated as a depreciable asset, and so continually until the time "immediately before the transfer" to the respondent.

Regarding an ARQ submission that the Reg. 1102(1)(d) equivalent was intended only to preclude a double deduction (for SR&ED and CCA) and not to avoid the ½ step-up rule, the Court stated (at para. 34):

Regarding the appellant's position that the deduction of salaries over the years as an expense does not preclude the Software being depreciable property, it must be remembered that the salaries were deducted as an expense paid to maintain the profitability of the business activities which were, as such, an expense on income account even though the sums spent on the initial creation of the Software could have qualified as capital costs. It seems to us that the appellant's position does not take into account the undisputed facts found by the judge. In this regard, it must be emphasized that the fact that an expenditure is incurred to produce "a capital asset, in the sense of an enduring benefit" does not necessarily transform an (ordinary) expense into a capital expense.

The taxpayer bought units in a limited partnership, which was to acquire a large yacht to be used for catered vacation charters. The general partner ("OCGC") purchased a smaller yacht (the S/Y Garbo) to be used for the provisioning of supplies to an envisaged fleet of yachts for the partnership in question and 35 others, which were never acquired. The purported business plan for the 36 partnerships represented a "Ponzi-like scheme [which] was set to collapse eventually" (para. 344, see also 356).

In finding that no capital cost allowance could be claimed by the partnership in question in respect of the S/Y Garbo, Rossiter ACJ found (at para. 402) that OCGC did not acquire title in the interest of the partnership.

The taxpayer purchased farm equipment from a corporation ("Case") for sale or lease. to farmers. In the case of a lease transaction, it entered into a lease of the equipment from a leasing company affiliate of Case ("Case Credit") at the same time as the taxpayer, in turn, leased the equipment to a farmer, generally for a term of five years. Case Credit held title to the equipment as security for the payment of lease payments by the taxpayer to Case Credit. In 75% of the leases with farmers, the farmers did not exercise their option to purchase the equipment on completion of the lease, in which event the taxpayer would sell the equipment.

Bowie J. found that the equipment was converted from inventory to capital property in the taxpayer's hands when the equipment commenced to be leased to a farmer, and it again changed character and became inventory once again when the equipment became available for sale by the taxpayer at the conclusion of the lease. He stated (at para. 8):

The characterization of an asset as inventory or depreciable capital asset may change from time to time depending on the circumstances, and in particular, the use to which the unit is being put at a given time: see Plaza Pontiac-Buick ... Canadian Kodak Sales ... . Equipment of which the appellant has taken possession and which is available to be sold or leased is properly treated as inventory. When it is either sold or leased, it is no longer available to be disposed of, and it ceases to be inventory.

Under these arrangements the taxpayer was found to be the beneficial owner of the equipment notwithstanding the holding of title by Case Credit. Accordingly, the taxpayer was eligible for investment tax credits in respect of the equipment.

A film that was described in evidence as being over 50% complete was found to be depreciable property described in Class 10 given that it was acquired on capital account for an income-producing purpose and given that it had a readily discernable comedy plot, appropriate sound, a beginning, and a developing sequential story, and it had reached the state where it could be shown to professional marketers through a videotape medium. Furthermore, even if it did not qualify as a "motion picture film", then, as an incomplete film, it would qualify as tangible property and, therefore, as a Class 8 property.

At the request of a customer ("Cronin"), a corporation ("Transportaction") acquired motor vehicles from a dealer, and then entered into agreements (styled as motor vehicle lease agreements) with Cronin. The leases could be terminated after six months by either party. Following termination of the lease, Transportaction was to sell the returned vehicle. If the net sale proceeds exceeded the termination book value, Transporataction was required to pay Cronin the excess; whereas if the net sale proceeds were lower, Cronin was required to pay the deficiency to Transportaction except to the extent that the net sale proceeds were less than 20% of the termination book value.

Rosenberg J. found that there was only a "remote possibility" that a vehicle would be sold for less than 20% of the termination value, and found that "the result of the lease agreement was that effectively all benefits and risk of ownership of the vehicle were transferred to Cronin" (p. 273). Accordingly, the lease in substance created a security interest which was unperfected on the date of bankruptcy of Conin.

At the time the taxpayer contacted the lessor ("Hewitt") of equipment to it that it wished to exercise the purchase option, Hewitt suggested another institution ("Lafleur") as a source of financing the purchase. Accordingly, the taxpayer entered into a lease with Lafleur.

In finding that the taxpayer did not acquire the equipment pursuant to the lease with Lafleur (and therefore, was not eligible for an investment tax credit under s. 127(5)), Tremblay TCJ. noted that one clause of the lease provided that "ownership of all vehicles leased shall remain with the lessor, and said vehicles should be registered in the lessor's name"; that another clause provided that at the expiry of the contract the lessor (Lafleur) was required to attempt to arrange the sale of the vehicle, with any shortfall to be paid by the taxpayer, and any excess to be refunded by Lafleur; and that a transfer of ownership took place between Hewitt and Lafleur.

The taxpayer entered into "leasing contracts" respecting heavy equipment which typically had a term of approximately five years, provided for monthly rental payments, provided that five months before the expiry date the taxpayer could exercise an option to purchase the equipment for a sum equal to the remaining rentals, and provided that the taxpayer was responsible for the maintenance and good condition of the equipment.

Lamarre Proulx TCJ. found (at p. 1384) that the definition of "depreciable property" meant that:

"A taxpayer's depreciable property is property for which he or she has already claimed and received deductions, and in respect of deductions for the current year, it is property which the taxpayer owns at the end of the year."

Furthermore, she found (at p. 1385) that "the words 'property acquired' must be taken to mean property in which the taxpayer has a right of ownership, or if not such a right, then all the attributes of a right of ownership, as in the case of a conditional sale". Accordingly, because the taxpayer neither owned the property nor had acquired it, it was not entitled to capital cost allowance.

The taxpayer leased three forklift trucks and two trucks which it was entitled pursuant to options to purchase on the expiration of the leases either for the sum of $1 or (in the case of two items) for 5% of the original cost. Given the lack of evidence as to the fair market value of the trucks at the time of exercise by the taxpayer of its options, Mr. Prociuk affirmed assessments the Minister had made on the basis that the lease agreements represented conditional sales contracts.

Rent payments made by the taxpayer pursuant to crane rental lease agreements with a term of six months and purchase options for more than a nominal amount, were found to be fully deductible given that only one of the six factors described in former IT-17 was applicable in this case. After noting that the only potential evidence of the fair market value of the cranes was the capital cost allowance rates applicable to Class 10, Mr. Taylor stated (at p. 181):

"It does not appear to the Board that any reasonable calculation of 'probable fair market value', based on such ... depreciation schedules would show the option purchase price for either crane to be so low that it could not possibly be turned down by the appellant, and that, therefore, at the date of signing the lease agreements, purchase of the cranes would be a foregone conclusion."

The taxpayer leased equipment from finance companies generally for a term of 36 months and with the option to acquire the equipment on expiry of the lease for $1. Before finding that the lease agreements were "shams" and that the legal substance of the contracts were purchases of the equipment on a time-payment plan, Mr. Flanigan referred to evidence that the equipment was worth at least $40,000 and stated (at p. 137) that "it would strain the credulity of the Court to believe, that an internationally successful company would convey to a stranger at a nominal price an asset worth such an amount".

Contracts of the taxpayer with the U.S. Air Force and Navy for the production of munition trailers stipulated that title would "forthwith vest" in the U.S. government upon the making of progress payments. The court held that although the government purported to acquire title to the property, in fact it acquired only a lien to secure the progress payments it made (which were viewed by the Court as being repaid as a deduction from the amounts due upon final performance). "[I]t would do violence to the system that the clause and regulations set up to say that the government 'owns' covered property when it is apparent that the government specifically exempts itself from most of the incidents of ownership."

A piano was let on hire on the basis that the hirer was to pay a monthly rent, could terminate the hiring by delivering the piano to the owner without being responsible for any future payments, and became the owner of the piano upon making all 36 monthly instalments. In finding that this contract was not an agreement of sale, Lord Herschell L.C. noted (at pp. 476-477) that although it was "very likely that both parties thought it would probably end in a purchase", this did not establish that there was a sale agreement given that one could very well conceive of cases in which a person who had not made up his mind to continue payments for three years would nevertheless enter into such an agreement. Lee v. Butler, [1893] 2 Q.B. 318 was distinguished on the basis that, there, as soon as the agreement was entered into, there was an absolute obligation to pay both instalments, with no ability of the person who obtained the goods to insist upon returning them and thereby absolve himself from any obligation to make further payments.

Accordingly, a pledging by the hirer of the piano with a pawnbroker did not defeat the owner's rights.

A lump sum which the taxpayer received in settlement of an action it brought because a "quench and temper" pipe treatment system that had been installed at its pipe manufacturing plant did not perform to specifications, was an exempt receipt rather than proceeds of disposition of depreciable property. There was no disposition of depreciable property on general principles (as the taxpayer did not abandon or transfer its assets), nor was there "compensation for property injuriously affected" under paragraph (e) of the definition of "proceeds of disposition" given that this phrase referred only to consequential damage to other property where expropriation of a particular property had occurred.

The taxpayer was found to have disposed of its land and building at the same time that it sold the balance of its business to a purchaser when it agreed that the sale of the business was conditional upon the purchaser entering into a lease of the land and building for five years with an obligation to purchase within that period of time for a specified price (with such a lease - purchase agreement subsequently being entered into but made retroactive to the date of the sale of the business).

The owner ("Miss Glass") of a car "disposed of" it for purposes of the Customs Act when she entered into an agreement with the plaintiff under which he received a chattel mortgage as security for a loan to Miss Glass, an irrevocable option to purchase the car, the right to sell the car provided it was sold by a certain date and the right in the interim to the car's possession. "Having regard to the control which the [plaintiff] could exercise over the car, including his right to possession and use, there remained in fact and in law very little of the incidents of ownership and title in Miss Glass."

The verb "to dispose" (which should receive the same meaning as the expressions "disposition", "proceeds of disposition" and " disposed of") should be given the broadest possible meaning, and encompasses the idea of destruction or extinguishment. The acquisition by a lessee of the lessor's interest led to the extinguishment or "disposition" of the lessee's leasehold interest for the purposes of Regulation 1100(2) (since repealed). In addition, the transfer of full ownership rights in a building subject to the obligation of the transferee to demolish the building, was a disposition of that building.

There was found to be a disposition or sale of a property by the taxpayer at the time of the closing of the agreement of purchase and sale in 1970, notwithstanding that litigation, in which the purchaser sought rescission, was not finally resolved in favour of the taxpayer-vendor until 1974.

Each year the taxpayer took delivery of a new fleet of automobiles from the vendor (Ford) for use by the taxpayer's employees and transferred possession of the previous year's fleet to Ford or an auctioneer acting for Ford. Although the intention of the parties was to transfer property in the automobiles to Ford on November 1 of each year (i.e., after the taxpayer's October 31 year end) in order that high undepreciated capital cost balances would be maintained by the taxpayer as at October 31, there had been a disposition of the old fleet in October because by October 31, the taxpayer had an unconditional entitlement to enforce payment of the purchase price for the old fleet vehicles: "Inspections were complete; vehicles were in a deliverable state; the price was fixed; and, possession had been transferred. Even the diligently followed arrangement to meet on October 31st each year to ensure registration and passage of legal title on November 1st, had the effect of absolutely and unconditionally crystallizing Ford's obligations to pay HP for the old fleet before the end of the day" (p. 1341)

Although the provision in the definition of undepreciated capital cost providing for a reduction referred to a "disposition before that time of property" rather than using the defined phrase "proceeds of disposition", no other conclusion could be drawn but that "Parliament, in defining 'disposition of property' intended an express directive not to leave the timing of dispositions for CCA purposes solely to the expressed intentions (or even manifestly clear, self-evident incredibly attested to intentions) of the parties to an agreement of sale." (p. 1342)

After a customer had negotiated the purchase price with a supplier, the taxpayer would purchase equipment from the supplier and enter into a net lease with the customer that typically had a term of 36 months and (under a collateral arrangement that generally was not written into the lease terms) gave the customer the right to acquire the equipment at 10% of its actual cost on expiry of the lease. Sarchuk TCJ. found that the arrangements of the taxpayer with each lessee (which were treated under GAAP as a direct financing lease) should be characterized as a sale and financing rather than as an operating lease for tax purposes given that "the option permitted a lessee to acquire the property at a price which at the inception of the lease was such that no reasonable person would fail to exercise, and indeed the evidence was that a substantial percentage of the lessees exercised the option" (p. 253).

Before finding that leases of equipment made by the taxpayer should be characterized as such rather than as conditional sales agreements, as submitted by the taxpayer, Sarchuk J. stated (p. 1789):

"There was, as I see it, no enforceable right during or at the expiration of the lease, to acquire the property at a price which at the inception of the lease is substantially less than the probable fair market value of the property at the time of permitted acquisition by the lessee, nor can it be said that the lessee had the right, and by this I mean enforceable right, during the lease or at its expiration to acquire the property at a price which the lessee knew at the inception of the lease was such that no reasonable person would refuse."

After litigation between the taxpayers, who had interests in a MURB project, and the manager of the project, in which the manager alleged that the taxpayers were responsible for operating losses incurred with respect to the project, a settlement was reached pursuant to which the taxpayers and the manager each released the other from all claims, and the taxpayers conveyed their interest in the project to the manager pursuant to an offer to purchase which provided for the payment of $1 plus the assumption by the manager of mortgages. Lamarre Proulx J. held that the taxpayers' proceeds of disposition included the indebtedness assumed by the manager, but did not include the amount of the operating losses which, prior to settlement, the manager had been claiming from them. "Since the claim did not proceed in court and the resale of the building put an end to all such claims, I consider that it is not for me to put any value on these mutual releases, and in any event I could not do so."

Two companies after the sale of their operating fleets of vessels avoided recapture of depreciation by selling the proceeds of disposition to other companies.

A partnership agreed to lease real estate under a lease that ran for 25 years, that provided for a yearly rental of $27,396 payable in monthly instalments, and that provided that during a period of approximately five years beginning shortly after the commencement of the lease, the lessee was entitled to acquire the property for a price equal to $710,000 minus 30% of all payments previously made under the lease. Mr. Fordham found that the exercise of this option over two years after the commencement of the lease could not result in 30% of the rent payments received up to that date being excluded from the taxpayer's income and stated (at p. 87):

"I know of no authority for the proposition that money received as rent initially can later be treated ... as having been paid on capital account by reason of a subsequent happening."

The taxpayer, which operated a fishing camp on land leased from the Crown, was unable to obtain the consent of a secured lender to a sale of that business. Accordingly, the taxpayer entered into a form of sublease agreement with the purchasers which provided that the property would be sublet to the lessees for one year at a rental of $10,000 and that the lessees would have the option to purchase the property for $80,000, with the $10,000 rental being applied to the purchase price.

Mr. Fisher accepted the taxpayer's evidence that the transaction was intended to be a sale. Although the purchasers never in fact exercised their option, it was necessary to consider the situation as it initially existed. Accordingly, the $10,000 received by the taxpayer was a capital receipt.

A "lease with promise of sale" between the taxpayer and the supposed lessee was found to be an agreement of sale given that its terms were fully consistent with a contract of sale, including the fact that the consideration was structured in the same manner as instalment payments, with provision being made for the separate payment of interest thereon, and in light of provision for conveyance of the property (a motel) to the lessee for $1 on payment of all the instalments. The only reason for the transaction being styled as a lease was a requirement to discharge a mortgage on any sale of the property. Accordingly, the instalment payments represented tax-free capital receipts.

Mr. Monet found that an agreement styled as a "lease and option to purchase" in fact was an agreement for the sale of a hotel and related assets by the taxpayer in light of the terms of the lease agreement (the lessee was responsible for all municipal taxes and for insuring against damages and assigned the policy to the taxpayer as security for the payment of sums payable under the agreement; the lessee could prepay sums payable under the agreement; and the lessees had the right to obtain a gratuitous transfer of the lands at the expiration of the term) and in light of the other evidence given (the taxpayer stated that there had never been any question of a rental; and the lessee, after taking possession, spent at least $2,000 in alterations and improvements to the buildings). Accordingly, the rent payments received by the taxpayer were tax-free capital receipts.