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Business Associations TAXATION Joshua

VIEWS: 61 PAGES: 104

									                                               TAXATION

                                             Joshua Krane

TAXATION.................................................................................................. 1
   BASIC CHARACTERISTICS OF INCOME TAX .................................. 7
   CALCULATING TAXES......................................................................... 9
   PRINCIPLES OF STATUTORY INTERPRETATION ........................... 9
           Stubart Investments Ltd. v. R. (1984) SCC .................................... 10
           Canada v. Antosco (1994) SCC ...................................................... 11
           Quebec (Urban Community) v. Notre-Dame de Bon-Secours (1994)
           SCC................................................................................................. 11
   SOURCE ................................................................................................. 12
           Bellingham v. The Queen (1996) FCA........................................... 13
           Schwartz v. The Queen (1996) SCC .............................................. 14
           Tsiaprailis v. The Queen (2005) SCC ............................................ 15
   RESIDENCE ........................................................................................... 15
           Thomson v. MNR (1946) SCC ....................................................... 16
           Dennis M. Lee v. MNR (1990) TCC .............................................. 17
           R & L Food Distributors Ltd. v. MNR (1997) TRB ....................... 17
           Schujahn v. MNR (1962) Ex. Ch. .................................................. 18
           The Queen v. Reeder (1975) FCTD ............................................... 18
   RESIDENCY OF CORPORATIONS ..................................................... 19
SOURCES OF INCOME – EMPLOYMENT INCOME ....................... 21
   EMPLOYMENT INCOME .................................................................... 21
   DISTINCTION BETWEEN EMPLOYMENT AND BUSINESS
   INCOME ................................................................................................. 22
           Wiebe Door Services Ltd. v. MNR (1986) FCA ............................ 22
           Cavanaugh v. The Queen (1997) TCC ........................................... 23
           Curran v. MNR (1959) SCC ........................................................... 24

                                                       1
   CALCULATING INCOME FROM EMPLOYMENT ........................... 24
       1. Benefit to the Employee .......................................................... 25
          Sorin v. MNR (1964) TAB ............................................................. 25
          The Queen v. Savage (1983) SCC .................................................. 25
          Laidler v. Perry (1965) HL ............................................................. 26
          Lowe v. The Queen (1996) FCA .................................................... 27
       2. Material Increase in Wealth ................................................... 28
          The Queen v. Huffman (1990) FCA ............................................... 28
          Ransom v. MNR (1967) Ex. Ct. ..................................................... 28
          The Queen v. Phillips (1994) FCA ................................................. 29
       3. Valuation ................................................................................ 30
          Giffen et. al v. The Queen (1995) TCC .......................................... 30
          Youngman v. The Queen (1990) FCA ........................................... 31
   ALLOWANCES ..................................................................................... 32
          Campbell v. MNR (1955) TAB ...................................................... 32
   DEDUCTIONS – SECTION 8 ............................................................... 33
          Martyn v. MNR (1962) TAB .......................................................... 33
          The Queen v. Swingle (1977) FCTD.............................................. 34
BUSINESS INCOME ................................................................................ 35
       1. Organized Activities ............................................................... 35
          Graham v. Green (Inspector of Taxes) (1925) K.B. ....................... 35
       2. Pursuit of Profit ...................................................................... 36
          Stewart v. The Queen (2002) SCC ................................................. 36
   INTEREST INCOME ............................................................................. 38
          Groulx v. MNR (1967) SCC........................................................... 38
   RENTS AND ROYALTIES ................................................................... 39
   CALCULATING BUSINESS INCOME ................................................ 40
          Imperial Oil Ltd. v. MNR (1947) Ex. Ct. ....................................... 40

                                                  2
           Royal Trust Co. v. MNR (1957) Ex. Ct.......................................... 41
       1. Personal Expenses .................................................................. 42
           Benton v. MNR (1952) TAB .......................................................... 42
           Leduc v. The Queen (2005) TCC ................................................... 42
           Symes v. The Queen (1994) SCC ................................................... 43
           Scott v. MNR (1998) FCA ............................................................. 44
       2. Commuting Expenses Between Home and Work .................... 45
           Cumming v. MNR (1967) Ex. Ct. .................................................. 45
       3. Home Office Expenses ............................................................ 46
       4. Entertainment and Meals ....................................................... 46
   PUBLIC POLICY ................................................................................... 47
       1. Expenses of Carrying on an Illegal Business ......................... 47
           M.N.R. v. Eldridge (1964) Ex. Ct. ................................................. 47
       2. Fines and Penalties ................................................................ 48
           65302 British Columbia Ltd. v. The Queen (2000) SCC ............... 48
   INTEREST EXPENSES – MONEY USED TO SERVICE THE
   BORROWING OF CAPITAL ................................................................ 49
           The Queen v. Bronfman Trust (1987) SCC .................................... 49
           Singleton v. The Queen (2002) SCC .............................................. 51
   REQUIREMENT OF REASONABLENESS (GENERALLY NON-
   ARMS LENGTH) ................................................................................... 53
TIMING...................................................................................................... 55
           Canderel Ltd. v. The Queen (1998) SCC ....................................... 55
   UNBILLED REVENUE ......................................................................... 57
           MNR v. Colford (1960) Ex. Ch. ..................................................... 58
           MNR v. Benaby Realties (1967) SCC ............................................ 58
           West Kootenay Power v. The Queen (1992) FCA ......................... 59
           Maritime Telegraph v. The Queen (1992) FCA ............................. 59
           J.L. Guay v. MNR (1971) FCTD.................................................... 60
                                                      3
          Brock v. MNR (1991) TCC ............................................................ 63
   INVENTORY ......................................................................................... 63
          Friesen v. The Queen (1995) SCC.................................................. 64
   CAPITAL OUTLAYS ............................................................................ 65
      1. Tangible Assets ....................................................................... 65
          British Insulated and Helsby Cables v. IRC (1926) HL ................. 65
          Denison Mines v. MNR (1972) FCA ............................................. 66
          Johns-Manville v. The Queen (1985) SCC..................................... 66
      2. Intangible Assets .................................................................... 67
          MNR v. Dominion Natural Gas (1940) SCC.................................. 67
          Canada Starch v. MNR (1968) Ex. Ct. ........................................... 68
      3. Repair of Tangible Assets ....................................................... 68
          Canada Steamship v. MNR (1966) Ex. Ct. ..................................... 68
          The Queen v. Shabro (1979) FCA .................................................. 69
          Goldbar v. The Queen (1987) FCTD.............................................. 69
   CAPITAL COST ALLOWANCE .......................................................... 70
          Ben’s Ltd. v. MNR (1955) Ex. Ct. ................................................. 73
   TAX TREATMENT OF INTANGIBLE PROPERTY ........................... 74
          Royal Trust v. The Queen (1982) FCTD ........................................ 74
          The Queen v. Saskatoon Drug & Stationary (1978) FCTD........... 74
CAPITAL GAINS AND LOSSES ............................................................ 77
          Californian Copper v. Harris (1904) Scot. Ex. Ct. ......................... 77
          Regal Heights v. MNR (1960) SCC ............................................... 77
          Irrigation Industries v. MNR (1962) SCC ...................................... 78
          MNR v. Taylor (1956) Ex. Ct......................................................... 79
   RULES FOR CALCULATING CAPITAL GAINS ............................... 80
   ADJUSTED COST BASE ...................................................................... 82
      1. Deeming Provisions ............................................................... 82

                                                   4
   2. Rollover Provisions ................................................................ 83
   3. Special Rollover (Replacement Property, Section 44) ........... 84
   4. Additions to the Cost Base (Section 53) ................................. 86
DISPOSITION AND PROCEEDS OF DISPOSITION ......................... 86
   1. Triggering a disposition ......................................................... 87
   2. Avoiding triggering a disposition ........................................... 88
   3. Allocating cost base when a partial disposition of land occurs
   .................................................................................................... 89
   4. Charitable Donations ............................................................. 90
   5. Reserves – Postponing the Declaration of Capital Gains...... 90
   6. Expenses of Disposition ......................................................... 91
CAPITAL LOSSES................................................................................. 91
THE DE MINIMIS RULE, SUPERFICIAL LOSSES, COMPUTING
THE ACB FOR DISPOSITIONS OF IDENTICAL PROPERTY.......... 92
INTRA-FAMILY TRANSFERS ............................................................ 94
PRINCIPAL RESIDENCE ..................................................................... 94
   1. Maximum size requirement .................................................... 95
   2. Ordinarily Inhabited .............................................................. 95
   3. Calculating the Taxable Gain ................................................ 95
   4. Change in Use Rules .............................................................. 96




                                                 5
6
The Income Tax Act is a revenue-raising statute. The government
started to tax income during WWI to raise money for the war effort.
Although income tax was supposed to be a temporary measure,
following the creation of the social welfare state, income tax became
a permanent source of revenue for the government.

The purpose of this course is to understand that tax rules are not
discrete or arbitrary; they serve underlying social and economic
objectives. Tax law strives to achieve horizontal equity so that all
forms of increase to net worth are taxed (although the source
concept conflicts with this idea) and vertical equity so that taxpayers
at all income levels pay their share (although excise taxes conflict
with this idea too).

To study tax law, the focus should be on the interpretation of
legislative provisions. In terms of the jurisprudence, the facts are very
important to understanding the outcome of a case. Slight alterations
in a fact pattern can yield a different result.

Basic Characteristics of Income Tax

TAX BASE – the thing that is subject to tax. The government has
three tax bases:

       1. Income – calculated by adding net revenue from different
          sources, including office & employment, capital gains, and
          business income.1
       2. Consumption – some taxes are assessed at each level
          of production (i.e. GST, which is a value-added tax) others
          are assessed at point-of-sale (largely for constitutional
          reasons). Excise taxes, like the Tobacco Tax, are meant
          in part to penalize people for deviant behaviour.
       3. Property/Wealth – paid when wealth is transferred or on
          accumulations (savings). Municipalities will tax the value
          of real estate for school taxes. There are no more estate
          or donation taxes in Canada.

1
  Alternatively, income can be calculated by adding consumption + savings.
The Income Tax Act probably takes the above mentioned approach in order
to allow for deductions based upon source (i.e. capital gains at 50%).
                                    7
GST               Producer Distributor   Retailer   Consumer
                    Makes Buys 1000 Buys 1000 Buys 1000
                  1000 Units Units    Units     Units

Cost                          1000        2000        5000
Unit Cost                        1          2           5
Tax Paid (7%)                   70         140         350
Tax Rec'd (7%)       70        140         350

Tax Remitted to      70        70          210
Gov't
Figure 1 - Example of GST as Value-added Tax


FILING UNIT – the government assess income tax on the basis of
each person (incl. an individual and corporations). Trusts, though not
legal persons, pay tax as well. Partnerships are not legal persons,
and therefore, the partners file returns individually.

In Canada, spouses file separate tax returns, as do children.

RATE – section 117 sets out the marginal tax rates for federal
income tax. The tax is progressive, in that taxpayers in the bottom
margins pay less tax per dollar earned than higher income earners.
Taxpayers all have a credit of $1384.00, which means that a person
who earns $8929.00 pays $0 in federal tax.

FILING PERIOD – individuals must file their taxes annually, with the
reporting year being the calendar year. Corporations can choose
their fiscal period, but they must also file annually. When income is
included in a tax year will affect tax planning. A person may want to
defer income or costs to another filing period.

ADMINSTRATIVE AGENT - Income tax is a system that relies on
self-reporting. Employers are responsible for deducting tax and
remitting it to the government. Businesses are also responsible for
remitting the tax on their profits. The government can choose to
accept or reject the assessment. A taxpayer may object to the
assessment and appeal it to the Canada Revenue Agency, the Tax

                                     8
Court, and eventually the Federal Court of Appeal (or Supreme Court
of Canada).

Revenue Canada may issue Tax Bulletins that advise Canadians of
the agency’s interpretation of a tax provision.

Calculating Taxes

Taxes are calculated using the following steps:

      1. Identify the sources of income. For each source of income
         add up all of the revenue earned and subtract the costs.
         Calculate capital gains on the basis of 50% of actual profit.

      2. Add the sources of income together to generate income for
         tax purposes. This value approximates total income,
         although it does not include windfall earnings and under-
         accounts for capital gains.

      3. Determine deductions with reference to retirement or
         pensionable savings (RRSPs), exemptions that apply by
         virtue of statuts (charitable status), strike pay,2 worker’s
         compensation (section 56), etc.

      4. Subtract deductions from income for tax purposes to yield
         taxable income. Apply the marginal rates to this value to
         generate tax payable.

      5. Subtract any tax credits from the tax payable to determine
         whether you owe tax or are entitled to a refund.

Principles of Statutory Interpretation

Courts regarded income tax legislation as an affront to property
rights. The initial approach taken by English courts was a textual
interpretation (Pardington v. Attorney General, 1869). The courts
looked at the “ordinary and plain meaning” of the statute to see if it
applied. Although this generally worked to the benefit of the taxpayer,
it sometimes worked to the advantage of the Crown when deductions

2
    Canada v. Fries (1990) SCC
                                   9
were read strictly (Whitthuhn – rocking chair case). The court does
not recognize “ambiguities” in tax provisions.

Johns-Manville Inc. v. The Queen (1985) SCC – recognized the
presence of ambiguity; still take “plain and ordinary meaning” but any
ambiguity is resolved favour of taxpayer. This was the time of the
optimal payment for the taxpayer.

The obtuse drafting style of the ITA was a product of this interpretive
history. The judicial attitudes began to change however. Taxation
statutes were seen as more than simply mechanisms to raise
revenue; they have important social and economic objectives.

Stubart Investments Ltd. v. R. (1984) SCC
Reasoning:
Per Estey J.: The application of strict construction has receded. The
only applicable rule is the “modern rule” of statutory interpretation
which requires that courts look to the words of the provision in their
context and in their grammatical and ordinary sense, harmoniously
with the scheme and object of the Act, and the intention of Parliament
(Sullivan and Driedger).

The court should look the “business purpose of the transaction”
to see if it was designed specifically to avoid the application of a
provision. In short, the tax statute, by this interpretative technique, is
extended to reach conduct of the taxpayer which clearly falls within
the “object and spirit” of the taxing provisions.3

This means that the importance given to “plain meaning” falls away.

In Bronfman (1987), discussed below, the court will look at the true
commercial nature of the transaction. This is in the context of the
analysis of the facts of a case, not the interpretation of the Act, which
is a question of law. This “comment” has at times gotten mixed into
statutory interpretation, and gets discussed under object and spirit of
the act. In Bronfman, the court was looking at the factual
interpretation of a loan-repayment scheme in order to permit the trust
to deduct losses on the interest to repay the law.

3
   This extends beyond mere statutory interpretation and conflates the
interpretation of facts and the interpretation of legislation.
                                   10
Canada v. Antosco (1994) SCC
Facts: The transferee, Antosco, did not want to pay tax on interest
accrued on an obligation that was held by the transferor, the NB
Industrial Finance Board. The sellor did not have to pay tax on this
interest because it had tax exempt status. The Crown wanted
Antosco to pay the interest, but it refused.

Issues: Was Antosco required to pay tax on the interest?
Holding: No.

Reasoning: Per Iacobucci J: Taxpayers are not entitled to take
advantage of deductions or exemptions based upon “sham
transactions”. There was, however, a valid transfer of assets.

A contextual analysis must not alter the outcome when the words of a
provision are clear and unambiguous. The substance of the
transaction in this case meets the requirements of the provision. The
accrued interest is income of the transferor not the transferee. The
section, though it is meant to ensure that the interest is not taxed
twice, it does not mean that the transferee must pay the tax on the
interest if the sellor did not pay it.

Rationale: When an ordinary reading of the statute provides a
clear outcome, a contextual analysis is not necessary. When
there are ambiguities, they are resolved by looking to context
and not based on presumptions.

This is a more accurate application of the modern rule. Estey J. gets
it wrong in Stubart.

Quebec (Urban Community) v. Notre-Dame de Bon-Secours
(1994) SCC
Facts:    Notre-Dame provided housing for low-income, elderly
individuals. About 11% of its services fell under a tax exempt
category; it sought to exempt the other 89% from tax as well.

Issues: Is Notre-Dame entitled to exempt the remaining services on
the basis of a liberal construction of the exemption provision?
Holding: Yes.


                                 11
Reasoning: Per Gonthier J: Stubart changed the way in which courts
interpret tax statutes. No longer must the courts take a strict
interpretation, but the courts should look to the legislative intention.

(1) The interpretation of tax statutes should following the ordinary
rules of statutory interpretation, (2) the choice is not one between a
strict or a liberal reading, but by reference to the purpose of the
provision, and (3) only a reasonable doubt, not resolved by the rules
of statutory interpretation will be resolved in favour of the taxpayer.
This brings the presumption rule back in.

Today, following the decision in The Queen v. Province of Alberta
Treasury Branches et al. (1996) – tries to reconcile Stubart and
Friesen – affirms that the gateway step is “plain and ordinary
meaning”. A secondary analysis requires that we look at purposes
and intentions. If there is still no resolution, we resolve the situation in
favour of the taxpayer.

The court is trying to reconcile plain meaning and teleological. There
are two choices:

    1. You stop if there is no ambiguity after plain meaning
       (Friesen)
    2. You continue to find the purpose regardless of ambiguity
       (Treasury Branches)4

Source

Section 3 provides that income is taxed based upon its source. The
source is both geographical (Canadian and worldwide income) as
well as modal (employment, etc.). Capital can provide a source of
income, but it is not subject to income tax. Income by windfall is also
not subject to tax, such as gambling gains, lottery winnings,
inheritances, and gifts.




4
  “Even if the ambiguity were not apparent, it is significant that in order to
determine the clear and plain meaning of the statute it is always appropriate
to consider the scheme of the Act, the object of the Act, and the intention of
Parliament.”
                                     12
The definition is not exhaustive, although this was the subject of the
Haig-Simons Commission. The commission also recommended
including windfall gains.

Bellingham v. The Queen (1996) FCA
Facts:    Bellingham’s property was expropriated. At first, the
municipality underbid for the property and Bellingham challenged the
bid. As a penalty for underbidding, the municipality was forced to pay
Bellingham an indemnity.
Issues: Is the indemnity subject to income tax?
Holding: No.

Reasoning: The indemnity was not compensation for the property
but punishment for the municipality’s actions. It is akin to a punitive
damage award and thus not taxable.

These awards, like gambling income, do not flow from a “source”.
They do not represent the creation of new wealth or a quid pro quo.
The courts can look at certain indicia to determine whether the
property is income including:

   (1)   the presence of an enforceable claim,
   (2)   effort on the part of the taxpayer to receive payment,
   (3)    whether it was sought or solicited,
   (4)   whether it was expected,
   (5)   foreseeability of recurrence,
   (6)   whether the payer was a customary source of income,
   (7)   whether the payment was consideration.

Robertson J.A. warns against relying too heavily on Cranswick, as
even payments to discharge a questionable right may be regarded as
income. Money, for example, to induce a person to quit his job is
considered to be income (Curran v. MNR, infra).

The “source” of the income in this case was legislative, but it did not
show the above mentioned indicia of a taxable source.

Rationale: Punitive damage awards are not subject to income
tax.



                                  13
Notes: In London and Thames Haven Oil Wharves Ltd. v. Attwool
(1967), the House of Lords applied the SURROGATUM PRINCPLE
to explain that compensation received in lieu of lost profits is taxable.

Schwartz v. The Queen (1996) SCC
Facts: Schwartz was a partner at a law firm. One of his clients
offered to hire him. Before the contract was executed, however, the
company advised Schwartz that his services were not required.
Schwartz received a $360 000 award for lost salary and stock options
as well as an additional fee for costs.
Issues: Is the settlement taxable as income?
Holding: No.

Reasoning: Per La Forest J: The damages did not arise from a
source of income under section 3. Section 3 is open-ended, which
means that it allows for the possibility of other sources of income.
The Court distinguishes Curran. It also explained that the “retirement
allowance” provisions do not apply to the case at hand, because
Schwartz never started work with the company.

The court did not divide up the settlement to pull out parts that could
be tax exempt (such as non-pecuniary damage awards).

The specific provision which dealt with “retirement allowance”
(section 56) qualified the term “other income” in section 3.

Schwartz was never in the service of the company. There was no
actual loss of position since Schwartz never held it. At no time was
Schwartz under an obligation to provide services to the company.
The money, therefore, was not a retiring allowance and thus not
subject to tax.

Major J., concurring, explained that the settlement represented an
accretion of wealth, but not all accretions of wealth are taxed.
Parliament never intended to tax all accretions, as evidenced by the
fact that it did not adopt the recommendation of the Carter
Commission.

Rationale: Payment in breach of a contract of employment when
the employment period did not begin is tax exempt.


                                   14
This judgment is problematic because the settlement is not a windfall.
The court seems to narrow the definition of income and negates the
meaning of “includes”. The settlement represented what Schwartz
would have received as employment benefits; the fact that he did not
work should not be determinative that the money is not income, only
that it is not “employment income”. The money did flow from a
bargain.

Tsiaprailis v. The Queen (2005) SCC
Facts: Tsiaprailis received an indemnity from her former employer.
Half of the money represented loss of past benefits, the other half
represented the present value of her entitlement to future benefits.
Issues: Is the latter half of the settlement taxable?
Holding: Yes.

Reasoning: Charron J. held: to determine whether the settlement is
a surrogate for income, the court must ask:

   (1) what was the payment intended to replace?
   (2) would replaced amount have been taxable?

The majority held that the first half represented a surrogate for past
benefits owed, and was thus taxable. The latter half was not.

Critique: Abella J, in dissent, explained that the payment was not
made pursuant to the “policy” because the insurer denied liability.
The taxpayer did not necessarily have an enforceable claim to the
funds and therefore the finds were simply a way for the insurance
company to avoid future claims, thus representing an “unsourced”
cash flow and not, therefore, subject to tax.

In Buckman v. MNR the court explained that income from unlawful
activities is taxable. Since the income that Buckman appropriated
derived from his position as a lawyer, the government could assess
that income as “employment” income.

Residence

Although other bases for imposing tax exist: citizenship, domicile, for
example, the ITA uses “residence”. Residence is not statutorily
defined. It is, however, outlined in section 250.

                                  15
If you are a resident, it does not matter where you earned the
income, you are subject to Canadian income tax. If you are not
resident, only income earned in Canada is subject to tax.

Residency is part of a person’s customary mode of life. The courts
will determine residency by reference to several factors; however, the
intention of the taxpayer does not play a direct role.

The burden of proof of proving/disproving residence lies with the
taxpayer. The Crown does not get the benefit of the presumption with
regard to alternative arguments.

Thomson & Lee deal with case law “residence”. If a person is not a
common law resident, then it can be a “deemed” resident if it
sojourns in Canada for 183 days or more in a year (an irrebuttable
presumption of residence). A person can be either a case-law
resident or a deemed resident, but cannot count one toward the other
(Schujan, infra).

Thomson v. MNR (1946) SCC
Facts: Thomson is a wealthy person who had a dispute with the
village authorities in NB. He sells his home in NB and moves to North
Carolina. He declares himself of Bermuda. He had a British passport.
He never spent more than a few days there. Thomson spends his
time travelling and golfing.
Issues: Was Thomson a resident of Canada for the 1940 tax year?
Holding: Yes.

Reasoning: The assessment of residency is a question of fact. The
burden of proof is on the taxpayer to establish that it is either a
resident or not (except in response to alternative arguments by the
Crown).

Thomson lived in New Brunswick for 50 years before “claiming”
residency in Bermuda. He remained a citizen of Canada, regularly
returned to Canada, and had strong family ties to the country.
Thomson built a home in New Brunswick. This shows how difficult it
is to stop being a resident.

A person must be a resident somewhere. The “time, object, intention,
continuity, and other relevant circumstances” demonstrated that
Thomson was a resident for tax purposes. Physical presence in
                                 16
Canada is not a sufficient or necessary pre-requisite.

Rationale: Residency requires a contextual analysis and may
change if those contextual factors change.

Critique: Taschereau J. dissented, stating that Thomson was a
resident of the United States. Thomson made occasional visits to
Canada which should not mean that he is a resident of Canada.

Dennis M. Lee v. MNR (1990) TCC
Facts: Lee was a British national who did business in the United
States. In 1982, he married a Canadian and guaranteed a mortgage
on their matrimonial home.
Issues: Is Lee a resident of Canada for the 1982 tax year?
Holding: Yes. He was not, however, a resident in 1981.

Reasoning: Lee’s marriage to a Canadian and the mortgage on the
matrimonial home was sufficient to tie Lee to Canada as a resident
for tax purposes.

It was significant that Lee was not a resident elsewhere.

This case provides a convenient list of factors that a court can
consider when it considers a person’s residence.

We can contrast the Lee case with Min Shan Shih. In that case Min
worked in Taiwan as a pharmacist. His wife and children lived in
Saskatchewan, where the children attended school. Min was not
considered to be a resident; the court analogized the children’s
attendance at school to boarders.

R & L Food Distributors Ltd. v. MNR (1997) TRB
Facts: The shareholders of R & L wanted to benefit from a small
business tax exemption available only to Canadian owed companies.
The shareholders, therefore, wanted to claim residence in Canada for
that purpose.
Issues: Did the applicants sojourn in Canada for 183 days?
Holding: The applicants did not sojourn in Canada.

Reasoning: The applicants spent more than 183 days in Canada.
They came to Canada simply for work purposes. Although sojourning

                                  17
does not approach residence, sojourners must have links and ties to
the communities. Their social ties and families were in the United
States; they resided there as well.

Rationale: Sojourning for a day requires that a person spend at
least part of the day in Canada, but also for purposes other than
work.

Alternatively, when a person only sleeps in the United States and
comes to Canada for all other purposes, that person remains a
resident of Canada (see e.g. Shpak). It is harder to stop being a
resident according under the Thomson test than it is to become one.

Schujahn v. MNR (1962) Ex. Ch.
Facts: Schujan moved to Canada with his family to take charge of a
subsidiary of an American company. He moved back to the US in
August of 1957, but his wife and son remained in Toronto to facilitate
the sale of the family home. Schujan returned to Toronto only on 3
occasions, until the rest of his family moved back.
Issues: Was Schujan a resident of Canada for tax purposes in 1957?
Holding: No.

Reasoning: A change in residence depends upon factors external to
the will of the individual. Presence of a family may serve to establish
residence. Although Schujan could return to Canada at any moment,
he cut many of his social ties to the city by then, transferred his
personal belongings to the US, including his car.

Schujan’s original country of residence was the US. The sole
purpose for his wife and son to remain in Toronto was to facilitate the
sale of the house.

Rationale: The severing of social, employment, and residential
ties to Canada evidences the severing of residence in Canada.

The Queen v. Reeder (1975) FCTD
Facts: Reeder was born in Canada. He was offered a job with
Michelin and was required to go to France for training. He stored his
furniture and car in Canada, and he and his wife moved to France.
Reeder bought a car and rented an apartment, although he still drove
using his Ontario driver’s license.

                                  18
Issues: Was Reeder a resident of Canada for tax purposes in 1972?
Holding: Yes.

Reasoning: The court explained that tax laws could be avoided by
jet-setters based on a notion of residence as “physical presence” in a
jurisdiction. To determine residence, a court should examine:


    (1) the present and past habits of life,
    (2) the regularity and length of visits to the jurisdiction,
    (4) ties to the jurisdiction,
    (5) ties elsewhere, and
    (6) permanence/purpose of the stays abroad.

Reeder had to establish a home in France only insofar as to provide
a place for his family to live. His absence from Canada was
temporary and he abandoned his ties to France when he returned to
Canada at the end of 1972. The court felt that Reeder would
otherwise self-identify as a Canadian.

Rationale: Temporary stays abroad do not terminate a person’s
Canadian residence for tax purposes.

Residents who depart from Canada permanently and sell all of their
Canadian assets have to pay a “departure tax” (s. 128.1) for any
capital gains.

Section 250(5) protects residents from the effects of double taxation
under tax treaties.

Residency of Corporations

Like residency of human persons, a corporation can be deemed a
resident or can be a resident under the common law. The House of
Lords in De Beers Consolidated Mines Ltd. v. Howe (1906)
explained that a corporation is resident where its board of directors
meets; that is, where the mind and central management (control) of
the corporation is present. The location of the shareholders and
officers is not relevant.5
5
 This does not explain what happens when corporations dispose of their
board of directors under a USA.
                                    19
Section 250(4)(a) deems a corporation resident of Canada when it
has been incorporated in Canada. If the corporation incorporated
before April 27, 1965, then so long as it has been a resident or has
carried on business in Canada after 1965, it is a resident of Canada.
A corporation may terminate Canadian residency by filing “articles of
continuance” in another jurisdiction and if necessary, by moving its
management to another jurisdiction (so that it is not a common law
resident).

Additional Notes:




                                 20
        SOURCES OF INCOME – EMPLOYMENT INCOME

Employment Income

Section 5-8 of the ITA pertain to income arising from office or
employment. To be an employee, one must be in the service of
someone else.

There are four key differences between employment and business
income.

   1. The employer deducts an employee’s income at source. A
      business must remit its tax quarterly or monthly.

   2. An employee calculates cash flow when money is actually
      received or spent. A business calculates cash flow when
      income is earned (though not necessarily received) or losses
      are incurred (though not actually paid).

   3. An employee’s reporting period is the calendar year. A
      corporate business’ reporting period is its fiscal period not to
      exceed 53-weeks.

   4. An employee as a limited scope of deductions (section 8).
      A business has a much wider scope (sections 9-20).

Section 5-6 inclusion provisions, section 8 sets down the deductions.
Section 5(1) taxes salary, wages, and other remuneration including
gratuities received during the year. Section 6(1)(a) includes the value
of board, lodging, or any benefits received in the course of, in respect
of, or by virtue of employment. The policy rationale is that
employment constitutes the biggest source of tax income and the
government is concerned with horizontal equity. The government
does not want some employees better off than others (horizontal
equity).

The law has to balance the administrative requirements to collect tax
on non-monetary benefits against the potential gains. The employer
has a duty to assign a value to these benefits because they have a
duty to remit taxes to the government.


                                  21
Distinction between Employment and Business Income

Wiebe Door Services Ltd. v. MNR (1986) FCA
Facts: Wiebe allegedly failed to remit CPP and EI premiums for 12
door installer technicians involved with its business of installing
doors. Wiebe contended that these persons were “independent
contractors” and not employees. The installers and Wiebe were
under a common understanding that the installers were running their
own businesses.
Issues: Are the installers employees?
Holding: Yes.

Reasoning: The courts should not rely solely on the control test to
determine whether a person is an employee or an independent
contractor.6 An employer may grant greater discretion to an
employee to perform the work if those employees are highly skilled
professionals. The intention of the parties do not count.

Therefore, the courts must look at other factors including:

    (1) ownership of tools,
    (2) chance of profit, and risk of loss.

The court must look at the business model/”scheme of operations” to
see how the goods or services provided by the company are
delivered.

The court rejects Lord Denning’s “organization” or “integral to              the
business” test because it is over-inclusive. Simply by asking                the
question, the court will realize that the contractor is integral to          the
business, otherwise the business would not have hired                        the
contractor.

The court should also consider whether the independent contractor
has an established business of its own; or whether it shares office
spaces, whether the employer is the sole/principal client, the nature
of the contract, etc. The circumstances may change from year to
year.

6
  (1) the power of selection of the servant; (2) the payment of wages; (3)control
over the method of work; (4) the master’s right of suspension or dismissal.
                                       22
Rationale: The courts will consider a multiplicity of factors to
determine whether a person is an employee or an independent
contractor for the calculation of income. The courts are not
bound by the intentions of the parties.

Another factor that the courts can consider is the distinction between
“accomplishment of a specific job/task” (results-based test) and the
responsibility of the employee to be present and the work place and
working (process-based test).

Cavanaugh v. The Queen (1997) TCC
Facts: Cavanaugh was a tutorial leader and grader at York
University. He provided his own supplies and was responsible for off-
campus expenses. He received limited supervision from the
professor in the course.
Issues: Was Cavanaugh’s income that of employment or business?
Holding: Cavanaugh’s income was business income. As such,
Cavanaugh could deduct the costs of the supplies.

Reasoning: The court proceeded using the tests set down in Wiebe.
Cavanaugh supplied his own “tools”. He was in control of the tutorial
sessions with minimal supervision by the professor. He could set the
times for the tutorials. Cavanaugh negotiated his contracts; he had
no tenure and there was no guarantee that he’d be hired back.
Cavanaugh risked a loss, in the sense that he could have
underestimated the number of students attending his tutorials. His
services were not integral to the university, since Cavanaugh could
be replaced by another tutorial leader.

Rationale: A person who negotiates his own contract, sets the
terms of the work, is under minimal supervision, purchases his
own supplies, and assumes a risk of profit and loss is an
independent contractor for tax purposes.


Attempts were made to interpose a corporation in such situations.
Since a corporation cannot be an employee, this was a way to re-
characterize income as business income. Parliament amended the
act to eliminate the tax-effectiveness of this scheme.


                                 23
Curran v. MNR (1959) SCC
Facts: Curran was induced to leave his job and forego his pension in
order to join another company. That company paid Curran $250 000
as compensation for the loss of the benefits foregone by the change
of employment.
Issues: Is the $250 000 taxable as employment income?
Holding: Yes.

Reasoning: Per Martland J: The payment made to Curran was
income and not a capital receipt. It replaced the foregoing of future
advantages that would otherwise be income.

Rationale: Amounts paid to future employees to induce them to
work are taxable.

Critique: Per Taschereau J: Part of the money represented
compensation for lost income; however, part of it was an inducement
to join the new company and therefore it should not be taxed.

The court in Bellingham, supra, and in Schwartz, supra,
distinguished Curran on the basis that those cases did not involve
income from a “source” under s. 3 of the Act.

Calculating Income from Employment

Tenant v. Smith is cited for three propositions, the first of which no
longer applies.7 Where the employer benefits the goods are not
taxed. Goods that did not increase net worth are not taxable.

The Court must consider three issues in this set of cases:

    1. Is the remuneration or goods principally for the benefit of the
       employee or employer?
    2. Does remuneration or goods increase the material wealth of
       the taxpayer?


7
  A bank manager was expected to live in the bank to service clients after
hours. The lodging was not considered to be a benefit because the manager
received the lodging for the purpose of facilitating his work. Any benefit to
the employee was ancillary. The courts have rejected the proposition that
only things convertible into cash are tax able.
                                     24
   3. Were the remuneration or goods received in respect of the
      taxpayer’s employment?

1. Benefit to the Employee

Sorin v. MNR (1964) TAB
Facts: Sorin was a partner in a hotel business. He worked the
“beverage room” until the wee hours of the morning. Instead of going
home after work, he would crash in a hotel room used otherwise for
storage. The tax authorities assessed him for part of the cost of
renting the room. Sorin contested the assessment.
Issues: Is the lodging a benefit to the taxpayer?
Holding: No.

Reasoning: Sorin would have preferred to stay at his own (his
brother’s) residence. He used the room only because it was too late
to travel back after work. Using a room for “cat naps” does not
constitute lodging.

Rationale: Not every privilege provided by the employer is a
taxable benefit. When the benefit is lodging, the taxpayer is not
taxed if the taxpayer is required, by virtue of his work, to use the
lodging.

The Queen v. Savage (1983) SCC
Facts: Savage worked for an insurance company. She undertook a
voluntary training course. Her employer paid her $300 as a reward
for completing the course.
Issues: Is the $300 a taxable benefit?
Holding: The Court decided that it was not. Legislative amendments
following the decision overruled the Court.

Reasoning: Per Dickson J: The definition of benefit must be given
the widest possible meaning. It does not matter that Savage did not
render a service to her employer for the reward. She would not have
received the reward had she not been an employee (“must arise
because of the employment relationship”). Therefore the reward was
a benefit in connection to her employment.

Section 56(1)(n) is a specific provision that exempts “prizes for
achievement”. The court looked to this specific provision to hold that

                                 25
Savage received a prize for achievement under the prescribed value
and therefore it was exempt from tax.

Rationale: Prizes for achievement earned in the course of
employment are subject to tax.

Laidler v. Perry (1965) HL
Facts: The company gave all of its employees £10 vouchers at
Christmas. The conferral of this bonus occurred annually and was
given to all employees. The employees argued that this was a gift.
Issues: Was the voucher a taxable benefit?
Holding: Yes.

Reasoning:
We have to look at the nature of the benefit from the employer’s
perspective. The employer gave the vouchers in order to promote
employee loyalty. It was meant to foster positive relationships
between the employer and the staff. The court distinguishes the case
of an employer that gives an employee a gift out of benevolence,
because the employee suffers a financial hardship. The regularity of
the gifts militates against its “donative” qualities.

Rationale: Regularly expected gifts to employees are taxable as
benefits of employment.

In a similar case, Dunlap v. The Queen, the employees received an
assessment for the value of a Christmas party. The court dismissed
the opinion/policy in the government’s own interpretation bulletin and
applied the statute as it understood it.

Consider the case of Mindszenthy. He received a $4000 Rolex
watch from his employer. The employer testified that he gave the
watch to the employee because he was a good employee.

In Waffle v. MNR, the employee received a trip from his employer.
The employer received the trip from the manufacturer. Waffle claimed
that the trip was not employment income. Although a third party paid
for the trip, Waffle received it because he was an employee and not




                                 26
because of another capacity or quality.8 The alternative would be to
tax this income as income from an unnamed source.


Lowe v. The Queen (1996) FCA
Facts: Lowe worked for an insurance company. He went to New
Orleans on his employer’s expense to help run a conference for other
brokers. His wife accompanied him. Lowe testified that the trip was
not a “perk” as he was required to maintain and promote
relationships with the brokers. The company paid for Lowe’s
babysitting expenses. Lowe and his wife had almost no time to
themselves. Lowe enjoyed the trip and his job.
Issues: Is the trip a taxable benefit of employment?
Holding: No.

Reasoning: The purpose of the rule in s. 6(1)(a) is to equalize the
taxation of benefits of employment, whether they are received in cash
or in kind. The absence of such a rule could lead to inequities among
employees. The court, however, must consider whether the receipt of
the good/service (in this case, the trip) represented a benefit to the
employee.

The trip was not for Lowe’s personal pleasure. Lowe and his wife
were occupied constantly. There was nothing of “value” to Lowe, in
that the trip did not replace or provide for a “holiday”. There was no
element of reward for Lowe. The trip was taken entirely for the
service of the employer. Any benefit that Lowe or his wife took from it
was merely incidental to the service purpose.

Rationale: Trips taken for the sole or primary purpose of serving
an employer are not taxable benefits. An employee may derive
ancillary or incidental pleasure from the trip and it can still be
tax exempt.

Although Lowe’s trip was not taxed, the Minister can assess tax on a
proportion of the trip.


8
  The full value of the trip is taxed in the employee’s hands. Even if the
spouse is entitled to go, the spouse does not have to declare the trip as
income because the spouse is not the employee.
                                   27
2. Material Increase in Wealth

The benefit must yield a material advantage to the employee (i.e.
something of tangible value to increase the size of his patrimony).
Taxpayers should not be subsidizing the consumption preferences of
employees (that is, whether they choose to drive or walk to work, or
what they wear). This is why a “but for” analysis for costs associated
with employment does not work well.

The Queen v. Huffman (1990) FCA
Facts: Huffman was a plain clothes police officer. He received an
allowance of up to $500 from the police force to purchase cloths for
work.
Issues: Is this allowance a taxable benefit?
Holding: No.

Reasoning: An employee is responsible for making themselves
available for work. In this case, however, Huffman could not wear his
uniform, because he was a plain clothes office. As such the court
found that the clothes were akin to a uniform. They served no other
usefulness outside of the employment context, as they were too big
and not fashionable. The employee’s net worth was simply being
“restored” by the reimbursement.

Rationale: Clothes used for work purposes that serve no
function outside of that context are not taxable benefits.

Had Huffman incurred the expense himself, he would not have been
able to deduct it.

Ransom v. MNR (1967) Ex. Ct.
Facts: Ransom was transferred from Sarnia to Montreal by his
employer, DuPont. Ransom was forced to sell his home and he took
a loss of $2809. DuPont reimbursed Ransom the amount, but the tax
authorities taxed this payment as employment income.
Issues: Is the compensation for the loss taxable?
Holding: No.

Reasoning: Ransom stands for two propositions. The first, is that a
goods, services, or money received must be for services rendered.
The SCC overturned this holding in Savage, supra.

                                 28
The importance of this case lies in the distinction that the court draws
between:

   (1) REMUNERATION – payments for work performed.
   (2) REIMBURSEMENT – an employee may be out-of-pocket by
       reason of his employment, which adversely affects his
       financial situation. The repayment costs are generally exempt
       from tax because the initial dispensation involved after-tax
       dollars.
   (3) ALLOWANCE – arbitrary amount paid by the employer in lieu
       of a reimbursement; the employee can spend the money as
       he wishes without accounting.

The loss on the sale of the home was an out-of-pocket expense paid
by the employee and therefore the payment by DuPont merely
restored the employee to the same financial position he would have
been in had he continued his employ in Sarnia and did not have to
sell the house.

Rationale: Reimbursements for losses on home sales are tax
exempt in common law. The ITA deals with this issue under ss.
6(19) - 6(23).

The Queen v. Phillips (1994) FCA
Facts: Phillips moved from Moncton to Winnipeg for a job. His
employer paid him $10000 to compensate him for the higher cost of
living in Winnipeg.
Issues: Is the payment a taxable benefit?
Holding: Yes.

Reasoning: The court recognized that Savage overruled Ransom on
the issue of consideration for services. The court also recognized that
it must be careful from making reimbursements immune from taxation
since it could create a gap or a horizontal inequity in the tax system.

The court holds (in obiter) that payment for an increase of a
mortgage rate is a tax free reimbursement, because the employee’s
estate does not increase in value. The court distinguished Ransom
on the fact that the compensation was not for a loss, but was a
supplement or subsidy for housing. This amounts to a salary
increase. Phillips will be able to buy a more expensive house and
                                  29
increase the value of his own estate (even though he does not have
more disposable income).

Again, in obiter, the court held that compensation for increase on
interest payments does not yield a benefit (which is later overruled by
the above-mentioned amendments to ss. 6(19)ff).

If the payment were tax free, then the taxpayers would in effect be
subsidizing a life style choice to live in a “similar house” in Winterpeg.
It would otherwise create a “window of opportunity” for employers to
move their employees to higher cost/income areas to avoid the tax
implications.

Rationale: Payments made to compensate for an increased cost
of living are not tax exempt.

In Krull v. Canada, the court applied Ransom to hold that payments
reflecting increases in mortgage payments were not taxable. Krull
moved from Alberta to Ontario where house prices were more
expensive.

In Gernhart v. The Queen, the court held that “tax equalization”
packages to reflect higher tax rates in Canada were not
reimbursements.      A    Canadian   employee   in   comparable
circumstances would have to pay the same amount tax and could not
benefit from this exemption.

House selection is a function of personal taste and consumption. The
government should be careful not to subsidize this choice in order to
create inequities in the tax system.

3. Valuation

The seminal case is Wilkins v. Rogerson (1961, U.K. C.A.) in which
the court explained that the value is determined by looking at the
value to the employee and not the price paid by the employer.
Although this rule applies generally, it does not apply all of the time
(see e.g. Youngman, infra).

Giffen et. al v. The Queen (1995) TCC
Facts: Giffen collected air miles while he travelled in the course of
employment.
                                   30
Issues: Are air miles taxable? What is their value?
Holding: Yes. Their value amounts to the equivalent price of a fare
discounted by the restrictions on the use of the air miles.

Reasoning: The proper measure of the value of the ticket is the
value of the benefit to the employee: what would the employee have
been obliged to pay for the ticket?

Rationale: Despite the fact that the points are not transferable or
saleable and have no economic value themselves, air miles are
a benefit because they have value to the employee.

Air miles presumably reflect a marginal cost to the airline. They cost
nothing to the employer to cede. Furthermore, air miles are useful
only when there are empty seats and there is no black-out period.
This means that the value of an air mile seat represents a heavily
discounted value compared to a seat purchased at regular fare.

Youngman v. The Queen (1990) FCA
Facts: Youngman is the controlling mind and principal shareholder of
Andrich Developments Limited. The company built a home for
Youngman and his family. Youngman paid the company a rent of
$1100 per month including utilities. Youngman was assessed for the
value obtained from the rental; he claimed, however, that because he
paid rent at the market rate, he obtained no value.
Issues: Did Youngman receive a taxable benefit?
Holding: Yes.

Reasoning: The corporation, had it been under arms-length control,
would have expected to earn a profit from the lease of the home. By
looking at the value from Youngman’s perspective, we under-
estimate the value of the benefit, because it does not account for the
profit. The company would otherwise have been entitled to a return
on its investment.

Rationale: When calculating value, it may be instructive to look
at the surrounding market to determine the cost of (or the lost
opportunity for) providing the benefit.

Even if a person receives a benefit, like a parking space, but does
not use it, it can still be taxed (see e.g. Chow).

                                 31
These case show that there is an overlap “valuation” and “benefit”.

Allowances

An allowance is a fixed amount based upon estimated costs incurred
by the employee. The employee is not required to account for the
disbursement of the allowance. The worst case scenario, described
in Cambell below, is that the government will tax the allowance as
income, and not allow the employee to deduct the cost over-run
under section 8.

Campbell v. MNR (1955) TAB
Facts: Campbell, a nurse, received $50 a month (which increased
over time) as an allowance for transporting supplies and patients in
her own car. She spent more than $50 per month on these expenses
and wanted to exempt the allowance from her income.
Issues: Is the allowance tax exempt?
Holding: No.

Reasoning: Campbell was not required as part of her duties to
transport things and people. She undertook these tasks voluntarily.

Rationale: Where an employee receives an allowance to cover
the cost of a particular work-related expense, if the employee
pays more to cover than the expense, the employee is not
entitled to deduct the cost-overrun.

The tax authorities in Huffman also argued that the $100 surplus
given to Huffman for clothing was an allowance, because he did not
have to present vouchers. The court rejected this argument on the
basis that this was a one-time increase which was made in the
course of collective bargaining.

This case highlights how courts will take a strict approach to
deductions and exemptions.

Note:

   If the allowance > expenses, try to declare the allowance as a
    tax-exempt allowance.


                                 32
   If the allowance < expenses, try to declare the allowance as a
    taxable allowance and the expenses as deductions.

A taxpayer cannot benefit from both a tax exempt allowance and a
deduction.


Deductions – Section 8

Section 8 is structured so that deductions are available only if the
wages, benefits, and allowances are taxable income. In some cases,
a person may receive a taxable allowance and be unable to benefit
from the deductions.

Personal consumption choices are not deductible. Only once a
person is at work can that person make employment deductions.

Martyn v. MNR (1962) TAB
Facts: Martyn is a pilot. He is on call 24-7 and wanted to claim
deductions for driving and parking expenses. He claimed that public
transportation to the airport was limited. He also argued that his work
“started” when he was at home.
Issues: Are the driving and parking expenses deductible?
Holding: No.

Reasoning: Employment does not start when the employee leaves
the house. The employee has a significant burden to convince the
court that an otherwise personal expense is deductible from
employment income. Traveling to an from the airport is not part of
Martyn’s duties.

In Evans, however, the taxpayer was a school psychologist. She was
allowed to deduct travel expenses for the drive to her first school and
from the last school. The court explained that Evans kept office
supplies in her car. What distinguish Evans from Martyn is that
Evans’ office is her car.

Legal expenses are deductible when the taxpayer needs a lawyer
either to collect wages or since 1990, establish a right to wages. A
taxpayer cannot claim legal expenses for the purpose of preserving
employment.

                                  33
Union dues and professional dues are deductible.

The Queen v. Swingle (1977) FCTD
Facts: Swingle, a chemist, pays dues to several associations.
Revenue Canada allows the deduction for PSAC, because Swingle
was a member of the public service. Swingle argued that he had to
be part of the other organizations to keep up-to-date.
Issues: Are these fees deductible?
Holding: No.

Reasoning: Membership in these associations were not necessary
for Swingle to maintain his status as a chemist. Furthermore,
Swingle’s “profession” is not recognized by statute as required by
8(1)(i)(i). There must be a direct relationship between membership in
the society and the ability to practice the profession.

Rationale: Membership dues directly necessary to maintain
employment are deductible.

Additional Notes:




                                 34
                         BUSINESS INCOME

Basically, business income is represented by the profit earned from
business. Profit is calculated by ordinary commercial principles.
Income from business is recorded on the accrual basis (it is
recognized when it is incurred). Farmers and fisherman can record
income when it is received – on a cash basis.

A business is: “a profession, calling, trade, manufacture or
undertaking of any kind whatever, and… an adventure or concern in
the nature of trade, not including office or employment.” Wiebe Door
Services, supra, distinguishes between business (independent
contracting) and employment.

Property means: “property of any kind whatever… a right of any
kind.”

In Smith v. Anderson, the Court explained that “anything that
occupies the time, attention, and energy” to obtain a profit constitutes
a business. They have to be an organized set of activities undertaken
for the pursuit of profit.

1. Organized Activities

Graham v. Green (Inspector of Taxes) (1925) K.B.
Facts: Graham was in the habit of betting on horses. He made a
substantial living from it.
Issues: Is Graham’s gambling income from business?
Holding: No.

Reasoning: A bet is an irrational agreement. The results of the bet
are not predictable. If however Graham was a bookmaker and
organized his gambling. Instead, however, the court found that
Graham was addicted to gambling. The Crown does not tax habits or
addictions (in this way).

Rationale: Despite frequency of gambling activities, court still
concludes that it is not the source of income that is a business:
(1) betting is an irrational agreement (2) taxpayer is addicted to
gambling, not in the business of gambling.


                                  35
MNR v. Morden although the taxpayer used to gamble regularly,
gambling was a hobby. Since it was not a regular activity, he is not
liable. These cases will depend on their facts. Contrast to Walker v.
MNR in which the taxpayer intended to profit. He had the benefit of
inside information from the jockeys, he attended all of the races, and
he bet on most of the events.

2. Pursuit of Profit

The court applied the “reasonable expectation of profit test” (REOP),
to determine whether a business is a business for tax purposes. The
analysis, per Moldowan v. MNR, is objective. A person must have a
reasonable expectation of profit. The criteria used to assess a REOP
include:

   (1) profit/loss experience of the taxpayer,
   (2) taxpayer’s training/skill,
   (3) business plan,
   (4) capability of producing profit.

In Landry v. The Queen, the taxpayer began practicing law after 23
years away from the profession. The court found that Landry had no
REOP because he practiced “so inefficiently”. The courts seemed to
be substituting their business judgment for their taxpayer’s own.

Consider the advantage of having a business which declares regular
losses; a taxpayer can use those losses to reduce tax liability for
employment income and capital gains. Also, some people try to
deduct home office and entertainment expenses.

Stewart v. The Queen (2002) SCC
Facts: Stewart had invested in condo units with very little money
down. He did not make a profit on the condo units as had been
anticipated, as the interest payments were very high. Stewart had
expected the value of the condo to rise (so that he would receive a
capital gain). Meanwhile, Stewart was deducting the losses from
other income.
Issues: Is the condo venture a business?
Holding: Yes.

Reasoning: There are tax implications if he can declare losses
immediately and offset capital gain with reduced tax burden. Stewart
                                 36
must have a business in order to deduct the losses.

The courts rejected the CRA’s argument that because Stewart
intended to make a capital gain, his deductions should not count for
business income/losses. The courts have interpreted the REOP test
too strictly (see also Tonn).9 Therefore, the test was re-characterized
as follows:

    1. The courts should look at the subjective intentions of the
       taxpayer to determine whether the activity is commercial
       (business or property) or personal.
    2. If there is any doubt about the commerciality of the
       enterprise, then the court should reference the objective
       criteria discussed in Moldowan. When activities are clearly
       commercial in nature, the REOP test should be applied lightly.

Simply because the condos were a tax shelter does not mean that
the condo venture is not a business. The court also explained that
the REOP test does not have a legislative foundation. The term
appears in the definition of “personal and living expenses” as
business deductions. The court sought to restore some certainty and
consistency to the law.

If, for example, the business is too heavily finances, then this adds to
the commercial nature of the business; under the old test, it would
have been the reverse.

Rationale: The REOP test is applied only when there is real
doubt as to the commerciality of the venture.

Although the government proposed to reintroduce the test, it never
made it into legislation.

PROPERTY is given the widest possible meaning under the act. It
includes rights of any kind. It does not include things that do not have
the quality of ownership (such as non-compete covenants).

In Hollinger v. MNR, the determination as to whether a venture is
business or property is based on four factors: (1) whether the income

9
  The court overruled Landry to state that professional practices and
restaurants are clearly commercial in nature.
                                  37
was the result of efforts or labour made by the taxpayer, (2) trading
character to the income, (3) is the income from a business described
by the act, (4) the nature or extent of the services performed.

For example, the provision of laundry or maid services could
transform a property rental unit into business.

Interest Income

Interest from property can, in some circumstances, be characterized
as property income or from the bank. One problem facing the courts,
however, is how to distinguish between interest income and a capital
receipt. Interest is compensation for the use of money or property
paid as a percentage of the property’s value and accrues daily.

Example #1: The taxpayer acquires a debt at a DISCOUNT (a $100
debt for $75). The debt is paid over 3 years. Is the $25 discount
interest income? This is a question of fact. When the $25 is in lieu of
interest, the income is taxable.

Example #2: If the taxpayer receives a BONUS ($110 for a $100
debt), the bonus is taxable if it is above the interest rate.

Example #3: If the debt is payable as a FUNCTION OF REVENUES
or sales (taxpayer is entitled to 5% per year on an outstanding
principal). This does not make a different to the taxpayer, since it will
be taxable anyway. It will make a difference to the payor, since the
interest is deductible in computing income; a distribution of profits will
not be tax deductible.10

Example #4: Late payments or PENALTIES on a debt repayment
constitutes interest.

Groulx v. MNR (1967) SCC
Facts: Groulx sold his farm. He received part of the capital upfront,
and the rest was paid over the next few years. Groulx agreed to forgo

10
  The distinction between sales revenue and interest/licensing revenue may
not make a difference to the recipient; however, it may make a difference to
the payor; see e.g. computer software. Revenue Canada treats sales of
software as sales revenue, unless the software is custom made.
                                    38
the “interest” on the outstanding amount, and as a result, Groulx tried
to construe the total value of the sale as a capital gain.
Issues: Is the entirety of the sale receipt a capital gain?
Holding: No, part of the sale receipt constitutes interest.

Reasoning: Per Hall J: The test to determine whether part of the sale
price is taxable income is as follows:

   1. Would interest normally be charged on the balance of the sale
      on this transaction?
   2. Was the sale price greater than the market value of the
      property?

If the answer to both questions is yes (as it was in this case), the
seller is liable to declare part of the sale price as interest.

Reporting interest: Interest must be reported as it accrues (see ss.
12(3), (7)), even if the interest compounds each year. This leaves s.
12(1)(c) without force or effect.

Also, recall Antosko, supra, if a debt instrument is sold with accrued
interest, it is the seller who is responsible for paying the taxes, not
the buyer.

Rents and Royalties

A RENT is received for the use of real or personal property; a
ROYALTY is received for the use of intangible property. Under s.
12(1)(g) of the ITA, even if taxpayers characterize the production or
use of revenue-generating property (such as an oil well, natural gas
line, copyrighted song, etc.) as a “sale” if the “seller” receives periodic
payments for production and or use, then for tax purposes, it is
income from property.

A notable exception from this is computer software. Under an
Interpretation Bulletin, “over the counter” and “online access”
software is “sold” not licensed. Custom software is treated as the
product of a license. As stated above, the characterization is relevant
for corporate tax purposes.



                                    39
A DIVIDEND is a payment received on shares from a corporation as
a distribution of profits. Since this is after-tax corporate income, there
are specific provisions in the ITA to limit double taxation.


Calculating Business Income

Business income is calculated based on PROFIT. The term is not
defined in the act, but the determination of profit is based on ordinary
business practices, see s. 9(1) (see also Daley v. MNR). The
interpretation of the word is a question of law, but the courts
look to commercial trading practices. A deductible cost is one that
is taken for the purpose of making profit. Personal and living
expenses, under s. 18(1)(a) and following are not deductible. Section
18(1)(a) is a prohibition. The “business purpose test” derives from
section 9.

Imperial Oil Ltd. v. MNR (1947) Ex. Ct.
Facts: Imperial Oil’s ship was involved in a collision. It settled
damages and sought to deduct those damages from its business
income.
Issues: Is Imperial Oil entitled to make the deduction for liabilities
incurred following the collision?
Holding: Yes.

Reasoning: Per Thorson P: “The ordinary risks and hazards of that
business must be accepted … including the possibilities of loss
inherent in it.” Collision damage at sea is a contingency that falls
within the normal risk of loss.

The court cited Re Herald and Weekly Times, which involved the
deductibility of payments for libel taken by a newspaper. Libel is an
ordinary business risk for newspapers.

The expense does not need to be wholly or directly related to the
earning of income per se. A causal connection is too strict of a test,
nor is the court supposed to look at the cost in isolation. Collision
damage is a discharge of a liability and is part of the cost of
transporting oil.



                                   40
Rationale: A person is not entitled to deduct expenses that are
too remote from the profit-making process. Where, however,
liabilities are incurred in the normal course of business, those
liabilities are deductible.

In Faerie v. Hall (not referenced in the case book), a sugar broker
was denied a deduction for damages paid following a slanderous
statement. Slander is not a normal business risk incurred in the
course of brokering sugar. See also Strong & Co. Limited v.
Woodifield (1905) referenced in Imperial Oil.

Royal Trust Co. v. MNR (1957) Ex. Ct.
Facts: Royal Trust paid for the cost of memberships to social clubs
for some of its employees. This was an industry practice. An
accountant testified that this expense was a proper one to incur.
Issues: Is the cost of club memberships an ordinary business
expense?
Holding: Yes.

Reasoning: Thorson P reviewed his judgment in Imperial Oil and
explained that he would have omitted the reference to “ordinary
accounting practice” leaving only “ordinary commercial trading”.

Thorson examined the context in which the expenditure was incurred.
It found that (1) the policy was considered and tailored to the needs
of the business, (2) it endured for several years, (3) it was the
practice of Royal Trust’s competitors, (4) it generated real benefits for
the company, and (5) it was a way of gathering business. The court
equated this expense to a promotional expense.

The fact that the deduction was incurred in the ordinary course of
business does not make it tax deductible. The expense must be
incurred for the purpose of gaining income (see s. 12(1)(a)). In this
case, the company’s purpose was to increase its business through
the fostering of personal contacts between its employees and
prospective investors.

Thorson also did not distinguish between the annual dues paid and
the initial membership fee. He felt that they both served the purpose
of providing the employees access to the club and therefore both
were deductible when they were incurred.

                                   41
Rationale: Expenses incurred to increase business by fostering
personal contact with clients are deductible under common law.

Note: Section 18(1)(l) now prohibits deductions for membership fees.

1. Personal Expenses

Personal expenses are generally not deductible. Sections 62 and 63
do allow for some deductions, namely moving expenses and child
care expenses.

Benton v. MNR (1952) TAB
Facts: Benton was a semi-invalid farmer, who hired a housekeeper
to assist him with household maintenance. This freed Benton to work
on the farm. Benton sought to deduct the cost of the housekeeper
from his farm income.
Issues: Is the cost of a housekeeper a business expense?
Holding: No.

Reasoning: The expenses incurred to get you to work are not
business expenses. They are consumption expenses. Although
taking care of the household responsibilities is useful to Scott, they
are not part of the income-earning work on the farm.


Leduc v. The Queen (2005) TCC
Facts: Leduc spent $140 000 in legal fees to defend himself against
charges of sexual misconduct. Several of his clients, who happened
to be priests, were charged. Leduc argued that he had to hire a
lawyer to protect his professional status. Following the charges,
Leduc’s business improved and he earned more income.
Issues: Is Leduc entitled to deduct the cost of his legal expenses?
Holding: No.

Reasoning: Leduc was motivated to defend himself for two reasons:
to protect his liberty and to protect his professional standing. The fact
that there is a personal motivation is not sufficient to negate the
deduction. Therefore, the court must look to see if the expense was
an ordinarily incurred expense.

The court looked at the nature of the expense, citing Symes, infra.

                                   42
   (1) Is the expense ordinarily allowed by accountants?
   (2) Is it normally incurred by others?
   (3) Would it have been incurred had the taxpayer not been
       engaged in business?
   (4) Would the need have existed apart from the business?

In this case, the need would not normally have been incurred by
lawyers. Leduc would have had to defend himself anyway.
Furthermore, his earnings actually improved following the charges. It
was not certain that following a conviction Leduc would have lost his
license.

The court distinguished Vango v. Canada and Mercille v. The
Queen. In both of those cases, the charges related directly to the
business activities. Perhaps had Leduc been charged with
professional negligence, he might have been able to deduct the cost.
The deduction, therefore, was too remote.

Rationale: Legal expenses incurred for charges that do not
relate to an ordinary business risk are not deductible.

Symes v. The Queen (1994) SCC
Facts: Symes was a partner at a law firm. She wanted to deduct the
cost of a nanny, who she employed to look after her children. Symes
even remitted CPP and EI on behalf of the nanny.
Issues: Is Symes entitled to deduct the cost of the nanny?
Holding: No.

Reasoning: Per Iacobucci J: Symes incurred the childcare expenses
to make herself available for work. Although he does not discount the
possibility of such a deduction and states that the courts must take a
progressive interpretation for deductions, he does not consider
Symes’ deduction to be one which enabled her to make a profit.
Someone would have had to take care of the kids and therefore the
need existed independently of the business.

The courts must strive to achieve “equity” among taxpayers.
Iacobucci considers it to be inappropriate for the courts to be
subsidizing the consumption choices of taxpayers. Symes (or her
partner) is entitled to a child care deduction under section 63 (which
is available to employees as well). The specific provision overrides
the general one.
                                 43
What Symes is trying to accomplish is to claim the cost of a nanny –
which is a greater cost than the cost of day care. This represents a
consumption choice.

Rationale: Although the courts should take a progressive
interpretation for deductions, they should not allow deductions
incurred to prepare the taxpayer for work.

Critique: Per L’Heureux-Dubé J: The business purpose test is
informed by the interests of men. The law is premised on the view
that the commercial sphere must accommodate the needs of men.
The real costs of childcare is incurred by women and those costs are
no less real than other business expenses.
Scott v. MNR (1998) FCA
Facts: Scott was a foot and transit courier. Scott travelled 150 km
per day, working 10 hours per day, 5 days per week, 52 days per
year. He tried to deduct the increased cost of food and water that he
consumed daily as a business expense. The tax authorities denied
the deduction.
Issues: Is the cost of food and water deductible?
Holding: Yes, but under limited circumstances.

Reasoning: Food and water is normally not deductible, since
everyone has to consume it. The court referred to the principles
articulated in Symes to explain that courts must recognize the
changing needs of businesses and be flexible in terms of deductions.
Had Scott operated a vehicle, the cost of gas would have been
deductible (“horizontal equity”). In this case, Scott consumed his fuel
in the form of food and water.

The Court was careful to limit the scope of the decision to businesses
where food and water substitute for another fuel. A rickshaw driver,
for example, would be able to deduct the additional cost of food and
water.

Rationale: Where a person consumes additional food and water
in lieu of gasoline, the cost of the additional food and water is
deductible. 11
11
   Had Scott incorporated his business and hired himself, he might have had
to declare the food and water consumed as a taxable benefit.
                                    44
The result of this jurisprudence is that the “but for” test for
deductibility is not applicable. There must be a real nexus between
the expense and the profit making activity. Expenses incurred merely
to get oneself to work are not deductible.

2. Commuting Expenses Between Home and Work

Cumming v. MNR (1967) Ex. Ct.
Facts: An anaesthetist earns income from business at a hospital. He
is claiming the deduction of travel expenses from home to hospital
and a deduction of capital cost allowances. His home office is his
only office space. The space is out of bounds to his children. He
spends about 12 hours a week there, and his wife also spends 12
hours a week doing administrative work there.
Issues: Is Cumming entitled to deduct the cost of travel to and from
the hospital?
Holding: Yes.

Reasoning: Cummings “base” of operations is his home office,
although he administers services at the hospital. He would return
there when he was not busy at the hospital. Travel between these
points is required. This is not an issue of personal preference. He
simply did not have an office at the hospital where he could do his
work.

Where a person lives relative to work is a personal consumption
choice. The court gives him 25% of his operating costs, since work
travel constituted about 25% of his mileage. On capital cost
allowance issue, court uses a different measure (50%). Based not
only on the use of the car, but also on obsolescence, which is as
much a factor of time as use. It is decreasing in value while it is
parked at the hospital.

Rationale: Where a professional has to travel to and from two
working locations, that expense is partially deductible.

The court in Henry distinguishes Cumming on the basis that Henry
had an office at the hospital; he returned to his home for dinner and
not to work.


                                 45
One way to get the commuting expenses deductible is to describe
the use of the car as a work-to-work expense. Otherwise the use of a
car is a consumption choice.

3. Home Office Expenses

Section 18(12) of the Act limits the ability to deduct home office
expenses, by constraining the definition of what constitutes a home
office and by limiting the amount (of the loss) to the amount of
income that the taxpayer earns (therefore, no carry-over losses).

For example, Cumming would not have qualified under 18(12)(2),
since he did not meet clients, customers or patients at his home
office. He would have to have relied on 18(12)(1), although it is not
clear that it would have been enough. It was the principle place of
administrative duties, but the hospital was the principal place where
he anaesthetized people. However, this relates only to the expenses
to maintaining the office itself.

The most common method of allocation is based on square-footage
of the office as a percentage of the square footage of the home. The
same percentage would be applied to the capital cost of the office as
well as the current expenses of maintaining the home including
insurance, utilities, etc.

4. Entertainment and Meals

There is often a high level of personal enjoyment associated with
entertainment expenses. These deductions also tend to benefit high
income taxpayers who can afford to incur these deductions, thus
creating horizontal inequities. Likewise, they can be subject to abuse.

Section 67.1(1) limits the deduction to 50% of the actual cost or a
reasonable amount.

In Roebuck (1961), a lawyer wanted to deduct 85% of a daughter’s
bat mitzvah, because most of the guests were clients. The court
denied the deduction. In Grunbaum (1994), the costs of the wedding
reception was allowed.



                                  46
Public Policy

1. Expenses of Carrying on an Illegal Business

Illegal income is taxable.

M.N.R. v. Eldridge (1964) Ex. Ct.
Facts: Mrs. Eldridge ran a brothel. She was taxed on the income for
her illegal business activities. She deducted her expenses including:
rent, telephone inspection, payment for assistance to prostitutes,
protection fees, liquor payment fees (bribes to civil administrators).
She paid $1,300 in cheques, $18,900 in cash. She had to pay bail
bonds to get her employees out of jail.
Issues: What expenses was she entitled to deduct in computing that
income?
Holding: Most of the expenses are not deductible.

Reasoning: The court allowed Eldridge to deduct the rent paid to
operate the premises where her call girls would meet their clients.
The court did not allow the cash allowance paid to the occupier of the
premises, as Eldridge did not record how this allowance was used.

The expenses that cannot be proven are not deductible. These
include the “telephone inspection fee” and the “protection fees”.

The expenses for buying up the “defamatory” newspapers were
refused, since the circulation of the newspaper would probably have
been good for business, so not expenses made to earn income.

Bail bonds are deductible for her employees, but not for herself. Her
business had already been terminated at that point, so it was purely
personal. But getting the employees out was part of an obligation
incurred while she was in business.

Rationale:

Note that proving the cash expenses is difficult. This is also an issue
in legitimate businesses where under-the-table payments are
common.


                                  47
2. Fines and Penalties

In Day & Ross the court allowed a deduction for accidental/good
faith fines where the fines are compensatory.

In Amway fines that are avoidable and intentionally violated are not
deductible.

65302 British Columbia Ltd. v. The Queen (2000) SCC
Facts: The company was an egg producer. It deliberately produced
and over-quota to maintain its customer base until it could acquire an
increased quota. The CEMB levied a fine against the company.
Issues: Were the fines deductible?
Holding: Yes.

Reasoning: Per Iacobucci J: The tax authorities are not concerned
with allowing a taxpayer to deduct the costs associated with criminal
activity (see e.g. Eldridge), even if it frustrates the Criminal Code.
The same principle should apply with reference to fines.

Bribes are not deductible. Since Parliament did turn its mind to the
disallowance of some deductions on policy grounds, then it shows
that Parliament could have considered including fines as prohibited
deductions.

The court does not even have to look to the compensatory-
deterrence distinction. This is distinction is judge-made and
unnecessary. So long as the fine is taken while earning business
income, it should be deductible.

Per Bastarache J: It would frustrate the purpose of a penal statute if
its fines were tax deductible (applying similar principles to (Day &
Ross). The purpose behind the egg marketing policy is to ensure that
egg producers pay appropriate fees based on their production quota.
The fees are not geared to deter over-production but to defray costs.

Rationale: Fines that serve a compensatory purpose are tax
deductible at common law.

Parliament amended the act in 2005 (s. 67.6) to deny deductions for
fines and penalties imposed after March 22, 2004 unless they are
                                 48
“prescribed”. To date, there are no prescribed penalties. This means
that any fines issued after 2004 are not deductible.

Thefts by low-level employees are deductible; thefts by people in
control of the business are not. See General Stampings Ltd. v.
MNR, (1957).

Interest Expenses – Money used to service the borrowing of
capital

One tax shelter plan involves the acquisition of capital property,
deducting the interest expenses and then benefiting from the capital
gain (see e.g. Stewart).

A taxpayer can deduct interest only when the taxpayer has a “legal
obligation” to pay in the taxation year (section 20(1)(c)). The interest
is deductible when for the acquisition of capital property used for
earning income. Personal use borrowing does not produce deductible
interest.

If the source of the income disappears, the interest on the loan is no
longer deductible (Tennant v. Queen). So long as the taxpayer
maintains the source – or traceable proceeds – the taxpayer can
continue to deduct the interest expenses (see section 20.1). Also, if
the taxpayer uses the proceeds of disposition to repay the loan, the
taxpayer can continue to deduct the interest expenses.12

The Queen v. Bronfman Trust (1987) SCC
Facts: The trust borrowed $2.3 million from the bank, so as not to
sell off income-earning stocks. It paid the money to its beneficiaries.
The trustees argued that they should be able to deduct the interest
expenses because they preserved the income-producing assets in
the trust.
Issues: Are the trustees entitled to deduct interest expenses?
Holding: No.

Reasoning:       Per Dickson CJC: Not all borrowing expenses are

12
  For example, if a taxpayer buys shares for $100 using a loan and sells them at a
loss for $50, the taxpayer can continue to deduct interest if (1) he repays the $50
loan or (2) acquires other income-generating property with the remaining $50.
                                        49
deductible. Interest on borrowed money for personal expenses is not
deductible.

The court will look at: (1) the current use of the property, (2) the direct
use of the property. Borrowing money for the purpose of making a
capital gain is not a bona fide purpose (see e.g. Stewart). Likewise
the fact that the Bronfman trust wanted to prevent the realization of
capital losses is also not enough to justify interest deductability. The
proceeds of the borrowed money in this case is traceable to the
beneficiaries, and was not retained in the trust.

In Transprairie, the company raised money by selling preferred
shares. The taxpayer decided to re-capitalize its debt by taking out
debentures to repay its shareholders. Transprairie pays interest on
the debentures. The taxpayer did not acquire a new income-
producing asset with the debenture money. It simply repaid its
shareholders. Although the court in that case allowed the deduction
of interest, because Transprairie recapitalized its business. The Court
in the present case did not allow the deduction.13

The money was used to make a capital distribution. The purpose of
the borrowing was not relevant – what is relevant is what the money
is used for.

Rationale: The court will look at the current use of borrowed
money to determine whether a taxpayer is entitled to deduct
interest.




There are policy reasons for not allowing indirect use deductions. A
wealthy person could have income-producing savings, borrow money
13
  Transprairie use the debenture money to refinance its business. The Bronfman
trust used the money to pay its beneficiaries. Trans-prairie, therefore, can be
distinguished on its facts.
                                      50
and then deduct the interest on the basis that the income-producing
savings would be preserved. That is why the courts will look at the
direct use of the borrowed money.

In The Queen v. Attaie, the taxpayer borrowed money to pay for a
home, which he rented out. Attaie moved back into the house. He
then received $200 K from Iran, and instead of paying off the
mortgage, he put the money into interest-earning investments.
Because Attaie lived in the house, he was no longer entitled to
deduct the interest payments on the mortgage; it was not an income-
earning property.

Singleton v. The Queen (2002) SCC
Facts: Singleton is a partner in a law firm. He has $300 K in his
capital account at the firm. He borrows $300 K from the bank to re-
finance his firm, and withdraws the $300 K from the firm. He uses the
money from the firm to buy a house.
Issues: Is the interest on the bank loan deductible?
Holding: Yes.

Reasoning: Per Major J: cited Shell to explain (1) the amount must
be paid in the year it sought to be deducted, (2) there must be a legal
obligation to pay the interest, (3) the property must be used for the
purpose of earning income, (4) the amount must be reasonable. 14

Citing Bronfman, Major explained “if a direct link can be drawn
between the borrowed money and an eligible use” the third element
is satisfied. We cannot look to far into prima facie eligible uses;
taxpayers are entitled to structure transactions to minimize tax.

14
   Shell needed $100 M USD. It could have borrowed $USD at a rate of 9.1%.
Instead, Shell borrowed $150M NZD at a higher interest rate and converted it into
USD. They used some of the money to buy foreign exchange contracts. Although
Shell paid more interest, this cost was offset by the capital gain on the foreign
exchange contracts. This allowed Shell to defer the capital gain, but deduct a higher
rate of interest.
The taxpayers have structured their loan in a way to take advantage of a higher
interest rate. The tax authorities argued that Shell should have been limited to the
lower interest rate. The Court allowed full deductibility; it was a market rate of
interest. The direct use of the borrowed money was to acquire capital.
The fact that Shell could have gotten a lower rate was irrelevant.
                                         51
The court must simply apply s. 20(1)(c) rather than look at the
economic realities of the transaction. Major held that this was not
just a “shuffle of cheques”. The fact that Singleton made the
transactions on the same day --- does not alter the direct use of the
money, which was to finance the practice.

The court cited Ludco (2001), to explain that it does not matter
whether the losses exceed what the property will return.15 Nor does it
matter that income is a “net” concept. So long as there is a
reasonable expectation that the capital will generate income, the
interest expenses are deductible.

The court is not concerned with the purpose behind the borrowing,
but the purpose behind the use of the money. Singleton used the
borrowed money to refinance his practice. The legal relationships
between the parties are relevant when considering the use of the
borrowed money.

Rationale: If borrowed money is used for an eligible purpose,
the court is not entitled to look to see how other money offset
by the borrowing is used.

This case is highly problematic, because anyone with capital in a
professional practice can borrow money and then deduct the interest
from the bank.

After Shell, Parliament amended the ITA to address weak currency
loans.

The last hurdle that a taxpayer faces is the general anti-
avoidance rule (GAAR). Consider Lipson (2007); it worked under s.
20(1)(c), but it was considered to be abusive under GAAR.




15
   Ludmer and others borrowed money and bought shares in an offshore company.
The company invested in secure debt instruments. The company paid occasional
dividends. Ludmer cashed in the shares and received the value of the capital and the
interest. Ludmer paid tax on the capital gains, but only at 50%. It was like an RRSP
without a limit.
                                        52
Ironically, this case may even better than Singleton, is that Mrs.
Lipson owns shares in the company. However, the court held that
this was (1) a tax-avoidance transaction, and (2) there was a misuse
of the provisions of the act.

The SCC could overturn Singleton in Lipson.

Requirement of Reasonableness (Generally non-arms length)

Section 67 is not source-specific. An expense is deductible if it is
reasonable. This is an objective test. It allows the tax authorities to
reduce the amount of the expense. In Mulder Bros. v. MNR (1967),
a company was controlled by two brothers. One of the wives is paid a
salary. The tax authorities contest the amount of the salary.
Objectively, the court considered whether the salary was reasonable
for the services that she renders (as if she was not married – or
dealing at arms length).16 Part of her salary was disallowed.

It seemingly is more likely in a non-arms length transaction that the
objective cost of an expense will be over-estimated so as to avoid
tax.

Additional Notes:

    Consider X borrows $10000, uses the proceeds to take a
     vacation, and then borrows $10000 to require the shares. The


16
  Although section 67 does apply in arms-length situations, the court likely will not
substitute its own judgment, because the parties are able to negotiate a fair price for
goods and services required by the business.
In No. 511 v. MNR, a lumber company deducted money to subsidize a baseball
team. The court felt that the advertising fee was unreasonable, when the net income
was not even twice the fee. There was a personal element to this expense. See
also Beauchemin v. MNR (the taxpayer sought to deduct a Porsche 911).
                                         53
    borrowed money to buy them back is an eligible use, while the
    interest first loan is not eligible.

   Consider X borrows to repay an existing loan. If the use of the
    existing loan is eligible, then the interest is deductible (see section
    20(3)).

   Consider X borrows to repay outstanding interest. Under section
    20(1)(d), the interest on the loan is deductible.




                                    54
                                TIMING

A person can defer having to recognize revenue or accelerate the
recognition of expenses in order to benefit from timing. This is
available to businesses that recognize benefits when they are
“accrued” and expenses when they are “incurred”. An ideal situation
would allow the deduction of the cost at present, even though the
payment for the actual cost will come later. The focus of this
chapter is on when a taxpayer can declare/deduct.

Canderel Ltd. v. The Queen (1998) SCC
Facts: Canderel is in the real estate business. They sign up tenants
for buildings, so that tenants will move in when buildings are
complete. Canderel makes payments to prospective tenants, even
though the tenants are not leasing the properties yet. In its
accounting statements, Canderel amortizes the TIPs over the term of
the lease; however, it wants to deduct the TIPs right away as
“incurred expenses”.
Issues: Is Canderel entitled to deduct the TIPs immediately?
Holding: Yes.

Reasoning: Per Iacobucci J: The basis for calculating income is
profit. This is a question of law, and not a question of accounting. The
court must consider express provisions in the act, and in the absence
of those rules, it is the rules developed by the court (“generally
accepted commercial practices”). GAAP is not determinative; they
are interpretive aids. The motivation behind GAAP is to present a
conservative picture of income and this is not necessarily appropriate
for tax purposes. GAAP is interested in a comparative picture, but
again, this is not relevant for computing income for tax purposes.

The Court discusses the matching principle. The taxpayer should try
and match the revenue with the expenses incurred to earn that
revenue, which will produce a true picture of income in a give year.
This is why it is inappropriate to deduct capital costs in one year. It is
at the root of the deduction of capital outlays and which provides for
the capital cost allowance payments.

Iacobucci notes that there is more than one principle applicable to
certain cases. In this case, there are 3 ways to recognize payments
(immediate deductibility, amortization, or adding to cost of building).

                                   55
Immediate deduction is not inconsistent with the law. Nothing in the
act does not prohibit this deduction. It is also in accordance with
generally accepted commercial practice. Furthermore, the taxpayer
discussed the benefits achieved from the payment. The benefits
were not limited simply to the lease. Canderel had to satisfy
interim financing and an essential element to obtain long term
financing.17 Because the payments were referable to present and
future benefits, the taxpayer met its burden of proof; the matching
principle did not require that these expenses be spread out over time.

Rationale: In determining income for tax purposes, the taxpayer
must present arguments justifying that its way of calculating
income presents a true picture. The burden then shifts to the tax
authorities who must show that another means of calculating
income would present a truer picture.

 #1 Mary, the lawyer, p. 445

 Revenues                            Cash           Accrual
                                     basis
 $50,000       Fees for services     Incl. 2005     Incl. 2005 and
                                                    perhaps some in
                                                    2004
 $10,000       Billed amounts        Incl. Later    Incl. 2005



17
   To obtain financing, a builder must get leases in advance in order to show the
financer that the building will be a viable enterprise. This also prevents a gap in
income following the completion of the building. Furthermore, Canderel had to
maintain its position in the market. The rentals, themselves, were benefits.
                                        56
$5,000      Not yet billed        Incl. Later   Incl.         2005;
                                                Professionals can
                                                elect out of work in
                                                progress (s. 34)



Expenses
$16,000     Secretary             Dedt. 2005    Dedt. 2005
$1,000      Office    supplies    Dedt. 2006    Dedt. 2005
            payable in 2006
$3,000      Insurance    until    Dedt. 2005    Pursuant to s.
            2008                                18(9) she has to
                                                spread out the
                                                expense. $1000 in
                                                2005.
$1,000      Photocopier           Capital       Capital      cost
            (capital outlay, s.   cost          allowance.
            18(1)(b))             allowance.


#2 Robert, the computer sales
person (computer = inventory)


Revenues                          Cash          Accrual
                                  Basis
$3,000      Sale of computer      Incl. 2006    Incl. 2005




Expenses
$1,000      Cost of goods         Incl. 2005    Incl. 2005

Unbilled Revenue




                                    57
MNR v. Colford (1960) Ex. Ch.
Facts: Payments to Colford are made based on the progression of
the construction work. The final 10% of the contract can be held back
by the buyer so that it can pay sub-contractors in case the contractor,
Colford, defaults. Colford will get the holdback only when the
contractor gets an architect certificate.
Issues: When is Colford entitled to received the final 10%? The
issue, though, is when does Colford have to declare the holdback in
its taxes?
Holding: Colford was entitled to receive the holdback and therefore it
had to declare the holdback as income.

Reasoning: Colford was entitled to receive the holdbacks only once
the architect’s certificate was issued. The holdback was receiveable
on March 9, when the certificate was issued, even though according
to the contract, Colford would not actually be eligible to obtain the
money on April 11.

Rationale: Money is receivable when there needs to be an absolute
right to receive the money.

MNR v. Benaby Realties (1967) SCC
Facts: The taxpayer’s year end was April 30, 1954 (1954 taxation
year). The land is expropriated in January 1954. In November 1954,
an amount is determined. The tax authorities sought to have the
value declared in 1954. Benaby argued that he did not know the

                                  58
amount until the 1955 year.
Issues: Is the value added to the taxpayers income when the
expropriation occurs?
Holding: No.

Reasoning: The taxpayer must include the value of the expropriation
once the amount becomes known. Since the amount was not known
until the 1955 fiscal year, that is when it should have been included.

Rationale:  Ascertainability of the amount is a necessary
requirement to declare income for a taxation year. This makes
sense, because the taxpayer was to plug a number into the tax
return.

West Kootenay Power v. The Queen (1992) FCA
Facts: A power company has distributed electricity, but they have not
billed their customers. The company argues that it does not have to
include amounts delivered and not yet billed (a “billed method” as
opposed to “full accrual”).
Issues: Does West Kootenay have to include revenues owed for
distributed electricity even if their customers are not billed yet?
Holding: Yes.

Reasoning: Electricity is considered to be property under the Sale of
Goods Act. Under the Act, a seller is entitled to payment upon
delivery of the property and bill is not a precondition to payment. The
amounts representing the value of the electricity delivered is accrued
and ascertainable, and there is an absolute right to receive payment
once the electricity is delivered.

Rationale: The billing cycle does not alleviate a taxpayer’s
burden to include amounts receivable.

Maritime Telegraph v. The Queen (1992) FCA
Facts: A telephone company provided telephone services (Sale of
Goods Act does not apply).
Issues: Does Maritime have to include earned but unbilled income?
Holding: Yes.

Reasoning: GAAP authorizes both the billing and the “earned
method”. The earned method, however, provides a truer picture.

                                  59
Maritime argued, to no avail, that only “amounts receivable” means
that payments are included only once the bills are sent out (or would
be sent out if there is no undue delay). Pointing to section 12(2),
section 12(1)(b) is not the first basis for inclusion; it is an overriding
provision. The basis for inclusion is section 9 (which is where to
start).

A taxpayer should not read section 12(1)(b), an anti-avoidance
provision, to delay the declaration of income.

Rationale: The billing cycle does not alleviate a taxpayer’s
burden to include amounts receivable.

The following case is the flip of the Colford case. Guay wants to
deduct the holdback.

J.L. Guay v. MNR (1971) FCTD
Facts: Guay was a contractor. The holdback amount became
payable only after the architects certificate was issued. It wasn’t
issued until the following taxation year.
Issues: When is the holdback deductible in the earlier year?
Holding: No.

Reasoning: An architects certificate is an outside condition. The
holdbacks become payable only when the certificate is issued and
the obligation to pay is no longer contingent, but certain.

Rationale: In a mirror image of Colford, an amount is deductible
when there is a legal obligation to pay and the amount is
ascertained or ascertainable.

Section 18(1)(e) contingent liabilities are not deductible in a taxation
year. A taxpayer must find a specific provision of the ITA to allow for
the deduction of a reserve fund or contingent liabilities.

 MATCHING INCOME TO REVENUE
 #3, X the lawyer, p. 462; Receives $10,000 in 2005, $9,000 costs in 2006
 Instead of having a $10,000 gain in 2005 and $9,000 loss in 2006:


                                    60
                       2005             2006
 Revenues
 s. 12(1)(a)           $10,000                      Declared
 s. 20(1)(m)18         -$10,000                     Deducted
 s. 12(1)(e)                            $10,000     Declared

 Costs
                                        -$9,000     Deducted
                       $0               $1,000      Profit

 Under accrual method, we would get the same result.

 SPREADING PROFITS AS A RESERVE

 #6, Sale         of     land     for
 business

                       01-Jun-05        01-Jun-06   01-Jun-07
 Received
 Proceeds of
 Sale; Land
 is inventory
 in        this
 context;
 land     cost
 $60,000               $30,000          $35,000     $35,000

 Profit                $40,000

 Sale Price            $100,000
 Costs                 -$60,000

18
   20. (1) Notwithstanding paragraphs 18(1)(a), 18(1)(b) and 18(1)(h), in computing
a taxpayer's income for a taxation year from a business or property, there may be
deducted such of the following amounts as are wholly applicable to that source or
such part of the following amounts as may reasonably be regarded as applicable
thereto … (m) subject to subsection 20(6), where amounts described in paragraph
12(1)(a) have been included in computing the taxpayer's income from a business for
the year or a previous year, a reasonable amount as a reserve in respect of (i)
goods that it is reasonably anticipated will have to be delivered after the end of the
year, […]
                                               61
 Profit             $40,000

 ITA has a series of provisions to defer profit to correspond to receipt of cash

               19
 s. 20(1)(n)        -$28,000      -$14,000

 s. 12(1)(e)                      $28,000         $14,000

 Tax
 Payable            $12,000       $14,000         $14,000        $40,000


 Received           $20,000       $20,000         $20,000        $20,000      $20,000
 proceeds           2005          2006            2007           2008         2009
                                                                 No reserve allowed
                                                                                20
                                                                 under s. 20(8)
 s. 20(1)(n)        -$32,000      -$24,000        -$16,000
 s. 12(1)(e)                      $32,000         $24,000
 Taxable
 Proceeds           $8,000        $8,000          $8,000         $16,000      $0
 s. 20(1)(l)        Can deduct a "doubtful" debt
 s. 12(1)(d)        Carry over the reserve to the next year
                    Can deduct a "bad" debt, without carrying it over
                    as income next year. Do not need to take all efforts
 s. 20(1)(p)        to collect ("honestly & reasonably determines").
                    See Gurberg (2002) TCC
 s. 12(1)(i)        Include as income only if the debt is ever paid




19
   (n) where an amount included in computing the taxpayer's income from the
business for the year or for a preceding taxation year in respect of property sold in
the course of the business is payable to the taxpayer after the end of the year and,
except where the property is real property, all or part of the amount was, at the
time of the sale, not due until at least 2 years after that time, a reasonable amount
as a reserve in respect of such part of the amount as can reasonably be regarded as a
portion of the profit from the sale;
20
  20. (8) Paragraph 20(1)(n) does not apply to allow a deduction in computing the
income of a taxpayer for a taxation year from a business in respect of a property
sold in the course of the business if (b) the sale occurred more than 36 months
before the end of the year.
                                         62
Brock v. MNR (1991) TCC
Facts: Brock was a lawyer. He sent out interim bills to his clients. He
argued that since this was work in progress, he could defer the
income until the next taxation year.
Issues: Can Brock defer the income?
Holding: No.

Reasoning: The bills were not framed as “statements” about work in
progress. They were collections from the clients, who were given 10
days to pay. Although section 34 of the Act allows professionals
(lawyers, accountants, doctors) to defer work in progress until the
work is complete, amounts are deemed receivable when they are
invoiced or should have been invoiced.

Brock invoiced his clients and therefore he has to include those
amounts in his income.

Inventory

Inventory can include property bought and sold in an “adventure in
the nature of trade” (see Friesen, infra). Costs of inventory are not
deductible. If you buy inventory, the costs are easier to calculate.
However, if you manufacture inventory, the costs to produce the
inventory include salary for employees, costs of production, storage,
etc.

Gross Profit = Proceeds of sale or Revenue – Cost of goods sold

Cost of goods sold = Value of opening inventory + Cost of goods
acquired – Value of closing inventory21

Under s. 10(1), a taxpayer can reduce the value of closing inventory
to reflect fair market value. It can revalue the inventory. If the fair
market value of the closing decreases,22 then cost of goods sold
increases and income is reduced. The taxpayer can reduce the value
of property even though the property is not sold yet.


21
 Value of opening inventory (Yrn) = Value of closing inventory (Yrn-1)
22
 Maybe all of the shoes in the inventory have gone out of style and the shoes in the
warehouse are worth less at the end of the year.
                                        63
Friesen v. The Queen (1995) SCC
Facts: Friesen and others had acquired a piece of land as a
business venture. The value of the land decreased and the taxpayer
wanted to declare a loss with respect to his business that year.
Issues: Is Friesen entitled to treat a decrease in market value of land
as a cost of goods and therefore make a deduction?
Holding: Yes.

Reasoning: Per Major J: The plain reading of s. 10(1) allows a
taxpayer to deduct the lower of the cost of the market value or the
paid value of the closing inventory. A piece of land is inventory for the
purposes of an “adventure” in land.

Using the lower cost of valuation wanted to declare a loss of ; ability
to declare a loss before the sale of the property.

The tax authorities argue that s. 10(1) should be limited to “rolling
stock” and not for isolated transactions.


 Friesen calculation

 Proceeds of Sale          $0
 Cost of Goods Sold        -$30,000
 Gross Profit              -$30,000

 Opening Inventory         $100,000
 Closing Inventory         $70,000
 Cost of Goods Sold        $30,000

Rationale:

Note: When Friesen was decided, s. 10(1) did not read the same
way. When Freisen was decided, inventory for a business or for
property held as an adventure in the nature of a venture of trade.
Section 10(1) was amended after Friesen.


As for calculating inventory, last-in-first-out is not appropriate;
otherwise, first-in-first-out or average inventory produces an accurate
picture.

                                   64
Capital Outlays

Immediate CAPITAL OUTLAYS are prohibited under s. 18(1)(b)
because capital outlays produce value over a series of taxation
years. The ITA does not define the term.

If you have an expenditure, you could have:

                  Expenditure




   Cost of          Current        Capital
 Goods Sold        Expenses        Outlays
 (Inventory)


            Non          Depreciable     Eligible cost   Nothing (no
        depreciable      capital costs   expenditures    deduction)
        capital costs


Recall that before 1972, capital costs were not deductible. Today,
they are.

1. Tangible Assets

British Insulated and Helsby Cables v. IRC (1926) HL
Facts: The company invested a significant sum of money into a
pension fund. The company sought to deduct the expense as a
current expense. The tax authorities contended it was a capital
outlay. Had the company started the fund years prior it would have
been current expenses.
Issues: Is the start-up fund a capital outlay?
Holding: Yes.

Reasoning: The expense was non-recurring. It brought about the
existence of the pension fund. The benefit was an enduring one. The
contribution formed the “nucleus” of the pension fund.
                                  65
Denison Mines v. MNR (1972) FCA
Facts: The taxpayer wants to treat the cost of extracting ore as a
capital cost. It argued that the extraction process created
throughways or passageways, which was new capital. The
passageways would provide an ensuring benefit to allow Denison’s
employees to access ore.23
Issues: Are the costs incurred in creating the passageways capital
outlays?
Holding: No.

Reasoning:      The court must look at ordinary commercial
principles to determine whether said expenses are current
expenses or capital outlays. Denison would have incurred the
costs regardless. No new costs were incurred to extract the ore, nor
was any new property created.
Johns-Manville v. The Queen (1985) SCC
Facts: The mining company bought land at the perimeter of its open-
pit mine to allow it to expand and to keep its road in operation. The
tax authorities contended that this acquisition became part of the
capital cost of the mine. The company contended that it was a
current expense.
Issues: Is the land a capital outlay?
Holding: No.

Reasoning: The land did not produce anything permanent or
enduring. Acquiring land was a constant cost, as the land was
consumed for the purposes of expanding the bottom of the mine. The
company did not acquire a new asset since the land disappears as
the mine expands.

Note: It would have been doubly bad had the company lost this case.
First, it would not have had the benefit of declaring the land as a
current expense, and second, because land is not depreciable as a
capital cost (see below), it could not have benefited from CCA.




23
   Denison would have received preferable tax treatment by calling the expenses
capital outlays. It could defer the expenses into future tax year when it would have
to begin paying tax.
                                        66
With regard to advertising campaigns, the courts treat those
campaigns as current expenses. See Tower Investments (1972).
There is an argument, however, that because advertising campaigns
can have enduring benefits – they create new goodwill – taxpayers
should be able to treat them as capital expenses. Under some
circumstances, taxpayers can defer current expenses, like
advertising expenses into future years, when the taxpayer actually
generates an income (see e.g. Tobias).

2. Intangible Assets

The following case produced a most unfortunate result in terms of the
cohesiveness of the jurisprudence. It is hard to reconcile the DNG
case with other repair cases, which are current expenses. Deal with
it by distinguishing it (such as the expenses are not legal
expenses).

MNR v. Dominion Natural Gas (1940) SCC
Facts: The company was finding an injunction to stop them from
selling natural gas in a particular municipality. The company had a
perpetual license to sell natural gas in the municipality. The company
hired a lawyer to defend the injunction, and wanted to deduct the
cost.
Issues: Is the legal expense a capital expense?
Holding: Yes.

Reasoning: The cost was incurred to protect an enduring benefit (to
preserve/protect the asset). The court equates the protection of an
enduring benefit with bringing a new asset into existence.

Kellogg Company v. MNR (1942) Ex. Ct.
Facts: A competitor alleged that Kellogg misused the SHREDDED
WHEAT mark. Kellogg defended its use of the mark and sought to
deduct the legal fees as current expenses.
Issues: Are the legal costs capital outlays?
Holding: No, they are current expenses.


Reasoning: The company was not asserting a “property” right
analogous to Dominion Natural Gas (distinguishing the case). No
new asset was brought into existence or repaired. The company did
not get a material advantage except the re-affirmation of a right or
                                 67
advantage already in existence. The costs of the litigation were not
incurred for the purpose of acquiring an asset to earn future profits. 24

Based on the Dominion Natural Gas case, you would think that the
expenses incurred would have been capital expenses.

Canada Starch v. MNR (1968) Ex. Ct.
Facts: The company paid $15 000 to induce another company to
drop its trade-mark opposition. The tax authorities argued that this
caught was part of bringing the trade-mark into existence.
Issues: Is the inducement a capital outlay?
Holding: No.

Reasoning: The court cites Sun Newspapers to explain that the
court must look at the situation from a business perspective. The test
to be applied is as follows:

     (1) An expenditure for the acquisition or creation of a business
         entity or structure is a capital expenditure;
     (2) An expenditure to maintain the process or operation of profit-
         making is a revenue expenditure.

The trade-mark is not created by registration but by its use. It is not a
capital asset that is acquired, because underlying the trade-mark is
the goodwill of the business.

If you go out and buy a trade-mark, the goodwill acquired is a capital
outlay. If you repair the trade-mark by defending claims, the expense
is a current expense.

3. Repair of Tangible Assets

The courts make a distinction between repairs, which are current
expenses, and improvements or upgrades, which are capital outlays.

Canada Steamship v. MNR (1966) Ex. Ct.
Facts: The company wanted to deduct the cost of replacing the
floors and the walls in its ship. It also wanted to deduct the cost of

24
  Since the mark SHREDDED WHEAT is descriptive, no one can claim a trade-
mark over it, so there were no “rights” in issue in this case per se.
                                   68
replacing its boilers. The ships are capital assets and the capital
authorities argued that the repairs were capital outlays.
Issues: Are the costs to replace the walls and boilers capital outlays?
Holding: Only the costs to replace the boilers are capital outlays.

Reasoning: The walls and floors needed to be replaced. The ship
survived as a ship and therefore these are current expenses. The
costs to the taxpayer are not relevant, unless they show that the
expenses incurred were for upgrades, which might suggest that a
new asset was being brought into existence.

(Ironically) The boilers are a separate asset, which is why they are
treated as a capital outlay, even though they are integral to the ship.
The court was bound by precedent to hold that boilers constitute
separate assets and thus capital outlays.
The Queen v. Shabro (1979) FCA
Facts: The company’s apartment building was built on landfill. The
ground floor started to sink and the company replaced it, with a
reinforced concrete floor.
Issues: Is the repair a capital outlay?
Holding: Yes.

Reasoning: The installation of the piles and concrete floor was
necessary to preserve the value of the building. This ensured that the
building was a long-term usable asset. The floor was a permanent
addition that had not previously existed and it was not a mere repair.
The taxpayer replaced a substantial part of the building.
Goldbar v. The Queen (1987) FCTD
Facts: An exterior wall of the company’s apartment building needed
to be replaced. The company replaced the wall with metal cladding.
Issues: Is the repair a capital outlay?
Holding: No.

Reasoning: The court emphasized the taxpayer’s purpose. Most
repairs will produce at least some enduring benefit. The expenditure
was not a voluntary expenditure made with a view of bringing into
existence a new asset. The expenditure represents a small (3%)
proportion of the value of the asset.




                                  69
New technology is not a decisive factor. Correcting a hidden defect is
also not a decisive factor. The results of these cases are
surprising.

Once we have determined that we are dealing with a capital outlay,
we have to determine the value of the depreciation. We look to the
Regulations (s. 1100ff) and Schedule II. The rate of depreciation in
the Regulations may not have anything to do with the actual rate of
depreciation. This is a policy question. The tax authorities want to
encourage people to

Capital Cost Allowance

Under s. 20(1)(a), a taxpayer is entitled to deduct capital costs as
prescribed by the Regulations. Section 1100(1)(a) outlines the rate of
the deductions. Capital costs are deductible at year’s end, as a % of
the value, and on a class basis, not on an asset-by-asset basis.

Under s. 1102(1) and (2) of the Regulations, the Legislature has
clarified the following rules:

   A taxpayer may not deduct CCA for current expenses already
    deducted in the year (no double deducting);
   A taxpayer cannot deduct the cost of inventory;
   A taxpayer cannot deduct CCA for personal use property;
   A taxpayer cannot deduct CCA for certain types of property
    including land, shares, and debentures.

Under Schedule II, the DECLINING BALANCE METHOD is used for
all classes except Class 13 (leases and leasehold improvements
which are amortized over the span of the lease and the first renewal
term) and Class 14 (intangible assets such as patents and franchises
which are amortized over the useful life of the property. Class 13 and
14 capital cost deductions thus use the STRAIGHT LINE METHOD.

A taxpayer does not have to take a CCA in a given year. The
taxpayer may postpone taking the CCA; however, it cannot
accumulate CCA deductions over multiple years and deduct the
accumulation all at once.



                                 70
RECAPTURE means that the property was sold for more money than
the value after CCA. Since the CCA system uses the class method,
so long as a person keeps replacing depreciated property (by selling
used property and buying new), then the taxpayer can postpone
recapture indefinitely as the capital costs in the class will increase
yearly.

Recapture is treated as business income.

Under some circumstances, the taxpayer can once again return
recapture to the capital cost, if it acquires new property, in the class,
within a certain period. Therefore, if Byear5 = - $4 000 (and therefore
the taxpayer must repay $4 000), then B year6 can be $4 000 if the
taxpayer meets conditions under section 13(4).

TERMINAL LOSS occurs when the property was sold for less money
than the CCA. Again, since the CCA system uses the class method,
terminal losses may be offset. A taxpayer can deduct the terminal
loss in the year that the property was sold, per s. 16(1).

Both recapture and terminal loss re-adjust the taxpayer’s actual costs
(or gains), because the act imposes a fixed rate of depreciation for
each class.

Property that is acquired or sold during the year is subject to the ½
year rule. This amounts to a sort of rough justice, because a person
could acquire property in January or in December and otherwise
benefit from the full CCA. Furthermore, if the taxation year is a
shortened one (because the business is starting up), the taxpayer
has to pro-rate the CCA that year, per s. 1100(3).

When the taxpayer has more than one source of business or property
income, the taxpayer must separate the classes for each source.
Furthermore, under s. 1101(1ac), the act requires that the taxpayer
put each building used for rental purposes with a value over $50,000
in separate classes.




                                   71
The CCA system uses cumulative formulae. Look at row A for
example.


           Year 1         Year 2       Year 3
           Acquires     3 Sells bus #1 Buys        a
           buses          for $18,000  $50,000 bus,
                                       sells bus for
                                       $15,000
A+         $75, 000       $75, 000     $125,000      Total Capital Costs


B-         $0             $0             $0              Recapture     (usually
                                                         $0.00)

E-         $0             $11,250        $24,975         Accumulated CCA


F          $0             $18,000        $33,000         Lesser of capital cost
                                                         or proceeds of dispo.

0.50    (A- $37,500       n/a            0.50 ($50,000   For    new     property
                                                         acquired     or     old
F)                                       - $15,000) =    property sold; (A-
                                         $17,500         F)>$0, s. 1102(2)
Sum        $37,500        $45,750        $49,525         A+B-(E+F) – 0.50(A-F)
total
Rate       0.30           0.30           0.30

CCA        $11,250        $13,725        $14,857


How do we assess capital cost allowance for non-arms length
transactions?

Under section 69(1)(b)(ii), a taxpayer who has given away capital
property as a gift is deemed to received fair market value for the
property. This could trigger recapture. Under section 69(1)(a), if the
seller sold the property for more, the seller will have to pay capital
gains and the buyer will have to reduce the value to fair market value
for tax purposes. Section 13(7) is another anti-avoidance rule.

For some classes of property, the CCA is limited to the amount of
revenue generated from the property.




                                    72
What is the cost of the property in the class?

Ben’s Ltd. v. MNR (1955) Ex. Ct.
Facts: Ben’s acquired a neighbouring piece of land with three
buildings. Ben’s allocated $39000 for the purchase of the buildings
(to be used for capital cost allowance) and $3000 for land (which is
ineligible for CCA). The tax authorities claimed that the entire $42000
was dedicated for the purchase of the land, because Ben’s had no
intention to using the buildings to generate revenue.
Issues: Is Ben’s entitled to take CCA?
Holding: No.

Reasoning: The courts have to look at the commercial purpose of
the transaction. The taxpayer acquired the property to build and
extension to their business. Under Reg. 1102(1)(c), for the property
to be depreciable, it must be used to earn income from business or
property.

A person cannot capitalize interest payments and it those payments
to the capital costs of acquiring property acquired for a capital gain
(see e.g. Sterling). Interest to service the purchase is considered a
cost of ownership not part of the purchase price. Storage costs are
also not considered part of the capital cost, but legal costs related to
the acquisition are, because they form part of the purchase price.

Section 68 allows the tax authorities to change the allocation of
proceeds of disposition, if the authorities consider the allocation
unreasonable (see Ben’s). This provision is generally not used for
arms-length transactions, because the parties determine for
themselves the purchase price. The tax authorities may use section
68 for transactions between arm’s length transactions involving tax-
exempt authorities (e.g. charities).

When is property acquired?

Capital property is acquired when the expense is incurred and when
the taxpayer acquires the elements of the property (i.e. possession,
control, benefits, title, risk, etc.). Mere retention of the title by the
seller to guarantee payment will not prevent acquisition for tax
purposes.


                                   73
Under section 13(28), the Act explains that a building is available for
use when (i) it is first used, (ii) construction is complete, (iii) 2 year
rolling start date, and (iv) time of disposition.




Therefore, even if construction is incomplete, the taxpayer can
deduct the CCA under the 2-year rolling start date. The ½-year rule
also does not apply under that condition.

Tax Treatment of Intangible Property

Eligible capital expenditure (ECE) is the equivalent to CCA. The
definition is one of exclusion, as it excludes CCA and costs of
tangible property. It is a “catch all” category with respect to capital
outlays. The taxpayer can depreciate ¾ of the cost, with a rate of 7%
(one class). Unlike CCA, capital gains and losses are calculated
within the ECE system under section 14(1)(b).

If proceeds of disposition exceed what remains of the undepreciated
capital, the taxpayer only has to account for ¾ of the proceeds. A
with recapture under the CCA system, recapture is treated as
business income.

Royal Trust v. The Queen (1982) FCTD
Facts: The company wants to raise capital by selling shares. The
receipt of the investment money is a capital receipt. The company
had to pay a fee to the underwriters and wants to deduct the fee as
ECE.
Issues: Is the commission ECE?
Holding: Yes.

Reasoning: The commission was the cost of raising the capital and
therefore a capital outlay.
The Queen v. Saskatoon Drug & Stationary (1978) FCTD
Facts: The company wants to attach goodwill to a lease, so that it
can deduct the cost. The taxpayer paid a premium for the leases on
top of the balance of the rent because of the goodwill attached to the
location.
                                   74
Issues: Is the goodwill a capital expenditure?
Holding: Yes.

Reasoning: The court concluded that the premium was part of the
cost to acquire the lease. The parties determined the price in an
arm’s-length transaction. The lease conferred the taxpayer the
goodwill of the location.

Had this case been decided today, the result might have been
different.

Additional Notes:




                                 75
76
                   CAPITAL GAINS AND LOSSES

Prior to 1972, capital gains were tax exempt. Now, they are taxed at
50% of the gain but deductible at 50% of the loss. The retention or
use of property does not give rise to a capital gain; only the
disposition of property does. Property that is used to produce
business or property income, when sold, can also give rise to a
capital gain.

Intuitively, one would think that a person who buys property on the
speculation that it will increase in value is seeking a capital gain. That
person would be wrong. Intention to make a capital gain is indicative
of income from a business or property. The court places
tremendous emphasis on intention (both primary and
secondary).

Californian Copper v. Harris (1904) Scot. Ex. Ct.
Facts: The company bought a copper field on speculation. They did
not have sufficient capital to develop it. They sold it to another
company.
Issues: Are the proceeds from the sale of the field a capital gain?
Holding: No. They are business income.

Reasoning: “Where the owner of an ordinary investment chooses to
realise it, and obtains a greater price for it than he acquired it at, the
enhanced price is not profit.” However, speculative investments that
are under-capitalized have to be sold quickly. Those investments
produce business income.

Rationale: Flipping property is regarded as an activity in the
nature of trade and thus gains are to be treated as business
income.

Regal Heights v. MNR (1960) SCC
Facts: The company purchased land outside of Calgary to build a
shopping centre. They talked to city officials about zoning. They
made sketched, composed a list of clients, and discussed financing.
They soon discovered that another person was building a mall a few
miles away and they abandoned their project. They sold the land at a
profit.
Issues: Are the proceeds from the sale of the land a capital gain?

                                   77
Holding: No. The proceeds are business income.

Reasoning: The primary purpose of the taxpayers was to build a
shopping mall. They did not sign up tenants, or obtain capital; their
work was promotional in nature. Their secondary intention, however,
was to sell the land at a profit if the mall business did not work out.

Rationale: A secondary intention to sell property can turn a
would be capital gain into income from business.

In Hughes, the court divides
the      income       between
business and capital gains.
Hughes         bought        an
apartment for the purpose of
renting out the units. When
that       plan        became
unfeasible, she converted
the apartment into condos
and sold them. Between the
original purchase and the
decision to convert the units, the growth in value was treated as a
capital gain; the latter part was treated as business income, because
she sold “inventory”. Again, the secondary intention of the taxpayer
was to sell the building for a profit, which triggers business income.

The next case is somewhat problematic. Unlike the previous cases
that pertain to land, Irrigation Industries involves shares. The court
treats the sale of the shares as a capital gain.

Irrigation Industries v. MNR (1962) SCC
Facts: The taxpayer bought shares in a mining company issued at
an IPO. The shares were highly speculative in nature, because the
mining company was starting up. There was no chance of payment of
dividends in the foreseeable future. The taxpayer’s intention was to
sell the shares at a profit. The investment was under-capitalized as
the taxpayer sold some of the shares after only a few months to
repay the loan used to finance the original purchase.
Issues: Are the proceeds from the sale of the shares a capital gain?
Holding: Yes.

Reasoning:    Corporate shares are different from land (distinguish
                                  78
Regal Hastings), because shares are primarily a vehicle for
investment.

The court generalizes as states that in every case involving the
purchase of securities, the taxpayer intends to sell the securities at a
profit. By their very nature, shares are an investment and the mere
speculation that they will increase in value does not render their sale
income from business, unless per Taylor, infra, the taxpayer
    (1) Deals with the property in the same was a dealer of that
         property, or
    (2) The nature and quantity of the property is such that it
         excludes the possibility of keeping the property (that it must
         be disposed of in a trade transaction).

There is nothing to enjoy from the purchase of the shares (unlike the
purchase of land).

Rationale: The purchase and sale of shares outside of the
context of dealing in that property results in capital gain.

Critique: Cartwright dissented and applied Regal Hastings to hold
that the sale of the shares produced business income.

Note: Section 39(4) allows a taxpayer to elect to characterize
gains and losses from the disposition of Canadian securities as
capital gains and losses. A Canadian security is, pursuant to
section 39(6) a security in a corporation resident in Canada. Section
39(5) prohibits traders or dealers in securities from benefiting from
this exemption. The court will look at contextual factors such as the
knowledge of the taxpayer, the frequency of trades, the duration of
the holdings, and the nature of the securities to determine whether
the taxpayer is a dealer under section 39(5).

Does this distinction really make sense? Look at the problem that it
has caused in other cases (see e.g. Ludco, where the court has to
say how shares can be treated as giving rise to business income).

MNR v. Taylor (1956) Ex. Ct.
Facts: Taylor is the president of a company. The company needs
lead, but it is only authorized to purchase a 30-day supply. Taylor
bought lead and resold it to the company at a profit.
Issues: Did the sale of the lead result in a capital gain or business
                                  79
income?
Holding: It resulted in business income.

Reasoning: The court focused on Taylor’s intention. He bought the
lead for the purpose of re-sale; he couldn’t do anything else with it
because of the nature of the property. Taylor bought it as a trader in
lead.

Rationale: A one-time flip of property does not preclude the
possibility that the sale results in income from a business, nor
is intention to make a profit determinative either. So long as the
taxpayer acts in a manner consistent with a trader of the
commodity, the sale can be qualified as income arise from an
adventure in the nature of trade.

In the end, the court must assess: (1) frequency of the transactions,
(2) quantity of the property, (3) length of time it is held, (4) skill of the
taxpayer, (5) time spent trading, (6) circumstances surrounding the
trading.

Rules for Calculating Capital Gains

A taxable capital gain is 50% of the capital gain. The capital gain =
proceeds of disposition – adjusted cost base (“ACB”) – outlays to
make the disposition.

Section 54 defines the ACB: for depreciable property (ACB = Capital
Cost = Cost + Capital Expenditure25) and for non-depreciable
property (ACB = cost of the property, because no capital
expenditures can be taken, see Sterling – the case with the gold
bars). To assess the cost of the property, the court will consider
commercial principles. The court will also look at section 53 which
contains a series of inclusions/deduction.

The taxpayer starts with the purchase price, then it adds the adds the
delivery costs, engineering fees, legal fees, provided they are
incurred to inquire the property.


25
  The taxpayer’s own labour does not count as a capital expenditure. The law draws
a distinction between capital and labour.
                                       80
Costs of ownership are not added (i.e. interest to service the loan,
municipal property taxes, maintenance and repairs)26 but
improvements treated as capital costs are added to the capital costs.
Also, costs incurred to protect the property can be added to the
capital cost (i.e. costs to fight expropriation), see Bodrug Estate v.
Canada.

The cost to acquire the property can include a debt to pay or a debt
forgiven (see problem below).

What about barter transactions? This is a valuation issue: what would
someone else have paid in cash for the same item (D’auteil
Lumber). If one side of the transaction is easy to valuate, that’s the
value of the other side. This rule works for the disposition of property
as well.

Problems on p. 570

#1: The taxpayer offers a prospective executive the offer to buy his
shares to induce him to take the job. The taxpayer reneges on the
offer and the executive sues. The taxpayer pays $1.3 M to settle and
keep the shares. This money is paid to preserve the title and can be
added to the capital cost. If the taxpayer’s company is taken over and
fails to disclose the settlement (fraud) and settles the second case for
$2.5 M, that money cannot be added. Title to the shares was never in
issue. The shares were not at risk.

#2: Debtor owed $50 in interest. The creditor takes $100 for the
property and clears the debt. The creditor’s cost to acquire the
property is $150.

#3: Taxpayer buys bonds for $1200, $200 representing interest
accrued (see Antosko). The buyer must declare the income under
section 9, but can deduct the interest already accrued under section
20(14). Under section 53(2)(e), the taxpayer has to reduce the
amount of the interest from the capital cost, yielding a result of
$1000.
26
  Under section 21, the taxpayer can add interest expenses to depreciable property
and depreciate the interest in the CCA system, instead of deducting it as a current
expense. Then the taxpayer can add the interest to the capital cost to minimize the
capital gain.
                                        81
Finally, for depreciable property (i.e. buildings) under the CCA
system, the act needs a way to account for any capital gains (in
case the property depreciates but the taxpayer sells it for a
profit). For non-depreciable property the act needs a way to
account for both capital gains and capital losses (i.e. land).

Adjusted Cost Base

The transition rules (ITAR) are designed to protect pre-1972 capital
gains from taxation. The rules provide for a rule, under Section 26(3)
ITAR. The taxpayer can select the median of the following values:

     (1) The actual cost of the property
     (2) The fair market value on “V”aluation Day (Dec. 31, 1971 for
         property, Dec. 22, 1971 for publicly-traded shares)
     (3) Proceeds of disposition

Example

If the cost of the property was $30, the V-day value, $40, and the
proceeds, $60, the rule protects the increase between $30 and $40.

Individuals can also elect to use Section 26(7) ITAR to use the V-day
value for all capital gains.27

For depreciable property, there is no capital loss (because of the
terminal loss system under the CCA system). Again, the Act protects
the pre-1972 gain. The proceeds of disposition = capital cost +
amount in which the proceeds > V-day value.

1. Deeming Provisions

The Act deems the value of property after particular transactions. We
have seen examples of deeming provisions before (section 69 deems
the transfer of property as gifts at a price equalled to fair market
value).


27
   This is advantageous if the V-day value of the property is greater than the
proceeds of disposition. It applies to all property.
                                     82
Fair market value
     Death (section 70(5)): a person is deemed to dispose of
       property and the estate has to declare capital gains. The
       legatee is deemed to acquire the property at fair market
       value.

        Prizes (section 52(4)): deems the value of the prize to be the
         fair market value at receipt.28

        Dividends in kind (section 52(2)): deems the value of the
         dividend to be the fair market value at receipt. The receipt of
         the dividend is taxable as income from property.

Nil value
     Shareholder of a bankrupt corporation (section 50(1)):
        deems the value to be $0 so as to avoid the need to dispose
        of the worthless shares; if the corporation becomes solvent
        again then the shareholder pays capital gains on the increase
        in value because the shareholder is deemed to re-acquire the
        shares at $0.

Adjusted Cost Base
    Transfer to a spouse (Section 73(1)): the acquiring spouse
       is deemed to acquire the property at the ACB of the
       transferor. This works to rollover any capital gains until the
       transferee spouse sells the property.

2. Rollover Provisions

A rollover allows a taxpayer to transfer accrued capital gains or
losses to another taxpayer without triggering the obligation to pay.
We have also seen examples of this before (section 73(1) allows
spouses to transfer property inter vivos, see Lipson).29

        Transfer to widow (section 70(6)): the widow is deemed to
         acquire the spouse’s property at cost, but upon the widow’s

28
  Recall that in Canada we do not pay tax on lottery or prize winnings unless they
are obtained in the course of employment.
29
   This can create a latent tax liability especially in divorce settlements, as the
receiving spouse will eventually be liable to pay capital gains if the property is sold.
                                          83
       death, the base capital cost is deemed to be the same
       amount. The widow can elect out of this provision.

      Transfer of farm property to a child (section 73(3)): the
       rollover is mandatory.

      Transfer to a corporation (section 86(1)): when a person
       incorporates a sole proprietorship, for example, there is a
       transfer of property between two tax-paying persons. The Act
       allows the transferor to transfer the accrued capital gains and
       losses. Both the corporation and the transferor must agree to
       the rollover.

      Exchange of shares (section 51): converting preferred
       shares into common shares or debentures (debt) into shares
       (equity) triggers a rollover.

      Exchange for shares (section 85(1)): transfer of assets to a
       corporation in exchange for shares can roll over a capital gain
       provide both parties elect in.

3. Special Rollover (Replacement Property, Section 44)

If the taxpayer’s property is destroyed by fire, for example, this will
trigger a capital gain (BCN). The proceeds of the insurance
settlement represent the proceeds of disposition. Furthermore, if the
taxpayer sells property, like a manufacturing plant, and buys a new
one, this will also trigger a capital gain.

Section 44 allows the taxpayer to defer the capital gain until the
eventual and voluntary re-sale of the property. The taxpayer must
elect into the deferral. The taxpayer can acquire the new property
before the old one is disposed of; however, it would look suspicious
for involuntary dispositions.

For involuntary dispositions (“former property”)

      Proceeds must compensate for theft, destruction or
       expropriation of the property
      The property cannot be stock in a corporation
      The deeming provision becomes available in the year when
       the settlement amount is receivable
                                  84
        Can take the deferral up to two taxation years after the
         disposition

For voluntary dispositions (“business property”)

        Capital property of the taxpayer used for the purpose of
         producing business income (not property income)
        Must be immovable/real property
        Does not include rental properties
        The replacement property must be a “reasonable
         replacement” and the use must be the same or similar to the
         former use.
        Can take the deferral up to one taxation year after the
         disposition

Consider the following example:
The adjusted cost base of a plant = $300,000
The proceeds of disposition = $500,000
The fair market value = $500,000

If the taxpayer does not elect to replace the plant, $200,000 of the
proceeds becomes taxable as a capital gain. Suppose that the
taxpayer used only $475,000 to purchase the new plant:

Section 44(1)(e)(i): The taxpayer must calculate:

     A. The proceeds of disposition – adjusted cost base ($200,000)
     B. The proceeds of disposition – total replacement cost
        ($25,00030)

The amount that the taxpayer can then defer is A-B (or $175,000).

Section 44(1)(f) adjusts the cost base for the new property. The new
cost base will be: Cost of the Property – A – B ($475,000 - $200,000
- $25,000 = $300,000, which is what the taxpayer paid originally for
the plant).




30
  This number cannot be negative. Therefore if the replacement case exceeds the
proceeds (because the taxpayer under-insured), this value is $0.
                                      85
4. Additions to the Cost Base (Section 53)

The ACB is not allowed to fall before $0 unless the situation involves
a partnership. If the ACB falls before $0, then a capital gain is
triggered automatically and the ACB is reset to $0.


Disposition and Proceeds of Disposition

A DISPOSITION includes anything that gives rise to proceeds of
disposition. The court in Compagnie Mobilière BCN gave the term a
large scope. It includes loss, theft, destruction, and permanent
transfers of use.

According to IT-170R, an entitlement to the proceeds of disposition
arises when the right to payment is absolute, but not necessarily
immediate. The payment is not therefore subject to a condition
precedent. A transaction structured in a way to defer payment to
make it appear as a lease will be interpreted by the courts in its
substantive form (i.e. a capital acquisition and not a capital lease).
The presence of a condition subsequent or determinable condition do
not affect the initial disposition, but may, if realize, trigger another
disposition sometime in the future.

Problems on p. 575

#1: The purchaser sells property for $10,000. He receives $5,000 in
cash and a $5,000 mortgage. The vendor sells the mortgage
immediately for $4,000. The proceeds of disposition are $9,000. By
combining the transactions or by breaking them apart, the result
would be the same.

#2: The developer has a claim against the purchaser for $65,000 on
the construction of an immovable. The purchaser sells the immovable
back to the developer. The proceeds of disposition include the $1
cash, the $160,000 bank mortgage which the developer assumes
from the purchaser, and the $40,000 waiver of the promissory note.
The $65,000 is not treated as part of the proceeds of disposition
unless the developer could prove an absolute right (either by
demurrer or by judgment). In this case, the developer only had a
claim, but no right.

                                  86
#3: Frank acquires shares in X Co from Charlie for $7.8 million.
Charlie agrees to buy a $1.4 million debt from X Co for $600
thousand (fair market value). The proceeds of disposition of the
shares, therefore, is $7.8 million - $1.4 million + $600 thousand (or
$7 million). Charlie was required to acquire the debt as a condition of
the sale of the shares.

     The interest that the debt produces then forms part of
     Charlie’s income, while repayment of the capital may in
     future trigger a capital gain if the debtor pays Charlie more
     than $600 thousand

1. Triggering a disposition

        Transfer of beneficial ownership but not legal title triggers
         a capital gain (loss).

        Transfer of the elements of ownership also triggers a
         capital gain.

        Compensation for damaged property (section 54): triggers
         a capital gain or loss, unless the (insurance) money is used to
         acquire replacement property. The taxpayer has to allocate
         the amount to the portion of the property that was damaged.
         The taxpayer is deemed to have disposed of that part of the
         property.31


        Changing the characteristic of the property without
         disposing of it can trigger a capital gain. This applies to
         shares and to debts primarily (IT-448). If the taxpayer
         changes enough of the fundamental characteristics, it is
         deemed to have disposed of the property. Fundamental
         characteristics in case of a debt include: (1) the identity of the
         debtor, (2) the interest rate, (3) the maturity date, and (4) the

31
   Consider the following example. A’s immovable is damaged in a fire and 40
percent of the building is destroyed. A receives insurance proceeds of $100
thousand. If the value of the building was $400 thousand, this could trigger a capital
gain or loss. If the cost of the building was $200 thousand, then the cost of 40
percent of the building is $80 thousand. The taxpayer would have a net capital gain
of 50 percent of ($100 thousand - $80 thousand) or $10 thousand.
                                         87
       principal amount (see General Electric Capital Equipment
       Finance (2002) F.C.A.)

      Transfer of a legal title to a trust that is not a bare trust
       triggers a capital gain.

      Transfer of legal title to an RRSP triggers a capital gain.

Deemed dispositions
    Change in use (i.e. from income-producing to personal use
     or vice versa) will trigger a capital gain. This is not in the Act,
     but derived from case law (see Hughes, supra). The tax
     authorities have adopted the court’s position from that
     decision (see IT-218R).

      Ceasing to be a Canadian resident (section 128.1) triggers
       a capital gain.

      Death (section 50(5)).

      A trust is deemed to dispose and re-acquire its property
       every 21 years. Income trusts, for example, never die and
       therefore if this rule was not in place, a trust could avoid
       paying capital gains.

2. Avoiding triggering a disposition

      Legal title transferred to secure a debt (like a mortgage)
       does not trigger a capital gain as there is no change in the
       beneficial use of the property.

      Partition of co-ownership does not trigger a capital gain
       unless the co-owners do not divide the property according to
       their proportion of ownership.

      Issuance of debt or shares does not trigger a capital gain.

      Granting of an option to acquire does not trigger a capital
       gain. If the buyer exercises the option, the price paid for the
       option is subsumed into the purchase price. If the buyer
       does not exercise the option, the money paid for the

                                  88
         option is a capital gain, as the ACB for the option is
         deemed to be $0.

Problems on p. 581

#1: Property was disposed of in 2005 but the final payment was not
received until 2007. The property is disposed of in 2005. The
existence of conditions precedent is irrelevant to the analysis.

#2: Trying to disguise a sale as a lease does not postpone the
triggering of a capital gain. The court will look at the substantive
relationship between the parties and treat the lease (or part of it) as
capital repayment (see Groulx, supra). Capital leases are treated as
sales for tax purposes.

3. Allocating cost base when a partial disposition of land occurs

Under section 43, when part of the property is sold, it may trigger a
capital gain. The taxpayer can determine the capital gain/loss by
looking at the relative value of the property of the part sold.

                                              The capital gain would be
                                              $5000 ($25,000 as proceeds
                                              of disposition and $20,000 for
                                              the cost).

                                              In The Queen v. Golden
                                              (1986) SCC, the court put a lot
                                              of weight on the bargain struck
                                              by parties in an arm’s-length
                                              transaction.32 Also, the court
                                              should not judge the matter
                                              solely from the perspective of

32
   The buyer allocated most of the proceeds to the sale of the land as opposed to the
building. The reduced allocation for the building avoids recapture, taxable at 100%.
The profit on the sale of the land is taxable at a rate of 50% of the gain. The
opposite would be true for the purchaser. The purchaser would want a higher
allocation for the building so that it could depreciate the value under the CCA
system. This represents true bargaining and thus the court should not interfere,
unless (1) one party is not taxable, (2) the building is demolished, or (3) the
seller has an inordinate amount of business losses carried forward.
                                         89
one of the taxpayers. Although the land might have been worth more
to the vendor, it may not have been the same for the purchaser.

Under section 13(21.1)(a), a taxpayer is not entitled to allocate
proceeds from the sale of a building to produce a terminal loss
when there is a capital gain generated on the land. The taxpayer
has to readjust the proceeds of disposition for the building to an
amount greater than the UCC. For example, if the sale price for land
and a building was $100,000 and the taxpayer had a UCC on the
building of $50,000 and the land was bought for $40,000, the
taxpayer has to allocate $50,000 to the sale of the building. Anything
less would result in a terminal loss, which is not allowed under the
provision.

4. Charitable Donations

The act provides substantial subsidies for persons who give capital
property other than money to charities.

      Real and personal property (section 118.1(6)) – if a person
       gives capital property to a charity, the taxpayer can choose
       the amount of the proceeds of disposition, despite the rule
       under section 69 which deems the donative transfer to be at
       fair market value. The result is that the taxpayer can trigger a
       capital loss, but it can nullify the amount of the charitable tax
       credit determined by the value of the gift.

      Shares (section 38(a.1)) – deems the capital gain to be $0
       (ACB = POD). Furthermore, the taxpayer does not have to
       reduce the amount of the tax credit

      Ecological property (section 38(a.2) – deems the capital
       gain to be $0. Furthermore, the taxpayer does not have to
       reduce the amount of the tax credit

      Canadian cultural property (section 39(1)(a)(i.1) – same.

5. Reserves – Postponing the Declaration of Capital Gains

       Sale Price         $100,000
       Cost to Purchase   $70,000
       Profit             $30,000

                                     90
                      Year 1       Year 2       Year 3       Year 4       Year 5       Year 6
Payment         by
Buyer                 $25,000      $15,000      $15,000      $15,000      $15,000      $15,000


Profit                $30,000

                                   $22,500      $18,000      $12,000
Reserve
Carryover
                                                                                       No
Reserve        =      -$22,500     -$18,000     -$13,500     -$9,000                   carryover
Outstanding
                                                                                       after
Payments / Sale
                                                                                       Year    5
Price * Profit
                                                                                       unless
"Alternate                                                                             family
Reserve"                                        -$12,000     -$6,000                   farm or
                                                                                       small
                                                                                       business
Amount Declared       $7,500       $4,500       $6,000       $6,000       $6,000



Capital gain reserves require an additional calculation. The maximum reserve is the lesser
of the two reserves. It is determined by taking 0.20 * (4 - number of preceding years after
disposition).

Profit                $30,000
                                   $24,000      $18,000      $12,000      $6,000
"Alternate
Reserve"              -$24,000     -$18,000     -$12,000     -$6,000
Amount Declared       $6,000       $6,000       $6,000       $6,000       $6,000


6. Expenses of Disposition

Expenses incurred to dispose of the property are deductible. They
include for example, fixing up expenses (for income-earning property
only, not for personal use property), finder’s fees, commissions, legal
fees, surveyor’s fees, transfer taxes (?).

Capital Losses

Capital losses generally are only deductible against capital gains.
They can be carried forward or backward. Some capital losses are
deductible against all sources. These include ALLOWABLE
BUSINESS INVESTMENT LOSSES which are not business losses,
but capital losses on the disposition of debt/shares of small business
corporations that are private corporations and therefore not publicly
traded and that carry on active business (see section 38(c)). Capital
                                              91
losses incurred on death are deductible against all sources in the
year of the death and retroactively in the year preceding the death.

Capital losses for PERSONAL USE PROPERTY are generally not
deductible at all; even though capital gains on personal use property
are taxable. Personal use property is property that is for the personal
use or enjoyment of the taxpayer, and includes debt payable over
time that arises from the sale of personal use property as well as
options to acquire personal use property. Section 40(2)(g)(iii) deems
capital loses to be $0. There are some exceptions:

        If a purchaser of personal use property defaults on a debt, the
         amount of the loss can offset the gain on the same property
         (section 50(2)).

        A taxpayer also may deduct capital losses for LISTED
         PERSONAL PROPERTY against gains made on that
         property (section 41). Listed personal property means prints,
         etchings, drawings, paintings, jewellery, rare books, stamps,
         and coins. The definition is exhaustive (therefore hockey
         cards are not listed personal property). Section 41(2)(b)
         allows the taxpayer to deduct the loss retroactively for three
         years or up to seven years after the loss is incurred.33

Capital losses for depreciable property are not deductible. Those
losses are terminal losses and are treated as business losses.
Eligible capital property has a built-in capital gains/losses formula.

The De Minimis Rule, Superficial Losses, Computing the ACB
for Dispositions of Identical Property

Section 46 provides that a person does not need to declare a capital
gain for property sold for under $1000.

             Actual     Deemed
 POD         $1,200     $1,000      Always


33
  The provision reads from the perspective of the gain: (b) deduct from the amount
determined under paragraph 41(2)(a) such portion as the taxpayer may claim of the
taxpayer's listed-personal-property losses for the 7 taxation years immediately
preceding and the 3 taxation years immediately following the taxation year, except
that for the purposes of this paragraph […]
                                       92
                                take the
                                greater
                                value
ACB        $800      $1,000

Actual     $400
Deemed               $200

This is susceptible to abuse if a person fragments property and
alienates it in units under $1000. If the property comprises a set and
the components are sold to the same person then the act will join the
adjusted cost bases and the proceeds of disposition together (section
46(3)).

A SUPERFICIAL LOSS occurs when a person sells and buys back
property to artificially trigger a loss (section 40(2)(g)(i)). Section
53(1)(f) stipulates that the amount of the loss is added to the adjusted
cost base of the new property if the new property is (i) the same or
identical property (i.e. shares in the same company), (ii) the new
property was acquired within 30 days before or after the disposition,
and (iii) the property was acquired by the taxpayer or an
AFFILIATED PERSON which is a smaller group than related persons
and includes spouses and corporations under the taxpayer’s control.
This provision is an anti-avoidance rule designed to ensure that
taxpayers do not benefit from capital losses until they really dispose
of the property. The taxpayer needs to wait more than 30 days to get
around this rule.

Finally, to compute the adjusted cost base when identical property is
sold (like shares), the taxpayer must take the weighted average of
the costs to acquire the property. Consider the following example. A
taxpayer acquires 20 shares in X Co. in 2002, 2003, and 2004,
paying $8, $10, and $15 per share respectively. If in 2005 X sells 10
shares for $20, the capital gain is calculated as follows:

Adjusted cost base = average cost x number of shares sold / total

ACB = ($8 x 20 + $10 x 20 + $15 x 20) x 10 / 60
ACB = $110

The capital gain would therefore be $90.



                                  93
Intra-family Transfers

We have already looked at various roll over provisions (see section
73 for transfers between spouses). Section 69 treats gifts as being
transfers at fair market value. However, for sales in non-arm’s length
transactions, the transferor is deemed to have received fair market
value even if the sale was less than fair market value (and vice
versa). The transferee does not get the benefit. This can be avoided
by using PRICE ADJUSTMENT CLAUSES. Lawyers will include
these clauses when dealing with the sale of goodwill, which is hard to
value. The clause stipulates that if the tax authorities re-assess the
transaction, the parties will adjust the sale price retroactively. Courts
have approved the validity of these clauses, if:

       The parties intend to transact at fair market value; and
       The parties agree to adjust the price retroactively.

Usually a rollover provision (section 85) applies when dealing with
transfers to corporations (in exchange for shares). Again, the share
value may have to be adjusted if the tax authorities look at the
transaction again under section 69.

Principal Residence

If the taxpayer so elects, the taxpayer does not have to pay capital
gains on his or her principal residence. The requirements to benefit
from the exemption include:

   (a) It must be “ordinarily inhabited” in the year by the taxpayer, its
       spouse, former spouse, or child.
   Or
   (b) The taxpayer needs to file a section 45(2) or (3) election
   (c) Only one personal residence is allowed
   (d) If an election under (b) is filed, the election can last up to 4
       years unless the taxpayer was forced to live elsewhere
       because of the taxpayer’s current employment.
   (e) The land upon which the principal residence lies is less than
       ½ hectare.
   (f) The principal residence does not have to be situated in
       Canada.

                                   94
Married couples are entitled to exclude only one principal residence
per family. Since December 31, 1981, they cannot have more than
one.

1. Maximum size requirement

The test to determine whether it is “necessary” for the taxpayer’s
personal residence to exceed ½ an acre is an objective test. In Yates
v. The Queen (1983) FCTD, the court held that because the
municipality imposed minimum property requirements through a
zoning bylaw, the tax payer necessarily had to live on a 10 acre
property and thus the capital gain was exempt. In Carlile v. the
Queen (1995) FCA, the court held that the test for necessity was
subjective, finding that the leased portion of farm land did form part of
the principal residence. The FCA later criticized this decision in
Stuart Estate v. The Queen (2004) returning to an objective test.
The court can consider zoning restrictions, barriers to subdivision,
accessibility to roads, but will not give much weight to personal space
and privacy. The capital gain on the unnecessary/excess portion of
the property is taxable, because it represents a personal
consumption choice of the taxpayer.

2. Ordinarily Inhabited

Flipping houses could preclude the taxpayer from benefiting from the
personal residency exemption. Because a flipper trades in homes,
the homes are considered to be inventory and the income generated
is business income.

3. Calculating the Taxable Gain




                                   95
Duplexes are treated as separate residences unless access is
created between them, turning them into one space. If however, the
taxpayer has a boarder or a home office, the whole of the space can
be treated as the taxpayer’s principal residence. If however the
taxpayer takes CCA on the portion of the house used to earn
income, then the house is treated as two pieces of property, the
personal residence part being exempt from capital gains.

4. Change in Use Rules

Consider the following example.

Year      Event                       Option 1             Option 2
1995      X buys a house in           X can claim the      X can claim the
          Montreal and lives in it    exemption      on    exemption       on
          with his wife and kid. He   the capital gains    the capital gains
          pays $100,000.              until now.           until now.
2000      X moves to Calgary on a     X can claim the      X     can    elect
          job. His kid remains in     capital     gains    under      section
          the house.                  exemption on his     45(2) to deem
                                      Calgary home if      the      Montreal
                                      he owns it, but      house to be his
                                      cannot claim it      personal
                                      for the Montreal     residence       so
                                      home.                long as he does
                                                           not take CCA.
                                                           This can apply
                                                           for 4 of the 5
                                                           years     he     is
                                                           away.
2004      X returns from Calgary      X pays capital       X pays capital
          and lives in the house.     gains on the         gains on the
                                      Montreal home.       Calgary home.
2007      X sells the house for       X can claim the      X can claim the
          $300,000.                   exemption       on   exemption       on
                                      the capital gains.   the capital gains.

Under option 1, to determine the capital gain on the Montreal home,
X would have to apply the formula.




                                  96
Taxable gain = $200,000 – ($200,000 x (1 + 834)/13) = $47,000.

Recall that in Hughes, when the property changed from capital
property (the apartment) to inventory (condo units for sale), nothing
happened in terms of triggering a capital gain. However, when the
property is converted from personal use to income earning, section
45(1) of the Act deems a disposition (see Duthie Estate v. The
Queen (1995) FCTD).

Section 45(1)(a)(ii) provides that for any capital property when its
use changes from personal use to income producing, the taxpayer is
deemed to dispose and re-acquire the property at fair market value.
This is not necessarily disadvantageous for the taxpayer as the
taxpayer can then deduct current expenses, such as interest, as well
as CCA.

Section 45(2) allows a taxpayer to avoid the effect of the deeming
provision provided the taxpayer does not take CCA. The taxpayer
must still report any income earned from the property as business
income, but the taxpayer can maintain the designation as personal
use property (such as principal residence). The election is
rescindable and if it is, a disposition is deemed to occur in the year
that the election is rescinded. The election does not wipe out the
exemption period retroactively.

Section 45(3) applies to protect the taxpayer from paying capital gain
on property that was income-producing and which became personal
use. The election does not have to be made until the taxpayer
disposes of the property.

Recall, the taxpayer cannot take a capital loss on personal use
property. Furthermore, depreciable property is not subject to capital
losses either. If, however, the taxpayer recognizes a terminal loss on
the property (i.e. the house burns down while it is being rented), then
the taxpayer recognized a deemed disposition when there was a
change of use and section 45(2) does not apply.




34
     For taxation years: 1995-1999, 2005-2007.
                                         97
Under a section 45(2) and 45(3) election, a personal residence can
qualify as such only for 4 years when the taxpayer is not ordinarily
inhabiting it, unless section 54.1 applies and as such
         (i)     the taxpayer was required by his employer to move,
         (ii)    the employer was not a “related person”
         (iii)   the taxpayer continued in that person’s employ and
                 thus did not change employers, and
         (iv)    the taxpayer moved back into the principal residence
                 when the period of employment ended or the taxpayer
                 died.
If the taxpayer changes employment while he is away or stays away,
the taxpayer cannot benefit from the extension period under s. 54.1.

Additional Notes:




                                 98
                      FINAL CALCULATIONS

So far, we have looked at determining which source we are in. Then
we look at calculating the income in each source and timing rules.
We keep each business separate. Section 3 brings all of the sources
together.

Sections 56-59 set out a series of mandatory inclusions. Sections 60-
66 set out a series of permitted deductions. These are separate and
not source-specific.

1. Moving Expenses (Section 62)

If the employee has to pay his own expenses, the expenses are
personal expenses. This employee is at a disadvantage. This
provision applies for individuals with an “eligible relocation” to the
extent that they were not paid on the taxpayer’s behalf (cannot
double-dip).
      The expenses cannot exceed the amount earned in the new
        job or business in the year, or the amount earned on taxable
        scholarships and bursaries.
      An “eligible relocation” means a re-location where the
        relocation allows a taxpayer to carry on a business in
        Canada, to be a student (Canadian destination not required,
        under Section 62(2); either the destination or the point of
        departure needs to be)
      The move has to be 40km closer to the new work location.

If, however, the taxpayer is physically absent from Canada, but
remains a resident for tax purposes, the deduction for moving
expenses is available even if the taxpayer is moving to a job outside
of Canada.

This is a separate deduction.

2. Childcare Expenses (Section 63)

Recall that in Symes, the Court held that section 63 provided a
“complete code” for child care expenses.

Section 63 requires that the lower of the two income earner to take
the deduction. There are exceptions, such as when one spouse is in
                                 99
prison, has a disability that impairs his ability to work, or is a student.
The child care expenses cannot exceed 2/3 of the earned income,
but again, these expenses are not deductible at source, they are
deducted separately. There is also another maximum amount of the
deduction ($7000 for children under 7, $4000 for other children).

The taxpayer must support the deduction with receipts.

3. Alimony or Maintenance Payments

The rules are found in sections 56(1)(b) and 56.1, and 60(b) and
60.1. Prior to May 1, 1997, support payments could be deductible
under 60(b) and had to be included in the recipient spouse’s income.
In Thibodeau, the mother had custody of the children. She
challenged the constitutionality of the inclusion provision. The court
held that the provisions were added to help out separated families.
The purpose behind the inclusion-deduction provisions was to shift
income from tax purposes from the higher to lower income earner.
Normally, personal living expenses are not deductible.

If a child support order is made or amended after May 1, 1997, the
child support payments are neither deductible nor included. If the
amount is for spousal support, then the provisions will apply. If the
parties have not specified, then the act treats it as child support.

Section 56.1(4) defines “support amount” for the purpose of the
inclusion and deduction rules under 56(1)(b).

"support amount" means an amount payable or receivable as an
allowance on a periodic basis for the maintenance of the recipient,
children of the recipient or both the recipient and children of the
recipient, if the recipient has discretion as to the use of the amount,
and

(a) the recipient is the spouse or common-law partner or former
spouse or common-law partner of the payer, the recipient and payer
are living separate and apart because of the breakdown of their
marriage or common-law partnership and the amount is receivable
under an order of a competent tribunal or under a written agreement;



                                   100
(b) the payer is a natural parent of a child of the recipient and the
amount is receivable under an order made by a competent tribunal in
accordance with the laws of a province. [no marriage]

All of the underlined terms have been the subject of litigation.

For example, when one spouse wants to pay the mortgage directly to
the bank, the spouse would not benefit from the deduction. Sections
56.1(2) and 60.1(2) deal with this problem, deeming these payments
as “allowances”.

The taxpayers’ first instinct is not necessarily to workout a written
agreement and to sign it. Until the legislature introduced 56.1(3) and
60.1(3), the amounts did not fall into the system.

In McKinnon – the real issue is not the periodic part; the real issue
is: are the payments made for maintenance, or are the payments
made to create a source? The provisions are not intended transfers
of wealth, but payments made for the maintenance for the spouse.
This concept is meant to cover current expenses and not to build up
savings.

Sections 56(1)(b) and 60(b) are not optional. The only way to get
out of these rules is to not abide by one of the conditions.

Calculating the Totals

If we look at the following problem:

Taxpayer earns (loses) as follows:
    salary from employment $ 50,000.00
    deductible expenses incurred to earn salary (10,000.00)
    revenues from a business on the side 15,000.00
    deductible expenses incurred to earn revenues from
    business (20,000.00)
    received support amount solely for spouse [56(1)(b)]
      12,000.00
    paid out child care expenses, of which deductible portion is
      (16,000.00)
    the following capital gains or (capital losses):
      - CG on sale of gold bars 16,000.00
      - CL on sale of pleasure boat (10,000.00)
                                  101
       - CL on sale of stamp collection (40,000.00)
       - CG on sale of jewelry 8,000.00
       - CL on sale of shares of public company (6,000.00)
       - CG on sale of vintage automobile 14,000.00
       - Business Investment Loss (24,000.00)

Section 3(a): calculate income from all sources = $52,000

Employment: $50,000 - $10,000 = $40,000
Spousal support = $12,000

Section 3(b): deduction of capital gains and losses, cannot be a
negative figure = $12,000

(i)(A): Taxable capital gains but not listed personal property: $16,000
+ $14,000 ÷ 2 = $15,000
(i)(B): Net gain from L.P.P.: $8,000 - $40,000 = $0, $32,000 left over
loss

(ii): ($6,000) ÷ 2 = ($3,000)

Section 3(c): deductions in subdivision (e), which cannot exceed the
sum of 3(a) + 3(b); cannot be a negative figure = ($16,000)

Childcare expenses: ($16,000)

Section 3(d): other deductions, which cannot exceed the sum of 3(a)
+ 3(b) + 3(c); cannot be a negative figure = ($17,000)

Business loss: ($5,000)
ABIL: ($24,000) ÷ 2 = ($12,000)

Section 3(e), (f): Total income for tax purposes = $31,000.

This taxpayer has a $16,000 allowable loss under section 41 (L.P.P.),
which can be used retroactively 3 years or prospectively for 7 years.

Section 111 provides the carryover rules for other losses.
     Non-capital losses (losses from employment, business,
        property, and ABILs) can be carried back 3 years and
        forward 20 years, after which they go stale;

                                  102
       Net capital losses (losses under section 3(b)) can be carried
        back 3 years and carried forward indefinitely; they never go
        stale. Net capital losses can serve only to reduce taxable
        capital gains. Unlike non-capital losses, the taxpayer cannot
        save these losses for use in future years if the taxpayer has a
        capital gain. The left over net capital losses can be carried
        over.

In death and in the immediately preceding year, net capital losses
can be used against income from all sources.

After the 20 year period, ABILs can still be carried over, but it must
be used as net capital loss, which is only deductible against taxable
capital gains.

Tax credits

Tax credits are deducted from tax payable, after the marginal rates
have been applied. Therefore, if the taxpayer owes $20,000 in taxes,
the taxpayer’s tax credits will reduce the amount of tax payable.

Everyone gets a personal tax credit of approximately $1,400.
Taxpayers are also eligible to take other credits. Most credits are
non-refundable, with the exception of GST, the child tax credit, and
the medical expenses credit for low income earners.

1. Charitable donations

Everything over $200 is multiplied by the highest marginal rate.
Everything under $200 is multiplied by the lowest marginal rate. The
taxpayer can only give up to 75% of income and benefit from tax
credits, except in the year of death.

In McBurney, the taxpayer paid an amount to his children’s schools
were gifts and not required as tuition. The taxpayer gave an amount
based on the taxpayer’s capacity to pay. These payments were not
gifts. Gifts must be (i) voluntary, (ii) not in the expectation for securing
material advantage, (iii) no contractual obligation, (iv) detached an
disinterested generosity

Unused charitable donations can be carried forward for 5 years.

                                   103
In Klotz v. Queen the taxpayer bought artwork and sells the art to a
Canadian resident, and the resident donates the art to a university or
a museum with a high fair market value, gets a charitable receipt,
and computes a tax credit on the basis of the fair market value. The
donation of the property would normally produce a capital gain. For
personal use property, the de minimis rule applies (using the ACB
and POD of at least $1000). The court concludes that the fair market
value is not $1000 and the taxpayer lost the benefit of the intended
tax credit.

2. Medical Expenses

The medical expenses have to exceed a certain threshold ($1813).
After which, the taxpayer can take a credit valued at the lowest
marginal rate for the excess expenses over the threshold. The act
defines what qualified as an eligible medical expense.

3. Tuition and education tax credits

These are credits available for post-secondary education, interest on
loans, textbooks, and additional costs and expenses.




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