PART I – INTRODUCTION - LSA McGill - AÉD McGill...

Tax Summary December 2004

PART I – INTRODUCTION.......................................................................................................................................3

CHAPTER ONE: INTRODUCTION TO THE INCOME TAX...............................................................................................3Introduction (no reading).......................................................................................................................................3Basic Structure.......................................................................................................................................................3Source Concept of Income.....................................................................................................................................6Residence...............................................................................................................................................................7

Case law residence................................................................................................................................................................8Deemed Residence..............................................................................................................................................................10

Sojourning Rule.............................................................................................................................................................10Ordinarily Resident........................................................................................................................................................11

CHAPTER TWO: INTRODUCTION TO STATUTORY INTERPRETATION.........................................................................12Introduction..........................................................................................................................................................12Interpretive Doctrines..........................................................................................................................................12Sources of Interpretation.....................................................................................................................................15

PART II – COMPUTATION OF INCOME OR LOSS..........................................................................................16

CHAPTER 4: INCOME OR LOSS FROM AN OFFICE OR EMPLOYMENT.........................................................................16Introduction..........................................................................................................................................................16Characterization..................................................................................................................................................16

a. Employees vs. Independent Contractors........................................................................................................................16b. Wolf v. The Queen.........................................................................................................................................................19

Inclusions.............................................................................................................................................................20Remuneration......................................................................................................................................................................21

Inducement payments.....................................................................................................................................................21Tort damages for personal injury or death.....................................................................................................................22Gratuitous payments.......................................................................................................................................................23Strike pay.......................................................................................................................................................................24

Benefits...............................................................................................................................................................................25General rule....................................................................................................................................................................25Specific rules (no reading).............................................................................................................................................33

Allowances..........................................................................................................................................................................33Statutory exclusions (no reading).......................................................................................................................................36

Deductions (no reading)......................................................................................................................................36Timing Issues........................................................................................................................................................36

Inclusions............................................................................................................................................................................36Receipt and enjoyment...................................................................................................................................................36

Deductions (SH: nothing)...................................................................................................................................................38

CHAPTER FIVE: INCOME OR LOSS FROM A BUSINESS OR PROPERTY......................................................................39Introduction..........................................................................................................................................................39Characterization..................................................................................................................................................39

Business..............................................................................................................................................................................39Reasonable Expectation of Profit........................................................................................................................................43

Inclusions.............................................................................................................................................................47Profit....................................................................................................................................................................................47Illegal Activities..................................................................................................................................................................47Damages..............................................................................................................................................................................48Voluntary payments............................................................................................................................................................50Interest.................................................................................................................................................................................52

Deductions...........................................................................................................................................................55Illegal payments..................................................................................................................................................................55Damage payments...............................................................................................................................................................57Fines and penalties..............................................................................................................................................................58Theft....................................................................................................................................................................................60Promotional Expenses.........................................................................................................................................................62Recreation, meal and entertainment expenses....................................................................................................................62Clothing expenses...............................................................................................................................................................65

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Home office expenses.........................................................................................................................................................65Travel expenses...................................................................................................................................................................67Interest expenses.................................................................................................................................................................68

Timing Issues........................................................................................................................................................74Inclusions............................................................................................................................................................................75Deductions..........................................................................................................................................................................78

Amounts payable............................................................................................................................................................78Inventory Costs..............................................................................................................................................................80Capital Expenditures......................................................................................................................................................83

Characterization........................................................................................................................................................83CCA...........................................................................................................................................................................84Eligible capital expenditures.....................................................................................................................................89

Reserves..............................................................................................................................................................................93A. Unearned Amounts...................................................................................................................................................93B. Deferred Payments...................................................................................................................................................96C. Doubtful Debts and Bad Debts.................................................................................................................................97

CHAPTER SIX: TAXABLE CAPITAL GAINS AND ALLOWABLE CAPITAL LOSSES....................................................100Introduction........................................................................................................................................................100Characterization................................................................................................................................................100Computation.......................................................................................................................................................108

General Rules....................................................................................................................................................................108What is disposition?.....................................................................................................................................................109What are ‘proceeds of disposition’?.............................................................................................................................110What is ‘adjusted cost base’?.......................................................................................................................................112What are expenses?......................................................................................................................................................114Reserves for capital property.......................................................................................................................................115

Special Rules.....................................................................................................................................................................116Personal Use Property..................................................................................................................................................116Principal Residence......................................................................................................................................................118Other Deemed Dispositions.........................................................................................................................................121Rollovers......................................................................................................................................................................121Superficial Loss Rules..................................................................................................................................................122Carryovers....................................................................................................................................................................123

CHAPTER SEVEN: OTHER INCOME AND DEDUCTIONS...........................................................................................123Introduction........................................................................................................................................................123Inclusions...........................................................................................................................................................124

Prizes for achievement......................................................................................................................................................124Deductions.........................................................................................................................................................124

Support payments..............................................................................................................................................................124Moving Expenses..............................................................................................................................................................125Child-care expenses..........................................................................................................................................................125

CHAPTER EIGHT: RULES RELATING TO COMPUTATION OF INCOME......................................................................127Introduction........................................................................................................................................................127Limitations on deductions..................................................................................................................................127Deemed proceeds...............................................................................................................................................127

Non-arm’s length transactions..........................................................................................................................................127

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PART I – INTRODUCTION

Chapter One: Introduction to the Income Tax

Introduction (no reading)

Basic Structure

- Income tax 4 basic elements: tax unit (every person resident in Canada at any time in the year), tax base (taxable income), accounting period (calendar year), tax rates (below). Also tax credits which reduce tax otherwise payable or provide refunds

- Basic charging provision (includes unit, base and period):Subs. 2(1) An income tax shall be paid, as required by this Act, on the taxable income for each taxation

year of every person resident in Canada at any time in the year. - Tax rates:Subs. 117(2) 0-$30754 16%

$30,754-$61,509 22%$61,509-$100,000 26%>$100,000 29%

a. Tax Unit - What is a “tax unit”? the person or persons to whom the tax applies- Subs 2(1) = every person resident in Canada at any time in the year need meaning of “person” and

“resident in Canada.”

i. Persons - “Person” includes individuals as well as corporations and tax-exempt entities (per def’ns of “person”

and “individual” in subs 248(1).

ii. Residence (no reading)

b. Tax Base - Tax Base: amount to which the rate or rates of tax is applied to determine the amount of tax payable.

Includes all rules respecting measurement of income, including exemptions, deductions and inclusions. Per subs 2(1), the tax base is the taxpayer’s “taxable income” for each taxation year.

- Taxable income = taxpayer’s income for the year +/- additions and deductions permitted by Division C

i. Inclusions- s. 3 taxpayer’s income determined by adding amounts referred to in para (a) and those in para (b). - Income = income form all sources inside and outside Canada (including each office, employment,

business, and property) [para (a)] + net taxable capital gains from the disposition of property [para (b)].

- S. 38 defines “taxable” portion of a capital gain and “allowable” portion of a capital loss as ½ f the gain or loss otherwise determined.

1. Income- What is “income”? - courts say ordinary meaning- Dictionary def’n: Periodical receipts from one’s business lands, work, investments, etc.- Compare income to capital which is a “stock” of accumulated wealth or value. - Also compare income to gifts and inheritances which, unlike income, are not periodical or recurring.

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- Caselaw – distinction btwn capital and income has been importanto E.g. annuity payments – capital or income? o Shaw v. MNR: taxpayer received monthly payments of $700 under contract of life insurance

for which husband had paid total premiums of $37,000. Held: monthly payments are on acct of capital and are not income w/in meaning of Income War Tax Act, 1917.

o Note that while annuity payments are now subject to tax, the basic principle that tax applies to income not capital is expressed in Act – b/c Act allows deduction of the capital element of each annuity payment (see para 60(a)).

ii. Deductions- Act contains rules specifying amounts that may be deducted in computing a taxpayer’s income for a

taxation year - Text identifies several types of deductions that may be made:

o Para 3(a): Rules which apply to the computation of a taxpayer’s income or loss from a specific source, or to the computation of capital gains or losses. These rules allow for the deduction of costs that must be incurred in order to produce this income.

o Para 3(c): Subdivision e of division B of Part I para 3(c) permits deduction of subdivision e deductions except to the extent that they have been “taken into account” in determining the total referred to in paragraph 3(a) by their deduction in computing the taxpayer’s income from one or more of these sources.

o Para 3(d): other rules permit deduction of losses against all income, i.e. losses from an office, employment, business or property and allowable business investment losses.

o Para 3(b): note that deductions for allowable capital losses are generally restricted to the amount of the taxpayer’s taxable capital gains for the year.

o Division C of Part I – deductions in computing taxable income (as opposed to income for tax purposes). E.g. employee stock options, social assistance payments and workers’ compensation, home relocation loan, cumulative lifetime amount wrt capital gains arising on disposition of certain types of property, deduction for northern residents, carried over losses (i.e. from other years)

- Policy behind allowing deductions? Various. The accurate measurement of income (gross receipts measure is not accurate – overstates income/financial capacity of taxpayer), incentives for certain types of behaviour (e.g. saving for retirement, engaging in “risky” business ventures – if losses weren’t deductible, people might not take chances in biz)

- Problem with deductions – inequitable way to pursue any policy goal other than the accurate measurement of income. WHY? Because under a progressive system, higher-income taxpayers benefit more from a given deduction than do lower-income taxpayers (b/c deductions are made from income taxed at the highest rate). Results in inequitable subsidies. E.g. charitable contributions deductible – taxpayers with marginal rate of 40% get to deduct 40 cents for every dollar of charitable contribution whereas taxpayers with marginal rate of 20% only get to deduct 20 cents for every dollar.

- Fed gov’t accepted argument that these deductions constitute inequitable subsidies and response was conversion of deductions into non-refundable credits against total federal tax payable computed at the lowest marginal rate (16%). Critics of this change argue that it was a disguised way of moving the marginal rate schedule upward in order to offset reductions in the “official” tax rates that accompanied these reforms.

- While deductions are generally regarded as an inequitable way to pursue policy goals other than the accurate measurement of income, Cdn income tax still permits deductions to encourage specific kinds of behaviour (e.g. saving for retirement)

iii. Exemptions

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- Exemptions and deductions both reduce amount of taxpayer’s taxable income BUT deductions operate by way of subtraction from income otherwise determined while exemptions are excluded at the outset

- Again, text IDs different types of exemptionso Those which apply to computation of TP’s income or loss from a specific source or to

computation of taxable capital gains. E.g. para 40(2)(b) exempts gains on the disposition of a TP’s principal residence; para 38(a) exempts ½ of all capital gains by defining the “taxable portion” of capital gains as “1/2 of the TP’s capital gain for the year from the disposition of property.”

o Deductions in computing TP’s taxable incomeo Non-refundable credits in computing TP’s tax payable (SH: how do you have exemptions

that are credits or credits that are exemptions?)o E.g. of specific exemptions (book not clear as to what these are exempted from) expense

allowances for members of a provincial legislature, compensation paid by Germany to victims of Nazi persecution

- Policy considerations underlying these are discussed at p. 59

c. Accounting Period - income tax is paid for each taxation year- def’n per subs 249(1): “fiscal period” in the case of a corporation and a “calendar year” in the case of

an individual- subs 11(1): “where an individual is a proprietor of a business, the individual’s income from the

business for a taxation year is deemed to be the individual’s income from the business for the fiscal periods of the business that end in that year.”

- Old def’n of “fiscal period” allowed corps and individuals w/ business income to select their own accounting period provided it was consistent from one year to the next and did not exceed 12 months.

- Implications of this def’n plus 11(1) ability to select off-calendar fiscal period enabled a TP w/ business income to postpone tax on that income by selecting a fiscal period for that business ending in the following calendar year.

- This ability to defer income was later eliminated by a legislative amendment which provides that, in the case of individuals and partnerships, no fiscal period may end after the end of the calendar year in which the period began.

- What are the implications of a yearly account period? (3) o returns must be filed and taxed paid on an annual basiso Incentive to postpone recognition of income or accelerate recognition of deductions/creditso Relative hardship to taxpayers whose income fluctuates and “bunches” in single years

compared with TP whose income is consistent from year to year.

d. Tax Rates - Choice of tax unit, tax base, and accounting period concerns the manner in which the tax burden is

distributed among similarly situated taxpayers (horizontal equity)- Selection of rates and rate structures determine the manner in which these burdens are distributed

among taxpayers who are differently situated (vertical equity)- In Cda, personal income taxes are applied at graduated or progressive rates above basic exemptions

First $7412 is exempt from tax how does this work? Not included in income all together? Or included in income but just taxed at 0%?

e. Tax Credits

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- Tax credits are subtracted directly from the amount of tax otherwise payable or credited to the taxpayer as a payment of tax, resulting in a reduction of tax otherwise payable or a tax refund where no tax is otherwise owing

- Where credit is subtracted directly – it is called a “non-refundable credit”- Where credit operates as an overpayment of tax, it is a “refundable credit”

Source Concept of Income

- no def’n of “income” in the Act; system is based on the source concept of income- A receipt is only considered income and therefore taxable if it comes from a source. - Legislative basis for source concept para 3(a)

Para 3(a) Income of a taxpayer is the TP’s income for the year determined by following rules:(a) determine the total of all amounts each of which is the TP’s income for the year (other than a taxable capital gain from the disposition of a property) from a source inside or outside Canada including each office, employment, business and property.

- Source concept ties into distinction btwn capital and income (tree vs. fruit). - Para 3(a) IDs four specific sources – office, employment, business and property. These not

exhaustive (can be income from generic source ) but Cdn courts have tended to limit sources of taxable receipts to those specifically IDed in the Act. Response of leg various amendments designed to include otherwise excluded income from a particular source (e.g. scholarships – see 56(1)(n) and (o))

- [Note that courts’ restrictive interpretation imposed on 3(a) can be attributed to strict construction ambiguities in charging sections of taxing statute resolved in favour of TP]

What is income from source?

1. Receipt of capital is not income from a source (it is the source)- Distinguish btwn capital (the source) and income produced by the capital (income from a source). If

my Dad gives me an apartment building (source), it is a non-taxable receipt, but the income from the apartment building (income from source) is taxable.

- Then why are capital gains taxable? Some courts and commentators would say that capital gains are income but this type of income is better understood as income from the disposition of property that may itself constitute a source of income, rather than income from a source itself.

2. Windfall gains not income from a source (Cranswick, Bellingham)- Bellingham : categories which fall outside of 3(a) gambling gains, gifts and inheritances, windfall

gains (residual category). - Bellingham : underlying the source doctrine – understanding that income involves the creation of new

wealth. Income must flow from a productive source of income (gifts do not)- Indicia which should be applied when assessing whether a receipt constitutes income from a source

(Cranswick ; as applied in Bellingham ) (*none is conclusive):a) Does TP have enforceable claim to payment? b) Organized effort on part of TP to receive payment?c) Was payment sought after or solicited by TP in any manner?d) Was payment expected by TP, either specifically or customarily?e) Did payment have foreseeable element of recurrencef) Was payor a customary source of income to the TP?g) Was payment in consideration for or in recognition of property, services or anything else

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provided or to be provided by the TP (bargain, exchange, quid pro quo)? Was it earned by the TP, either as a result of any activity or pursuit of gain carried on by TP? [this is important one]

- If all of these YES could find that income comes from generic or unidentified source, though courts don’t usually find this

- Relevant cases: Fries, Cirella, Goldman, Federal Farms, Frank Beban, Campbell, Manley, H.A. Roberts

- Ask: income from employment, business, property, capital gain, generic source?

Bellingham: TP’s land expropriated; received compensation, interest and additional interest (which entitled to per legislation b/c gov’t made low ball offer for his land). Is additional interest income from a source (i.e. part of proceeds of disposition and thus biz income OR income from generic source)? NO. Additional interest not actually ‘interest’; more like punishment. Fact that TP had enforceable right to money and actively solicited it not determinative. Payment didn’t flow from performance or breach of market transaction; source was legislation; no bargain, no agreement, no quid pro quo; not earned.

Schwartz: Partner in law firm offered job by client. Signed employment agreement and gave notice to firm. Client backed out of agreement. Schwartz sued for breach and parties settled out of court for $400K. $400K income from source (employment income, retiring allowance, generic source)? NO. Not employment income b/c employment never started; he didn’t render services. Not retiring allowance b/c such an allowance compensates for past services and there were none. Not income from generic source b/c it is type of income contemplated by retiring allowance but doesn’t fit w/in words of section. Specific trumps general.

Shaw and Wilder: see above

Residence

2(1) An income tax shall be paid, as required by this Act, on the taxable income for each taxation year of every person resident in Canada at any time in the year.

2(3) Where a person is not taxable under sub (1) for a taxation year(a) was employed in Canada,(b) carried on a business in Canada, or (c) disposed of a taxable Cdn propertyat any time in the year or a previous year, an income tax shall be paid, as required by this Act, on the person’s taxable income earned in Canada.

- Cdn residents subject to tax on their worldwide income. Non residents only subject to tax on income from Canadian sources.

When is a “person resident in Canada”? 1. case law residents (Thomson, Schujahn, Lee, Min Shan Shih, Griffiths)2. If not case law resident may be deemed residents (s. 250) [only applies where person is not

resident in Canada under case law principles]*Note that case law rules allow for part-year residence. Deeming rules deem person to be resident (and therefore taxed) for the entire year.

250(1) Person shall be deemed to have been resident in Canada throughout a taxation year if the person(a) sojourned in Canada in the year for a period of, or periods the total of which is, 183 days or more…

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250(3) In this Act, a reference to a person resident in Canada includes a person who was at the relevant time ordinarily resident in Canada

Case law residence

Case law resident - principles:

1. Residence is Q of fact and residence has no special or technical meaning

2. Burden of proof is on TP to prove that he is not resident (Thomson)

3. Must be resident somewhere for tax purposes (Thomson). If TP leaves Cda but hasn’t established significant enough ties with another juris to be taxed there, he is unlikely to have broken tax ties w/ Cda [Thomson, IT-Bulletin]

4. Can have more than one residence for tax purposes [Thomson]

5. TP is resident in Cda if Cda is the place where he, in the settled routine of his life, regularly, normally or customarily lives. Pattern of behaviour, routine is important. [Thomson] [most significant factor]

6. Physical presence in Cda need not be continuous (3-4 months each year is sufficient when it is part of a regular annual routine, i.e. doing it for one or two years might not be enough) [Thomson]

7. Significant residential ties include (a) individual’s dwelling place, home ownership; (b) family ties (spouse and dependents in particular) (Thomson). Family ties not determinative [Schujahn, Shih, Griffiths]. Ownership of house not determinative [Schujahn]

8. Secondary residential ties includea) Personal property in Canadab) Social ties with Canada (e.g. membership in church)c) Economic ties with Cda (ownership of property – Thomson; bank accounts)d) Landed immigrant status or work permits in Cdae) Hospitalization or medical insurance coverage from Cdaf) Driver’s license from Cdag) Seasonal dwelling place or leased dwelling place in Cdah) Cdn passporti) Memberships in Canadian unions or professional organizations (Lee)

9. Intention to reside in a particular place don’t play direct role in determining residence. Intention may, however, play role in determining why certain factors which would otherwise weigh heavily in favour of residence (e.g. family ties) do not make person resident (Schujahn, Lee, Shih). Intention in sending family to Cda or leaving them there relevant (Schujahn, Shih)

10. Where TP has resided in Cda for lengthy period of time, clear and “virtually irreversible” measures are required to terminate this residency (Thomson). [SH: much easier to avoid becoming resident than to cease being resident – see Shih]

Thomson - TP lived in NB for 15 years. - 1922: Left NB and announced he was going to become resident of Bermuda. Got Bermudian

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passport, bought house in Bermuda, and signed affidavit saying that it was his intention to reside there.

- 1922-32: spent most of his time in the US but didn’t pay tax there. - 1932: Wife said wanted to go back to Cda. They bought summer house in NB and spent four months

per year there. During rest of year – golfed in US. - 1940: declared himself US resident for tax purposes and started to pay US taxes.

Held: resident of Cda during 1940 taxation year (see reasons above)

Schujahn - TP was US citizen sent to Cda by his employer- In August 1957, his employer sent him back to the US. His wife and child remained in Cda until

March 1958- TP argued that he ceased being resident in August 1957, and that wife and child only stayed in Cda

b/c it was easier to sell an occupied house

Issue: Resident in Canada until March 1958

Held: No – ceased being resident in Aug. 1957

Reasons:- The only reason wife and child stayed was to facilitate sale of house. Absent that fact, he would have

been considered a dual resident for tax purposes.- Why didn’t sojourning rule apply here? B/c only applies to period of time in which person is not

otherwise resident of Cda. TP here was case law resident until Aug. 1957, after which time the sojourning rule might have applied (likely didn’t in this case b/c min of 183 days not met).

- Note that if SJ rule had applied, he would have been required to pay taxes for entire year; case law resident can be part-year resident and pay taxes for part of year only.

Lee- Lee was English subject/resident employed outside of Canada- Entered Cda as a visitor, met a woman, married her, and guaranteed mortgage on her house- Never became a permanent resident but visited wife in Cda whenever wasn’t working

Held: Resident in Canada from day he married

Reasons:- Family tie significant enough to make him resident for tax purposes- Didn’t have residence anywhere else

Min Shan Shih- Taiwanese citizen and resident sent wife and kids to Regina for four years so that kids could attend

school- He remained in Taiwan for 300 days of the year, kept a home there, and worked there. He

occasionally visited his family in Canada.

Held: not resident in Cda

Reasons:- fact that kids attended school in Cda not enough to make their father resident in Cda for tax purposes

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- Significant that had very strong ties to Taiwan [Allard: if had roving business or no strong ties to any particular country, might have been resident in Cda on basis that strongest ties were to Cda and he had to have residence somewhere]

POINT: Significance of family ties to Canada depends on intention in sending family to Canada or leaving family in Canada

Griffiths- TP had been resident in Canada for most of his life- He retired, separated from his wife and moved to the British Virgin Islands to live on a yacht- His wife remained in Cda and owned a home in Cda. He spent a few days every year in her home,

and retained professional contacts in Canada

Held: not resident in Cda for tax purposes

Reasons: - Doesn’t matter that he was separated and not legally divorced – couple had amicably split and

reached an understanding that they were not going to live together- Fact that he spent a few days every year in her house wasn’t enough to make him resident

Deemed Residence

Sojourning Rule

R & L Distributors- Two R&L Distributors shareholders lived in Detroit and traveled to Windsor to work at the co.- SHs argued that they were Cdn residents for tax purposes under the ‘sojourning rule’ in 250(1)(a) [b/c

would result in huge tax break for co.]

Held: not resident in Cda

Reasons:- Sojourning rule is only relevant when one is not otherwise a resident of Cda- Dictionary def’n of “sojourn” – temporary residence, remain and reside for a time. Suggests that

some residential type factors must be present (e.g. home, social or family ties). - SHs in this case had no such ties; their presence in Cda was merely casual. Working in Cda not

enough to be a sojourner.

POINT: sojourning rule only applies when one is not otherwise a resident of Cda. Sojourning requires some residential type factors (i.e. social or family ties). Casual residence in Cda (e.g. to work) not sufficient.

Shpak- Shpak originally lived in BC, and decided to move to the US. Sold home and moved to US, but

continued to work in Cda

Held: case law resident

Reasons:

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- Social and family ties to Cda were significant enough to make TP resident of Cda

Allard:- Strange result b/c case law rules should require more than sojourning rules do. Same facts as R&L,

yet TP here resident per case law rules, and TP in R&L not resident, even under sojourning rules- Big difference – social and family ties- Also, result might change after lived in US for 10 years- **Easier to not become a resident than to lose residence

Ordinarily Resident

- Courts have relied on this provision to expand the concept of residence such that, even if TP was not physically present in Cda in a given year, could still be resident if there was presence in prior or subsequent years

- Effectively broadens the period of time that a court can look at to determine residence for a given taxation year. Note that court in Thomson was quite comfortable in finding residence w/o relying on 250(3).

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Chapter Two: Introduction to Statutory Interpretation

Introduction - Traditional approach in UK and Cdn courts strict interpretation of taxing statutes, i.e. language to

be construed literally and ambiguities resolved in taxpayer’s favour- More recently: courts have adopted objects/intentions approach. Stubart (rejected strict approach

and affirmed modern rule): the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act and the intention of Parliament

Interpretive Doctrines

b. Strict Construction- Strict Construction: statutory language construed literally. Required court to adhere to the letter of

the law reflected in the words of the statute, notwithstanding the spirit of the law (expressed in scheme of Act, object of Act or intention of Parliament). Ambiguities in taxing provisions resolved in favour of TP, ambiguities in provisions setting out deductions or exemptions resolved against TP.

- Leading judicial expression of this approach is in Partington v. AG: If the person sought to be taxed comes w/in the letter of the law he must be taxed, however great the hardship may appear to the judicial mind to be…no equitable construction admissible in a taxing statute…simple adhere to the words of the statute.

Allard: - Result of this strict interpretation is the Act we have today (i.e. very detailed, comprehensiveness at

the expense of comprehensibility). Legislators had to amend legislation whenever there was a case of doubt (b/c would often result in lost taxes).

- Strict rule often worked in TP’s favor, but b/c of second presumption (re deductions/exemptions), it could also result in great hardship: see Witthuhn v. MNR

Witthuhn v. MNR , [1957] Act provided medical expense deduction for those “necessarily confined by reason of illness, injury or affliction to a bed or wheelchair.” Board disallowed medical expense deduction for cost of full-time attendant for TP’s bedridden wife who could sit for a few hours a day in a special rocking chair.

MNR v. MacInnes , [1954] p. 98

Facts:- Rspdt made gifts of money and bonds to wife- Wife used money to purchase other bonds. Sold bonds for cash. Used cash to buy shares. Sold

shares for different shares. - In 1948, received income from these securities. MNR added this income to amount of taxable

income reported by rspdt on his annual return. - Act provides: where a husband transfers property to his wife, or vice versa, the husband or wife shall

nevertheless be liable to be taxed on the income derived from such property or from property substituted therefor.

Issue: Does term “property substituted therefor” include property substituted for substituted property? (if yes, rspdt must pay tax on it)

Held: No (application of strict construction rule)

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Ratio:- Well established that a tax liability cannot be fastened upon a person unless his case comes w/in the

express terms of the enactment by which it is imposed. It is the letter of the law that governs in a taxing Act.

- If Parliament had intended that husband should be liable to tax in respect of income derived from property substituted for property substituted for property transferred by him to his wife, it should have expressed its intention in clear terms. It could easily have done so.

POINT: illustrates application of strict construction approach to interpretation of Income Tax Act

Notes:- Case has been heavily criticized – some say plain meaning of property substituted therefor is

sufficiently wide, by its plain meaning, to cover any number of substitutions. Some say should have looked at purpose

- Implications of S.C. rule for manner in which Act drafted: much of length and complexity of Act is product of amendments designed to plug gaps exposed by restrictive interpretations. Result? A “hopelessly complex, unmanageable labyrinth”.

- Though S.C. method was dominant method until Stubart, it wasn’t only method (some courts referred to purpose, intention, context of stat language, etc.)

- Strict approach formally rejected in Stubart : role of tax statute in society changed and application of s.c. rule receded. Today’s approach: words of Act are to be read in entire context and in grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

- Corporation Notre-Dame de Bon-Secours : rejected presumption that ambiguities in relieving provisions should be resolved against the taxpayer

- One feature of doctrine has been retained residual presumption in the taxpayer’s favour; presumption is clearly residual and should play an exceptional part in the interp of tax leg; to be used where ascertaining meaning of statute is impossible.

c. Modern Rule- Quote from Stubart (above) which affirmed “modern rule”- Purposive/teleological approach vs. plain meaning? Determine purpose and read text in light of it vs.

apply provisions regardless of their object/purpose whenever couched in specific language that admits of no doubt or ambiguity [S.C.C. decisions used both]

- Recent S.C.C. decisions have returned to modern rule – combining plain meaning rule with purposive consideration. e.g. of this is Will-Kare

Will-Kare Paving & Contracting Ltd. v. The Queen , [2000] SCC

Facts:- Aplt paves for residential and commercial customers- Until ’88, purchased asphalt from competitors. ’88 – built own plant so as to be able to bid on larger

contracts. Used 75% of asphalt output in its own paving business and sold 25% to third parties- Aplt. claimed accelerated capital cost allowance and investment tax credit by claiming that plant was

property used primarily in manufacturing and processing of goods for sale- MNR reassessed aplt on basis that plant was not being used primarily for the manufacturing or

processing of goods for sale.

Issue: Does asphalt plant qualify for investment tax credit and accelerated capital cost allowance on grounds that it is being used primarily for mfing or processing of goods for sale? (Does goods for sale include goods sold through work and materials contracts?)

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Held: No – modern purposive approach used to ascertain def’n of “sale” from broader context of general commercial law. This conforms with legislative intent.

Ratio: - Cdn jurisprudence – 2 divergent interpretations of activities that constitute manufacturing and

processing goods for saleo Crown Tire: application of stautory and cml sale of goods rules only capital prop used

to mfr or process goods to be furnished through contracts purely for sale of goods qualifies. Use of good in provision of services (i.e. K for work and materials) doesn’t count. This characterization is based on method by which prop transferred to buyer.

o Halliburton, Nowsco: literal construction of sale such that provision of service incidental to supply of mfed or processed good doesn’t preclude receipt of tax incentives. Transfer of property for consideration = sale; form of K (goods, service) btwn TP and customer is irrelevant

- Ambiguity in def’n court looks to Hansard and concludes that language there not helpful – it neither dictates nor precludes application of cml sale of goods distinctions

- However, concepts of sale or lease have settled legal def’ns and Parliament was aware of these meanings and thus implications of using these words. Thus, benefit of incentives must be restricted to property utilized in supply of goods for sale and not to property primarily utilized in supply of goods through contracts from work and materials.

- Rejects plain meaning rule – assumes that the Act operates in a vacuum (i.e. w/o commercial law)- Referring to broader context of prvt commercial law is consistent with the modern purposive

principle of statutory interpretation. [Dissent]: - Tax Act is regime based on self-assessment and most TPs are not learned in the law. TPs thus are

entitled to the benefit of the plain meaning of an everyday word such as “sale.” - If the TP had sold asphalt in one K and installation of it in another, it would be entitled to the

deduction- Distinguishes this case from “repair” cases (e.g. involving overhauling aircraft engines) – there was

no “sale” in those cases b/c the items to be repaired were throughout owned by the TP’s customers. In this case, TP owned asphalt before customer did.

What interpretation method should be utilized? - Ordinary words in the Act like “for sale” should be interpreted in light of the “ordinary meaning of

the word in everyday speech.” The primary rule of statutory interpretation is to ascertain the intention of parliament. Where meaning of words used is plain and no ambiguity arises from context, then words offer best indicator of Parliament’s intent.

Why is plain meaning rule attractive? - Strength of plain meaning rule: recognition that words are vehicle by which Parliament conveys

intent to those who are trying to assess their rights and liabilities under Act. - Imported technical distinctions frustrate not only the plain meaning but the legislative purpose of the

tax provisions. Why plain meaning of “for sale” is correct interpretation in this case: - If Parliament had wanted “for sale” to be restricted to certain types of Ks, it was incumbent upon it to

so specify. - Adoption of plain meaning in this case reduces judicial discretion- Related text and legislative history confirms that plain meaning conforms with legislative intent

(major emphasis was on creating jobs – asphalt plant creates jobs regardless of nature of disposal contract)

- Administrative policy and interpretation (while not determinative) are entitled to weight and in this case support plain meaning interpretation.

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Sources of Interpretation

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PART II – COMPUTATION OF INCOME OR LOSS

Chapter 4: Income or loss from an office or employment

Introduction

- Para 3(a) TP’s income includes income for each “office” and each “employment.” - Para 3(d) permits TP to deduct losses from each office and employment in computing net income- Rules governing computation of income or loss from office or employment sub a of division B of

part I, ss 5 to 8- Subs 5(1) income for a taxation year from an office or employment: salary, wages, and other

remuneration, including gratuities, received by the TP in the year- Subs 5(2) loss: the amount of the TP’s loss, if any, for the taxation year from that source

computed by applying, with such modifications as the circumstances require, the provisions of the Act respecting the computation of income from that source.

- S. 6 and 7 specify amounts that must be included in calculating income from office or employment- S. 8 sets out amounts that may be deducted in computing income from office or employment

Income from office or employment1. Characterize source: business income or employment income? Ind-Kor or employee? Contract of

services or contract for services?2. Inclusions

a. Remuneration (wages, salary, gratuities)i. Inducement payments

ii. Tort damagesiii. Gratuitous paymentsiv. Strike pay

b. Benefitsc. Allowances

3. Deductions4. Timing – when must deduct and include?

Characterization

Tax treatment of employment income vs. business income1. Tax deducted at source by employer on employee’s behalf vs income recipient obliged to pay own tax

in instalments. [If taxes not w/held by employer, employer is personally liable and subject to penalties].

2. Employment income calculated on cash basis vs business income calculated on accrual basis3. Deductions: employees limited to deductions in s. 8 vs those earning business income can deduct

anything incurred to earn revenue (basis for deductions is the word ‘profit’) subject to certain overriding or circumscribing provisions.

a. Employees vs. Independent Contractors

Independent Contractor vs. Employee?Business Income vs. Employment Income?

Characterization: employee vs. independent contractor

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1. Intention of parties and nomenclature in K not determinative- look to substance of relationship. [Wiebe Door]. Wolf: in close case where factors point in both directions, parties’ characterization of relationship should be given weight (where genuine and not a sham).

2. Control test (traditional cml test): Employer has right to direct what employee must do and how it must be done. One who hires independent K-or directs what work is done and not how it is done (given a lot of weight in Moose-Jaw) (not useful for professionals)

3. Integration test : whether work being performed is integral to business (employee) or accessory to it (ind K-or). Wiebe: approach from perspective of so called e-ee, i.e. does e-ee consider himself integral? Is he performing services in course of his own or someone else’s biz?

4. Economic reality test : control, ownership of tools, chance of profit, risk of loss [note Wolf: court considers lack of health and pension benefits and opportunity for promotion as risk factors indicative of ind-Kor] [More appropriate – consider financial risk, i.e. will return/income vary if biz goes bust or succeeds?]

5. Specific Results test : K stipulates that worker shall provide services for specified period of time (employee) vs. K stipulates that worker shall complete specified task, and worker decides how to allocate time in order to accomplish it (good for professionals, see Alexander and Hauser)

6. Other factors :a. Remuneration: commissions (ind K-or b/c suggest risk-taking) vs. wages (employee) [but

see Macdonald – received commissions but held employee b/c had office at employer and was provided with secretary. See Vango, Norgaard for similar result]

b. Principal place of work: home office suggests ind-Kor (Martinez). Working on employee’s premises suggests employee (Vango, Macdonald). Contrast Wolf: held ind K-or even though worked exclusively on Bombardier’s premises and used its computers; i.e. work premises not determinative, particularly where specialized nature of work and security measures.

c. Ownership of tools: teacher – pen, pencils. Swim coach – whistle and stopwatch (Moose-Jaw)

d. Vacation pay, overtime and holidays: traditional indicia of employment relationship (though all present in Wolf and court held ind K-or)

e. Modern work context: many workers consciously trade off job security for higher income and this type of contractual choice should be respected by courts (Wolf)

f. Reimbursement of travel expenses: suggests e-eeg. Whether or not get T4 slip: suggests e-ee but not determinativeh. Already established businessi. Ability to hire own staff, send in replacement

7. Quebec : note art. 2085 suggests, and court in Wolf indicates, that key distinction btwn employment and business K lies in element of subordination or control. (*But court in Wolf went on to say that cml and cvl law tests are the same, and to adopt the tests from Wiebe).

Wiebe Door Services Ltd. v. MNR , [1986] F.C.A., p. 190

Facts:- Applicant in business of installing and repairing doors- Carries on business through services of door installers. Co. has specific understanding w/ these

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installers that they are ind. K-ors and thus responsible for own income tax, EI, workers comp and CPP payments

- Minister assessed applicant for EI premiums and CPP contributions as though workers were employees.

- Applicant sought reassessment – was denied by tax court

Issue: Employees or independent contractors?

Held: Matter referred back to Tax Court for a determination consistent with these reasons

Ratio: - Intention of parties (i.e. in this case specific understanding that workers were operating as

independent contractors) is not determinative.- Traditional CML criterion of employment relationship control test

o Master has right to direct what servant must do as well as how it is to be done. Principal only has right to direct what the agent has to do.

- Control test alone is problematic; has an air of deceptive simplicity (Atiyah)- 2 more general tests formulated to deal with these problems:

o “Entrepreneur/Economic Reality test”: involves examining the whole of the various elements which constitute the relationship btwn the parties, including the four earmarks of an entrepreneur – control, ownership of tools, chance of profit, risk of loss.

o “Organization/Integration test”: Is the work integrated into the business (employee) or accessory to it (ind K-or)?

- Court rejects the “organization/integration” test as it was worded by the court below (i.e. w/o the installer, the Aplt would be out of business). This is not a fair test b/c in a factual relationship of mutual dependency (which exists w/ both ind K-ors and employee-employer), it must always result in an affirmative answer. The test, however, produces acceptable results if it is approached from the perspective of the alleged “employee” rather than “employer.” (from perspective of employer – very easy to assume that every contributing cause is arranged purely for the convenience of the larger entity).

- Court favours a test that balances and weighs all the various factors around a central questiono Central Q/fundamental test: Is the person who has engaged himself to perform these services

performing them as a person in business on his own account?o Considerations relevant to answering this Q (non-exhaustive list): control, hires own

helpers?, provides own equipment?, degree of financial risk taken, degree of responsibility for investment and management, opportunity for profit. Fact that he enters into K in the course of an already established business is impt but not determinative.

POINT: No one of these tests is determinative. Apply all factors to analyze overall relationship between parties.

NOTES:- Commentators on Wiebe Door: one argued that the court approved the use of the integration test

provided that it is approached from the perspective of the employee. Another noted that although the court redefined the integration test, it did not actually apply it or recommend its use.

- Specific Results Test: Contract for services is K under which one party agrees that certain specified work will be done for the other. Contract of service doesn’t usually envisage completion of specified work but rather contemplates servant putting his personal services at the disposal of master during some period of time.

- Other factors that courts may consider:

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o Individual’s principal workplace : Martinez v. Canada – court held dude to be self-employed b/c he worked primarily at home

o Method of remuneration : commission (ind K-or) vs. salary and wages (employee). Note, however, Norgaard v. MNR – field manager’s remuneration was calculated according to gross regional sales; found to be employee on basis that he (1) signed K with co. as an employee, (2) it was his only occupation and his activities were confined to promotion and sale of employer’s products and training of its dealers. See also Vango v. Canada: stock broker who worked on commission held to be employee b/c he (1) worked out of employer’s office, (2) used employer’s phones, promo lit and other facilities, and (3) relied on employer to email reports to stockholders

o Intention of parties/nomenclature in contract : this is not determinative. Must ask – did what actually took place substantiate the description in the written agreement? Test is not what the parties intended but what they accomplished. Legal substance prevails over nomenclature.

- Art. 2085 C.C.Q.: A contract of employment is a contract by which a person, the employee, undertakes for a limited period to do work for remuneration, according to the instructions and under the direction or control of another person, the employer.

o Does this mean that control test alone should be used in QC?

b. Wolf v. The Queen

Wolf v. The Queen , [2002] F.C.A., handout

Facts:- Aplt is mech engineer specializing in aerospace- Found job with Canadair (located in QC) through agent (Kirk-Mayer in Calgary). K was with KM- Under this K, aplt was described as a consultant and independent contractor and could be asked to

work on many projects at one time and to switch from some projects to others. Aplt received hourly wage (which increased for overtime hours), per diem (b/c not resident in Canada), pay for statutory holidays, completion bonus, and reimbursement for travel costs. KM deducted CPP, UI contributions and 15% non-resident w/holding taxes (required for contractors/self-employed workers)

- Aplt worked on Canadair premises (b/c needed access to computer there and to communicate with others) during regular working hours. He had ID card that indicated he was consultant. Did not receive company newsletter that was sent to employees or attend company meetings. Did not qualify to take courses.

- Aplt never knew when his job would be finished, had no promise of future engagement, no pension, and no employee benefits.

- Taxation years 1990-1995 aplt deducted business expenses. MNR disallowed deduction of biz expenses claimed on basis that aplt earned employment income.

- Tax Court held that aplt was employee

Issue: Independent K-or or employee?

Held: Independent K-or

Ratio:[Desjardins]: - QC courts have recognized that key distinction btwn a K of employment and a K of enterprise lies

with element of subordination or control. This criterion is mentioned expressly in Art. 2085 C.C.Q.- Rules for distinguishing btwn contract of service and contract for services – same in cml and cvl- [Adopts test supported by Major J in Sagaz and MacGuigan J.A. in Wiebe Door]: Look to total

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relationship of parties and not pay so much attention to the trees that we lose sight of the forest. Central Q – whether the person who has been engaged to perform the services is performing them as a person in business on his own account. Non-exhaustive list of relevant factors in answering this Q: control, hires own helpers?, provides own equipment?, degree of financial risk taken, degree of responsibility for investment and management, opportunity for profit.

- Application to facts: terms of written K will only be given weight if properly reflect the relationship btwn the parties. Control factor neutral b/c compatible with either status. Fact that work performed on premises not conclusive of employee b/c specialized nature of work and security measures. Tools are neutral factor b/c would have to use Canadair equipment regardless of whether ind K-or or employee. Degree of financial risk and profit favour status of K-or: In consideration for higher pay, aplt took all risks; was not provided with health insurance benefits nor a pension; had no job security, no union protection, no educational courses he could attend, no hope for promotion.

[Decary]: - “independent contractors” and “employees” to be interpreted in accordance with QC law- Test is whether, looking at the total relationship of the parties, there is control on one hand and

subordination on the other. Courts must NOT overlook the essence of the K-ual relationship, i.e. the intention of the parties. TPs may arrange their affairs in such a lawful way as they wish. When a contract is genuinely entered into as a contract for services and is performed as such, the common intention of the parties is clear and that should be the end of the search. (In this case, intention is supported by all other factors).

[Noel]: - In a close case, where relevant factors point with equal force in both directions, parties’

characterization of relationship (provided not a “sham” or “window dressing” or done with view to achieving a tax benefit) should be given great weight.

Allard:- Health benefits, pension plan and job security are not traditionally thought of in terms of risk – these

are perks! Most people in dead-end jobs don’t get these perks – are they not employees?- Court says fact of vacation pay, overtime and holidays is neutral; these, however, are traditional

indicia of employment relationship. May have been significant that these benefits were only in place for first year of Wolf’s K. If you want to be considered ind K-or, will probably have to forgo these benefits.

- Moose-Jaw: Swimming coaches hired by the Kinsmen – ind k-ors or e-ees? Held: ind K-ors. Ownership of tools, i.e. had to provide own whistles and stop-watches. Control, i.e. written K was motivated by need of TP to exert more control over the coaching. Written K properly reflected parties’ relationship and thus was given weight.

Inclusions

Relevant Tax Act Provisions Basic Rules

5(1) Income from office or employment. Subject to this part, a TP’s income for a taxation year from an office or employment is the salary, wages, and other remuneration, including gratuities, received by the TP in the year.

**Note the word “received,” is not “receivable” must calculate on cash basis and not accrual basis. 5(2) Loss from office or employment

Inclusions6(1) Amounts to be included as income from office or employment. In computing income

of TP for taxation year as income from an office or employment, must include the

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following amounts:

(a) Value of benefits. The value of board, lodging and other benefits of any kind received or enjoyed by the TP in the year in respect of, in the course of, or by virtue of an office or employment, except…

(b) Personal or living expenses. All amounts received by the TP in the year as an allowance for personal or living expenses or as an allowance for any other purpose, except…

(c) Director’s or other fees. Director’s or other fees received by the TP in the year in respect of, in the course of, or by virtue of an office or employment.

6(3) Payments by employer to employee. An amt received by one person from another

(a) while payee employed by payer(b) pursuant to agreement made by payer w/ payee immediately prior to, during or

immediately after payee was employed by payer

shall be deemed, for purposes of s. 5 to be remuneration for payee’s services rendered, unless it cannot reasonably be regarded as having been received

(c) as consideration or partial consid for accepting/entering into K of employment(d) as remuneration or partial remuneration for services(e) in consideration or partial consideration for a covenant

**6(3) extends 5(1). Some people say it is actually redundant (i.e. that these amounts would fall under “other remuneration.”)**Duff: 6(3) is a specific anti-avoidance rule designed to expand scope of TP’s income from employment by including amts that are connected to employment but not otherwise characterized as taxable remuneration.

OtherSome income may look as though it is connected to employment, but not fall into above sections. If so, can also have recourse to general language of para 3(a), i.e. generic sources

Para 3(a) Determine total of all amts each of which is TP’s income for the year from a source inside or outside Canada, including without restricting the generality of the foregoing, the TP’s income for the year from each office, employment, business and property.

Remuneration

Def’n of “salary,” “wages,” “gratuities,” “fees”- Not defined in Act thus look to dictionary- Fees: fixed payments in respect of an office- Salary, wages: regular payments to employees; distinguished from each other by reference to the

type of work performed and/or the period to which payments refer (i.e. salary usually paid for period of year, month, etc. whereas wages usually hourly)

- Gratuity: amounts paid “on account of legally non-enforceable claims.”- Remuneration: (as in “other remuneration”) generic term that includes fees, salaries, wages,

gratuities and other non-specified payments. - Note that most of these concepts are defined as being compensation for services. Sub. 6(3) thus

expands on sub. 5(1) to the extent that it includes payments which are not really for services rendered

Inducement payments

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- Inducement payment – arguably not taxable under 5(1). Could be taxable under 6(3) but only if inducement payment is made by current, former or future employer.

- Curran case

Curran v. MNR , [1959] S.C.C., p. 230

Facts :- Curran employed with Imperial Oil; received salary of $25,000 per year and when retired, would

receive generous pension- Brown, shareholder in a second company, paid Curran $250,000 to induce him to leave his current

employment and take on employment with the second company. - Curran signed two Ks on same day. First provided that grantor would agree to pay $250,000 in

consideration for grantee’s loss of pension rights, chances for advancement, etc and that grantee would agree to resign his position with Imperial Oil. Second K was employment K

Issue : Is the $250,000 payment taxable?Held : YesRatio :

- Aplt arg 1 : 6(3) enacted to broaden scope of s 5(1), i.e. to tax payments not otherwise taxable (under 5 or 3). 6(3) doesn’t apply here b/c payment was not made by future employer but by shareholder of employer. To then regard income as falling w/in s. 3 would render 6(3) meaningless. [i.e. B/c 6(3) is specific provision, not open to court to fit payment into some other more general section.]

- Court rejects: 6(3) is provision dealing with onus of proof. Fact that payment doesn’t fall into 6(3) doesn’t mean that cannot be income w/in provisions of s. 3

- Aplt arg 2: Portion of payment was to provide compensation for loss of capital (i.e. rights to pension, source of income, not income itself).

- Court rejects: First, K doesn’t divide payment into two parts. Second, bargaining of parties was not such that payer was receiving the rights (i.e. the capital) being relinquished. Might have been different had payment been made by Imperial Oil (i.e. former employer)

- Aplt arg 3: K for $250,000 not connected to employment K and makes no reference to it. - Court rejects: while no explicit connection btwn the two, they were signed at the same time. - Ultimate decision of court: essence of the agreement to pay $250,000 was acquisition of services

and the consideration was paid so that those services would be made available. Court thus appears to conclude that it can be considered income under para 3(a) (i.e. a generic source) or under subs. 5(1) (i.e. other remuneration)

[Dissent]:- Portion of payment was paid for personal services and portion as consideration for the loss of the

TP’s prior benefits. Notes:

- Allard: even if the payment was properly considered payment for giving up pension rights, still would have been Q as to whether capital or income (court didn’t discuss this)

- Volpe v. MNR : TP accepted new job that required him to move. Future employer promised to compensate him in event that former residence was sold for less than a stipulated amt. He received $27,000. Issue: income from employment or compensation for capital loss on disposition of former residence? Court: Income under 6(3) – payment was received as consideration for accepting the office.

Tort damages for personal injury or death

Cirella v. The Queen , [1978] F.C.T.D., p. 249

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Facts:- Cirella was injured in car accident in 1968. Tried to go back to welding job but couldn’t function

properly. Started own light welding business in 1970 or 71. In 1972, was awarded damages which included $14,500 as special damages for loss of income from time of injury to end of 1971

Issue: Are these special damages taxable?

Held: No

Ratio:- Govt argument based on surrogatum theory, i.e. when you are compensated for something that would

have been taxable income had you actually earned it, then that compensation is income of the same nature and taxed as such. Relied on London and Thames: commercial wharf damaged by someone’s negligence and took a year to repair; owner received damages for loss of income and tried to argue, for tax purposes, that it was capital payment (b/c received for damages to capital property). Court said it was income – amt awarded for repair of wharf would have been capital however.

- Court considered each income source and concluded that damages didn’t fall into any of them:- Business Income: court distinguished London and Thames. In this case, no income-producing asset

was damaged (human not asset). Also, these damages could not be for loss of income suffered by his new business, b/c business was started up well after injuries sustained and was unaffected by them.

- Employment income: not salary, wages, gratuity or other remuneration and was not paid or received as such. The money was not earned by working for or serving anyone. Not inducement payment. Statute is very precise as to what is to be included in income, and doesn’t specify such damages.

- Income from a generic source : No. Damages for loss of income, whether special damages for loss of income up to judgment or general damages for loss of future earning capacity, are of a capital nature. They are compensation for the loss of future earning capacity, which is a capital value. The description of damages in the judgment as being for loss of income refers merely to the method of calculation and not to the nature of the award.

Notes:- Allard: The reasoning in Cirella has been restricted to cases of personal injury damages and not

extended to cases of injury to property- Note that if injured at work – will not receive damages but will receive Workers’ Comp payments.

These payments are included in computing TP’s net income [56(1)(v)] but offsetting deduction is available in computing TP’s taxable income (thus payments effectively not taxed)

- Bad policy? Compensation to injured person is determined on after-tax basis. This lessens cost to tortfeasors do not confront full social costs of accidents (which includes lost tax revenue) might negligent behaviour thus be inadequately deterred?

Gratuitous payments

Mere fact that there is no legally enforceable obligation to make some payment doesn’t mean that recipient of that payment won’t be taxed on it (Goldman). This is true even outside the realm of “employment.” Whether or not the payment is legally enforceable is not an issue.

Goldman v. MNR, [1953] S.C.C., p. 254

Facts:- Aplt was head of shareholder committee. He was working with other committees on negotiating a

reorganization committee b/c the company was in receivership.

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- Scheme of arrangement provided that members of shareholder committees would not receive any remuneration for their services. However, it was agreed by all that counsel fees should be on a scale that would allow committees to get something.

- Black, counsel for aplt’s committee, submitted an inflated bill and then made two payments of $7000 to aplt. Aplt claimed that these amounts were gifts and thus not taxable.

Issue: Gratuitous payments made by lawyer to aplt taxable?

Held: Yes.

Ratio:- voluntary payment will be subject to income tax if it is made in connection with an office or

employment- Payment in this case was received by aplt as remuneration for the services which he performed. Both

parties intended the money intended to be paid and received as such. The fact that there was no assurance that the services would be remunerated doesn’t prevent the amt in Q from being taxable

- Even if not taxable as remuneration for services, the payment at bar would be taxable as coming from a generic source under s. 3

Notes:- MNR v. Gagnon : gov’t employee received $150 for making a good suggestion. Held: Payment was

remuneration for services w/in meaning of sub 5(1) [i.e. “other remuneration”] and thus taxable. While rewards for suggestions are not compensation for services performed in course of normal execution of duties, they are compensation for services to be performed in addition to normal duties. Good suggestions is service that, if not performed by employees, would be sought from ind K-ors (e.g. consultants)

- Heggie v. MNR : President of food co. out of work when company sold. He received gratuitous payment from purchaser equivalent to his former salary for a period of five months. Held: Not salary w/in meaning of 5(1) b/c payments made by purchaser and not TP’s employer. Not a benefit w/in meaning of 6(1)(a) b/c resulted from anticipated unemployment rather than prior employment

- Yaholnitsky-Smith v. MNR: TP received financial assistance from employer to attend educational program. Not employed during her studies and had no obligation to return thereafter. Held: remuneration under 6(3) b/c was consideration or partial consideration for her covenant to attend the program.

- Seary v. MNR : TP denied tenure of U of T threatened to take legal action. Received monthly payments and then lump sum payment when tenure granted. Held: monthly payments not taxable b/c TP held no office or employment at time they were made. Lump sum a taxable “gratuity” w/in meaning of 5(1). Duff: could monthly payments have been characterized as remuneration under 6(3), benefit under 6(1)(a) or income from unspecified source under 3(a)?

- Allard: these cases show that seemingly insignificant differences in the facts can have a significant impact on the outcome.

Strike pay

Fries v. Canada, [1989] F.C.A., p. 260

Benefits

- Generally receipt of benefits “in kind.”

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- Problem with receiving benefit in kind is that have to pay tax in cash even though didn’t receive cash. The recipient may not earn enough money to pay tax on the benefit received.

General rule

6(1): When computing TP’s income from office or employment, must include:6(1)(a) Value of benefits – value of board, lodging and other benefits received or enjoyed by the

TP in the year in respect of, in the course of, or by virtue of an office or employment, except any benefit (list of exceptions)

6(1)(b) Personal or living expenses – all amounts received by the TP in the year as an allowance for personal living expenses or as an allowance for any other purpose, excpt

(i) travel expense allowanceetc. (other exceptions)

- General rule is in 6(1)(a) ‘board,’ ‘lodging,’ and ‘other benefits of any kind whatever,’ provided they are received or enjoyed by the TP in respect of, in the course of, or by virtue of an office or employment

Is this receipt taxable as a “benefit”? 3 parts to this inquiry: 1. Characterize the receipt – is it a benefit?2. Was the benefit received in respect of, in the course of, or by virtue of an office or employment?3. What is the value of the benefit?

1. Characterization as Benefit Lowe v. The Queen , [1996] F.C.A.

Lowe v. The Queen , [1996] F.C.A.

Facts:- Lowe worked as an account executive at an insurance company. His job was to promote his

employer’s insurance to independent brokers and create smooth relationships with them- His co. introduced a broker incentive plan under which certain brokers were eligible for a trip to New

Orleans. - As the account executive responsible for these brokers, Lowe was required by his employer to go on

the trip and make sure the brokers had a good time. His wife was to accompany him. Both trips were at employer’s expense.

- MNR allocated 38% of aplt’s trip and 25% of his wife’s trip to business (i.e. not taxable in employee’s hands)

- Tax court judge reduced this allocation.

Issue: Are any portions of the aplt’s and wife’s trip taxable in aplt’s hands?

Held: No

Ratio:- What constitutes a “benefit” for tax purposes? Court quotes Krishna: (1) The receipt must provide

the employee with an economic advantage that is measurable in monetary terms or be a material acquisition which confers an economic benefit (latter isn’t Krishna) (2) If there is such an advantage, one asks: does the primary advantage enure for the benefit of the employee or the employer?

- No part of aplt’s trip should be regarded as a benefit unless that part represents a material acquisition for or something of value to him and provided that the valuable part was not a mere incident of what was primarily a business trip.

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- Court focuses on the latter inquiry: The principal purpose of the aplt’s trip was business and any pleasure was incidental to this business purpose. The aplt devoted an overwhelming amount of his time to business purposes. He and his wife had only 1 hour of time to themselves. The aplt’s trip cannot be characterized as a reward. It is not something he earned

- Wife’s attendance in New Orleans was not obligatory but her presence at the request of the employer was primarily to serve the employer’s business. She devoted most of her time to attending meetings with her husband and attending to the brokers and their wives.

- No doubt the couple enjoyed the trip, but this enjoyment, for both of them, was merely incidental to the business purposes.

Notes:- Wife’s trip taxable in husband’s hands. Why not income from generic source taxable in wife’s

hands? B/c we look to employer’s perspective – employers expect to get something from conferring benefits and they generally don’t expect to get that something from their employees’ spouses!

- This case – trip 100% business = no taxable portion. In many other cases, court will allocate btwn business and pleasure. This is a question of fact to be determined by an objective test (i.e. of what constitutes business vs. pleasure). Note that Duff seems to suggest that the court in Lowe took a totally different approach than that taken by courts which allocate, i.e. not percentage approach but ‘all-or-nothing approach.’

- Parsons: employer took all employees to Disneyworld as marketing stunt. Held: entire trip not taxable. Indicators – employer would not pay salary if didn’t go on trip (closing down office); promotional picture taking etc.

- SH: Is it a material advantage? Can ask: would the tax payer have had to spend money out of his/her own salary to secure the same advantage?

Note: def’n of benefit in Lowe must provide recipient with an economic benefit or advantage this raises Q of what constitutes an economic benefit or advantage.

What is an economic benefit/material advantage?

Ransom v. MNR, [1967] p. 276

- TP transferred by employer from Sarnia to Montreal- Received $3617 as partial compensation for a loss on the sale of his old house

Issue: Taxable benefit? Remuneration for services?Held: No and no

- The payment is a non-taxable reimbursement for loss incurred in the course of the TP’s employment- Reimbursement for expenses that put employee out of pocket by reason of his employment does not

constitute a taxable benefit or remuneration for services [court makes analogy to reimbursement for accommodation/food expenses on business trip]

- Ask: is this a loss that employee wouldn’t have suffered but for his/her employer?

Allard:- Benefit to employer is not totally obvious. Benefit to employee is being compensated for a living

expense

Phillips v. MNR, [1994] F.C.A., p. 279

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- TP received $10,000 “relocation payment” after transferring from Moncton to Winnipeg when employer closed Moncton establishment

- TP relied on Ransom and argued that the payment merely compensated him for increased housing costs associated with the move (i.e. a loss he would not have incurred but for the move he was required by his employer to make) w/o conferring an economic advantage.

Held: Taxable benefit

- The payment enabled the TP to acquire a more valuable asset and increased his net worth (basis upon which Ransom distinguished – Ransom lost money on sale of house whereas Philips owns more valuable one)

- The decision below (which accepted the TP’s argument) creates a window of opportunity for those intent on structuring tax-free compensation packages for employees required to relocate to urban centres where costs of living are higher.

- TP’s reasoning could be used to justify payment of tax-free bonuses to cover cost of cars, appliances, etc. in provinces with higher living costs.

- Bottom line : (1) TP has a more valuable house; (2) expense is based on personal consumption choice (i.e. chose to live in same type of house in same kind of neighbourhood) which, if not taxable, would effectively constitute an indirect subsidy by other taxpayers.

Allard:- Notion of personal consumption choice and indirect subsidy arises frequently. Desire to prevent

situation in which TPs are subsidizing personal consumption choices of others is underlying rationale for:

o denying deduction of personal living expenseso taxing amounts received from employer (i.e. benefits) to cover personal living expenses

Krull v. Canada, [1996] F.C.A., p. 278

- TP transferred from Calgary to Toronto- Received mortgage interest subsidy from employer to compensate for increased interest charges on

costlier Toronto homes. Increased interest charges resulted from (1) increased rates; and (2) increased cost of house

Held: Not a taxable benefit

- Subsidy did not increase TP’s equity in house- No economic gain accrued as result of subsidy. Net worth was not increased. Thus, fundamental

requirement of 6(1)(a) was unfulfilled

Splane v. The Queen, [1990] p. 277

- TP relocated by employer and compensated for increased mortgage payments on a new residence attributable to higher interest rates prevailing at time of transfer

Held: Not a taxable benefit

- Ptf moved at request of his employer, incurred expenses in so doing, and suffered a loss. When ptf was reimbursed for these expenses, he was simply restored to the economic situation he was in before he undertook to assist his employer by relocating to the Edmonton office

- Allard: court emphasized that he didn’t end up with an asset of greater value (SH: but Krull did and

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benefit wasn’t found to be taxable!)

Krull, Philips and Splane overturned by subs 6(23)For greater certainty, an amount paid or the value of assistance provided by any person in respect of, in the course of or because of, an individual’s office or employment in respect of the cost of, the financing of, the use of or the right to use, a residence is, for the purposes of [s. 6], a benefit received by the individual because of the office or employment.

Ransom-type non-taxable benefits now capped by ss. 6(19) to 6(22) and the definition of “eligible relocation” in ss 248(1)Employees must include in income one-half of the amount in excess of $15,000 paid directly or indirectly to an employee by an employer in respect of a decrease in value or impairment of proceeds of disposition of the employee’s residence.

Other Cases

Gerhart v. The Queen, [1996] p. 280

- American working in Canada for American company was given “gross up” on salary to cover increased taxation. This put net after-tax salary at level it would have been at home. TP argued that gross-up shouldn’t be taxable b/c merely compensated her for taxes she wouldn’t have had to pay but for her employment, which required her to work in Canada

Held: taxable as remuneration under sub 5(1) and as a benefit under 6(1)(a)

- Remuneration commonly adjusted to reflect advantages and disadvantages inherent in rendering services under an employment K but doesn’t for that reason cease to be remuneration

- The gross-up is an obvious benefit when aplt’s position is compared with that of any other resident of Canada in receipt of same income (minus tax equalization payment)

Guay v. The Queen, [1997] p. 281

- TP worked for Cdn foreign service. Employer reimbursed him for cost of sending children to private international school in Ottawa

Held: non-taxable

- Reimbursement did not increase TP’s net worth; it put him in same position as if he had not been compelled by the nature of his employment to send his children to this school. [Note: compelled b/c traveled all around the world and kids had to attend this school in order for them to receive a relatively seamless education]

Huffman v. The Queen, [1989] p. 281

- Plain-clothes police officer, pursuant to terms of collective agreement, receives money annually to cover cost of clothes

Held: non-taxable

- TP was required to purchase oversized clothing to conceal weapons, etc. He wouldn’t have

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purchased the clothes if not for his job – he was. Effectively reimbursement for uniform. - TP was therefore simply being restored to the economic situation he was in before his employer

required him to incur these expenses Allard:

- This is a borderline case and we must be careful not to take the result beyond these actual facts. In another case, a lawyer tried to argue that she would not have bought black suits but for her employment – court rejected this.

Other Examples

Case BenefitHeld –

taxable/non-taxable?

Reason/Principle

Pollesel v. The Queen Moving expenses when job requires relocation

Non-taxable TP didn’t receive economic benefit

CCRA Interp Bulletin Moving expenses when job requires relocation or TP accepts job in place where doesn’t live

Non-taxable

Pezzelato, [1995] Reimbursement of interest expenses on money TP had to borrow in order to acquire residence in location where transferred to (i.e. bridge financing)

Taxable No diff btwn paying mortgage interest, contributing to principal amt of purchase price, or increasing remuneration.

Leduc Estate v. The Queen, [1996]

Employer transported perishable foodstuffs to employee working in Northern QC

Taxable under para 6(1)(a)

Employer is paying a personal expense/consumer expenditure instead of directly increasing remuneration in order to allow for higher living costs. Cost of food and food transport is very high in North but is a necessary cost for everyone. Also, provisions in Act allows TPs residing in Northern regions to claim a specific deduction and exempts allowances or benefits for board and lodging and transport to/from a remote location.

Cutmore v. MNR, [1986] Reimbursement for cost of retaining accountant to prepare income tax return (so as to ensure that actions of employees didn’t reflect on credibility of reputation)

Taxable under 6(1)(a) Motivation behind the benefit and fact that the acceptance of it was a requirement of the employment doesn’t render 6(1)(a) inoperative.

Deith v. MNR, [1989] Employer paid professional liability insurance on behalf of employee lawyer.

Taxable benefit (1) Economic advantage to employee b/c would have had to purchase the insurance himself (otherwise not employable as lawyer) (2) protection from personal liability is a substantial economic benefit

Dunlap v. The Queen, [1998] Christmas party (valued at $302 per employee)

Taxable benefit Significant benefit even though unilaterally conferred. [Note int. bulletin: parties or other social events not taxable if cost is reasonable. Reasonable = up to $100]

Faubert v. The Queen, [1998] Reimbursement for tuition Taxable benefit Aplt not legally obliged or faced

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fees of accounting upgrading courses

with job loss consequences if failed to upgrade skills. Courses taken primarily for e-ee’s benefit.[Note int. bulletin: taxable benefit arises when the training is primarily for the benefit of the employee]

Pellizzari v. MNR, [1987] Employer paid legal fees to defend charge of fraud committed while employed by employer

Taxable benefit Legal fees paid by TP were her personal expenses

Clemiss v. MNR, [1992] Employer paid legal charges for TP charged with conspiracy to defraud the co. and theft of co. property

Taxable benefit Expenses were incurred by TP not incurred in order to do the job but to answer criminal charges laid against him personally. Not sufficiently close nexus between legal fees and ptf’s position as an employee. SH: might have been different if charges involved charges against co. or charge was levied against employee in his capacity as director

R v. Poynton, [1972] Employee embezzled funds Taxable benefit Two possible bases for taxation: (1) benefit from employment; (2) s. 3 [generic source] [TP didn’t receive the funds qua employee but qua thief]

See interpretation bulletins at 286 for treatment of subsidized meals, counseling services, discounts on merchandise and commissions on sales, transportation on the job, recreational facilities, transportation passes

2. Was the benefit received in respect of, in the course of, or by virtue of an office or employment?

**Need only ask this question if find that something is a benefit. Not benefit = end of story, do not advance to this Q. Watch out however b/c courts conflate these two questions; often do not clearly distinguish between them.

Argument advanced in Ransom: reimbursement for loss on house wasn’t direct consideration for services b/c he received regular salary in addition, i.e. must be causal link between a benefit and services rendered. This reasoning rejected in Savage.

R. v. Savage, [1983] S.C.C. p. 287

Facts:- Employer encouraged employees to take work-related courses by offering a $100 reward for

successful completion- Employer claimed it as a business expense but TP-employee didn’t include it in her taxable income.

Issue: Do the rewards constitute income of the TP from an office or employment? [More specifically, were they received in respect of, in the course of, or by virtue of an office or employment?]

Held: Yes

Ratio:

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- The words “in respect of” are of the widest possible scope – benefit need only be received in relation to or in connection with employment.

- Appropriate test is whether the benefit was conferred on the person as an employee or simply as a person (because he is nice guy)

- Payment need not partake of the character of remuneration for services in order to be received in capacity as employee.

- Case at bar: difficult to conclude that payments not in relation or connection to TP’s employment – TP took course to improve her knowledge and efficiency in the business and to better her chances for promotion.

Allard:- Result of this reasoning is ultimately assumption (will not go so far as to say presumption) that

anything you receive from employer will have been received in respect of…etc. your employment. Heavy burden on TP to show that received in capacity as individual (see Mindszenthy for example).

- One student commented that the courses seem to benefit the employer more than the employee. However, benefit at issue in this case is not reimbursement for course but rather cash reward for successful completion. Straight up cash payment always confers material advantage/economic benefit.

Mindszenthy v. The Queen, [1993] p. 290

- President of co. gave $3929 Rolex watch to employee and deducted the cost as a business expense. TP-employee argued that it was a personal gift and therefore not a taxable benefit

Held: taxable benefit under para 6(1)(a)

- Question is whether gift was given to employee in his capacity as an employee or as a friend. One would need very cogent evidence to show the latter (i.e. that gift given qua personal friend)

- Despite close personal relationship in this case, watch was given to employee in his capacity as employee.

- Note that while this decision seems harsh, TP could have sold watch for what it cost (Rolex watches don’t depreciate)

Phillips v. MNR: (relocation payment to compensate for higher cost of housing). Court rejected argument that not received in course of…employment. Fact that source of payment was collateral K cannot be conclusive of whether payment received in capacity of employee. Cannot focus on the existence of collateral K to the exclusion of its context (i.e. the fact that it arose out of an employment relationship)

Blanchard v. Canada: 6(1)(a) only requires some connection btwn the receipt of a payment and the recipient’s employment – nothing turns on the source of the payment

Waffle v. MNR: Waffle worked for Ford distributor and received free trip from Ford Canada (the mfr). Held: Benefit taxable. For payment to be received in course of employment – need to be provided by the employer.

Giffen v. Canada: TP who traveled frequently for work was assessed on value of frequent flyer points exchanged for free tickets. Held: taxable benefit b/c only available to employees who traveled and who were members of a frequent flyer plan. Free travel not a benefit received in a personal capacity and wholly divorced from employment

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Allard: - A finding that a benefit is not taxable doesn’t necessarily have implications for the employer’s

tax liability. An employer may be able to deduct payments, etc. as business expenses even though they are not correlatively taxed as benefits. However, a finding that a certain payment, etc. was not given in the course of employment but as a personal gift suggests that employer did not incur for the purpose of earning income but for personal reasons (therefore not deductible)

3. What is the value of the benefit received?

Allard: many of the same considerations that go into material advantage question arise at this stage also. Question of “whose benefit is it” also comes into play b/c will often be an apportionment of value between employee and employer (relative to benefit conferred on each)

- Monetary benefits (e.g. reward as in Savage) do not raise valuation issues; benefits which involve use of service or property present the most valuation problems

Detchon v. The Queen, [1996] p. 293

Facts:- TP is teacher at private college which charges tuition, and is permitted to send his children to the

school tuition-free - Teachers at the college are expected to send their children to the school and would be reprimanded if

they did otherwise. - MNR assessed free tuition as benefit and valued it as equal to tuition paid by other parents

Issue: What is value of tuition benefit received by taxpayer?

Held: Average cost to school of educating a student. Ratio:

- TP’s arguments:o “Value” doesn’t necessarily mean fair market value (gives examples to show that

Parliament contemplated that in some cases value means other than fair market)o Tuition charged to BCS parents as basis for valuation leads to absurd result – aplts do

not have enough money to pay the tuition or the taxo The value of the tuition should be the incremental cost of having the children attend BCS

(which is nil because the school is not at capacity)o If court concludes that value of benefit is not related to the incremental cost, the value

should be the value of obtaining equivalent education elsewhere in QC. - Court found that (1) the free tuition is a ‘benefit’ for the purposes of 6(1)(a) – it is of economic value

to the aplts; aplts got something for nothing; (2) value of benefit is average cost of educating a student at BCS. No obligation for an employer to charge employees any more than actual cost of good or service; employer need not add profit element. If tuition was based on sliding scale and was dependent on parents’ ability to pay, then court would have valued it at price paid by similarly situated parents [why court raised this latter argument is unclear]

- Court dismissed concern that TP wouldn’t be able to afford the tax: wouldn’t be just and reasonable to other Cdn TPs if some employees obtain tax free benefit from employer who doesn’t pay a higher wage.

Allard:

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- Cost to employer is common administrative approach to valuing certain benefits (according to IT bulletin)

Valuing use of property – Taylor- Employee had personal exclusive use of employer’s yacht worth $175,000- Held: valued based on presumed annual rate of return (SH: profit?) on the cost of the yacht- Allard: note that valuation is based on rate of return on the cost of the property. If employer’s

business is renting out yachts would value at rate of return on yacht rentals. If employer is a manufacturer, would value at what rate of return would have been had money been invested in mfing business. Ask: what would the company have done with the money if it wasn’t invested in the property being used by the employee?

Valuation is (generally) simple when employer goes out and buys something (e.g. plane tickets)- Generally value at cost to employer. - Exception Wisla v. The Queen

o Issue: What is value of gold ring stamped with employer’s corporate logo? o Held: not cost to employer ($562) but scrap value ($63). o General rule is that where employer gives employee some merchandise or other non-

cash items it should be valued at f.m.v. F.m.v. of an item engraved or stamped with corporate logo is usually negatively affected, however, and value of benefit should be reduced accordingly.

o Allard : case also raises question of ‘for whose benefit?’ Perhaps ring is, in part, for employer’s benefit, and thus value should be apportioned accordingly.

Does it matter that benefit is not convertible into money? NO- Waffle v. MNR : TP argued that free Caribbean vacation for two should be taxable at its subjective

value to the TP b/c it could not be converted into money. Court: doctrine that remuneration not taxable unless it is money or money’s worth and convertible into money stems from English case of Tennant v. Smith, and is effectively overcome by the inclusion of ‘board, lodging and other benefits…’ in s. 6(1)(a). Value of trip = cost of trip to Ford, and not what TP would have paid for the trip.

Other CasesGiffen v. Canada: What is value of free travel received in exchange for frequent flyer points acquired in course of employment? Held: Price that employee would have had to pay for a ticket entitling him to travel on the same flight and subject to the same restrictions as are applicable to reward tickets.

Richmond v. The Queen: Employer provided TP with year-round reserved parking spot. Employer only used it occasionally and argued that value for tax purposes should reflect that. Held: whether TP actually used the property is of little consequence. What is important is that it was available to him.

Specific rules (no reading)

Allowances

1. Characterization- See 6(1)(b) above – allowances (for any purposes, not necessarily personal or living expenses) are

taxable (subject to certain exceptions such as travel allowances)- Allowances are outside of ‘remuneration,’ i.e. received over and above salary

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- Unlike benefits, where receipt of something that is nothing more than reimbursement for cost incurred in course of employment would not be taxable, all allowances (even if they cover expenses incurred by reason of employment) will be taxable.

- Def’n of an allowance: Macdonald- To avoid paying tax on an allowance , try to (1) set it up as reimbursement (i.e. require that all monies

spent be accounted for with receipts); (2) fit it into para 6(1)(b) exception or (3) fit it into a s. 8 deduction.

o (3) is preferable to (2) if expenses incurred > allowance which covers themo (2) is preferable to (3) if expenses incurred < allowance which covers them

- Note that some s. 8 deductions require that you receive a taxable allowance, i.e. expense only become deductible when you are including that expense in your income. Many other deductions are available whether or not you receive a taxable allowance

Canada (AG) v. Macdonald, [1994] FCA p. 335

Facts:- TP was member of RCMP who was transferred from Regina to T.O.- After transfer, was paid $700 housing subsidy per month

Issue: Housing subsidy a taxable allowance? [What is the def’n of an ‘allowance’?]

Held: Yes – taxable allowance therefore no need to decide whether taxable benefit

Ratio: - Para 6(1)(a) vs. para 6(1)(b): former directed mainly twds benefits of non-monetary nature, such as

board and lodging, but can also include specific sums of money; latter designed to capture money payments that meet criteria of ‘allowance.’

- Allowance is composed of three elements:1. An arbitrary amt in that it is a predetermined sum set w/o specific reference to any actual expense or

cost. Amt may still be allowance, however, if determined with reference to projected or average expense or cost.

2. Allowance will usually be for a specific purpose. (though no ob to use for that purpose)3. Use of allowance at discretion of recipient in that recipient need not account for the expenditure of

the funds (i.e. submit receipts). Fact that allowance is used for its intended purpose or doesn’t overcompensate recipient doesn’t lead to conclusion that there was obligation to so use it.

- Application to facts of case: Housing subsidy is a taxable allowance. Round, arbitrary amount (not determined in respect of an actual cost or expense) given for a particular purpose (to cover a personal living expense). Doesn’t fall w/in exception. Money was given totally in TP’s discretion – didn’t have to buy a house or pay rent to receive it. No receipts had to be submitted.

- Court distinguishes Splane (money for increased mortgage payments following move). TP in that case had to submit receipts.

SH: Policy reason behind taxing allowances – b/c no obligation to account, could be hidden remuneration.

R. v. Demers: TP received a ‘cost of living adjustment’ when posted to Haiti. Held: remuneration w/in meaning of subs 5(1) and 6(3). Not an ‘allowance’ (which might have been exempt under sub 6(6)). [Note sub 6(6) is exemption for an allowance in respect of expenses incurred while employed at special work site or remote location]

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Huffman v. The Queen: TP received a $500 clothing allowance pursuant to policy that required presentation of at least $400 in receipts. MNR argued that difference btwn amount paid and receipts actually submitted was taxable. Held: not taxable. $500 in issue was not an allowance b/c employees required to account by submitting receipts. Special exception to receipts requirement was made for $100 b/c amount was increased from $400 to $500 during year in issue. This doesn’t change nature of payments b/c general rule required submission of receipts.

Verdun v. The Queen: TP worked at newspaper co. with two locations. He received annual meal allowance of $1400 which, he claimed, merely reimbursed him for evening meals consumed while working at one of the two locations. Held: Taxable allowance. Even when these amounts are not used for any improper purpose, and even when they are reasonable estimations of the cost, our law treats them as additional remuneration, not as reimbursement, which requires detailed receipt submission. Duff: How might TP and employer have structured matters in order to avoid value of food being taxable?

2. Exclusions

- General rule in 6(1)(b) is subject to numerous exceptions

6(1)(b) TP not required to include in income from office or employment(v) reasonable allowances for travel expenses received by employee in respect of a period when

employee was employed in connection with the selling of property or negotiating of Ks for the employer

(vii) reasonable allowances for travel expenses (other than for use of a motor vehicle) received by an employee (other than an employee employed in connection with the selling of property or the negotiating of Ks for the employer) from the employer for traveling away from:

A. the municipality where the employer’s establishment at which the employee worked or reported to is located

B. the metropolitan area, if there is one, where that establishment was located

(vii.1) reasonable allowances for the use of a motor vehicle received by an employee (other than an employee employed in connection with the selling of property or the negotiating of contracts for the employer) from the employer for traveling in the performance of the duties of the office or employment

What does ‘travel expenses’ mean? Blackman

Blackman v. MNR, [1967] p. 342

Facts:- TP required, by reason of employment (transporting passengers and goods), to live away from home

for periods of 3 to 4 months.- Employer paid allowance to cover increased cost of living while away from home

Issue: Are allowances exempt from taxation on grounds that given to cover travel expenses?

Held: No

Ratio:- Sums of money paid to TPs were not in the nature of traveling expenses but were personal and living

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expenses. - Def’n of traveling: go on a journey, move back and forth w/in a short period of time. This is quite

different than sojourning which means to live temporarily in a place. TP in this case is not traveling from place to place but living away from home for short periods of time.

- If an employee must sojourn or live temporarily away from regular place of work/home, and he has right to deduct the allowance he is receiving to make up for personal expenditures he may incur while at the other locality, he will be overpaid vis-à-vis employees who, in order to carry out duties, do not need to travel or sojourn away from their ordinary place of residence.

Notes:- TP might have been able to exclude this allowance under sub 6(6)- Bouchard v. MNR, [1980]: TP lived in QC City where worked for gov’t. Also worked as part-time

professor in Sherbrooke, and, pursuant to K, received $1500 as allowance for travel and living expenses. TP argued that payment was non-taxable travel allowance w/in meaning of subpara 6(1)(b)(vii). Held: taxable. Expenses in respect of which payment made were personal expenses for travel voluntarily incurred by TP, just like expenses he incurred from going to his residence in QC City to the Parliament Buildings. Note: outcome legislatively revered by sub 81(3.1).

Statutory exclusions (no reading)

Deductions (no reading)

Timing Issues - In which tax year will inclusions and deductions be taken into account for tax purposes?- General preference: TPs prefer to delay recognition of income and accelerate recognition of

deductions (except in situation where expect that income will jump into higher bracket)- Income from office/employment computed on ‘cash basis,’ i.e. income recognized in period when

actually received and expenses recognized in period when actually paid- Cash method can create opps for TPs to deliberately delay receipt of income to defer tax

Inclusions - Note language which denotes cash basis of accounting

o 5(1) – salary, wages, etc. received by the TP in the yearo 6(1)(a) – value of benefits received or enjoyed by the TP in the yearo 6(1)(b) – all amts received by the TP in the year as an allowance

- Note that other provisions allow TPs to defer recognition of amts or prevent undue deferral

Receipt and enjoyment- Dictionary def’ns of words ‘received’ and ‘enjoyed’ suggest that income from employment/office

will generally be recognized in the tax year in which the recipient is legally entitled to the amounts in Q (salary, wages, and other remuneration), except for benefits, value of which may be included in taxation year in which TP obtains use of good or service regardless of legal entitlement.

- Meaning of word ‘received’ Cliffe

Cliffe v. MNR, [1957] p. 431

Facts:- TP was SH, manager and president of closely held logging company- 1953 – TP and his father (also SH) agreed that TP should receive $7500 salary for fiscal year- When co. hit rough times, SHs agreed not to pay full amt of salaries until situation improved. TP and

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father merely w/drew sufficient funds to enable them to get by. - End of fiscal year – co. claimed full amt of TP’s salary as deductible but TP didn’t claim

corresponding amount as income.

Issue: Was the full amt of TP’s declared salary received by TP in 1954 fiscal year (even though he didn’t actually take it)? [Should TP be considered to have constructively received the balance of his salary?]

Held: No

Ratio:- MNR’s arguments : balance of TP’s salary owing to him was credited to an account of his in the co’s

books (court: no evidence of this); co. charged balance of salaries as expenses in determining income for 1954 fiscal period; aplt and father were controlling SHs of co and it was their decision which resulted in non-payment of balance of salaries; co. had sufficient cash at year end to pay balance of salaries; amts of salary which remained in co. should be seen as loan to company by two main SHs

- Court rejects these arguments and finds that balance of salaries was not, as required by s. 5 of Act, actually received in the year.

- Co’s officials were in best position to determine whether co. should pay out balance of salary or whether, for good of the co., it was necessary that a considerable amount of cash should be kept on hand to finance possible operations which co might undertake under future contracts.

Allard:- When create scheme to defer receipt of income, court will likely find constructive receipt. - How to avoid finding of constructive receipt? Put condition on employee’s ability to receive the

money (SH: such as profits, revenues, etc.), such that it is not purely the employee’s actions/decision/choice which delays receipt. In this case, employees were also SHs/officers and thus controlled money in co. – nothing prevented receipt except their own actions (they controlled the employer, agreed on the salary and didn’t take it though it was available). Court did not however find constructive receipt, likely b/c felt that decision to retain money in co. was business decision and not tax-motivated. Very borderline case.

Notes/Other Cases:Rousseau v. MNR: TP was controlling mgr and SH of company that agreed to pay him x amount as salary, but only paid him portion of that amount, and credited the rest to an account on company’s books from which TP could draw funds ‘at his discretion and according to his needs.’ Held: no constructive receipt. Fact that amount owing to aplt had been credited to him cannot be considered payment w/in the meaning of the Act. What if the co. had gone b-rupt before he was able to take money?

Declaration of bonuses: b/c businesses calculate income on accrual basis, frequent tactic employed by businesses was to declare bonuses payable but delay actual payment. Result: business can deduct in year declared but employee need not declare until actually received. Sub 78(4) has limited this practice: where employer declares bonus or salary payable to employee, must actually pay it w/in six months of employer’s year end, otherwise will be denied deduction.

Salary vs. Loan- Park v. MNR: TP, SH and VP of company that agreed to pay him annual salary and bonus. He

received (most of) it and characterized it as a non-taxable loan. Held: taxable remuneration. TP signed no note or acknowledgement of debt in favour of co; no mention was made of interest rate; no term was set. Relationship of borrower and lender never existed.

- Brum v. MNR: Pres and controlling SH of co. w/drew funds from it on regular basis to pay personal expenses; entered amts as indebtedness in TP’s SH’s loan account, which was credited a year later by

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payment of ‘accrued salary payable.’ Held: loans not remuneration. Park doesn’t set down rule that some or all indicia of a debtor-creditor relationship are required.

- Randall v. MNR: TP requested advance on his salary in Nov 1985 to cover period in Jan 1986 when he planned to be on vacation and at a conference. TP argued that the advance was a non-taxable loan which he would have had to repay had he ceased employment at end of 1985. Held: not loan but pay in advance thus taxable in 1985.

- Meredith v. The Queen: TP was director and SH of real estate co. for which he worked as commissioned salesperson. W/drew cash on regular basis ‘as needed’ during period when real estate biz was in recession and commission wasn’t enough to meet personal expenses. Issue: non-taxable loan or pay advances? Held: non-taxable loans. In order for these advances to be considered income receipts, Court must be able to find that under and by virtue of his K of employment aplt was entitled to commission based income and to advances on possible future earnings repayable solely out of future commissions, with no liability to repay if future earnings provide to be inadequate.

- Note that while principal amt of loan made to officer or employee is not taxable, a taxable benefit may be assessed if the loan is low-interest or interest free.

Deductions (SH: nothing)

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Chapter Five: Income or Loss from a Business or Property

Introduction

- Income from biz/property source taxable pursuant to para 3(a) and sub 9(1)- Rules for computing income from biz/property found in ss. 9-37- Tax treatment of income from business and income from property is basically the same. Exceptions

include:o Goodwill – for tax purposes, only businesses can have good willo Deduction for cost of two conventions per year only available if earning biz income

Characterization

- Business vs. hobby/personal activity (gambling, treasure cases, REOP?)- Business vs. property (Orchison)- Gains/losses from business or property vs. capital gains/losses (Taylor v. MNR)

Implications of Characterization in these various ways- Where source of profit or loss is characterized as ‘business’ or ‘property,’ income is fully taxable

under sub 9(1) and para 3(a) and losses fully deductible in calculating aggregate income under para 3(d)

- Where gain or loss is of capital nature, only ½ is taxable (s. 38), whereas loss only ½ deductible (s. 38) and deductible only against capital gains for the year [para 3(b)]

- Thus, where realize gain, advantageous to argue (1) gain not contemplated by act (e.g. is mere hobby) or (2) that the gain originated from the disposition of capital rather than biz or property. Where suffer loss, most advantageous to characterize it as arising from biz or property

Business

Def’n of ‘business’

248(1) ‘Business’ includes a profession, calling, trade, manufacture or undertaking o fany kind whatever and…an adventure or concern in the nature of trade but does not include an office or employment. **Note that inclusion of ‘adventure or concern in the nature of trade’ extends the dictionary def’n of business

‘Property’ is property of any kind whatever whether real or personal or corporeal or incorporeal.

Case law def’n: business involves organized activity of any kind which occupies the time, attention and labour of a man and is carried on for the purpose of profit (Smith v. Anderson)

Business vs. property- Examples of income from property: interested earned on term deposit, dividends earned on shares- Business vs. Property (Hollinger, Micay, Orchison – cottages case)

o Property income passively owned – you earn b/c you owno Higher degree of activity/labour involved in business than in propertyo Level of services provided - e.g. rental of a room or apartment vs. rental of a hotel room

(in latter case, renter is paying for services in addition to room). Orchison – small proportion of rent was for services.

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o Whether owners of property have other employment or business income (Orchison – both owners had other full-time jobs; renting cottage was not their business)

Business Activities vs. Personal/Hobby Activities

MNR v. Morden, [1961] Ex. Ct. p. 452

Facts:- From 1942-1948, TP owned racing stable and raced horses. He regularly placed bets on his own and

other horses- He disposed of his horses in 1948 but continued to gamble. TP claimed that, from 1949-1955

(taxation years in Q), his gambling activities were only occasional, amounted to nothing more than a hobby or recreation and that therefore his income therefrom was not taxable.

Issue: Income from gambling taxable?

Held: No

Ratio:- There is no tax on a habit. - To be taxable, gambling gain must be derived from a business as defined in 248(1). Reasonable test

to use in this regard: What is the TP’s dominant object – to conduct an enterprise of a commercial object or primarily to entertain himself? Also look to the degree of organization a TP brings to activities (Graham v. Green)

- In this case, no evidence that TP conducted an enterprise of a commercial character or has so organized these activities as to make them a business, calling or vocation.

- While his bets were high at times and gains substantial, no evidence that operations amounted to carrying on business.

Notes:- Are educated bets at the horse track any different than educated bets on the stock market?- Judge in Morden suggested that, to be taxable, gambling gain must be derived from biz as defined in

Act. Could it alternatively be characterized as income from a generic source?

Buried Treasure Cases:- MacEachern v. MNR : TP searched for and recovered treasure from a sunken ship. Issue: income

from sale of coins recovered taxable? Held: Yes. o TP and his partners intended to sell for profit anything of value that was recovered o The search was a well-organized business endeavour – parties were prepared to invest

time, money and equipment in finding the treasure, retaining it and selling it- Tobias v. The Queen : TP involved in unsuccessful search for treasure argued that the operation was a

business, and thus that costs of search were deductible as businesses losses. Held: Businesso Fact that high degree of uncertainty does not defeat finding of business – lots of business

activities are very uncertain; people are willing to undertake them in the belief that the substantial rewards in the event of success will compensate them for uncertainty involved.

- Cameron v. MNR : salmon and herring fisherman went on two whale catching expeditions. Caught

two whales and sold them to aquariums for a profit. TP argued that not income from business b/c he was not a whaler, his boat was not equipped for whale catching, and due to the highly fortuitous and

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uncommon nature of the events, money received was a windfall and not income. Held: not business income

o Two occasions were ‘fortuitous” and not a business venture in the usual sense but a third catch might have fallen in a different category (sufficient to conclude that running a biz)

Business Gains/Losses vs. Capital Gains/Losses – what is an adventure in the nature of trade?

- Adventure or concern in the nature of trade: main boundary between characterization as income or loss from a business and capital gain/loss

MNR v. Taylor, [1956] Ex. Ct., p. 459

Facts:- TP Taylor was employee of Cdn sub of U.S. co and was earning employment income- Employer was restricted by parent from buying supplies of lead more than one month in advance- When lead became cheap, Taylor asked parent if could purchase foreign lead for delivery in 3

months. Parent refused, so instead he got permission from the parent to buy it himself and resell it to the company.

- He purchased 1500 pounds of lead in exactly the same way as company would have bought it (delivery to broker). When the co. needed it, he resold it at the going rate and made a nice profit

Issue: Purchase and sale an adventure in the nature of trade? (i.e. was profit from sale of lead income from business? Or capital gain? Or not from a source at all?)

Held: Adventure in the nature of trade. Profit thus taxable as business income.

Ratio:Criteria for determining whether a transaction was an adventure in the nature of trade:1. There is no single criterion. Answer in each case depends on facts and surrounding circumstances2. Negative Factors

a. Fact that transaction is isolated is not determinative; can be business if only one transactionb. Need not have organization or scheme set up to carry the transaction into effectc. Doesn’t matter than transaction is totally different from/unconnected to TP’s ordinary

activities and that TP has never before and never will again enter upon such transaction (though court admits may be easier to conclude that adv in nature of trade if the transaction is in the individual’s own line of trade or occupation).

d. Need not have intention to profit. TP’s declaration that he entered upon transaction w/o intention of making profit should be scrutinized with care.

3. Positive Factorsa. Was the transaction of the same kind and carried on in the same way as a transaction of an

ordinary trader or deal in property of the same kind? [Behave like an amateur – more likely to be characterized as capital gain]

b. Nature and quantity of subject matter. Is nature and qty of subject matter such as to exclude possibility that sale was the realization of an investment or that it could have been disposed of otherwise than as trade transaction? This case: what else was he going to do with the lead except resell it? Property that doesn’t earn income or give personal enjoyment – will be difficult to characterize sale as capital gain. E.g.

i. Rutledge: TP bought load of cheap toilet paper and resold itii. Fraser: TP bought whiskey and resold it.

c. Allard: purpose in acquiring the property (resale, enjoyment, etc.)? If you buy for the purpose of making a profit upon resale (rather than for personal enjoyment or to earn

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income), will probably be found to be business income. - Application to facts: Nature and qty of subject matter? What else was he going to do with 1500 lbs

of lead but resell it? Dealt with it in exactly same manner as dealer in imported lead would have done. His adventure was a speculative one.

Allard: - if you buy something which cannot be enjoyed or produce income – will probably be found to have

been purchased for purpose of resale (business)- Allard’s pet peeve – courts have said that “there is something about shares that is inherently

investment in nature.” Profit on sale of shares will almost always be characterized as capital gains and intention is not really considered. This is case even though shares can be bought and sold very easily and quickly and are not often bought for income earning properties (i.e. dividends).

Role of Intention:- Intention is relevant to determining whether transaction is adventure in nature of trade: For what

purpose did TP purchase property? For long-term investment, personal enjoyment, income earning potential? (= capital in nature) OR, to resell at a profit? (= business in nature)

- Courts have recognized that can be two purposes (Fraser) and both of these can both be considered, i.e. transaction may be characterized as adventure in nature of trade (or otherwise) on basis of secondary or primary intention (Regal Heights)

Regal Heights Ltd. v. MNR, [1960] SCC p. 471Facts: Corp bought vacant land for primary purpose of developing a shopping centre (to sell or rent for income). They didn’t build a shopping mall, and eventually resold the vacant land for profit. Issue: Adventure in the nature of trade? [Significance of secondary intention]Held: YesRatio: Income is business income from an adventure in the nature of trade on basis that TP had secondary intention to resell property, notwithstanding that its primary purpose in acquiring property was to develop shopping centre (sale of which would have been capital gain).

Subsequent Cases:- Only characterize as adventure in nature of trade if re-sale at profit was one of the motivating

considerations that entered into TP’s decision to acquire property in question- But for test: Would TP have acquired the property were it not for the possibility of resale at a profit?

Other intention issues:1. Intention of corporations - Presumption from Anderson Logging: activities consistent with the stated objects of a corporation are

necessarily carried out in the course of the corporation’s business and thus result in business income.- Marconi: presumption easy to rebut- Today this presumption is not as relevant b/c corporate statutes no longer require companies to list

their corporate objects. - Regal Heights; Vaughan Construction: intentions of corporations are intentions of those who manage

and/or control it (officers, controlling shareholders)

2. Intention of partnerships - Could be imputed from dominant partner. If one partner knows what’s up, is managing the

transaction, etc., his intention may be imputed to the other partners for the purpose of determining the group’s intention.

3. Changing Mind

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- What if TP’s primary and/or secondary intentions change while owning property? - What if primary intention frustrated?

Notes:Stringham Farms Ltd. v. MNR: TP operated a feed lot for cattle, owned land on which cattle were grazed, sold cattle for slaughter, and bought and sold futures contracts in cattle, rapeseed, soybeans and barley. Held: transactions in cattle futures are part of TP’s principal business. Transactions in other futures are adventures in the nature of trade. WHY? Commodity futures are short-term and speculative; thus inconceivable that TP’s intention was to invest in long-term capital assets. TP was seeking to make a profit on a purchase and quick sale. SH: note imptce of intention and subject matter of transactions (not inherently long term investments)

IT-459 contains summary of the law which was cited with approval by SCC in Friesen v. The Queen. See page 472-474.

Reasonable Expectation of Profit

- issue of REOP arises at stage of characterization

The REOP ‘Saga’

Part I: Moldowan v. The Queen, [1978] S.C.C. - Issue in this case was whether farming was one of TP’s principal sources of income [Act limits losses

which can be claimed by TPs who use a hobby farm as a tax shelter/means to reduce total taxable income. To qualify for loss deduction, one must be able to show that farming was one of your principal sources of income].

- Court held: in order to have a ‘source of income’ (business or property) the TP must have a profit or a reasonable expectation of profit.

- Where did the court get this phrase? From the def’n of personal and living expenses in s. 248(1): the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or common-law partnership or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit.

Part II: Adoption by subsequent courts- Following Moldowan, courts accepted REOP as pre-req for having a business or property source of

income- Over time, courts applied the REOP test more aggressively, and demonstrated willingness to reassess

the business decisions of taxpayers. Examples: o Landry: TP who came out of retirement at age 71 to practice law was held not to have a

reasonable expectation of profito Sirois: TP running restaurant business at a loss was held not to have a reasonable

expectation of profit (based on review of operations of the business, seating capacity, opening hours, etc.)

- Several cases then tried to attenuate the effect of this aggressive test. Court in Tonn stated that tax system should not penalize honest but erroneous business decisions; it is not up to court to substitute its business judgment for that of the TP. In circumstances where activities have no personal element at all, court should apply the test sparingly favouring taxpayer.

Part III: Stewart- In Stewart, court threw out the REOP test and replaced it with the pursuit of profit test (see below). - REOP no longer a requirement for finding a sourcePart IV: (Proposed) Amendment to Act

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3.1(1) Limit on loss [REOP required] A taxpayer has a loss for a taxation year from a source that is a business or property only if, in the year, it is reasonable to expect that the taxpayer will realize a cumulative profit from that business or property for the period in which the taxpayer has carried on, and can reasonably be expected to carry on, that business or has held, and can reasonably be expected to hold, that property.

3.1(2) For the purpose of subsection (1), profit is determined without reference to capital gains or losses.

- These amendments reintroduce the REOP test but for a different purpose. It is not a pre-requisite for having a ‘source’ of income. Rather, it is a condition for being able to deduct losses from a business/property source.

- Arguably this is worst case scenario for TP. When REOP went to question of source, a finding of no REOP resulted in no income and therefore no tax payable. Now, question of source is governed by test in Stewart (much easier to satisfy). Ability to deduct losses from that source, however, is determined by a more stringent test (REOP). One could thus find himself in a situation where he is required to pay taxes on business/property income but cannot deduct business/property losses from total taxable income.

Stewart v. The Queen, [2002] S.C.C. p. 474

Facts:- TP purchased real estate investment ‘package’ (4 condo units) entirely financed by mortgage and

promissory notes (= high interest charges)- The package was marketed for its tax advantages. The advantages were two-fold: (1) deductibility of

(substantial) interest as business/property loss; and (2) fact that capital gains are only included in income and taxed when the property is ultimately disposed of (and then only 50% of the gain is taxed).

- The investment was projected to operate at a loss for ten years, which loss would (supposedly) be deductible against all other sources of income.

- MNR disallowed TP’s deduction of losses on basis that he had no reasonable expectation of profit for the years in question, and had just purchased the property as a tax shelter.

Allard: note that there are three ways TP could have characterized the investment package (1) as pure capital gain/investment property (but, under 20(1)(c), can only deduct interest costs which were expended for purpose of earning business or property income); (2) as a business (can deduct interest costs and disposal of property would be a capital gain); (3) as an adventure in the nature of trade (can deduct interest costs on yearly basis but gain is business income and thus full amount, rather than 50%, is taxable. TP wanted best of (2) and (3) – wanted to characterize as business so that could deduct interest and get capital gain BUT also wanted to have REOP analysis relate to profit on resale (rather than profit from running biz during ownership). Chose to characterize as business, thus had to show gain during ownership. Problem was that he had a great deal of literature which showed that making profits wasn’t really part of the plan.

Issue: Is the REOP test the test for determining whether the TP has a business or property source of income under the Act? If no, what is the test?

Held: Discard REOP test. Test for determining whether source pursuit of profit.

Ratio:- Problems with REOP test:

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o Has been applied independently of provisions of the Act to second-guess bona fide commercial decisions of the TP and thus runs afoul of the principle that courts should avoid judicial rule-making in tax law

o Vagueness and uncertainty of its application results in unfair and arbitrary treatment of taxpayers.

o Requirement of REOP doesn’t accord with dictionary and common law definitions of business, i.e. requires labour, time, organization of activities and pursuit of profit but not REOP

- Court distinguished/reasoned away Moldowan: (1) misapplied a principle from another case; (2) one of Dickson’s remarks suggests that test is only applicable where there is some personal element to the TP’s endeavor; (3) issue in that case was not whether there was a source of income in the first place but whether a certain source was the TP’s primary source of income.

- REOP thus should not be accepted as the test to determine whether a TP’s activities constitute a source of income.

- The new test for determining whether source (business or property) or mere personal activity: 1. Is the activity of the taxpayer undertaken in pursuit of profit, or is it a personal endeavor? (i.e.

is there a source of business/property?) The ‘pursuit of profit’ source test will only require analysis in situations where there is some

personal or hobby element to the activity in question. Where activity is clearly commercial in nature, there is no need to analyze the TP’s biz decisions. Such endeavors necessarily involve the pursuit of profit.

Pursuit of profit test is subjective , i.e. TP must have subjective intention to profit, BUT this determination should be made by looking at a variety of objective factors. Q to answer: Does the TP intend to carry on an activity for profit and is there evidence to support that intention? This requires TP to establish that his/her predominant intention was to profit from the activity and that the activity has been carried out in accordance with objective standards of business like behaviour. (Objective factors – see below)

Motivation of capital gains may be taken into account in determining whether the TP’s activity is commercial in nature, i.e. whether pursuit of profit, because accords with the ordinary business person’s understanding of pursuit of profit.

2. If it is not a personal endeavor, is the source of the income a business or property? (i.e. if 1 = yes, what kind of source?)

- REOP is appropriately considered when determining whether a given expense is deductible (b/c of def’n of ‘personal and living expenses’ in 248(1)). The deductibility of an expense is a separate question from that of the existence of the underlying source of income.

Bottom line post-Stewart and post-amendment:1. Look at activities being carried out

a. If purely commercial in nature, and there is nothing in those activities suggesting TP is in it for fun or personal interest, pursuit of profit test met and there is source of business or property income.

b. If there is any doubt or any personal element – look to objective factors to give evidence of TP’s intention in carrying out the activities. Is the TP’s predominant intention the pursuit of profit? This is a subjective test but need objective factors (as below).

2. If conclude that source of income exists, then must ask ‘were expenses deducted incurred to earn income business/property income or were they personal/living expenses (such as expense of home office)?’ REOP comes in here [interpreted using criteria that came out of the REOP cases, e.g. Moldowan]

3. Now, if there is loss from these activities, must go to s. 3.1 which limits ability to deduct that loss. 3.1(2) makes it clear that in applying the REOP test, you ignore expectation of any capital losses or

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gains. REOP has to be irrespective of any capital gains that you expect to make. [Note that court in Stewart says that in determining whether pursuit of profit, can take into account TP’s intention of making capital gains.]

Objective factors used to determine whether subjective intention to profit:**Note that these factors come out of the REOP cases (court in Stewart said that was appropriate). Also note that these factors will be relevant for determining whether REOP pursuant to sub 3.1(1) AND for issue of personal/living expenses.

1. Whether REOP is question of fact – no easy answer; depends on facts. 2. Determination is made for a given taxation year but is not made only on the basis of TP’s

expectation in that year. Expectation overall is what matters (look at past years, this year, anticipated profits in future years). This doesn’t mean however that finding of REOP in one year means REOP forever. Facts may change such that no longer REOP.

3. Don’t need to actually make a profit . You can have a biz that loses money every year and still have an REOP. Fact that has been profit, however, would be relevant factor.

4. Moldowan criteria:a. Profit/loss experience in past years. Projected profits for future yearsb. TP’s training, skill, competence and experience in carrying out the claimed business

activitiesc. TP’s intended course of action (was there a business plan? A feasibility study? A

marketing plan?)d. Capability of the business, as capitalized, to eventually earn a profit (after deducting

depreciation on any capital equipment). What is meant by “as capitalized”? One of the problems that Stewart had in lower courts: courts typically say that if undercapitalized (most of the capital in the business is borrowed) can go against finding of REOP. If interest expense is very high, reasonableness of expectation to profit is in doubt. Pursuit of profit test in Stewart said opposite – large degree of borrowing doesn’t go against finding of pursuit of profit; in fact, might go the other way (??).

e. The way in which activities are carried out. Case of two teacher-spouses who claimed to be writing a book; they took trips to Europe for research. Court said that way in which they wrote their books was inefficient; trips to Europe were for fun.

5. Quite reasonable to expect start-up losses . Bringing in industry examples can be helpful to TP: e.g. in restaurant industry, common to experience losses for first four years in business, etc. Ask: how long has the TP been in business?

6. Tonn decision would still come into play if personal elements. i.e. REOP test applied more stringently if personal elements are present. Courts, post-Tonn revised this somewhat: personal element – not enough that you just enjoy what you are doing; must be something more (i.e material personal benefit) (??).

7. TP’s good faith and reputation, the quality of the results obtained and the time and energy devoted are not in themselves sufficient to turn the activity carried on into a business (Landry).

Casebook: court in Stewart said that even if TP in that case had used one or more of the properties for his personal benefit (i.e. used them for himself or family), he would have opportunity to establish that his/her predominant intention was to make a profit from the activity and that the activity was carried out in accordance with objective standards of businesslike behaviour. Whether a REOP existed may be a factor that is taken into consideration in that analysis. [SH: this makes no sense to me…I thought the test was pursuit of profit and that court got rid of REOP test]

Inclusions

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Profit

- Computation of income from business/property is governed by ss 9-37 of the Act- Starting point is sub 9(1)

9(1) Subject to this Part, a taxpayer’s income for a taxation year from a business or property is the taxpayer’s profit from that business or property for the year.

- s. 12 contains required inclusions; s. 18 contains prohibited deductions; s. 20 contains permitted deductions.

- How do these provisions interact? Some argued that if could not find deduction in s. 20, then could not deduct, or that if inclusion was not in s. 12 then need not include.

- These arguments have all been dismissed the starting point is sub 9(1) and the word ‘profit.’ Ss 12, 18, and 20 are derogations from the basic profit rule and (to the extent they are not redundant – many are redundant) override sub 9(1).

- Profit is a net concept (revenues minus expenses)

Imperial Oil, Daley, Royal Trust Company, Canderel

Imperial Oil : deductibility of disbursements or expenses is to be determined according to the ordinary principles of commercial trading or well accepted principles of business and accounting practices (Royal Trust: omit reference to accounting practices) unless their deduction is prohibited by reason of their coming w/in the express terms of the excluding provisions of the section.

Daley: Deductibility stems from s. 9(1) of the Act and the concept of annual net profit or gain, not, even inferentially from para 18(1)(a). First enquiry is whether deduction is permissible by ordinary principles of commercial trading. If no, end of story. If yes, then look to see if falls w/in exclusions of s. 18.

Canderel: Profit is not defined in the Act, and this was probably a deliberate legislative choice. Profit, for tax purposes, is the difference between the receipts from the trade or business during such year…and the expenditure laid out to earn those receipts. Determination of profit under 9(1) is a question of law, not of fact. [Allard: courts aggressively maintain that profit is a question of law, not a question of accounting].

Illegal Activities

Two issues: Should gains from illegal activities be taxable? If yes, how do we compute income earned from illegal activities?

No. 275 v. MNR, [1955] p. 495

Facts: Woman earned living as a prostitute.

Issue: Does Act apply to gains from illegal activities? Are fruits of prostitution taxable?

Held: Yes

Ratio:- To exclude such gains from tax would be to increase the burden on those throughout Canada whose

businesses are lawful- When the Q in issue is whether profits arising from illegal sources are liable to tax are not, the courts

are not concerned with either the source of the TP’s income or by the means taken him to earn it but merely with the Q as to whether or not the said income is liable to tax under the provisions of the

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taxing statute.

MNR v. Eldridge, [1964] handout

Facts:- TP operated call-girl organization- She and her staff were convicted on charges of conspiring to live from the avails of prostitution.

Police seized records and turned them over to Minister who used them to assess taxes for 1959 and 1960.

- TP objected to calculation of income (claimed that expenses were greater) and argued that it is incongruous that gov’t should seek to live on the avails of prostitution.

Issues: Are earnings from illegal businesses subject to tax? If yes, how should such earnings be computed?

Held: Yes. Computation is based on gross revenues minus expenses incurred to earn income (expenses can only be included to extent that are provable by acceptable evidence).

Ratio:- It is abundantly clear from the decided cases that earnings from illegal operations or illicit businesses

are subject to tax. - Earnings should be computed in the same way as are earnings from legal activities, i.e. by deducting

the cost of earning the income from gross revenues. Cost of earning in this case includes police bribes, boxes of liquor she gave to local politicians, etc. (!)

- Court responds to TP’s argument that it is incongruous that gov’t should seek to live on the avails of prostitution:

o Is the State coming forward to take a share of unlawful gains? It is mere rhetoric. The state is doing nothing of the kind; they are taxing the individual with reference to certain facts. They are not partners; they are not principals in the illegality or sharers in the illegality; they are merely taxing a man in respect of those resources. I think it is only rhetoric to say that they are sharing in his profits…

Allard: this is higher court authority on issue of taxation of gains from illegal activities and rules for computation of such gains

Damages

Recall Cirella: damages for personal injury are not taxable as employment income (rejection of surrogatum rule)

R. v. Manley, [1985] F.C.A. p. 498

Facts:- TP entered into agreement to find purchaser for shares of co. owned by Levy. Consideration was

finder’s fee- TP found a buyer but Levy did not pay. TP sued and was awarded dmgs for breach of warranty of

authority

Issue: Are damages taxable income?

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Held: Yes

Ratio: - Court adopts surrogatum rule from London & Thames: Damages are treated, for tax purposes, in the

same way as that which they replace would have been treated. - In this case, damages received were compensation for TP’s failure to receive the finder’s fee. Had he

received the finder’s fee, it would have been profit from a business required to be included in income in the year of its receipt.

Rule: For tax purposes, damages are treated in the same way as the loss they replace would have been treated. Compensation for loss of business income is thus treated as business income. Compensation for loss of income earning asset treated as capital receipt.

Allard- principle is simple; may, however, be difficult to characterize the loss

o SH: might have to use the Taylor case to determine if selling asset = capital gain or income (b/c adventure in the nature of trade)

o E.g. Bellingham v. The Queen: compensation for expropriation of land characterized as business income from an adventure or concern in the nature of trade [must mean that Bellingham was in biz of selling land, i.e. land wasn’t capital asset].

o See p. 502 for compensation characterized as income and as capital receipto SH: could you also use cases from s. on capital expenditures (would they be relevant?)

- If characterize the loss as capital receipt – are damages taxed as a capital gain? - Parties tried to argue that the damages didn’t come from any source. Court found that they come

from same source as loss replaced. Court could have held the damages income from generic source (s. 3). Courts don’t like to do this, however, b/c there are no concrete rules for calculating income from a generic source.

Notes:- E.g. of damages as income receipt vs. capital receipt: breach of charter party = loss of profit

damages = income. Ship negligently run down and sunk = loss of capital asset damages = capital receipt

- Can be allocation btwn capital and income (M.V. Donna Rae Ltd v. MNR, [1980] p. 502]

Compensation for cancellation of contracts H.A. Roberts

H.A. Roberts Ltd. v. MNR, [1969] SCC p. 503

Facts:- TP carried on real-estate biz in course of which it managed mortgages for corporate clients- TP received compensation when two clients discontinued long-term Ks

Issue: Compensation income or capital receipt?

Held: non-taxable capital receipt

Ratio:- Mortgage department was separate business.- The cancelled contracts were so significant to this separate business that the business ceased to exist

[was ‘sterilized’] when the contracts were cancelled. The Ks themselves were capital assets of an

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enduring nature the value of which had been built up over the years.

Rule: [1] Compensation for cancellation of Ks will be capital receipt if the Ks are so significant that the cancellation effectively terminates a separate business of the TP. If biz keeps operating, compensation for cancellation of Ks will be compensation for lost profits and thus income from business. [2] Compensation for cancellation of Ks will be capital receipt if K was a capital asset of an enduring nature. Notes:- How to determine if two simultaneous business operations by TP is the same business (IT Bulletin):

depends on the degree of interconnection, interlacing or interdependence and the extent of the unity embracing the biz operations. Relevant factors include:

o Do two ops have common factors (e.g. customers or machinery)?o Are two ops carried on in the same premises?o Does one op exist primarily to supply the other?o Do the two ops have the same fiscal year-ends?o Separate accounting records?

IT Bulleting re. cancellation of contracts- Where the rights and advantages surrendered on cancellation are such as to destroy or materially to

cripple to whole structure of the recipient’s profit-making apparatus, involving the serious dislocation of the normal commercial org and resulting perhaps in the cutting down of staff previously required, the recipient of the comp may properly affirm that the comp represents the price paid for the loss or sterilization of a capital asset and is therefore a capital receipt.

- Where compensation is capital receipt What to do with it? o IF amt received relates to a particular asset which is sold, destroyed or abandoned as a

consequence of the breach receipt will be proceeds of dispositiono If amt relates to particular asset that was not disposed of receipt will reduce cost of

that asset to TPo If amt received is of capital nature but does not relate to a particular asset (i.e.

compensation for destruction of business) receipt may result in an ‘eligible capital amount’

Voluntary payments

What is a “voluntary payment”? payment made ex gratia (i.e. no legal entitlement on part of recipient)

Federal Farms Ltd. v. MNR, [1959] Ex. Ct., p. 507

Facts:- Hurricane damaged TP’s farm. TP received assistance from Relief Fund (one amt for crop loss and

another for containers and supplies lost)

Issue: Is the payment income OR a gift/casual gain/windfall?

Held: Windfall therefore not taxable

Ratio:- monies received from insurance policies on stock-in-trade destroyed would be income- Monies received from relief fund not analogous to insurance proceeds. Relief fund didn’t receive any

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contribution or premiums from TP. TP had no legal right to demand payment and, at time of loss, no expectation that would get anything. No contract between donor and donee .

- Giving/receiving of the payment was not a biz operation and did not arise out of the TP’s biz. - Court had to distinguish cases in which voluntary payments were found to be income receipts – here,

unrelated to any services rendered and to biz activities of the TP- Payment unlikely to ever occur again - Contributors to fund could not have thought that they were entering into biz transaction w/ flood

sufferers!

Rule: Voluntary payment may be non-taxable windfall/gift if – no K-ual or legal (e.g. expropriation) right to get money, no expectation of recurrence, unrelated to business/does not arise out of business, no payment of premiums/contributions

Notes:- Allard: degree of connection w/ biz is key. Windfall transaction – no bargain, no flavour of a

business relationship

R. v. Cranswick TP minority SH. Majority SH made payment to minority SHs in hope of avoiding controversy or potential litigation on behalf of minority SHs (b/c division of co. sold at unfavourable price)

Non-taxable windfall

- TP had no enforceable claim to the payment

- TP did not engage in any organized effort to get the payment

- Payment neither sought after nor expected by TP

- No foreseeable element of recurrence

- Payer (i.e. majority SH) not a customary source

- TP provided no consideration

Mohawk Oil Co. v. The Queen

TP received money from settlement of claim for damages resulting from negligent construction of waste oil reprocessing plant

Argued that ‘windfall’ b/c (1) paid to ‘get rid’ of claim and preserve reputation; (2) in excess of amt provided for in limitation of damages clause contained in purchase agreement

Income and capital receipt (allocation)

- Court rejected TP’s arguments must look to what damages compensate for

- TP sought from outset to be made whole (i.e. to be compensated for lost profits and expenditures thrown away). Thus, payment received partly on acct of income in recognition of lost profits, and partly on account of capital in recognition of capital outlay involved in construction of plant

Frank Beban Logging Ltd. v. The Queen

TP received payment from BC gov’t when it decided to turn logging area into a park

Non-taxable windfall

- Payment not received pursuant to any legal or statutory right

- Gov’t made payment out of sense of moral duty; it was an act of kindness OR political strategy during election time (get rid of a controversy).

- Payment did not relate to any past, present or future dealings existing or contemplated by

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payer and the recipient.

Allard:- Borderline case. Was gov’t

really acting upon a moral duty? This is getting close to compensation for loss of biz opportunity.

- Had court not held windfall, might have discussed whether income or capital receipt (capital lost = the opportunity to do logging in the area).

Campbell v. MNR TP entered into K with Toronto Star under which agreed to attempt to swim across L. Ontario in exchange for $600 and further $5000 if swim completed

TP didn’t complete the swim but Star paid her $5000 anyway

Income - No legal obligation to pay money but reputation would have been harmed if hadn’t paid

- Star felt obligated to pay $5000 for services which she rendered exclusively to it

- True nature of this transaction was the performance of services for which payment was made

Interest

12(1)(c) Must include as income from business or property:Interest – any amount received or receivable by the TP (depending on the method regularly followed by the TP in computing income) as, on account of, in lieu of payment of or in satisfaction of, interest to the extent that the interest was not included in computing the TP’s income for a preceding taxation year.

**Must include amt received/receivable on account of, in lieu of payment of or in satisfaction of interest

- Provision is redundant (interest would be included pursuant to 9(1)- Interest usually income from property (e.g. bonds, bank account) unless in money-lending biz- Even if not interest, doesn’t mean not taxable – could be taxable as something else- What is interest ? Perini

Perini Estate v. The Queen, [1982] FCA p. 519

Facts:- TP sold shares. Consideration for sale of shares composed of 3 elements: (1) cash paid at closing,

(2) percentage of after-tax profits over three years (‘earn-out payments’), (3) interest on these ‘earn-out’ payments (7% from closing until day of payment)

-Issue:Was ‘interest’ on ‘earn-out’ payments interest or part of purchase price?

Held:InterestRatio:

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- What is interest? Looks to case-law and concludes that key elements are:o Accrued day-to-day on respect of principal sum o Percentage of the principal sum

- TP argued: payments are called interest, calculated like interest and serve the purpose of interest but they are not interest because did not accrue from day to day on an existing principal amount. The principal amount on which the ‘interest’ was based didn’t come into existence until close of year; until then, no principal sum upon which interest could accrue

- Court rejected: obligation to pay ‘interest’ was contingent or conditional liability – payment was conditional on making profit. Fulfillment of condition, however, had retroactive effect from the day on which the obligation was contracted (such that obligation to pay principal existed all along)

- Court distinguished Huston case: payments from war fund paid in 1958, and regulation provided that 3% per annum interest should be paid from 1946. Amts were not interest because from 1946-1958 recipients were not legally entitled to a principal amount upon which interest could accrue.

Rule: Two key elements of interest – accrues day-to-day on a principal sum; is a percentage of that principal sum. Where obligation to pay principal is contingent/conditional, fulfillment of condition will have retroactive effect such that obligation to pay principal existed from day on which obligation was contracted. (= principal sum on which interest can accrue).

Interest payments made pursuant to statutory scheme Bellingham, Huston

Bellingham v. The QueenTP received amt pursuant to s. of Expropriation Act that authorized the payment of ‘additional interest’ on compensation awarded by gov’t where compensation offered is < 80% of the amt ultimately awarded

Held: not interest

Ratio: - The label ‘interest’ is not determinative – court will look at substance- Payment in this case is more like punitive dmg award than interest- Significant that there is also an element of ordinary interest payable to the TP

Participatory Interest payments Yonge-Eglington, Sherway

**Note these cases usually from perspective from payer (deductible or not?). From recipient’s perspective, will be taxable whether interest or something else (i.e. regular biz income)**Main issue – percentage of a principal sum?

Yonge-Eglington Building Ltd.TP borrowed money to finance construction of an office building. Agreed to pay quarterly interest computed at annual rate of 9% AND ‘additional interest’ equal to 1% of its annual gross rental income for 25 years (“participating interest”)

Issue: ‘additional interest’ deductible under 20(1)(c)

Held: No

Ratio:- Not a percentage of the principal sum

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Sherway Centre Ltd. v. The QueenTP issued bonds paying 9.75% interest per annum AND “participatory interest” equal to 15% of TP’s operating surplus in excess of $2.9 million

Issue: “participatory interest” deductible under 20(1)(c)?

Held: Yes

Ratio:1. Accrual day-to-day - holder’s entitlement to interest must be able to be ascertained on a daily basis- interest here payable once per year but it was based on % of operating surplus for the year and

therefore capable of being allocated on a day-to-day basis (?)2. Percentage of principal sum - participatory interest is not interest where it is clearly paid in addition to the obligation to pay interest

on the loan- Here, payments were not in addition to the interest but rather in pursuit of the objective of a 10.25%

interest rate. Purpose of participating interest was to compensate for having to issue the bonds at a lower interest rate (9.75%) b/c if TP had issued at 10.25% interest rate, would have gone b-rupt.

- The Q is whether the interest is a percentage of or in any way related to the principal sum. Even though the amt here is not a percentage of the principal amt, it is nonetheless related to it b/c (1) only payable so long as principal amt outstanding and (2) calculated in such a way as to give effective return of 10.25% on principal amt.

RULE: To qualify as interest, payments must be percentage of principal or in any way related to the principal sum. “Participating interest” may thus qualify where, as here, it is payable so long as principal amount outstanding AND purpose of it is to increase effective interest rate on principal amt.

Received ‘in lieu’ of interest Hall, Greenington

Hall v. MNR: TP sold detachable coupons from Cda savings bonds (effectively sale of accrued interest). Held: Proceeds of sale were received in lieu of interest and thus taxable under 12(1)(c)

R. v. Greenington Group: A owed interest to B; B bought property from A. Price of property reduced by amount of interest owed. Held: financially speaking, equivalent to interest being paid and full amt. of purchase price being paid. Amt received in lieu of interest and thus taxable.

Interest owing on late payment Lebern Jewellery, Thyssen

Lebern Jewellery Co v. MNR : TP agreed to pay watch supplier 7.5% interest per annum on late payments. Held: part of agreed selling price, not interest.

R. v. Thyssen Canada Ltd.: TP paid late payment charges on steel. Held: Payment is interest b/c late payment charges were not included in the price of steel sold to the TP.

Allard: courts will generally follow Thyssen and hold late payments to be interest. Occasionally will find that payment is disguised as interest and is really part of the cost.

Deductions

Basic Stat rules

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- S. 9(1) is basis for deduction of expenses. Income from biz/property is profit, which is a net concept to be determined in accordance with normal rules of commercial trading and biz practices.

- Other more specific provisions of Act override s. 9(1) [or are redundant] s. 12: required inclusions s. 18: prohibited deductions s. 20: permitted deductions

**Basic principles re. deductibility of expenditures**

1. Amt deductible only if incurred to earn income from business or property - S. 9 is source of this rule, but courts often ground it in para 18(1)(a)- Para 18(1)(a): No deduction shall be made in respect of an outlay or expense except to the extent

that it was made or incurred by the TP for the purpose of gaining or producing income from the business or property. [note: redundant; implicit in concept of profit]

2. Personal and living expenses not deductible- Para 18(1)(h): No deduction shall be made in respect of personal or living expenses of the TP, other

than travel expenses incurred by the TP while away from home in the course of carrying on the TP’s business

- [Partly redundant b/c implicit in concept of profit. Not entirely redundant b/c may be personal and living expenses with income-earning component]

3. Capital costs not deductible - Para 18(1)(b) : No deduction shall be made in respect of an outlay, loss or replacement of capital, a

payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part [see para 20(1)(a)]

- Completely overrides s. 9 b/c, under this section, normal commercial and accounting principles re. depreciation of property don’t apply to computing income for tax purposes.

4. Amount of deduction must be reasonable in the circumstances (s. 67)

5. Types of expenses which have own rules- Fines and penalties- Interest [20(1)(c)]- Capital Costs [20(1)(a)]

5. Subjective purpose test (i.e. for income-earning purpose) but must be manifested by objective evidence (Symes)

See Symes

Illegal payments

Computing income of an illegal business: Profit of illegal biz has to be established in the same manner as for any other (legal business). TP may thus deduct ordinary expenses that are incurred for the purpose of gaining or producing income from illegal business. (Angle v. MNR)

Deducting payments that are themselves illegal (Espie Printing): legality of payments (in this case wages) has no bearing on question of whether deductible.

Espie Printing, [1960] Ex. Ct. p. 572

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Facts:- TP’s biz not itself illegal but TP and his employee entered into an illicit agreement to enable

employee to avoid payment of tax. Wage expenses were thus, MNR says, illegally incurred and should not be deductible.

Held: Deductible

Ratio:- Wages, absent illegality, are among the commonest of ordinarily deductible expenses- Illegality of arrangements with the employee has no bearing on the question of whether wages are

deductible

Muller’s Meats Ltd. v. MNR, [1969]

Facts:- TP sought to deduct “under the table” payments for which he had no receipts. He refused to disclose

names of people to whom payments made.

Held: not deductible

Ratio:- Court accepted argument that payments incurred for purpose of gaining/producing income- BUT…TP failed to discharge onus of proving that expenses had been incurred- Burden of proof heavier for bribes or other improper payments .

Allard:- Not ab necessary to keep paper trail (i.e. receipts). If can show that cash payments are industry

practice, will be deductible regardless of receipt. Will be difficult to prove amt of payments however

Neeb v. The Queen

Facts:- Drug dealer imported and sold MJ. TP was arrested and his drugs seized by police. Sought to deduct

the cost of MJ seized

Held: not deductible

Ratio:- Cost of lost inventory would normally be deductible in computing income, as part of cost of goods

sold- BUT, the amount was not established with any degree of particularity and to allow the deduction

would contradict public policy. Pub policy is two-fold: (1) shouldn’t be able to benefit from illegal activity; (2) Cdn public shouldn’t be expected to subsidize a drug dealer’s loss through forfeiture of illegal drugs.

Allard:- Taxation purists would say profit is profit and that pub policy has no place in tax law- Public policy in this case largely obiter.

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67.5 Prohibits deduction of certain payments made to gov’t officials or employees in the public sector or the bribery of private sector agents or employees under circumstances where the making of the payment would constitute an offence under various provisions of the Criminal Code.

Damage payments

Imperial Oil Limited v. MNR, [1947]

Facts:- TP in biz of transporting petroleum and petroleum products- TP’s ship, as result of employee’s negligence, collided with and destroyed another ship- Parties settled for $526,995 in damages. TP sought to deduct this payment

Issue: Was dmg payment incurred for purpose of gaining/producing income? [posed this Q in negative way – does 18(1)(a) exclude deduction?]

Held: Yes

Ratio:- Issue of fact is whether the payment made was in respect of a liability for a happening that was really

incidental to the business- Deductibility of a particular expenditure is not to be determined by isolating it. It must be looked at

in light of its connection with the operation, transaction or service in respect of which it was made so that it may be decided whether it was made not only in the course of earning income but as part of the process of doing so.

- It is no answer to say that an expense is not deductible on the ground that it was not made primarily to earn income but primarily to satisfy a legal liability. All payments are made to satisfy legal liabilities!

- Look behind the payment and enquire whether the liability which made it necessary was incurred as part of the operation by which the TP earned his income.

- Where nature of operations is such that risk of negligence of ees is really incidental to such operations, damages arising from that negligence deductible.

- Application to facts : Transport of petro products part of the business from which it earned its income. Risk of collision between vessels is a normal and ordinary hazard of marine operations. Amt of liability is unusually large but there was nothing unusual about the collision itself. Negligence on part of TP’s servants in operation of its vessels was a normal and ordinary risk of the marine operations part of the TP’s business and really incidental to it?

RULE: - Dmg payments deductible if activities which gave rise to liability took place in the course of earning

income from biz or property and were part of the process of earning that income. - Inherent in normal/ordinary risk of business? - Degree of connection btwn activities which gave rise to biz activity and normal biz activities? - Incidental to income-earning activities?- Expectations - might loss have reasonably been contemplated to happen in course of events which

were a necessary incident to the production of income? (Todd)- Why was liability incurred? Not Why was expense made?Generally, look at the activity giving rise to the expenditure and ask whether the activity is part of

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the company’s operations.

Allard:- Result would have been different if employees had crashed the ship while using it to fish outside of

biz operating hours.

Other cases:Herald and Weekly Times: Newspaper publisher paid damages for libel and sought to deduct them. Held: Deductible. Reason: Liability to damages was incurred because of the very act of publishing the newspaper. Risk of libel inherent in newspaper publishing activities.

Fairrie v. Hall (Inspector of Taxes): Sugar-broker got mad at local gov’t authority (competing sugar broker), libelled him and had to pay damages. Held: payment not deductible. Reason: libel only remotely connected to TP’s trade as a sugar-broker. Libelling not a risk inherent in sugar-broking biz

Davis v. MNR: Pig farmer traveled in car (with family) to look at boars at bro’s house. Car accident led to damages. Held: damages not deductible. Reason: accident was in no way incidental to the business of farming or hog-raising. Might have been deductible if business concerned had been that of a company engaged in the transportation of goods or passengers. Allard: Fact that family in car and that visiting brother at same time probably conclusive – primary purpose of driving in car was personal.

Poulin v. The Queen: TP real-estate broker sought to deduct damages incurred for false and fraudulent representations made by him. Held: not deductible. Reason: risk of having to pay dmgs for wrongful professional activities is inherent in carrying on any trade or profession. BUT, difference btwn involuntary act and reprehensible act committed deliberately with aim of causing damage. The latter is not a risk that was necessary for TP to assume in order to carry on his biz.

McNeill v. The Queen: TP sought to deduct damages incurred for breaching non-compete covenant. Held: deductible. Reason: In order to earn income, had to compete. Income earning activity was in and of itself a breach. Not even a Q of inherent risk – income earning activity gave rise to the liability.

IT-BulletinFactors used to determine whether an event that was cause of liability for damages is incidental to or is a risk normally inherent in usual conduct of business operations(a) relationship btwn event and biz operations(b) TP’s inability to avoid the occurrence of the event (c) TP’s concern about the event or risk and any protective measures taken(d) Frequency with which these events occur in TP’s business

Fines and penalties

**Special rules apply

- Traditionally, Cdn courts disallowed deduction of fines and penalties on grounds that either (1) not incurred for purpose of gaining/producing income OR (2) deductibility would contradict pub policy

- Rationale for PP test? deductibility would frustrate the purpose of the penalty (be a disincentive to follow the rules); public purse shouldn’t subsidize illegal/negligent activity.

- Public policy test introduced in Alexander von Glehn & Co., [1920] and was used primarily to deny deductibility (Day & Ross broke the pattern, but good outline of pp test)

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Day & Ross Ltd. v. The Queen, [1976] FCTD p. 586

Facts:- TP sought to deduct fines levied for overweight trucking violations. Argued that the penalties

resulted from the day-to-day ops of the business and were a necessary expense

Held: deductible

Ratio: Two-fold test for determining whether stat fines and penalties are deductible:

1. Were they incurred to earn income from business or property? (income-earning purpose test)

2. If yes, should deductibility be refused by reason of public policy? a. Avoidability

o Was it possible to avoid the transgression which gave rise to the fine? o In this case, no. TP relied on weight information given by customers. o [Note also significant that consistent approach to dealing with fines – would ask customer

w/ overweight load to reimburse fine, and then include that amt in income]b. Whether or not the action which gave rise to fine was an

‘outrageous transgression’o Ready availability of permits for overweight trucks indicates that violation not an

outrageous transgression of public policyo [Subsequent decisions made distinction btwn punitive/deterrent fine vs. compensatory

fine (e.g. fine in this case – overloaded truck = damage to the roads fine = compensate for repair). Deduction of latter not violation of pp.]

Amway of Canada Ltd. v. The Queen- TP falsified value of goods imported into Canada in order to avoid customs duties and excise taxes. - Held: not deductible- Court moved “avoidability” consideration into the income-earning purpose test. Fine or penalty

cannot be considered to have been incurred for the purpose of producing income unless the incurring of the fine or penalty must be seen as an unavoidable incident of carrying on the business. In this case, the TP engaged in an intentional and cynical scheme to avoid duties/taxes, so resulting fine was avoidable. Avoidability test applies only to fines and penalties, not to other types of expenses.

- Court also affirmed public policy test.

65302 British Columbia v. The Queen, [2000] SCC p. 589

Facts:- TP deliberately oversold egg quota and was assessed an over-quota levy- Aplt claimed the levy as a deductible expense for 1988 taxation year

Issue: Status of public policy test for deductibility of fines and penalties

Held: throw out public policy test. Levies, fines and penalties which are incurred for the purpose of earning income are deductible business expenses

Ratio:- If expense is incurred for purpose of earning biz income – it is deductible

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- There is no avoidability test. The language of 18(1)(a) doesn’t support it. - There is no public policy test:

o Deduction of expenses incurred to earn income generated from illegal activities is allowed. Tax authorities not concerned with the legal nature of an activity. Prohibiting deductibility of fines and penalties is inconsistent w/ this practice.

o PP test places high burden on TP; undermines objective of self-assessment underlying our tax system. Also introduces much uncertainty into system

o Tax neutrality and equity are key objectives of our system; any departure from such principles is best left to Parliament (and Parliament has so departed , e.g. s. 67.5)

- Court leaves pp test door slightly ajar: it is conceivable that a breach could be so egregious or repulsive that the fine imposed could not be justified as being incurred for the purpose of producing income. Such a situation would be rare.

[Bastarache, concurring in result]:- Looking at 9(1) + 18 it was not intention of Parliament to allow all fines to be deductible; to so

allow would operate to frustrate the legislative purpose of other statutes. - Distinction btwn deductible and non-deductible payments must be determined on a case-by-case

basis. Main factor is whether primary purpose of statutory provision would be frustrated or undermined. Punitive/deterrent purpose – not deductible. Compensatory purpose – deductible.

RULE (pre- 03.22.04): Levies, fines and penalties are deductible if they are incurred for the purpose of gaining/producing income (subject to same test as other expenses). No avoidability test. No public policy test. [Leaves open door for disallowing deductibility if breach very egregious/repulsive]

Notes: - Excerpt from Duff article He supports a public policy test and thinks it can be grounded in 9(1)

[the ‘business practices test’]. Courts have conflated 9(1) and 18(1)(a) – the business practices test and the income-earning purpose test. Possible that expense could be incurred in order to produce income but not ordinary nor well-accepted in its trade or business. Ordinary business practices don’t include violation of laws to earn money. This is a way to ground a public policy test in the Statute.

2004 Amendment- Whether or not a fine/penalty is deductible depends on the law which imposes it- If not characterized as fine or penalty, amt may deductible if incurred for purpose of earning income- If characterized as fine/penalty amt will not be deductible- This amendment doesn’t apply to penalties or damages paid under a private K- Only applies to fines and penalties imposed after 03/22/04

Theft

Can TP deduct money (or cost of inventory) stolen by SH or employee?Several factors go to making this determination:1. Level of employee in hierarchy (employee vs. CEO for e.g.). Question of control2. Whether money was stolen outside or inside of the income-earning process (outside = not deductible)3. Was risk of this kind of theft inherent in TP’s business activities? Was it avoidable? 4. Amts stolen in SHs capacity as SHs (or with knowledge/consent of other SHs)? Could just be sneaky

way of deducting dividend!

Thayer Lumber v. MNR, [1957] DTC p. 611

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Facts:- TP’s employee stole some cash receipts from co. vault- Aplt argued that money was lost in the course of carrying on its business and was therefore deductible Issue: Deductible?

Held: Yes

Ratio:- Loss suffered by TP occurred in biz operations carried on its usual manner. - TP could be criticized if, after discovering loss, took no steps to ensure that further losses didn’t

occur. However, past experience had shown that the methods used until 1954 (when money stolen) were satisfactory

- Loss was extraordinary event but nevertheless occurred in the usual routine of biz activities . Loss occurred because of a long0standing practice of the founder.

- Theft by employees or others is a risk inherent in the carrying on of the TP’s business

RULE: Theft by employee in ordinary course of business, i.e. as result of usual biz practices, is deductible.

General Stampings Ltd. v. MNR, [1957] DTC

Facts:- TP sought to deduct money which was stolen by TP’s GM, who was also the registered holder of one

share and a director of the TP

Held: Deduction disallowed

Ratio:- B/c this dude was GM, we was able to do just as he pleased with the funds on hand. The funds were

removed by an improper exercise of the control possessed by the GM and his action had nothing to do with the conduct of the co’s income-earning activities.

- Also, the monies involved were already earned and in the co’s coffers.

RULE: Amts stolen not deductible if (1) stolen outside of the business’ income-earning activities (i.e. after the income has been earned) and/or (2) stolen by person who was exercising improper control of the business (i.e. who b/c was in position of power, could do what he pleased with funds on hand)

Cassidy’s Ltd. v. MNR, [1990] TCC

Facts: - TP sought to deduct amts that had been embezzled by a senior employee (VP, GM and controller)

who had ‘complete discretion’ over the TP’s financial operations

Held: Deductible

Ratio:- Level of ee in hierarchy is not as impt as at what stage in income earning process the money is stolen

or embezzled- These losses were incurred in the normal course of the TP’s biz and were deductible in computing

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profit in accordance with ordinary commercial principles- In carrying on biz, there is an inherent risk that the employees may steal. Use of employees is

necessary to carrying on a business and there is a risk that employer may hire dishonest people- Misappropriated the money while dealing with it as part of the co’s activities and not by exercise of

overriding power or control outside those activities altogether – he drew cheques on TP’s account in same manner as when he drew cheques required in normal course of carrying on business.

RULE: Focus on stage of income-earning process, not on level of employee. Amts stolen are deductible if these amts were misappropriated as part of the co’s activities and not by exercise of overriding control outside of these activities.

Parkland Operations Ltd. v. The Queen, [1991] FCTD

Facts:- TP sought to deduct money which had been misappropriated by two SHs and directors of TP who

were authorized to sign cheques on TP’s behalf

Held: Deduction allowed

Ratio:- funds were appropriated in the course of the company’s activities- Directors misappropriated the funds not in their capacity as SHs, but rather as thieves, with neither

the knowledge nor consent of other SHs [SMH: if appropriated with consent of other SHs, could just be a sneaky way of trying to make a dividend deductible].

RULE: Amts stolen by SHs will not be deductible if misappropriated in their capacity as SHs and/or with knowledge and consent of other SHs. Will be deductible if misappropriated in capacity as thieves.

Promotional Expenses

Promo expenses, Rec/meal/entertainment expenses, clothing expenses, home office expenses. Consider: 2. 9(1), 18(1)(a), 18(1)(h)3. Expenses incurred merely to make TP available to work or business are not deductible (Symes). Cost

of getting from home circle to work circle (eating, travelling, wearing clothes) not deductible. 4. “Needs-based” analysis = but for the business, would the need for which the expense was incurred

have existed? (irrespective of whether need satisfied by third party or by opportunity cost of personal labour). If yes, personal expense. (Symes)

5. Reasonableness of expenses (s. 67): in computing income, no deduction shall be made except to the extent that the outlay or expense was reasonable in the circumstances.

6. Public purse should subsidize personal consumption choices (Symes)

Ace Salvage Alberta Ltd. v. MNR, [1985] TCC p. 623

Facts: - In computing income from carrying on scrap-metal business, TP sought to deduct losses that it

incurred from the training, maintenance and racing of horses. TP argued that the cost of these horse racing activities was a promotional expense incurred to earn income from scrap-metal business.

- TP argued that many of his customers were often at the stables, that he ran the horses under the name of Ace Stables, that he did very little other advertising and yet was in good position vis-à-vis his competitors.

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- [Note: important to distinguish btwn this and carrying on two separate businesses – TP in this case not claiming that carrying on two businesses and trying to deduct losses from one business from profits of another. Arguing that costs of horse racing activities are deductible as promotional expenses.]

- [Why not just characterize horse racing as another business? (1) might not be characterized as a business, just a hobby; (2) restricted farm losses.]

Issue: Cost of horse raising activities deductible as promotional expense?

Held: no

Ratio:- simply too remote- No Q that horse racing may have provided contacts, leads and information of benefit to his business

but so could going for coffee, mowing lawn, attending weddings, etc., cost of which wouldn’t be deductible.

- No hard empirical evidence whatever that a connection existed between the horse-racing expenditures and the salvage income.

- Look at purpose of expenditures: purpose of expenditures at issue here was for purchasing, boarding, training and racing horses, not for purposes directly (nor even indirectly) associated with the TP’s salvage biz.

RULE: promotional expenditures deductible if directly for business purpose. Remoteness test: must be relatively direct link btwn business and expenditure, otherwise any expenditure could be characterized as having income-earning purpose. If too remotely connected, not deductible.

Allard:- Recall Imperial Oil: activities giving rise to expense had to be incurred in course of carrying on the

business. Here, too remote. - Purpose test – purpose of these activities was not to earn income from scrap metal business- Always hints of 18(1)(h) in bkground of these decisions – Was he raising horses for scrap-metal

business or b/c he liked raising horses?

King v. Queen: Court allowed TP to deduct cost of raising, maintaining and showing horses and sponsoring horse shows in deducting income from an insurance biz. Reason: business name displayed prominently at horse shows. Horse-related activities produced customers for the business. Significant connection established between keeping of horses and selling of life insurance.

Olympia Floor & Wall Tile: Court allowed TP to deduct charitable donations as expenses incurred to earn income from business or property. Reasons: made to Jewish organizations in order to increase reputation amongst Jewish clientele.

s. 19 Prohibits deduction of advertising cost when advertising appears in non-Cdn magazines and newspapers [exists for policy reasons]

Recreation, meal and entertainment expenses

Royal Trust Company v. MNR, [1947] Ex. Ct., p. 630

Facts:

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- Trust company believed that best way to get business was to develop personal contacts. It therefore required its senior officers to join social clubs. The co. had a well-worked out policy whereby it designated clubs to which officers should belong, took steps necessary for introduction and admission and paid dues

- Sought to deduct dues paid in computing income from its business

Issue:Social club dues deductible?

Held:Yes

Ratio:-- First inquiry: whether the expense was made or incurred in accordance with well accepted business

practices. - Next inquiry: if made in accordance with well accepted business practices, is deduction prohibited by

s. 18? - The expense incurred was consistent with good business practice. Policy was well worked out and

benefits were real (lots of business contacts made at the club). The company’s competitors had similar policies in place.

- Is deduction prohibited by 18(1)(a) on grounds that not incurred for purpose of gaining or producing income? NO. Not necessary to show causal connection between expense and receipt. I.e. the expense need not result in any particular income; income need not be traceable to expense.

RULE: TP need not show causal connection between expense and receipt in order to show that expense was made for purpose of gaining or earning income from business.

18(1)(l) prohibits deduction of outlay or expense made or incurred by the TP (i) for the use or maintenance of property that is a yacht, a camp, a lodge or a golf course or facility, unless the TP made or incurred the outlay or expense in the ordinary course of the TP’s business of providing the property for hire or reward. (ii) as membership fees or dues (whether initiation fees or otherwise) in any club the main purpose of which is to provide dining, recreational or sporting facilities for its members.

Weddings and bat mitzvahsRoebuck: Lawyer tried to deduct % of costs of holding reception for daughter’s bat mitzvah. Calculated % based on proportion of client-guests to other guests. Held: deductibility denied on basis that business wasn’t the principal purpose of holding the event.

Fingold:: target of promotional activities needs to know it is the target; i.e. guests need to be aware that they are guests of the business and not the host personally

Grunbaum v. The Queen: President and primary shareholder of co. sought to deduct amount expended on portion of daughter’s wedding reception. Deduction allowed. Reasons: expenses were proportionate to the # of biz guests invited, invitations sent through co. on co. letterhead, all correspondence with guests was handled by the co. Decision to invite biz guests to the wedding clearly a business decision.

Scott v. The Queen, [1998] FCA

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Facts:- TP was self-employed foot courier. - Sought to deduct daily cost of extra food and water in computing his income

Issue: Cost of additional food and water deductible?

Held:Yes

Ratio:- traditionally, food and beverages have been considered non-deductible personal expenses. WHY?

B/c we all need food and water regardless of our business [making available for work; needs-based analysis – quotes Iac from Symes – does the need exist in absence of biz activity?]

- Just b/c classified this way in the past doesn’t mean should be classified as personal today [quotes Symes – tax law must respond to changing social fabric]

- TP is not choosing to eat more food or more expensive food, i.e. not a personal consumption choice. The extra food is necessary. He needs food like a car needs gas! Car courier allowed to deduct gas cost! Allowable deduction is limited to the extra food that he needs as result of his profession.

- Would moving away from bright-line rule against food and beverage deductions open the floodgates? NO. Deduction of food expense only allowed where can draw analogy btwn fuel for automobile and fuel for human [e.g. construction worker couldn’t deduct cost of extra food b/c cannot point to mechanical construction worker fuelled by gas]

67.1(1) An amt paid or payable in respect of the human consumption of food or beverages or the enjoyment of entertainment shall be deemed to be 50% of the lesser of (a) the amount actually paid or payable in respect thereof, (b) an amount in respect thereof that would be reasonable in the circumstances. **E.g. client lunches/dinners, gifts of fod and wine, etc.

Clothing expenses

If the clothing purchased was necessary for the business and only for the business, and could not be worn off the job (e.g. a uniform), cost of such clothing (as well as costs of cleaning and repairing it) would be deductible in computing business income. Other clothing – no. The need for clothing exists independent of any business.

Home office expenses

Locke v. MNR, [1965] DTC, p. 649

Facts:- TP was lawyer who had office in downtown Toronto- He owned and lived in a house in Thornhill Ontario, onto which he built an addition (containing a

study) in 1961- He used the study outside of regular working hours to make and receive work-related calls, research

in his home library, do prep work and see the occasional client (approx twice per week). - TP did not display (on house) sign or brass plate bearing his name and profession. Yellow Pages

listed only his work address. White Pages made no mention of his occupation- TP tried to deduct 1/6 of his home expenses as an expense incurred for purpose of earning income

from practice of his profession. MNR denied deduction.

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Issue: Is proportion of home expenses deductible on basis that it was incurred for purpose of earning portion of income from practice as a lawyer?

Held: No

Ratio:- Para 18(1)(d) provides that in computing income, no deduction shall be made in respect of (d) the

annual value of property except rent for property leased by the TP for use in his own business- As interpreted by English v. MNR, this provision means that a private individual cannot be the owner

of realty and his own tenant thereof – he cannot pay rent to himself. - In a proper case, however, a TP may be able to apportion his home expenses between personal living

expenses and business expenses, and deduct a reasonable amount as a business expense. - What is a ‘proper case?’ Court identifies the following questions:

o Is it recognizable that the TP has forgone the use of a definite part of his home for the sake of business?

o Is the room in Q definitely separate from the living quarters of the family? o Was an appreciable amt of biz conducted in the room or was it just used for

convenience?o Was the house partially municipally assessed for business purposes? o Was phone ordered for biz purposes? o Was there a sign on the house announcing to the general public that a professional office

was being maintained therein? o Was the home office in fact a second branch of a regular office?

- TP in this case used the study principally for his own convenience. Most young lawyers are called upon in their home and work in their home – nothing unusual about that. Very heavy burden on lawyer who seeks to claim deduction, over and above expenses for regular office, in connection with use of room in house as office-study

RULE: In certain cases, TP may be able to apportion home expenses btwn personal living expenses and business expenses and deduct a reasonable amt as a business expense. Factors: necessity vs. mere convenience (does he have another office? Is full-time office unsuitable for night-time work?), amt of business conducted there (income increased as result of business), separation of living and working quarters, sign on house, home office used primarily for business purposes? See also 18(12)(a)**Apportion expenses using square footage but taking into account any personal use of work space.

Stat provisions governing deduction of home office expenses

18(12)(a) No amount shall be deducted for any part (a ‘work space’) of a self-contained domestic establishment in which the individual resides except to the extent that the work space is either(i) the individual’s principal place of business, or(ii) used exclusively for the purpose of earning income from business and used on a

regular and continuous basis for meeting clients, customers or patients of the individual in respect of the business

**sub 248(1) defines self-contained domestic est as a dwelling-house, apartment, or other similar place of residence in which place a person as a general rule sleeps and eats.

18(12)(b) Amount that may be deducted in respect of the home office under (a) may not exceed the TP’s income from the business to which the home office relates [i.e. may not be used to

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generate losses that can be deducted against all other sources]18(12)(c) Allows amounts which cannot be deducted b/c of 18(12)(b) to be carried forward

indefinitely and deducted against future income from the business to which the home office relates.

Interpretation by case law

Meaning of ‘self-contained domestic establishment’:- Ellis v. The Queen: studio/store built on top of garage from which TP made and sold pottery;

connected to the house by interior passages; separate outdoor entrance. Held: is a ‘self-contained domestic establishment’ b/c formed part of TP’s residence. Physically connected to house; shared electrical, water and heating facilities

- Maitland: family operated B&B out of half the house (lived in other half). Court disallowed deduction of losses from B&B business on grounds that residence was their home and fell w/in statutory def’n of a ‘self-contained establishment.’

- Sudbrack v. The Queen: family operated a country inn and lived in one section of it. Court allowed deduction of losses from the business on grounds that the family’s separate living quarters were essentially a separate apartment w/in the inn and themselves a ‘self-contained domestic establishment’ without including the rest of the inn.

- Broderick: facts as in Sudbrack but court distinguished the Sudbrack and disallowed the deduction of losses on the basis that the business was largely seasonal and thus the residence was fully available to the TP and his family for seven months of the year.

- Lott v. The Queen: TP operated day-care business out of home. Tried deduct losses from day-care business on grounds that sub 18(12) didn’t apply b/c operated day-care throughout the house and not in ‘any part’ of it. Held: the expression ‘any part’ clearly includes the whole.

Regular and continuous basis for meeting clients…etc.- Vanka v. The Queen: Family doc with regular downtown office tried to deduct expenses related to

operation of home office where he saw one patient per week and received/made 7 phone calls per evening. Held: seeing patient once per week wouldn’t amount to regular and continuous use of home workspace BUT receiving average of seven phone calls per evening would so amount. Meetings can be held in person or over the phone.

Travel expenses

18(1)(h) Prohibits deduction of personal and living expenses, other than travel expenses incurred by TP while away from home in the course of carrying on the TP’s business

Cumming v. MNR, [1967] Ex. Ct. p. 658

Facts:- TP worked as staff doctor in Ottawa hospital but did not have an office there; he used his home as an

administrative base and travelled to the hospital to visit patients and respond to emergencies- He sought to deduct the cost of traveling (by car) between home and hospital in computing his

business income- MNR disallowed the deduction on the grounds that travelling to work is a personal and living expense

Issue: Travel expenses deductible?

Held:

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Yes

Ratio:- Allowing deduction would not be subsidy of personal consumption choice . The doctor didn’t choose

to live out in the country – his choice of home location was dictated at least in part by his work, i.e. the home was close to the hospital

- Also, the TP’s base of operations was not the hospital, but his home . If he had maintained a small office elsewhere, there is no doubt that the expense of travelling between it and the hospital would have been an expense of his business. The result should be the same here – the TP’s home was his office, and his travels between the office and the hospital should be deductible business expenses.

RULE: Travelling between home and a place of business might be a deductible business expense if home is the base of operations (owing to the fact that place of business cannot reasonably serve as such a base).

Interest expenses

Under what provision is interest deductible?- Interest as current expense (e.g. in money lending business) s. 9(1) [requirements of 20(1)(c)

need not be met]- Interest as capital outlay deduction prohibited by para. 18(1)(b) except as expressly permitted

para 20(1)(c) expressly permits

20(1)(c)

20(i)(c)(i) In computing income from business or property, may deduct: An amount paid in the year or payable in respect of the year (depending on the method regularly followed by the TP in computing the TP’s income), pursuant to a legal obligation to pay interest on…borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy)…or a reasonable amount in respect thereof, whichever is the lesser.

Requirements of para 20(1)(c)

3. Amt paid in year or payable in respect of year - ‘paid’ where compute income on cash basis- ‘payable’ where compute income on accrual basis

4. Paid pursuant to legal obligation - voluntary payment of interest not deductible; existence of legal ob determinative (compare to

Campbell – legal ob not necessary, look to business/commercial reasons for making payment)5. Must be interest

- Perini: (1) accrues on day-to-day basis (must be able to allocate to days); (2) compensation for use of borrowed money; (3) percentage of principal sum

6. Borrowed money must be used for the purpose of earning income from business or property

7. Other than exempt income - NB: income that is deductible is not exempt

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- E.g. rule which provides that dividends paid by sub to parent are deductible in computing parent’s income (s. 112). If parent borrowed money for purpose of buying shares in sub, interest on borrowed money would be deductible even though is borrowed for purpose of earning income which is deductible (i.e. the dividends). Deductible ≠ Exempt.

Loss on income-earning investment/business purchased w/ borrowed funds- What if I borrow money to buy shares in Co. X, the co. goes bust and I sell the shares for ≈ $0? I still

have to pay interest on the borrowed money – is it deductible? - Until several years ago – NO b/c borrowed money no longer being used to earn income from property- 20.1 introduced to address this hardship – allows you to continue to deduct interest provided that you

put proceeds of biz/property into reimbursing the loan or into another income-earning investment/business.

Rules re income-earning purpose test

Eligible use vs. ineligible use- purpose in using the money and not purpose in borrowing money is relevant (Bronfman)- must be used for purpose of earning income from biz or property

o Income doesn’t include capital gains [9(3)]9(3) “income from property” does not include any capital gain from the

disposition of that property and “loss from a property” does not include any capital loss from the disposition of that property.

o ‘Income’ for purposes of 20(1)(c) is not a net concept. Not up to court to Q the sufficiency of the income. As long as reasonable expectation of some income, and as long as this ‘some’ is not window-dressing (i.e. a sham), interest deductible. [Result = interest will be deductible even if interest greatly exceeds income] (Ludco)

- Must be income-earning purpose, but this need not be the predominant purpose. Court need ask only whether or not one of the purposes of the borrowed money was to earn income; doesn’t matter that it wasn’t the predominant one (Ludco)

Eligible Uses Non-eligible usesEarning income from business or property Making capital gains [9(3)]

Earning exempt income [20(1)(c)]Personal consumption [9(1) or 18(1)(h)]Life insurance policy [20(1)(c)]

Current use (of borrowed money) vs. original use- Current use of borrowed money, and not original use, is relevant (Bronfman) - Change in use : if TP uses borrowed money to purchase ineligible property (e.g. a cottage), sells it

and uses proceeds to purchase eligible income-earning property, can prospectively deduct interest payments provided that money used to buy new property can be traced to the proceeds of disposition of the ineligible property (Bronfman; Attaie may imply this). Not enough that TP has continuous obligation to make interest payments to a creditor. Borrowed money must stay in hands of TP. [Note correction by s. 20.1]

Direct use vs. indirect use

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- Whether interest deductible depends on direct use, not indirect use. Result = cannot argue that interest payable on money borrowed to purchase ineligible property is deductible b/c borrowing allowed TP to preserve income-earning property (Bronfman)

- Rationale: TPs with lots of assets could borrow money for any purpose and deduct interest- Exception : There are exceptional case in which TP might be allowed to deduct interest on funds

borrowed for ineligible use b/c of indirect effect on TP’s income-earning capacity. TP must satisfy the court that his/her bona fide purpose in using the funds was to earn income (Bronfman) (see CHC Helicopters)

Other- “Court must attempt to ascertain the true commercial and practical nature of the TP’s transactions”

(Bronfman)- Fact that (interest costs) > (income generated by investment) may be significant (Bronfman); Ludco

suggests otherwise however.

Deductibility of losses created by interest deduction- NB: many TPs try to use interest deductibility as a tax shelter – produce major investment losses and

deduct from all other sources of income. Potential for this greatly reduced by new REOP requirement in s. 3.1. [Pursuit of profit (source) + expectation of gross revenue (interest deductibility) + REOP (to deduct losses)]

Cases

Trans-Prairie Pipelines Ltd. v. MNR, [1970] Ex. Ct.

Facts:- Trans-Prairie issued preferred shares (typically carry cumulative dividend entitlement but don’t

increase in value)- Decided to issue bonds to raise additional money (debt vs. equity) and wanted to get rid of the

preferred shareholders. - Issued bond ($700,000) and used portion of it ($400,000) to redeem preferred shares, leaving balance

of capital ($300,000) to use in operations.

Issue: Is interest paid on the money used to redeem preferred shares (i.e. $400,000) deductible?

Held: Interest on borrowed funds deductible

Jackett:- Tax authorities argued that money used to redeem preferred shares was not used to earn income for

the business. Court rejected. Interest on borrowed funds deductible- Original subscription of $400,000 by preferred SHs was used to earn income from the business, and

since the borrowed funds merely replaced that $400,000, i.e. filled the gap left by the redemption, those funds are also used to earn income from the business (and interest is thus deductible). $400,000 should be characterized in same way as amt it replaced.- [Jackett made decision based on the financial reality – TP just refinanced the original share

subscription]

RULE: After Bronfman, will not apply outside of its specific facts. Where money is borrowed to redeem shares (preferred shares in this case), interest on money borrowed will be deductible b/c borrowed funds merely replace funds that were used to earn income from business (i.e. the share subscription).

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Bronfman Trust v. The Queen, [1987] SCC, p. 668

Facts:- TP is trust, assets of which are primarily low-yield securities. Trust investment policies were more

focused on capital gains than on income. - Trustees chose to make capital allocations to the beneficiary of $500,000 in 1969 and $2 million in

1970. To make these allocations, the trust borrowed money from the bank. The borrowed funds were used immediately and directly to make capital allocations to the B and not to buy income earning securities.

- It would have been possible for the trustees to make the allocations by liquidating the investments, but they chose to borrow funds because, at the time of the allocation, a disposition of the assets would have been commercially inadvisable.

- MNR disallowed deduction of interest expenses paid on borrowed monies. FCTD upheld. FCA allowed trust’s appeal.

Issue: Was the borrowed money used for the purpose of earning non-exempt income from a business or property?

Held: No

Ratio:- Trust argued: loans were for purpose of earning income b/c use of borrowed money to pay capital

allocations enabled trust to retain income-yielding investments. Court rejects- Not all borrowing expenses are deductible – Act sets out eligible and ineligible (purchase of life

insurance policy, personal consumption or making of capital gains) uses of borrowed funds. Eligibility for the deduction requires that the borrowed money be used for the purpose of earning income.

- Court must attempt to ascertain the true commercial and practical nature of the TP’s transactions. - It is the current use rather than the original use of borrowed funds by the TP which is relevant in

assessing the deductibility of interest payments. So if TP uses borrowed money to buy personal property (ineligible use) which she subsequently sells, can prospectively deduct interest payments if proceeds of sale are used to purchase income-earning (eligible) property.

o Note however, that it is not enough that the TP has continuous obligation to make interest payments to a creditor. The borrowed funds must still be in the hands of the TP, as traced through the proceeds of disposition of the preceding ineligible use, if the TP is to claim the deduction on the basis of a current eligible use [so if ineligible use results in no enduring benefit, e.g. is not saleable, borrowed money is obviously not available to TP for subsequent use]

- Direct vs. indirect uses of borrowed money : Trust is asking court to characterize the transaction on the basis of an indirect use of borrowed money to earn income (i.e. borrowing money allowed trust to retain income earning investments).

o Jurisprudence has been hostile to claims based on indirect, eligible uses when faced with direct but ineligible uses of borrowed money.

o Court cannot ignore the direct use to which a TP puts borrowed money. o If trust’s argument is successful, then any TP who owns income-earning assets could

borrow money for any purpose (vacation, life insurance policy, etc.) and deduct the interest on the basis that the borrowing is for the purpose of retaining (not liquidating) the income-earning assets. This is ridiculous.

o In this case, money was not borrowed for the purpose of earning income but to make a capital allocation

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- There are exceptional cases in which TP might be allowed to deduct interest on funds borrowed for ineligible use b/c of an indirect effect on the TP’s income-earning capacity. TP must satisfy the court that his or her bona fide purpose in using the funds was to earn income .

o Facts in this case don’t qualify. o Significant that interest costs exceed the income generated by the investment. TP cannot

point to a reasonable expectation that the income yield from trust’s investment portfolio would exceed the interest payable on a like amount of debt.

- Trust argued (and Crown conceded) that interest would have been deductible if trust had sold assets to make the capital allocation and borrowed to replace them. Court: we must deal with what the TP actually did and not what he might have done. Moreover, if same asset was sold and repurchased w/in short interval of time, court might consider it a sham or formality designed to conceal the essence of the transaction.

- Allard: fact that borrowing money may have prevented realization of capital losses wasn’t enough – this is not an eligible use of funds.

RULE: as above

SH: - Note purpose of allowing deduction of interest on money borrowed for purpose of earning income –

to encourage TPs to augment their income-producing potential (in this case, TP reduces income-earning capacity by (1) expending capital in manner that doesn’t produce taxable income, i.e. capital allocation; (2) by incurring debt financing charges

Attaie v. MNR, [1990] FCA p. 683

Facts:- TP borrowed money to buy house which he rented out (eligible use). TP moved into house (direct

use now ineligible). He had cash to pay off the mortgage but interest rates were so high at the time that he was better off investing the cash than paying off mortgage. Invested cash that would have been used to pay off mortgage in income-producing assets.

- Sought to deduct interest on mortgage (while living in house)

Held: deduction disallowed

Ratio:- Current use, and not original use, is relevant in assessing deductibility- Fact that TP decided to maintain the borrowing and use cash to make a more profitable investment,

does not render the interest paid on borrowing “interest on borrowed money used for the purpose of earning income from a business or property.”

- There is no tracing here of the borrowed funds to the income earned. The borrowed funds were put to a non-eligible use while the personal funds were used to as to produce income.

SH: This seems ridiculous – if he just paid off mortgage, re-mortgaged house and purchased income-earning property with monies borrowed, would have been able to deduct interest. BUT, wouldn’t have been able to get such a favourable mortgage rate (b/c interest rates had risen so much)

CHC HelicoptersSub borrowed money which it paid to parent to enable parent to purchase another co. Income-earning potential held by parent (parent owned co.) and not by sub, but sub argued that it would be benefited indirectly b/c would eliminate competition, etc. Held: Interest deductible. Reason: This is an

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exceptional circumstance envisaged by Bronfman.

Singleton v. The Queen, [2002] SCC p. 682

Facts:- Partner in law firm w/drew capital from his firm, purchased house, borrowed money guaranteed by

mortgage on house and put borrowed money back into firm (an income-earning purpose)

Held: Interest on mortgage deductible

Ratio: - Court relied on direct use test from Bronfman- Court must simply apply 20(1)(c)(i) rather than search for the economic realities of the situation. - Applying direct use test to facts – TP used the borrowed funds to refinance his capital account.

[Dissent]: must look at ‘economic realities’ of transactions – the borrowed funds were used to finance the purchase of a private home.

Shell Canada Ltd. v. The Queen, [1999] SCC p. 688

Facts:- TP needed $100 million US. Instead of borrowing US dollars at 9.1% interest rate, TP borrowed

$150 million NZ dollars at 14.5% interest rate (a ‘weak currency’ or ‘kiwi’ loan).- Upon borrowing money, immediately bought $100 million US and some forward contracts (which

gave it a right to buy the necessary amounts of NZ dollars it would need to pay the interest and refund the capital when due at a fixed price).

- Result of this scheme: cost of loan = 9.1% but TP was allowed to deduct 14.5% interest- [Combination of interest deduction + capital gain from forward Ks put TP in better situation than

would have been in had it merely borrowed US dollars]

Issue: Amt of interest deductible – 9.1% or 14.5%?

Held: 14.5%

Ratio:Tax authorities argued1. Bronfman: must ascertain the true commercial and practical nature of TP’s transactions. Thus, b/c

loan only cost 9.1%, should only be able to deduct 9.1%2. Money not used to earn income from business but to buy US dollars3. Part of money used to earn capital gain on forward K (which is not eligible use of borrowed money)Court rejected all three arguments:- NZ $150 million used directly in the business to earn income- The interest rate was reasonable (the going rate in NZ at the time)- Must be sensitive to the true economic realities of transactions, but cannot use economic realities to

re-characterize bona fide relations [Allard: this represents retraction from very purposive interpretation adopted in earlier decisions; to extent that plain meaning is unambiguous and clear, apply it; take it easy on looking at spirit, object and purpose of legislation. Pg. 22 notes]

- Capital gain on forwards K was accessory to overall transaction and thus should be characterized in same way as principal transaction.

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Notes:- Act was amended following Shell. Under 20.3, amount of interest deductible would be restricted to

9.1% (i.e. what would have been paid on a US dollars loan)

Ludco v. MNR, [2002] SCC, p. 682

Facts:- Offshore corp (“Justinian”) set up as tax shelter for small group of investors- Corp issued shares to investors. Share subscriptions were invested in low-risk investments which

attracted no w/holding taxes. Very few dividends were distributed, thus investment (and value of shares) grew. TPs eventually redeemed shares and realized nice capital gain. In this way, converted dividend income (100% taxable in year paid) to capital gain (50% taxable in year shares redeemed)

- TP in this case purchased shares with borrowed money and sought to deduct interest paid on it [total of $6 million]. Argued that money was borrowed to earn income from property – couldn’t point to capital gain b/c not ‘income’ [9(3)] therefore pointed to dividend [$600,000 in dividends paid over 8 years]. Prospectus was careful to point out that dividends would be paid.

Held:Interest deductible

Ratio:Tax authorities argued1. Predominant purpose in setting up scheme was to earn capital gains on redemption. Capital gain is

not eligible use under 20(1)(c). Never intention to earn income even equivalent to interest paid2. Income is net concept and interest not deductible where no reasonable expectation of earning any net

income (i.e. where interest far exceeds income)Court rejected- Predominant purpose: court need only ask if one of the purposes of borrowed money was to earn

income. If one purpose is to earn income, need not be predominant one- Income for purposes of 20(1)(c) is a gross concept: not up to court to Q sufficiency of income- In this case, there was a reasonable expectation that some dividends would be paid. The written

prospectus anticipated dividends. Significant that $600,000 was a considerable sum (not window dressing) and represented a rate of return comparable to what one could expect from common shares listed on TSE.

RULE: Interest paid on loan used to acquire shares is deductible if such shares can pay dividends, even if dividends expected are low. Need reasonable expectation of gross revenue, but not net income, in order to deduct interest pursuant to 20(1)(c). Income-earning purpose of borrowed money need not be the pre-dominant purpose. An ancillary income-earning purpose is sufficient to support interest deductibility.

Allard:- Tax authorities didn’t challenge characterization of redemption as capital gain; might have argued

that shares were purchased with intention to resell at profit therefore adventure in nature of trade and gains 100% taxable business income. Perhaps not surprising given tax treatment of shares.

- NB: at end of the day, 3.1 would deny deductibility of losses b/c no REOP

Timing Issues

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- Business income is (ordinarily) calculated on an accrual basis, i.e. revenues included in taxation year in which earned, even if not received, and expenses deducted in the taxation year in which they are incurred, even if not paid

Inclusions

Statutory Rules

9 Profit to be determined in accordance with general commercial principles. Under general commercial principles, usually calculate income on accrual basis, and therefore recognize income when earned

12(1)(a)

12(1)(b)

Must include as income from business or property:

Any amt received by the TP in the year in the course of a business that is on account of services not rendered or goods not delivered before the end of the year

Any amount receivable by the TP in respect of property sold or services rendered in the year, even if amount (or part of it) not due until subsequent year. UNLESS, the method adopted by the TP for computing income from the business does not require TP to include any amount receivable unless it has been received in the year.

For purposes of 12(1)(b), an amt shall be deemed to have become receivable in respect of services rendered in the course of a business on the day that is earlier of(i) day on which acct in respect of services was rendered (i.e. send bill)(ii) day on which account would have been rendered if there had been no undue delay

(i.e. day you would have normally sent bill but for delay). ** What amounts must be included? 1. Amts earned but not receivable or due (e.g. unbilled income as in West Kootenay) [s. 9(1)]2. Amts receivable but not due [para 12(1)(b)] [with exception for ‘acceptable method’]

*What is meant by receivable? (see cases)3. Amts received but not earned [para 12(1)(a)]

- Note that 12(1)(b) is consistent with general commercial practices (thus redundant), though it is narrower than general commercial practices (b/c doesn’t include income earned but not receivable), while 12(1)(a) overrides general commercial principles (under accrual method, amts received but not earned are not included in income).

West Kootenay Power & Light Co. v. The Queen, [1992] FCA p. 699

Facts:- TP generates and distributes hydro power to residential customers who are on a two-month billing

cycle- At end of fiscal periods in issue, TP had delivered electricity for which, as of year-end, customers

hadn’t been billed. - Co’s accounting practices, until 1979, did not take account of estimated unbilled revenue but, in 1979

were changed to account for such unbilled revenue (for financial statement and tax purposes)- In 1983, co. changed practices again, retaining accrual basis for calculating income for purposes of

financial statements but changing from accrual to ‘billed’ basis for income tax return (i.e. eliminating from its income the estimate of revenue unbilled at year-end).

Issue: Whether estimates of unbilled revenue at end of TP’s taxation year must be included in its income

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from business in that year.

Held: Yes

Ratio:Question 1: requirement of conformity btwn income tax returns and financial statements? - Under GAAP, it is acceptable to either include or exclude unbilled revenue in income. GAAP also

stipulates that accounting policies followed by a company should be consistent w/in & btwn periods- [Court sets out relevant provisions of the Act – sub 9(1) and s. 12, particularly para 12(1)(b)]- Trial judge concluded that Act does not require or permit a TP to use different methods to compute

income for tax purposes (billed) and financial statement purposes (accrued, earned). I.e. requirement of conformity btwn financial statements and income tax accounting

- CA rejects this conclusion: would be undesirable to establish absolute requirement of conformity btwn financial statements and tax returns. TP must use whichever method presents the ‘truer picture’ of a TP’s revenue, which more fairly and accurately portrays income, and which ‘matches’ revenue and expenditure. [Note policy reasons for this conclusion, bottom 704 to top 705]. In this case, expert testimony made it clear that accrual method presented a truer picture, b/c more accurately and fairly matched revenue and expenditure, despite the fact that estimate of revenue could only be approximation of actual revenue. [SH: Expert suggested that accruing of unbilled income usually produces a more accurate determination of net income for a particular period].

Question 2: whether unbilled revenues are amts ‘receivable’ under para 12(1)(b) and if so, whether exempted by ‘unless’ clause- Under GAAP, unbilled revenue at end of year is not considered an amount receivable for that year- Legal def’n of receivable: TP must have a legal, though not necessarily immediate, right to receive it;

collectible, whether or not due. Colford test: Two conditions for amt to be receivable: (1) right to receive compensation; (2) binding agreement between the parties or a judgment fixing the amt

- Aplt argued that amt in Q not receivable b/c, for practical purposes, could not be quantified exactly AND b/c regulations prohibited TP from claiming payment

- Court rejected TP’s argument, and concluded that unbilled amts were receivable b/co TP had a legal, though not necessarily immediate, right to receive ito Amt is sufficiently ascertainable to be included as an amt receivableo TP is entitled to enforce payment even though he has not done so [SH: not entitled to

enforce payment b/c of regulations!!]o Not exempted by ‘unless’ clause in para 12(1)(b) b/c of the words ‘accepted for the

purposes of this Part.’ The principle to be applied for the purposes of this Part is the ‘truer picture’ or ‘matching’ principle, which denies TP the right to use the billed acct method.

Allard’s interpretation of the case:- s. 9 notion of profit requires TP to use whichever generally accepted method gives the truer picture of

TP’s revenue. What method gives truer picture? That which matches revenue to expenses. This case: accrual (i.e. which requires inclusion of unbilled income).

- Court could have stopped there – the unbilled revenues were ‘earned’ and therefore had to be included pursuant to 9(1). Went on, however, to consider whether unbilled revenues are ‘receivable’ per 12(1)(b)

- Held: receivable. Reasons – TP had legal, though not necessarily immediate, right to receive payment; Amt is sufficiently ascertainable to be amt receivable (can estimate electricity usage based on past practices); Sale of Goods Act provides that when sell goods, are entitled to payment when goods delivered and even before bill sent out. The ‘unless’ clause doesn’t exempt TP b/c accepted for the purpose of this part means the method which gives the ‘truer picture’ – here it is the accrual

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method, not the ‘billed’ method.

MNR v. John Colford, [1960] Ex. Ct.

Facts:- TP was installed a/c, plumbing equipment, etc.- Entered into several Ks pursuant to which received progress payments, of which stipulated percentage

was held back until work was completed and certified by architect/eng

Issue: Must held back portions of progress payments be included in income?

Held: No

Ratio:- Def’n of ‘receivable’: TP must have a clearly legal, though not necessarily immediate, right to

receive it; collectible, whether or not due. Legal right has to be absolute, not conditional (?)- This case – under ON law, contractor has no legal right to amount of the holdback until the issuance

of the certificate, and no suit can be properly commenced before certification. - Holdbacks on projects that are yet to be certified are not “receivables” per 12(1)(b)

MNR v. Benaby Realties, [1967] SCC

Facts:- TP’s land was expropriated in Jan. 1954 and he received compensation in Nov. 1954- TP sought to include gains resulting from expropriation of land in computing income for year ending

April 30 1954- Argued that from the moment of expropriation, he no longer had land but instead the right to receive

compensation

Held: cannot include in 1954 taxation year

Ratio: - For amt to be either earned or receivable , amount has to be ascertained or ascertainable (i.e. by

objective formula or reasonable past practices as in West Kootenay). - If cannot be ascertained or ascertainable until future event (in this case judgment on amt of

expropriation compensation), then only included after this future event.- My opinion is that the Act requires that profits be taken into account or assessed in the year in which

the amount is ascertained.

Stevenson & Hunt Insurance Brokers Ltd. v. the Queen, [1993] FCTD

Facts:- TP sold insurance policies. Insurance companies paid it regular sales commission plus additional

commissions contingent on profit of policies sold- TP argued that not informed of 1982 amount until end of 1983. - MNR said contingent commissions earned in 1982, that amt of commissions should have been

estimated by TP and that this estimate could have been adjusted when commissions actually paid

Held: Contingent commissions not ascertainable and therefore not receivable until end of TP’s 1984 taxation

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year

Ratio:- No practical way for TP to reasonably estimate the commission until end of 83 – needed information

provided by insurance co. - While estimates and discounting of amts to be paid in future is acceptable practice, they must be

predicated on an ability to approximate what is expected or knowledge of the amount to be discounted.

RULE (Benaby, Stevenson): For an amount to be either earned or received, it must be ascertained or ascertainable (i.e. using some objective formula or making reasonable estimate based on past practices).

Publishers Guild v. MNR, [1957] Ex. Ct.

Facts:- TP sold books and magazines door to door. Computed income on ‘instalment basis’ according to

which amts receivable from door-to-door subscriptions were not brought into income until actually received and expenses incurred in order to earn subscription income were not deducted until income received

Issue: Is this appropriate system of accounting for tax purposes?

Held:Yes

Ratio:- Accounting evidence suggests that instalment basis of accounting is more appropriate than the accrual

method. It more accurately reflects TP’s income than any other system of accounting would do. - WHY? Period of payment of instalments is protracted, collection of instalment is uncertain and costs

of collection high, accounts are of such doubtful value that they cannot be discounted or readily sold, there are no valuable rights of possession in the articles sold.

- Where there is dispute about a system of accounting – consider (1) whether appropriate to the biz to which it is applied and tells the truth about the TP’s income and (2) whether there is any prohibition in the governing income tax law against its use.

RULE: A method other than the accrual method may be used for tax purposes if it is more appropriate than any other system and tells the truth about the TP’s income.

Note:Under s. 34, professionals need not use full accrual method for calculating income – are allowed to exclude work in progress. Effectively means can use billed method, i.e. only include in income what billed, not what earned.

Deductions

Amounts payable

Rules

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9(1), 9(2) Basic rule – ‘profit’*TPs who calc on accrual basis – expenses generally deductible when payable, even if not paid until subsequent year

18(1)(a) In computing the income of a TP from a business or property no deduction shall be made in respect of

(a) General limitation – an outlay or expense except to the extent that it was made or incurred by the TP for the purpose of gaining or producing income from the business or property

**This rule contemplates both accrual method (‘incurred’) and cash method (‘made’)

(e) Reserves, etc. – an amount as, or an account of a reserve, a contingent liability or amount or a sinking fund except as expressly permitted by this part.

*(e) overrides general commercial principles (see below)

- *Under general commercial principles, one is justified in deducting reserve for reasonably estimable contingent liabilities, so as to present the most conservative picture of business’s financial situation. Such a deduction is not allowed when computing profit for tax purposes [18(1)(e)]

- Examples: reserve in respect of pending litigation; reserve in respect of warranties/guarantees (i.e. b/c customers are bound to bring some things back)

Guay (def’n of ‘payable’): Obligation is payable and thus deductible as long as not contingent (i.e. existence of obligation subject to some condition that must be satisfied), and amount is ascertained or ascertainable (i.e. quantum of obligation known or knowable).

Day & Ross Ltd. v. The Queen: The terms ‘reserve’ and ‘contingent account’ of para 18(1)(e) connote the setting aside of an amount to meet a contingency an unascertainable and indefinite event which may or may not occur. The term expense in 18(1)(a) implies a liability present and certain, an amount definite and ascertainable.

Harlequin Enterprises: TP, a book publisher, delivered books to customers under terms whereby unsold books could be returned to company in exchange for credit against subsequent purchases. Sought to deduct a current liability in respect of unsold books remaining in the hands of the customers at end of year. Held: deduction disallowed b/c liability contingent. In any fiscal period, though it was known from experience that there would be returns, the # and actual value therof could not be fully known until all returns on sales made w/in the fiscal period had actually been received, which might not be until some considerable period of time has elapsed after the end of the fiscal period.

- TB: To the extent that income from a biz or property is generally computed on an accrual basis, with amounts included in the taxation year in which they are ‘receivable,’ the ‘truer picture’ principle by which Cdn courts have interpreted the concepts of ‘profits’ and ‘loss’ in subs 9(1) and (2) suggests that deductions should be allowed in the taxation year in which they are ‘incurred’ or ‘payable.’

- What is ‘payable’? Guay

J.L. Guay Ltee v. MNR, [1971] FCTD p. 724

Facts:- TP is general contractor which makes progress payments to sub-contractors. W/holds percentage of

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payments to be paid after work is finally approved by the architect (i.e. ‘holdbacks’).- TP tried to deduct ‘holdbacks’ as expenses- [Note effect of holdbacks: ensure payment of damages which owner or general contractor may incur

if work faulty; if damages exceed amts w/held, owner/general K-or will keep entire amt but if damages less than amts w/held, sub-Kor will be entitled to receive difference]

Issue: Is portion of payment w/held (i.e. the ‘holdback’ portion) ‘payable’ and thus deductible?

Held: No

Ratio:- In Colford, court found that similar ‘holdback’ payments were not ‘receivable’ in calculating income- Far from certain that the amounts w/held will be paid in full to the sub-contractor. Payment of these

amounts to the sub-contractor is, if damages are incurred, contingent. Until architect has issued certificate and 35 days have elapsed, the general contractor is under no obligation to pay the amount and it is not claimable by the sub-contractor

- Only amounts which can be exactly determined are accepted – ordinarily, provisional amounts or estimates are rejected, and it is not recommended that data which is conditional, contingent or uncertain be used in calculating taxable profits.

- Here, dealing with amounts w/held which are not only uncertain as to quantum if partial damages result from badly done work, but which will no longer even be due or payable if damages exceed amounts w/held.

- FCA aff’d: TP’s profit cannot be computed by taking, on one hand, 90% of the value of all the work done for the owner and, on the other hand, deducting the total sums paid by the TP to the subcontractors for their work.

RULE: Obligation is payable and thus deductible as long as not contingent (i.e. existence of obligation subject to some condition that must be satisfied), and amount is ascertained or ascertainable (i.e. quantum of obligation known or knowable).

Allard:- SH: Is this decision relying on 18(1)(e) or just 9(1)?

Inventory Costs

Is this an expense in respect of inventory? What is inventory? Inventory is property that gives rise to business income upon sale. Whether or not property is inventory depends on tax treatment of gain upon sale of that property. [248(1), Friesen] Inventory regularly sold in course of your business Property held and sold in adventure in the nature of trade [Taylor – lead was inventory in his hands]

How is profit on sale of inventory calculated?9(1) – ‘general commercial principles’ require that costs of inventory be deducted against revenue earned when inventory sold (the ‘matching principle’ at work). Accumulate inventory costs and deduct against proceeds of sale.

Profit (inventory) = Proceeds – Cost of Goods Sold (CGS)

How to determine CGS? Unique property = can trace exact historical cost of each piece of inventory sold Fungible property:

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CGS = (cost of opening inventory + cost of inventory acquired during year) – cost of closing inventory (LCM)

How to determine cost of closing inventory? Each unit of inventory acquired/produced at same cost = cost per unit * number remaining Units of inventory acquired/produced at different costs:

o Unique property = can trace exact historical cost of each unit soldo Fungible property: FIFO, LIFO, or weighted average (see Anaconda)

Anaconda : LIFO not an appropriate inventory-costing method for tax purposes [assuming cost of inventory is increasing steadily, would result in lower profits and tax deferral]. FIFO and weighted average methods are acceptable for tax purposes.

Can value closing inventory at lower of cost and market [ sub 10(1) ] , such that, if market value falls below cost, loss will be realized before inventory is actually sold (b/c lower value of closing inventory = higher CGS = lower profit = loss in there somewhere). Exception to general principle that only realize gain or loss upon sale of property.

o NB: Cannot realize gain until sell – value at lower of cost and marketo NB: Cannot write down inventory held as adventure in nature of trade [sub 10(1.10)]; can

only realize loss once sold.

10(1) For purpose of computing income from a business that is not an adventure in the nature of trade, property described in an inventory shall be valued at the end of the year at the cost at which TP acquired property or its fair market value, whichever is lower.

10(1.01) For purposes of computing TP’s income from a business that is an adventure or concern in the nature of trade, property described in an inventory shall be valued at the cost at which the TP acquired the property.

Special Case Professionals’ Work in Progress (s. 34)

34 In computing income from biz that is professional practice of an accountant, dentist, lawyer, medical doctor, vet or chiro, following rules apply(a) where TP elects, there shall not be included any amount in respect of work in progress

at the end of the year(b) where TP makes election, s. 34(a) shall apply in computing TP’s business for all

subsequent taxation years unless TP, with concurrence of Minister, revokes the election

Per s. 9, professional would have to recognize income when earned, i.e. when services are performed and not when K is completed. Professional would have to recognize work in progress at end of fiscal year.

Per 10(5), professionals’ work in progress is considered inventory and, as such, expenses associated with it could not be deducted until work in progress is completed.

Effect of s. 34, if professional elects – (1) need not include work in progress until bill is rendered; (2) expenses can be deducted when the expenses are incurred rather than being included in the computation of closing inventory.

Friesen v. The Queen, [1995] SCC

Facts:

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- TP purchased land for purpose of reselling it at profit. Relied upon LCM rule to deduct decrease in value of property as loss in computing his income.

Held: Allowed

Ratio:- Property ‘inventory’ w/in meaning of the Act- Court used ‘plain reading’ of sub 10(1) to hold that TP could trigger accrued loss on the property by

valuing the property at its FMV at the end of the year[Dissent]:- LCM rule limited to ‘stock-in-traders’ for whom the cost or value of inventory remaining at the end

of a tax year is essential to the computation of gross profit during the year [SH: when ad in nature of trade, don’t need to use closing value of inventory to calculate gross profit, b/c can trace specific cost of property]

Friesen before and after sub 10(1.01) Before:Buy land at $100KMkt value in next year = $50CGS = $100K + 0K - $50 K = $50KGross Profit from adv in nature of trade = 0K – 50K = loss

After:Cannot realize loss until soldSold for $50KProfit = $50K - $100K = -50K

Neonex International Ltd. v. The Queen, [1978] FCA p. 735

Facts:- TP custom builds and sells electrical signs- At end of each year, there are always several partially completed signs- For taxation years in issue, TP deducted costs incurred in respect of partially completed signs. MNR

disallowed deduction and trial judge found that he was right in so doing.

Issue: Are costs incurred in respect of partially completed signs deductible in year which incurred?

Held: No

Ratio:- Accepted accounting treatment for partially completed signs – costs incurred in a period but which

have not yet been expended in the revenue earning process are carried forward to accounting period in which the revenue they aid in producing is recorded; i.e. costs must be matched with the related revenues

- Q is whether Act requires or permits different accounting treatment in calculation of TP’s income for tax purposes than that applicable for accurately portraying financial picture of co in financial statements. Judge concludes that it does not. Method used by TP accorded neither with GAAP nor with proper method of computing income for tax purposes. Such method would not result in true, fair and accurate portrayal of income.

Allard:

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- TP tried to use 18(1)(a) as though a permissive deduction section, i.e. costs of producing inventory were incurred in order to earn income therefore are deductible. Answer: 18(1)(a) is prohibitive – cannot deduct ‘unless’ – this doesn’t mean that can always deduct when incurred to earn income. Starting point is 9(1) general commercial principles, and such principles dictate that costs of inventory are accumulated and deducted when revenue earned.

Capital Expenditures

18(1)(b) Cannot deduct any capital outlay [accords with gen comm principles]Cannot deduct any allowance [TP must substitute tax treatment of depreciation for accounting treatment of depreciation]

Four possible tax treatments of capital expenditures:i. Cap expenditure to acquire tangible depreciable property for

purpose of earning income- recognized in two ways – (1) depreciation system; (2) when sold, as part of cap gain calc

ii. Capital expenditure to acquire intangible depreciable property for purpose of earning income

- will be recognized in depreciation system for eligible capital expendituresiii. Capital expenditure to acquire non-depreciable property

(land) (not for purpose of earning income?)- not recognized until property sold (i.e. part of cap gain calculation)

iv. Nothing - money spent but not recognized, i.e. not depreciated and not taken into account upon sale- this was frequently the result prior to 1972 (b/c no cap gains and no system for depreciating

intangible property)

Characterization

Is the expense a current or capital expenditure?

(see chart)

Rules (in summary)

Repairs/Improvements to Capital Asset1. Enduring benefit (long useful life) vs. recurring expenditure b/c useful life of replacement is so short

(Haddon Hall; Damon Development)2. Maintenance vs. betterment: restore to original condition vs. improve beyond original condition

(Canada Steamship, Shabro, Gold Bar)a. Did expenditure improve income-earning capacity of asset?

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Expenditure

Current Capital

ECE CCA ACB Nothing


b. Can still be maintenance if use new technology (Shabro, Gold Bar)3. Reason for the expenditure (Gold Bar, but irrelevant per Shabro)

a. What was in TP’s mind? Intention to improve or better the asset? (capital)b. Did TP have no choice? (e.g. expenditure necessitated by emergency) (current)

4. Integral part or separate asset (Canada Steamship)a. Is part replaced a separate marketable asset?b. Where not clear cut (i.e. integral or separate asset) – relative values important (Steamship)

5. Relative Value: amt of expenditure in relation to value of whole property or to previous average maintenance/repair costs (Steamship, Thompson, Tugboat)

a. Of particular importance where replacement could be regarded as separate marketable asset (Steamship). If cannot be so regarded, not so important (Steamship)

b. Relative value not important where clearly integral (b/c major repair could be very expensive accumulation of lesser jobs not done earlier) (Steamship)

CCA

- depreciation system for tax purposes- What is CCA system supposed to accomplish?

o Matching recognition of cost with benefit obtained from that costo Create some socio-economic incentives (e.g. encourage TPs to buy certain things by

allowing them to deduct the cost very quickly)o Helps to figure out value of asset at given point in time (i.e. ‘book value’ of asset). Note

however that book value may not be accurate. E.g. we depreciate buildings even though value of buildings usually rises.

Rules

18(1)(b) Prohibits deduction of any capital outlay or allowance in respect of a capital outlay. 20(1)(a) Notw/standing 18(1)(b), may deduct in computing income from biz or property such part of

the capital cost to the TP of property, or such amount in respect of the capital cost to the TP of property as is allowed by regulation[Basis for depreciation]

13 Rules related to calculation of CCA20(16) Terminal loss

Reg. 1102 Rules re. what is depreciable and what is notSched II Classes in which property depreciated

Property depreciated on class basis- classify all assets in business- total cost of all assets in class is then depreciated together

Rate of depreciation generally applied on declining-balance basis- i.e. subtract percentage of (cost minus depreciation taken in previous years)- UCC = (cost minus depreciation taken in previous years), i.e. the ‘undepreciated capital cost’- Exception:

o Class 13 (leasehold improvements)o Class 14 (franchises, patents, etc.)o Apply rate on straight-line basis, i.e. subtract percentage of original cost each year

20(1)(a) is permissive

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- may deduct CCA, but don’t have to (wouldn’t, for e.g., if nothing to deduct from)- if don’t deduct CCA, cannot carry over to subsequent years BUT UCC doesn’t get reduced

Some property is not depreciable [Reg. 1102(1) and (2)]The classes of property described in this Part and in Schedule II shall be deemed not to include property1102(1)(a) Otherwise deductible – property, the cost of which, would otherwise be deductible in

computing TP’s income (e.g. inventory)1102(1)(b) Inventory – property that is described in TP’s inventory1102(1)(c) No income purpose – property that was not acquired by the TP for the purpose of gaining

or producing income[see Hickman Motors, Ben’s][excludes personal property, property for earning employment income and property held exclusively to earn capital gain]

1102(2) Land – classes of property described in Schedule II shall be deemed not to include the land upon which a property described therein was constructed or is situated.

**Combo of land and building/improvements on land (e.g. parking lot) – do allocation of cost and depreciate cost of latter

Exceptions to the class system- some assets must be must be depreciated on single-property basis (i.e. in their own class)

1101(1) If have different businesses, must have different classes for each business. Allard: i.e. rule that compute income from each source separately also applies in CCA context.

1101(1ac) Rental property over $50,000 – must put each rental property with capital cost of $50,000+ into its own separate class.

**Def’n of ‘rental property’ at 1100(14) – building owned by TP or leasehold interest in real property (if leasehold interest is property of class 1, 3, 6, or 13 IF property was used by TP principally for the purpose of gaining or producing gross revenue that is rent.

Terminal loss [Sub 20(16)]**Sub 20(16) provides for deduction of terminal loss (i.e. over-depreciation)

20(16) IF[1] UCC exceeds total of proceeds of disposition in respect of property of a particular class AND[2] TP no longer owns any property of that class (i.e. all disposed of)THEN[3] TP shall deduct, in computing income for year the amount by which UCC exceeds POD AND[4] TP shall not, in that year, deduct any CCA in respect of property of the class

This is not a capital loss, represents amount by which property was over-depreciated. Never incur capital loss on depreciable property – any loss fully deductible as terminal loss

Notes: A terminal loss is available as a deduction if all the depreciable property in a class is disposed of and there is still some unused cost (i.e. UCC) ‘left over.’

Recapture [13(1)]**Sub 13(1) provides for inclusion in income of recapture (i.e. under-depreciation)

13(1) When depreciable property is sold, proceeds of disposition, up to the original cost, are deducted from the UCC of the class. [Any excess over the original cost is a capital gain under 39(1)]. If as a result the UCC goes negative, 13(1) requires the balance to be included in income.

Where POD > UCC, must include in income the amount by which POD exceeds UCC but only up to the capital cost.

This is not capital gain, represents amount by which property was under-depreciated.

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The half-year rule [Reg. 1100(2)]In year of acquisition of property, assuming that there are no dispositions of property in the same class, UCC must be reduced by ½ the cost of the new property in the year. Create notional UCC by subtracting ½ cost of new property – use that to determine CCA for year Then, deduct that CCA from real UCC to get UCC for next year. i.e. only use notional UCC to

calculate CCA Arbitrary way of taking into acct fact that haven’t had use of property for the whole year **Reduction to UCC where disposition in same year =

o ½ [excess of acquisitions over (lesser of PofD and CC of property disposed in the year)]

CCA Pro-Ration [Reg. 1100(3)]Must pro-rate CCA where a taxation year is less than 12 months. CCA = (days in tax year)/365 * UCC Half year rule can apply at same time such that

o CCA = (days in tax year)/365 * (UCC – ½ cost of property acquired in year) When might taxation year be < 12 months? First taxation year of business, change of taxation year,

business dissolved mid-year

Calculating CCA/UCC when assets are pooled in classes

Notes- Recapture can be triggered when still have assets in pool; terminal loss cannot- Recapture, on class basis, will only occur when total of CCA on all assets plus (lesser of CC and

proceeds) exceeds total CC. Not triggered on asset-by-asset basis- There are two CCA reasons why should plan acquisitions and dispositions of property in same class

in the same yearo Defer recapture (i.e. keep UCC from going negative due to disposition by acquiring

property and therefore increasing the CC, i.e. what proceeds/CC is deducted from). [This explains why some assets are depreciable in separate classes, i.e. so cannot dispose of asset and buy asset to offset recapture]

o Reduce or completely eliminate the effect of the half year (b/c half year only operates if CC of acquired property exceeds lesser of CC and proceeds of property disposed of in year)

- When dispose of all assets in pool thereby triggering terminal loss, be sure to add that terminal loss in subsequent year (in CCA column) in order to bring the whole CCA account to zero.

- Receipt of proceeds on disposition reduces UCC and therefore CCA allowed in future years. Proceeds is like getting back part of the cost and therefore reduces basis for calculating CCA.

- When have several assets in class, but disposition of only one triggers recapture, adding back recapture in following year will bring UCC to zero even though there are still assets in the pool.

- **Determine lesser of CC/PofD on an asset-by-asset basis.

Other Issues

Property only depreciable if acquired for purpose of gaining or producing income [1102(1)(c)]

Ben’s Limited v. MNR, [1955] Ex. Ct., p. 789

Facts:- TP had bakery business and purchased three adjoining residential properties, each consisting of land

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and house. Intended to remove the houses and use land for bakery expansion. Some delay of sale b/c property needed to be rezoned. While rezone pending, TP received rent from one of the buildings b/c lease of vendor’s tenant didn’t expire until after purchase.

- Once property rezoned, buildings were sold for $1200 and removed from the land. - TP apportioned cost of acquisition between land and buildings and deducted 10% of cost of buildings

as CCA

Issue: Can TP deduct CCA? (Was the property acquired for the purpose of gaining or producing income?)

Held:No

Ratio:- TP argued that whole outlay was for purpose of gaining or producing income b/c acquired the site for

purpose of extending its building and increasing its business.- Court says no Q is not whether TP’s outlay as a whole was for purpose of gaining or producing

income but whether the property referred to in the class, in this case class 6 – “building of frame” – was acquired for purpose of gaining or producing income?

- Buildings on the lands were not acquired for the purpose of gaining or producing income; the sole purpose in making the outlays was to acquire land as site for factory extension.

- TP argued that secondary purpose – derive some rent from buildings and use as storage.- Court rejects sole intention in regard to houses was to have them torn down and removed at

earliest possible moment; mere fact that obtained some rental income doesn’t affect the real purpose of acquisition.

RULE: Property not depreciable unless acquired for purpose of gaining or producing income. Don’t look at outlay as whole but at the property referred to in the class Was that specific piece of property acquired for purpose of gaining or producing income? Must look at primary intention in acquiring property – secondary intention to use for income-earning purpose (e.g. rents) not enough.

Allard- Intent was effectively to acquire a vacant piece of land; TP put zero value on buildings therefore none

of purchase price allocated to buildings- Cost was incurred to purchase non-depreciable property (i.e. land)

Hickman Motors v. The Queen, [1998] SCC

Facts:- Wind up of sub. On winding up, all sub’s assets (leasing equipment) were transferred to parent (the

TP)- 5 days later, the property was transferred to another co. in the same corporate group- TP sought to deduct $2 million CCA even though revenue produced by leasing equipment during that

period was only $20K.

Issue:Is TP entitled to deduct CCA?

Held: Yes

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Ratio:- MNR used reasoning from Ben’s – didn’t acquire for purpose of earning income, b/c transferred

shortly after acquisition- Court rejects property produced rental income during the short period that it was held by the TP.

Reg 1102(1)(c) doesn’t require that depreciable property be held for any particular period of time. - Here the assets served only one function – to produce income.

RULE: As long as acquire property for purpose of earning income, fact that revenue is small or earned over short period of time is irrelevant.

Allard:- So parent and new owner would both be claiming CCA on same property in same year. Subject,

however, to half-year rule.

What = capital cost that can be depreciated?

- actual, factual or historical cost to the taxpayer of the depreciable property- might include architect’s fees, legal and engineering fees, cost of preparing site for construction,

interest and other financing expenses, but not any contingent liabilities-When can capital cost be added to UCC of class (such that allowance taken in respect of it)

2 concepts1. Acquisition2. Available for use

Acquisition- ‘A’ in def’n of UCC [13(21)] suggests can add CC to UCC when property acquired- Problems where (1) conditional sale (i.e. transfer of title w/held pending certain conditions) and (2)

capital leasing (i.e. lease with option to purchase; sale of property being financed by lessor and lessor retains title until option exercised) – if sale, then capital cost portion of rental payments would be cost of acquisition of property and interest portion would be deductible expense.

- Wardean Drilling : TP will have acquired property when title has passed or when TP has acquired incidents of ownership – i.e. possession, use and risk (e.g. obligation to insure) – even if title hasn’t passed (e.g. conditional sales agreement).

- Purchaser must have a current ownership right in the asset itself and not merely rights under a K, of which the asset is the subject, to acquire it in the future.

Available for use- TP has acquired if title has passed (even if no possession or use). CCA deduction if no possession or

use was thought to be an abuse Result = available for use rules [13(26) – 13(29)]

13(26) Prohibits any addition to the UCC of a class of depreciable property of the capital cost to a TP of property of that class before the time the property is considered to have become available for use by the TP .

13(27) Property (other than a building or part thereof) acquired by a TP shall be considered to have become available for use by the TP at the earliest of

a. the time the property is first used by the TP for the purpose of earning income

b. Two-year rolling start rule : if you

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never start using it and still haven’t disposed of it, 357 days after the end of the taxation year in which the property was acquired.

c. the time that is immediately before the disposition of the property by the TP (*note that you need to own the property at the end of the year in order to actually take CCA)

d. the time when property is delivered or deliverable

- This only applies for purpose of CCA (i.e. can’t deduct CCA if not available for use)- Add CC to UCC when property acquired. When calculating CCA, use notional UCC which =

(UCC – CC of property not available for use)- Half-year rule applied in the year property becomes available for use (i.e. reduce UCC by ½ CC of

property that becomes available for use) except where using the two-year rolling start rule (don’t apply half year rule)

13(28) For purposes of sub (26), property that is a building or part thereof shall be considered to have become available for use by the TP at the earliest of(a) the time all or substantially all of the building is complete(b) the time the construction of the building is complete(c) two-year rolling start rule(d) time that is immediately before the disposition of the property by the TP

What is a disposition?

Disposition of property [248(1)]: includes any transaction or event entitling a TP to proceeds of disposition of the property

Proceeds of disposition includes [13(21)]:(a) sale price of property sold(b) compensation for property unlawfully taken(c) comp for property destroyed and any amt payable under a policy of insurance in respect of loss or

destruction of property(d) comp for property taken under statutory authority (i.e. expropriation)(e) compensation for property injuriously affected(f) compensation for property damaged and any amount payable under a policy of insurance in respect of

damage to property, except to the extent that the compensation or amount, as the case may be, has w/in a reasonable time after the damage been expended on repairing the damage

(g) …(h) …

BCN Immobiliere : the words “disposition of property” should be given their broadest possible meaning, including the destruction of tangible property or the extinction of an item of intangible property (e.g. patent or leasehold interest). Don’t interpret 13(21) as creating requirement for actual proceeds.

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Eligible capital expenditures

- CCA system does not provide for (with exception of class 14 – patent, franchise, concession or license for a limited period) depreciation of intangible capital property. Until 1972, such property received no tax recognition – it was capital outlay (enduring advantage) therefore not currently deductible, but not covered by CCA. These expenses were thus known as ‘nothings.’

- 1972, Act was amended by introduction of separate category of eligible capital expenditures, ¾ of which may be depreciated on a declining-balance basis under a statutory scheme much like that for CCAs.

Terminology:CCA Eligible Capital Expenditure

Capital cost Eligible capital expenditure (ECE)UCC Cumulative eligible capitalProceeds of disposition (amt received on sale) Eligible capital amount (ECA)CCA [no word]? Eligible capital property

A. Differences btwn eligible capital expenditure scheme and CCA scheme:

- One class (ECE) vs. multiple classes (CCA)- Single depreciation rate of 7% of CEC/year [pursuant to 20(1)(b)] (ECE) vs. multiple depreciation

rates (CCA)- ECE – capital gain/loss is calculated as part of recapture/terminal loss calculation and ½ of any gain

(i.e. ECA minus ECE) is taxable as business income. There is no actual capital gain/loss (i.e. as in coming from separate source) for eligible capital property. [Duff: unlike the rules for depreciable property, which distinguish between fully taxable recaptured depreciation and partly taxable capital gains from the disposition of depreciable property for proceeds exceeding the original capital cost of the property, the rules for eligible capital property make no such distinction, since all amounts exceeding the TP’s CEC are effectively subject to a one-half inclusion rate.]

- Depreciate ¾ cost of eligible capital property (ECE) vs. depreciate 100% cost of capital property (CCA). When dispose of property, take into account only ¾ of the proceeds when calculating recapture (s. 14) or terminal loss (s. 24) (ECE) vs. take into account 100% of proceeds (CCA) (SH: what is the significance of this?)

B. What is an eligible capital expenditure?

**Def’n at sub 14(5)**Leading case - Royal Trust

Sub 14(5)To be an eligible capital expenditure, it is required that

1) The expenditure has been made in respect of a business (not property)2) as a result of a transaction3) which occurred after 19714) was on account of capital5) was for purpose of producing income, and6) was an outlay or expense

a. not otherwise deductible in computing income from the business and b. not made or incurred for the purpose of gaining or producing income that is exempt

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income andc. not non-deductible by virtue of any provision of the Act, other than para 18(1)(b) and d. not incurred to acquire tangible property or intangible property that is depreciable

property (i.e. depreciable under CCA scheme).

R. v. Royal Trust Corp of Canada, [1983] FCA p. 811

Facts:- TP wanted to do public offering of shares. Prospectus said that net proceeds of subscription were to

be ‘invested by the Company to enable it to continue the expansion of its operating facilities.’ - TP had agreement with underwriters, under which underwriter agreed to sell shares in consideration

for $0.54 commission per share sold. - TP treated commission payment as an eligible capital expenditure, adding one half of the amount to

its cumulative eligible capital in each of the tax years in Q. MNR disallowed deductions

Issue: Was sum paid by TP to underwriters an ‘eligible capital expenditure” w/in meaning of sub 14(5) and thus deductible pursuant to 20(1)(b)?

Held: Yes

Ratio:MNR made 3 alternative arguments:2) Commission was not expense but discount off of purchase price paid by underwriters (b/c no services

provided in consideration of the commission)3) The expense is, by virtue of another provision [namely 20(1)(e) which at this time prohibited

deductions in respect of a commission paid to person to whom securities issued] non-deductible 4) Even if expense, it was not incurred for purpose of gaining or producing incomeCourt rejected each:1) Payments were made for the services to be performed by the underwriter; clearly a cost of the share

issue and not merely a discount (i.e. TP spent $4 to get $100 of capital into the company and did not merely get $96 of capital)

2) …3) Hard to conceive that expenditures incurred in the raising of capital to be used in the operations of the

co. are not ‘for the purpose of earning income.’- The expenditures were made in respect of a business (that of United trust) as a result of a transaction

(the issuance of shares and the payment of a commission in connection therewith) on account of capital (i.e. those moneys raised from the issuance of shares – SH: enduring benefit; lasting advantage), which, in turn, was for the purpose of producing income. Expenditures were not otherwise deductible in computing income from the business and not non-deductible by virtue of any provision of the Act, other than para 18(1)(b).

Allard:- The money coming in is not income but an injection of capital, and thus a non-tax event.

C. What is an eligible capital amount?

Eligible capital amount = consideration received by TP for eligible capital propertyEligible capital property = consideration given by TP

Sub 14(5) “Mirror image rule”

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Eligible capital amount is amt that TP has or may become entitled to receive in exchange for consideration the payment for which would have been an eligible capital expenditure in respect of the business if it had been made by the TP. - Test as to whether amt received is an ECA is determined by the recipient being considered a notional

payor of the amount which he, in fact, received (R. v. Goodwin Johnson)

R. v. Goodwin Johnson (1960) Ltd., [1986] FCA p. 819

Facts:- TP was logging co. - Entered into agreement with Naden, under which TP sold its Timber Sale Contract (TSC) to Naden

and Naden appointed TP as manager of Naden wrt the TSC- Naden terminated the agreement and paid settlement of $830,000 as damages for termination or

cancellation of the agreement. - MNR argued that amount received was comp for destruction or loss of the whole profit-making

structure of the TP’s business and thus an eligible capital amt (i.e. consideration received by TP for disposition of eligible capital property) which should have been included in income pursuant to sub 14(1).

Issue: Is compensation received by TP an ‘eligible capital amount’?

Held: No

Ratio:- Test: consider TP a notional payor of the amt which he received; i.e. would the amount if paid by TP

rather than received by him, have been an eligible capital expenditure? - Applying this test, the payment deemed to have been made by TP as a notional payor was not given

for the transfer of the business or profit-making structure. The expenditure was made for the purpose of gaining or producing income by getting rid of an operational expense by paying damages for breach of that K. The purpose of Naden’s payment was not to acquire a capital asset but merely to get peace in the litigation and rid itself of a bothersome partner. The payment made by Naden was a deductible business expense.

- Payment thus not an eligible capital expenditure b/c failed to meet one of the criteria imposed by 14(5), i.e. that the payment not be a deductible business expense.

- [Note that court comes to this conclusion even though it admits that the compensation is a capital receipt in the hands of the recipient.]

[Dissent]:- The notional payment that must be assumed to have been made by the respondent is an ECE if it is an

expenditure made on account of capital- TP was paid to relinquish rights under the K, i.e. was compensated for loss of biz- If the TP, instead of being paid to relinquish the rights had paid to acquire them, the payment would

have been a capital outlay since it would have been made once and for all…with a view to bringing into existence an asset or advantage for the enduring benefit of the respondent’s trade.

- Question is not whether the payment made by Naden to the TP was a capital outlay. It probably was not. The real and only Q is whether the notional payment that must be assumed to have been made by the TP was on account of capital.

Rule: Application of mirror image rule = look at nature of expenditure from perspective of party which actually paid (does it meet requirements of 14(5)?). Dissent: look at nature of expenditure from perspective of party which received the payment.

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Allard:- Goodwill is example of intangible property which may be eligible capital expenditure. Recall

Canada Starch: cost of building up your own goodwill is currently deductible business expense. Cost of buying goodwill – eligible capital expenditure.

Notes:

Consumers Software Inc.: TP developed computer program and sold it to US software firm for US $750,000. MNR regarded money as ordinary income from TP’s business. Held: Eligible capital amt subject to tax under sub 14(1). The program was the source of the majority of the TP’s biz and the TP was not a trader or dealer in software. SH: Why would it be in interest of trader/dealer to characterize as eligible capital amount? B/c then only taxed on half of gain? Whereas if inventory, taxed on full amount.SH: I thought must look at it from perspective of person buying software (majority in GJ) OR of TP acquiring the software rather than selling it. Don’t we have to look to whether, if TP acquired it, would provide enduring benefit/lasting advantage to him? OR can look at the asset relative to the rest of the TP’s business??

Canadian Industries: TP mfd TNT. Entered into agreement with US gov’t to permit it to use process for military purposes and to provide ‘knowhow’ it had developed, in exchange for $378,000. TP argued disposed of capital asset b/c lost its entire biz. Held: business income; agreement was for ‘limited purpose’ and ‘limited time’ and not exclusive. Also, termination of TP’s business of mfing TNT was not directly caused by the agreements with the US gov’t.

Followed in Canadian General Electric Co.: sale of knowhow will not normally be regarded as ale of a capital asset, particularly when the sale is by non-exclusive license. Any exception to this rule must be strictly established as a total loss of knowhow which is a direct and necessary result of the license agreement.

Dixie Lee: TP carried on business by granting right to use franchise, name and formula (for fried chicken). TP received lump-sum payment of $23,000 when it sold its entire interest in the four Atlantic provinces forever. Held: capital receipt. Aplt forewent its rights and all control, completely and irretrievably, as regards doing biz in the Maritimes. TP was not in the business of selling franchises. Ordinary business was licensing under its TM rights, not selling those rights!

Samoth Financial: TP purchased from US company exclusive right to sell Century 21 franchises in Canada. Received franchise fees on sale of 10-year renewable franchises which it regarded as eligible capital amounts only partly taxable under sub 14(1). Held: franchises not eligible capital property but stock in trade or inventory in the TP’s business. TP is trader or dealer in real estate franchises. SH: Again, why didn’t court use the mirror image rule? Seems to me that should have said – if TP had acquired one of these franchises, would it have been eligible capital expenditure? But that doesn’t make sense to me really…b/c doesn’t take account of the fact that TP sells many of such franchises.

Reserves

- 18(1)(a) and (e) prohibit deductions in respect of unincurred expenses and contingent liabilities. 20(1), however, allows TPs to deduct amts in respect of reserves in respect of unearned amounts, deferred payments, and doubtful debts.

- Stems from underlying matching principle, i.e. which seeks to match recognition of expense with recognition of benefit.

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- TP not required to take reserve. Can take reserve but don’t have to (sort of like CCA).

A. Unearned Amounts

What happens when receive money in year 1 for goods not delivered or services not rendered until subsequent year? (I.e. money received but not earned)

Basic rule: cannot deduct reserves [18(1)(e)] and cannot deduct expenses not actually incurred [18(1)(a)].

12(1)(a) Must include in income any amount received by the TP in the year in the course of a business

1. that is on account or services not rendered or goods not delivered before the end of the year or that, for any other reason, maybe regarded as not having been earned in the year or a previous year

…

[i.e. whether or not earned; whether or not services rendered or goods delivered][exception to generally accepted commercial principles]

20(1)(m) Where amounts in para 12(1)(a) have been included in computing the TP’s business from a business for the year or a previous year, TP may deduct a reasonable amount as a reserve in respect of2. goods that it is reasonably anticipated will have to be delivered after the end of the

year3. services that it is reasonably anticipated will have to be delivered after the end of the

year4. …

[Reserve available to offset income inclusion in 12(1)(a)][what is ‘reasonable amount’? can be as high as total amt included in income]

12(1)(e) Must include in income any amount deducted under para 20(1)(m) in computing TP’s income from a business for the immediately preceding year.

[must include amt deducted under 20(1)(m) in income from following year. Can deduct another reserve if requirements of 20(1)(m) are met (i.e. if income still not earned)]

E.g. $1000 service or good paid for in year 1 but not delivered until year 4

12(1)(a) 20(1)(m) 12(1)(e)Year 1 $1000 $1000Year 2 $1000 $1000 from year 1Year 3 $1000 $1000 from year 2Year 4 $1000

Dominion Stores Limited v. MNR, [1966] Ex. Ct. p. 839

Facts:- TP, a grocery chain, distributed trading stamps equal to 1.5% of customer’s total grocery purchases- Trading stamps were redeemable for free gifts- TP did not keep separate records for trading stamps and merchandise, i.e. didn’t allocate each sales

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dollar received between an account for the redemption of trading stamps and the purchase price of the merchandise.

- TP deducted a reserve in respect of stamps outstanding at the end of the tax year. MNR disallowed the deduction.

Issue: Is TP entitled to deduct a reserve in respect of trading stamps distributed but not redeemed?

Held: Yes

Ratio:- MNR argued that no amount was received in respect of goods/services which were to be delivered in

the following year because TP didn’t actually receive separate amount in respect of trading stamps. The trading stamps were not paid for by the customer; they were given out for free. Evidence: no increase in the price of merchandise (relative to other stores) to cover trading stamps AND no segregation or allocation of the revenue received to the merchandise sold and the trading stamps distributed. All monies received were in respect of goods delivered in that year (i.e. the groceries).

- Court rejects this argument: Where two articles are sold together for one price w/o a price being put upon each separately, doesn’t follow that own article is free and that the price is attributable exclusively to the other article. Portion of amount received was received on account of goods to be delivered when stamps redeemed. Such amounts, wrt trading stamps which remained outstanding at the end of each taxation year, were on account of goods not delivered before the end of the year.

- TP can thus deduct a reasonable amount as a reserve.

Allard: - Critical finding: portion of total bill was for stamps. Reserve only available when 12(1)(a)(i)

inclusion, i.e. monies received though not earned- Interesting that ct came to decision even though TP couldn’t show that it charged higher prices for

groceries in stores w/ trading stamp program.

Notes:- Exclusion for warranties: sub 20(7) prohibits the deduction under para 20(1)(m) of a reserve in

respect of ‘guarantees, indemnities or warranties.’ Allard: why such an exclusion? Contingency. Expense incurred under warranty is contingent on something breaking down. Compare Dominion: only contingency was customer returning to redeem stamps

o Mr. Muffler: court adopted broad def’n of the words guarantees, indemnities or warranties, disallowing the deduction of a reserve for the cost of replacing defective mufflers guaranteed for as long as the purchaser continued to own the car.

- What is a ‘reasonable amount as a reserve’? IT-Bulletin: gross proceeds received in respect of those goods and services which past experience or other factors indicate will have to be delivered or provided after the end of the year. Brian Arnold: seems odd that 20(1)(m) would allow recognition of the cost of earning income and the profit to be deferred until the year when income actually earned. Would make more sense if estimated future cost of earning income were matched against amount received.

- Burrard Yarrows: TP was shipbuilder that entered into K with gov’t to build icebreakers. Sought to deduct reserve under 20(1)(m)(i) in respect of progress payments. Held: deduction disallowed. The payments were earned amount and thus 12(1)(a)(i) doesn’t operate to bring them into income. Why earned? Title to all materials, parts and finished work paid for by each progress payment vested at that point in purchaser. TP, upon completing a stage of work, became absolutely entitled to receive the payment. Right to these amounts not restricted by the K or otherwise. K did not even contain a provision requiring refunding of progress payments in event of TP defaulting.

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B. Deferred Payments

What happens when sell property under agreement which provides that some payments not due until future accounting period?

9 Under ordinary commercial principles, profit includes amounts receivable. Thus, taxable on full profit in year of sale (though proceeds paid in subsequent years).

12(1)(b) Must include in income amounts receivable in respect of property sold or services rendered in the course of a business in the year notwithstanding that amount or any part thereof is not due until a subsequent year [note exception to this]

20(1)(n) Notwithstanding 18(1)(a) and (e), TP may deduct reserve for unpaid amounts. Where amt included in TP’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 TP 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 two years after that time, TP can deduct a reasonable amt 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.

12(1)(e) Must include in income any amount deducted under para 20(1)(n)20(8)(b) Para (1)(n) doesn’t 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.

To qualify for 20(1)(n) reserve5) amount must have been included in computing the TP’s income from the business for the year or a

preceding taxation year6) amount included must be in respect of property sold in the course of the business (**note that

property must be inventory or property sold in adventure in nature of trade , not capital property . There is separate reserve in respect of capital property).

7) Property other than real property – all or part of the amt payable must, at time of sale, not be due until at least two years after the time of sale.

8) No reserve can be deducted if sale occurred more than 36 months before the end of the year (i.e. may claim reserve under 20(1)(n) for max of 4 years)

How much can deduct? 1) reasonable amount of the profit (i.e. unlike 20(1)(m) which deals with ‘revenue’ recognition)2) reasonable reserve in given year = Portion of proceeds not yet received * Profit on sale- Portion of proceeds not yet received = amt still due after year/gross selling price3) Recapture not profit for purposes of 20(1)(n) ( Odyssey )

Example #1: Real property (or personal property) purchased for $60 and sold for $100. Proceeds payable in installments of $20/year.

Profit = $100 - $60 = $40Would be cash flow problem if had to pay tax on full profit in year 1

Year 1 2 3 4 5Proceeds 20 20 20 20 209 OR 12(1)(b) 40

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Reserve 4/5*40 = 32 6/10*40 = 24 4/10*40 = 16 0 012(1)(e)(ii) - 32 24 16 8Income (?) 8 8 8 40-24 = 16

Example #2Personal property sold in year 1 for $100, proceeds payable in two annual installments of $50- 2 year ‘entry condition’ (applies only to personal property) not met therefore cannot deduct any

reserve under 20(1)(n). [Must have payments due at least 2 years later]- **Note that once two year ‘entry condition’ is met, reserve is calculated as above (entry condition

doesn’t affect amount of reserve).

Odyssey Industries Inc. v. The Queen, [1996] TCC p. 847

Facts:- TP disposed of assets. Disposition generated capital gain as well as recaptured depreciation. - TP reported the gain and recaptured depreciation and claimed a reserve for both (under para 20(1)(n))

on the grounds that a portion of the sale proceeds was not due until a day that was more than two years after the date of sale.

- MNR allowed the reserve in respect of the capital gain but denied it with respect to the recaptured depreciation.

Issue: Can TP deduct a reserve wrt recaptured depreciation taken into income under sub 13(1)? I.e. is recaptured depreciation part of ‘profit’ for purposes of 20(1)(n) reserve?

Held: No

Ratio:- TP argued: UCC is appropriate base from which to measure profit on the sale of depreciable

property. Recaptured depreciation is component of profit and thus reserve can be deducted in respect of it.

- MNR argued: (1) Property not sold ‘in the course of business’ b/c capital property. Capital property not contemplated by ‘property’ in 20(1)(n); (2) Recaptured depreciation is not profit from the sale

- Court: the word ‘excess’ in sub 13(1) and the word ‘profit’ in 20(1)(n) are not synonymous. Recapture is not profit; it is merely a counterbalance to what are considered to have been excessive deductions of CCA on the asset in Q that were made in computing the TP’s income for previous years. [Recapture included in income as biz income pursuant to sub 13(1) but is not profit on sale of goods][Do not need to address the ‘in the course of business argument b/c looking at the precise words of the Act is conclusive?]

Rule: Recapture is not profit for purposes of 20(1)(n) reserve. Cannot deduct a reserve wrt recaptured depreciation taken into income under sub 13(1).

Allard: - We will see that there is reserve available for capital gain portion, but not recapture.

C. Doubtful Debts and Bad Debts

9 Under ordinary commercial principles, profit includes amounts receivable. 20(1)(1)(i) Can deduct reserve for doubtful or impaired debts. Reserve = reasonable amount in

respect of doubtful debts that have been included in computing the taxpayer’s income for

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the year or a preceding taxation year. [exception to general rule in 18(1)(a), i.e. that may not claim deduction for losses that are contingent in nature]

12(1)(d) Must include in income any amount deducted under para 20(1)(1) as a reserve in computing the TP’s income for the immediately preceding taxation year.

20(1)(p) TP can deduct bad debts, i.e. all debts owing to the TP that are established by the TP to have become bad debts in the year and that have been included in computing the TP’s income for the year or a preceding year.

12(1)(i) Must include in income any bad debts recovered, i.e. any amount received in the year on account of a debt or a loan or lending asset in respect of which a deduction for bad debts had been made in computing the TP’s income for a preceding taxation year.

Copley Noyes & Randall Ltd. v. The Queen, [1991] FCTD p. 853

Facts:- TP mfd high quality men’s clothing and sold most of it to small independently run clothing stores- For 1982 tax returns, reviewed Nov 1982 A/R in Feb 1983. Made estimate as to whether repayment

of debt was doubtful and if so, the amt which should be recorded as reserve for fiscal yr ending Nov. 1982.

- TP would continue to ship goods to customers in arrears (part of biz philosophy – extend credit to fledgling stores)

- MNR investigated (b/c noticed that reserve for doubtful debts usually much larger than bad debt write-offs in following year) and reassessed.

Issue: Is ptf’s reserve for doubtful debts reasonable?

Held: Yes

Ratio:- In determining reserve for doubtful debts, GAAP applicable unless Act explicitly or implicitly

requires otherwise. In this case, no provisions which require departure from GAAP. Thus, use same method as would use to calculate reserve for financial statement purposes

- Senior mgmt in best position to determine which accts might be of doubtful collection. - Factors to be taken into account :

o Delay in payment alone is not sufficient to justify reserveo Age of overdue accounto History of the accounto Financial position of the cliento Any increase or decrease in the client’s total saleso TP’s past bad debt experienceo General business conditions in country and in particular locality of business

- Use these factors to determine if there is some reasonable doubt about the collectibility of the debt – this degree of doubt should then be expressed as a proportion of the total debt taken as a reserve

- MNR tried to argue that the fact that TP continued to ship goods to outstanding accts after year end indicates that TP expected the amounts outstanding on those accounts to be paid. Court rejected this argument: of course TP hoped they would be paid; in fact, probably continued supplying in order to keep possibility of repayment of accounts alive. This does not mean however, that accounts should not have been classified as doubtful.

- In preparing income tax return, all current information should be considered (i.e. amts that have been paid since end of fiscal year and amts that have become overdue since then). This assessment of

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accounts subsequent to year end does not result in change in amounts owing (i.e. don’t recalculate amounts owing by adding amts that have become overdue since year end and subtracting amounts paid since year end); after-acquired information merely used to assess the degree of risk attached to the collection of the account.

Rule (Doubtful debts): 1. Can take reasonable reserve for doubtful debts (20)(1)(1)(i)2. What is reasonable? Proportion of debt which corresponds to risk of uncollectibility (i.e. how

doubtful you are).3. Risk of uncollectibility (i.e. doubtfulness of debt) measured subjectively by TP using factors

above (debt-by-debt analysis). All current information can be taken into account in assessing the risk attached to collection (e.g. accounts which have become overdue since year-end and overdue amts which have been paid since year-end)

4. Fact that TP continues to ship goods to customer in arrears doesn’t prevent TP from classifying their accts as doubtful.

Anjalie Enterprises Ltd. v. Canada, [1995] TCC p. 865

Facts:- TP sold land; purchaser granted TP second mortgage (first mortgage to another corp)- 1981 – purchaser didn’t make payment. TP’s lawyer asked for entire outstanding principal plus

interest. Purchaser didn’t pay. TP foreclosed in 1982.- Purchaser filed for b-ruptcy and asset values were insufficient to fully repay first priority claim, let

alone TP’s. - In 1982 tax return, TP claimed deduction for bad debt- 1982 – TP’s accountant advised Revenue Canada that TP erred in claiming loss from debt in 1982.

Loss should have been claimed in 1983 taxation year b/c TP continued to seek recovery of amount outstanding until 1984 at least. [note Act changed in 1983 such that advantageous for TP to make this claim]

Issue: Could bad debt be deducted in 1983? [When is debt considered ‘bad’?]

Held: No

Ratio:- Q of when debt becomes bad – Q of fact- A debt is recognized to be bad when it has been proved uncollectible in the year- When is debt considered uncollectible ? Matter of TP’s own judgment as prudent businessman

o Debt should be written off as soon as but not before all normal collection procedures have been carried out without success. TP’s knowledge of debtor’s financial situation might, however, dictate deduction in earlier or later year

o Debt need not be absolutely irrecoverable [i.e. debtor need not be b-rupt]; possible recovery in future is not a bar to determination of uncollectibility.

o [Allard: don’t have to exhaust every single legal recourse; if in reasonable judgment you don’t expect to get paid, don’t have to keep suing the debtor]

- TP must be able to show that debt was bad but also that debt didn’t become bad in an earlier year (cannot defer recognition of bad debts to convenient time; can’t wait forever to deduct.)

- Determination of bad debt cannot be revised in light of facts which only became apparent at later date

Rule:

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Chapter Six: Taxable Capital Gains and Allowable Capital Losses

Introduction

- In computing net income for taxation year, must include ‘net taxable gain’ [para 3(b)]. That is:o ADD taxable capital gains (other than gains from disposition of listed personal property and

taxable net gain for the year from dispositions of listed personal property [3(b)(i)].o DEDUCT allowable capital losses (other than losses from disposition of listed personal

property and allowable business investment losses) [3(b)(ii)].- Cap losses only deductible against capital gains under 3(b). Losses from disposition of listed

personal property are deductible only against listed personal property gains [s. 41]. Business investment losses may be deducted against all sources [corporate-tax issue]

**Rules for computation ss. 38-55

38(a) Taxable capital gain for taxation year from disposition of any property is ½ of TP’s capital gain for the year from the disposition of the property.

38(b) Allowable capital loss for a taxation year from the disposition of any property is ½ of the TP’s capital loss for the year from the disposition of that property.

What is capital gain? S. 39?

39(1)(a) TP’s capital gain for tax year from disposition of any property is TP’s gain for the year (to the extent that gain not already included in computing the TP’s income for the year or any other taxation year) from the disposition of any property of TP other than(i) eligible capital property

- Recall that capital gain element of ECP is taxed as recapture under s. 14 ECE depreciation system - Gain only arises upon disposition- Capital gains is a residual category – i.e. if have disposition of property that doesn’t produce business

income (determined using characterization rules), the gain/loss is capital gain/loss

39(1)(b) TP’s capital loss for the year from the disposition of any property is the TP’s loss for the year (to the extent that not already deductible in computing TP’s income) from the disposition of any property other than(i) depreciable property

- Recall that depreciable property doesn’t give rise to capital loss; any loss would be terminal loss under 20(16)

40(1)(a) Capital gain/loss = proceeds of disposition minus adjusted cost base minus any outlays incurred in order to make disposition.

Characterization

FIRST Q: Does disposition give rise to capital gain/loss or business income?

- Disposition of capital property vs adventure in the nature of trade (gives rise to business income).

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- Disposition of capital property (acquired and used over long-term to earn income) vs inventory (purchased or produced for sale at profit).

Relevant Factors

1. TP’s intention (Regal Heights)a. Primary vs. Secondaryb. Change in intention (i.e. capital prop inventory or vice-versa)

i. May be deemed disposition at point when intention changes (Hughes)c. Most relevant when dealing with real estate

2. Nature of TP’s conduct – did TP deal with it in same way that trader would have? (Taylor, Irrigation)

3. Number and frequency of transactions [goes to Q of whether carrying on biz as dealer would]a. Most relevant when dealing with shares/commodities [intention less impt] (Irrigation)b. Isolated transaction can produce biz income; fact of isolated transaction not enough to say

capital gain (Taylor, California Copper)

4. Nature and qty of property disposed of (Taylor)a. Shares/commodities – inherently ‘investment’ in nature (Irrigation Industries)b. Vacant land vs. land w/ income earning property on it (Rheinhold). Not absolute (see

Montfort – gain on sale of vacant land capital gain)

5. Length of time for which property held – be careful: not determinative! (Irrigation, Rivermede)a. Rivermede: sale of property held for 17 years produced business incomeb. Irrigation: sale of shares held for ~ 4 months produced capital gain.

6. Circumstances surrounding sale – if original intention was to buy for use or income, fact that property sold at profit shortly after acquired may not make income biz income. Can rebut inference based on other factors.

a. Unsolicited offer? (cap gain)b. Voluntary vs. involuntary sale (e.g. expropriation) (cap gain)c. Action taken to make property more saleable or attract buyers (adv)d. Compelled to sell b/c of financial difficulties – can go both ways

i. Hughes: financial difficulties totally unexpected (cap gain) [SH: but in Hughes court found that intention changed!] SH: yes, but other cases in TB suggest that if original intention was to acquire property to earn income, but unexpected financial difficulties force sale before intention realized – cap gain

ii. Initial purchase entirely financed = no REOP b/c interest payments so high (adv)

7. Time/effort devoted by TP – capital gain has passive connotation (Vancouver Art Metal)

8. Background of TP a. Resemblance to regular biz activities (Taylor, Atlantic Sugar Refineries, Woods) (adv)

i. Atlantic Sugar Refineries: Sugar refiner purchased sugar futures and tried to argue that purchase/sale of futures was separate activity that gave rise to cap gain. Held: fact that raw sugar was going to be used in TP’s biz suggests that profits on futures Ks are business income

b. TP’s special knowledge (Kane) (adv)c. Fact that bought and sold on other occasions (adv)

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d. TP derives income from other similar [real-estate] property (cap gain)

9. Manner in which acquisition financed and ability of property to produce profit given financing a. Jack Dichter: acquisition with money borrowed on short term basis; revenues would not =

expenditures for a long time; purchase as financed not attractive investment advb. Belanger-Coady: TP said purchased vacant land to build restaurant and obtain a triple-A

tenant. B/c purchased w/ minimal down-payment and no concrete financing plans advc. If way in which financed = no REOP, how can you say you acquired for income??

**Allard: most of these factors go to intention! (support claimed intention, rebut claimed intention, etc.). Objective factors that can be used to determine what TP’s intention is. **Note however that with shares – intention much less important. Nature of property itself important.

Relevant factors given types of property1. Real Estate (Regal Heights)

a. Primary and secondary intention upon acquisition (see below)b. Nature of property (vacant land vs. active-profit producing property)

2. Shares and commodities (Irrigation Industries)a. Nature and qty of property

i. Shares/commodities inherently ‘investment in nature.’ii. Number of shares bought/sold

b. Dealt with shares as dealer would have? (i.e. underwriter, broker?)i. Number and frequency of transactions

c. Experience/knowledge/skill of TP (a broker?). Trading outside scope of biz activities?i. Woods: fact that he was an insider (i.e. director of companies whose shares he

traded) was indicative of advii. Kane: does the author of the transactions possess a particular or special knowledge

of the market in which he trades? (in this case, TP was a SH, director and president of company whose shares he traded)

d. Shares purchased from IPO or from third party on the stock market? i. Purchase from IPO doesn’t guarantee finding of capital gain (California Copper

Syndicate)e. Degree of time/effort put into activities (lots of time spent studying securities mkts?)f. Intention not very significant (note that ‘motive’ considered very impt by court in Woods).

Fact that purchased with borrowed funds and that shares not expected to yield dividend – insignificant.

g. IT Bulletin: period of ownership relevant; court didn’t address it in II but held cap gain even though held shares only for four months.

h. Where shares disposed of as alternative to disposing of corp’s assets, gain on sale will characterized as though property itself were sold (McKinley, Dumas)

3. Debt Obligations

4. Foreign Exchange (Tip Top Tailors)- Foreign exchange gain/loss takes on character of transaction that is attached to. Look at why the TP

is buying/selling currency – to meet what types of obligations? - SH: I don’t understand facts of this case. How to relate this to disposition? 5. Non-compete agreements

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**Intention upon acquiring property; changing intention

Primary and Secondary Intention- What was primary intention in acquiring property? (look at subj intention demo-d by obj factors)

o To hold property for use or to earn income capital gaino To sell property at profit adv in nature of trade

- Even if intention to hold property for use or to earn income was possibility of selling land for profit (should primary purpose be frustrated) an operating motivation for acquisition (Racine)?

o Look to: Why was primary purpose frustrated? Reason outside of TP’s control capital gain Poor planning; primary plan not feasible or well-organized; property purchased w/o

assurance that primary purpose could be carried out (as in Regal Heights) adv in nature of trade

Language in Regal Heights: ‘speculative venture’

What happens when intention (purpose for which property used) changes?

Investment Property Inventory (e.g. Kodak, Hughes)o original intention to hold property as investment changes to intention to sell as inventory (not

secondary intention but changed intention ) o Act does tell us how to deal with such a change – no deemed disposition under Act!o How have courts dealt with changed intention? Kodako This is change of intention case but court doesn’t analyze it that wayo Entire profit from sale of recordacks was treated as business income b/c the recordacks were

sold in course of ordinary biz of selling photo equipment and supplieso Interesting problem: recordacks likely depreciable property, i.e. Kodak probably took CCA

on them when they were rental property. Ct doesn’t tell us what happens with recapture! (Was recapture included in the income?)

Hugheso TP bought apt building with primary intention of renting it out. Got into financial mess and

couldn’t cover costs of financing. Converted building into condos and sold themo Held: changed intention, not secondary intention. Only intention upon purchase was to rent

out building but intention changed b/c of unexpected circumstances. Point at which intention changed property became inventory in her hands. When property sold, portion of profit is cap gain and portion is biz income

Notional cap gain/loss = Fair mkt value of property on day which she changed her mind (x) minus adjusted cost base

Biz income = Proceeds of disposition – x (x now = initial inventory value) Notional cap/gains losses give rise to capital gains or allowable capital losses for

taxation year in which actual sale occurs. **Note that position in Hughes is also administrative position: notional disposition of property occurs on the day on which investment property (real-estate specifically) is converted to inventory.

Inventory Investment Property o e.g. – acquire property for purpose of constructing building and selling it, but subsequently

decide to keep building as investment property

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o Courts: where property is originally acquired for purpose of resale, strong presumption that land retains this character in absence of clear and unequivocal acts implementing change of intention

o Administrative position: [echo strong presumption] but conversion to investment property may occur if

TP capitalizes the cost of the building in financial records TP makes use of building as capital asset for period of time in manner that is more

indicative of investing than trading (e.g. long-term lease, housing own business, rental). Temporary short-term rental before sale not enough.

SH: Does the fact that TP has been deducting CCA suggest that is a capital asset that gives rise to capital gain? Allard suggests YES.

**Note that no provisions in Act which deem disposition to have occurred when property converted from capital property to inventory. There is provision on the other hand which provides for deemed disposition and acquisition when property converted from personal use property (i.e. not for purpose of earning income) to business use property (i.e. for purpose of earning income), or vice-versa.

Regal Heights Ltd. v. MNR, [1960] SCC p. 887

Facts:- TPs purchased land for purpose of building shopping centre- Negotiations with lead tenant unsuccessful; apparent that couldn’t build shopping centre- Disposed of land for profit

Issue: Did disposition of land produce biz income or capital gain? I.e. was the profit derived from an adventure in the nature of trade?

Held: Biz income

Ratio:- While TP’s primary intention was to build shopping centre, intended to sell at profit if unable to carry

out primary aim- [Was secondary intention strong enough to make this adv in nature of trade? Effectively asking

whether the intention was an operating motivation. YES. Why?]o TPs hadn’t secured massive financing necessary to build shopping centre [no guarantees from

lenders]o TPs hadn’t secured lead tenant – no assurance when purchased property that would be able to

get a lead tenanto All planning and sketches were merely promotional

- Venture was thus entirely speculative; a speculation in vacant land. TP was hopeful of putting land to one use but that hope was not realized and they sold at substantial profit.

[Dissent]:- Sale of the land was a realization of TP’s capital assets when the purpose for which they acquired the

land was defeated by a factor outside of the TP’s control

Racine: refined concept of secondary intention i.e. must be operating motivation for acquisition

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- Not enough that TP who buys property with aim of using it as capital would be induced to sell if someone offered sufficiently high price. Purchaser must have in his mind at the time of purchase the possibility of reselling as an operating motivation for the acquisition

Allard: have to be able to say that “I hope I will be able to carry out my primary intention…but in any event I will buy the property b/c will be able to sell at profit if primary intention doesn’t pan out.” Assess strength of secondary intention (as court did in Regal Heights)

Canadian Kodak Sales Ltd. v. MNR, [1954] Ex. Ct. p. 902

Facts:- TP carried on biz of selling cameras and related business- In 1940 TP acquired business which leased and serviced ‘recordaks.’ Acquired co. had treated them

as capital assets wrt which it claimed CCA- TP continued leasing until 1951 at which point changed business policy and decided to offer

machines for sale to existing users. - MNR included profit from sale of recordacks in TP’s income. TP objected on basis that machines

were capital assets and gain on sale was capital gain.

Issue: Was the profit made on previously-leased recordacks taxable income?

Held: Yes

Ratio:- Fact that aplt’s recordacks were formerly leased and treated as capital assets…does not prevent the

profit from their sale being profit from the aplt’s biz once it made the business decision to sell them and sold them in the course of its ordinary business of selling photo equipment and supplies. It was in exactly the same position in which it would have been in if it had acquired the recordacks for sale.

- TP tried to argue that recordack division was effectively a separate business. Court rejected this arg – division wasn’t a separate biz; manner in which TP kept its accounts proves this beyond dispute.

**Vacant land vs. active profit-producing property

Vacant land vs. active profit producing property- Rheinhold : vacant land is category of property which itself stamps the transaction as a ‘trading

venture’ [vs. active profit producing property which is inherently investment in nature]- Gains on sale of vacant lands have been characterized as capital gains however!

o Montfort : gain on sale of vacant land originally acquired by principal SHs to build a summer cottage and held for benefit of children was characterized as a capital gain on grounds that property was acquired for personal use and not resale and sold in response to an unsolicited offer

- Fact that land is vacant not absolute but points to business income

**Shares and Commodities

Corporate shares can be (1) acquired and held for the purpose of receiving a regular flow of income (i.e. dividends); (2) acquired for resale at a profit; or (3) both of the above.

Irrigation Industries Ltd. v. MNR, [1962] SCC p. 909

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Facts:- TP, a corporation, bought 4000 shares of Brunswick Mining in Feb 1953 and sold for considerable

profit in March and June 1953 (i.e. sold all w/in 4 months!)- TP had no dealings in securities other than the purchase and sale of these shares

Issue: Was purchase and sale of shares an ‘adventure in the nature of trade’ such that profit on sale would be taxable income (and not capital gain)?

Held: No [with dissent]

Ratio:- Majority (somewhat randomly) says that two facts must be emphasized

o Shares were purchased directly from Brunswick (i.e. part of initial issue)o TP’s buying and selling of shares outside the scope of its business activities (as established

by Memorandum of Association). - Trial judge found adventure in nature of trade: purchase of shares was purely speculative and made

with intention of disposing of stock at profit as soon as reasonably possible. Based finding on three factors: (i) purchased shares with borrowed funds; (ii) dividends could not be expected to yield dividends for a long time (iii) shares held for short time

- Majority dismissed (i) and (ii) as being of no significance. - Intention issue: the question as to whether or not an isolated transaction in securities is to constitute

an adventure in the nature of trade cannot be determined solely on basis of subjective intention. - Must consider positive tests set out in Taylor:1) Nature and qty of subject matter- Corporate shares are different; they constitute something the purchase of which is, in itself, an

investment. They are not articles of commerce. Their acquisition is a well recognized method of investing capital in a business enterprise

- Qty of shares small (4000 out of 50,000 issue)2) Whether property dealt with in manner that ordinary trader would deal with it- This is not the sort of trading which would be carried on ordinarily by those engaged in the business

of trading in securities; not an underwriting nor a participation in an underwriting syndicate. [Dissent]:- TP, which was not at any time engaged in biz of trading in securities made isolated speculative

purchase of block of shares, not w/ intention of retaining them as an investment which would sooner or later yield an income by way of dividends but with the intention of disposing of the shares in the near future at an increased price. This intention was realized w/in 4 months.

- Note that dissent arrives at this conclusion with some hesitation – b/c based on subjective intent. (but that is the test enunciated in Regal Heights)

Notes: - Reasoning in II has been carried over to commodities, e.g. gold, even though mere ownership of a

commodity definitely doesn’t produce income; wouldn’t buy except to resell at profit. - While court rejected intention test in this case, held in subsequent case (Foreign Power Securities)

that the question of whether or not an isolated securities transaction is an adventure in the nature of trade ‘is essentially one of fact depending on the intention with which the respondent acquired the shares.’

- McKinley; Dumas: When disposition of shares in a corporation is merely an alternative method of realizing income from the sale of a property held by the corporation (e.g. real estate), the gains from the sale of those shares will be included in income as if property itself had been sold. [So if sale of property would have been adventure in nature of trade – sale of shares will be also]

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o Allard: court imputed company’s intention to SH; a form of piercing the corporate veil? Bordering on anti-avoidance case.

54.2 Where any person has disposed of property that consisted of all or substantially all of the assets used in an active business carried on by that person to a corporation for consideration that included shares of that corporation, the shares shall be deemed to be capital property of that person

- result: incorporate active business = subsequent sale of shares produces capital gains- note that “business” doesn’t include adventure in nature of trade; so if transfer assets which are the

subject of an adventure in nature of trade into corporation, sale of shares won’t = capital gain

**Debt Obligations

Wood v. MNR, [1969] SCC p. 920

Facts:- TP was solicitor in law firm which managed mortgages- TP purchased 11 mortgages at discount on face value and sold them for face value (=profit)

Issue: Was profit a capital gain or profit from an adventure in the nature of trade?

Held: Capital gain

Ratio:- investments made entirely from savings, not borrowings- income from the mortgages a relatively modest part of his gross income b/c engaged in very few

transactions in the year- Purchases not entirely speculative and were made after he had inspected each property and reached

decision that mortgage was safe investment [SH: this appears to go to adv!]- [SH: Fact that had special experience and knowledge of mortgages and that buying and selling

mortgages was similar to his regular biz activities – not held to be important/determinative.]

Notes:- Might find adventure in nature of trade if debt acquired with borrowed money, interest payments on

which exceed interest earned from debt instrument- Is TP in business of money lending? [suggests adv]- SH: impt to distinguish capital element of debt (principal) from interest (taxable under 12(1)(c))- Allard: discussed Loewen (pg. 927 TB) and Sissons (pg. 923 TB). I don’t think we need to know

them.- Allard: Court in Wood doesn’t suggest that anything special about debt obligations (i.e. such that

they should be treated differently than other assets). BUT…court (or other courts) may be leaning towards Irrigation-type reasoning, i.e. debt obs inherently ‘investment in nature.’ Non-interest bearing treasury bills, for e.g., might be held to produce capital gain upon disposition.

**Canadian Securities

Vancouver Art Metal Works Ltd. v. The Queen, [1993] FCA p. 930

Issue: the meaning of ‘a trader or dealer in securities’ in sub 39(5) which gives holders of Cdn securities the option to elect to treat all gains and losses resulting from dispositions of Cdn securities in that year as

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capital in nature. Traders and dealers in securities are excluded from election.

Held: def’n of ‘trader or dealer in securities’ not limited to those registered or licensed to buy and sell securities. Factors to consider: frequency of the transactions, duration of holdings, intention to acquire for resale at profit, nature and qty of securities held/transacted, time spent on activity (cap gain has passive connotation). Notes:Woods and Kane: deal with whether TP could be considered a ‘trader or dealer in securities’- Woods: key factor is question of ‘motive’ – why did TP acquire the property in the first place?

(here, obvious that he acquired securities to make a profit). Fact that Woods was an insider also important – he was the director of several companies whose share he bought and sold.

- Kane: see above

**Foreign Exchange

**Non-compete agreements

Manrell v. The Queen, [2003] FCA

Facts:- TP sold the shares of his bottling company- Received payment for agreement not to compete

Issue: Does payment constitute proceeds of disposition of property? [Does right to compete constitute ‘property’ and if yes, was it disposed of?]

Held: No [Right to compete not property]

Ratio:- MNR tried to argue that right to compete was property and thus that payment received for giving up

such right constituted proceeds of disposition of property giving rise to capital gain. - Concept of property in the Act requires an exclusive and legally enforceable claim and therefore does

not extend to a right to compete. A right that everybody has (e.g. a right to open up a bottling company) cannot be property. A right is a property right only if it is exclusive, and enforceable against someone else (i.e. someone has a correlative obligation).

Rule: Right that everybody has cannot be a property right. Concept of property in the Act requires an exclusive and legally enforceable claim. [Similar reasoning in Kellogg case]

Allard:- Note that, while reasoning re. nature of property under Act is still valid, the outcome in the case is

not. Act was amended such that payments in exchange for agreement not to compete are taxable (as capital gains?).

Computation

General Rules

Cap gain/loss = Proceeds of disposition minus (ACB + expenses incurred to effect disp) [40(1)(a)]

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Taxable capital gain = ½ capital gain [38(a)]

Net capital gain for year (cannot be < 0) must be added to income for tax purposes [3(b)]Effect of this = capital losses only deductible against capital gains

Losses from other sources deductible against all income, including any capital gains [Business losses can offset capital gains, but capital losses cannot offset business gains]

What is disposition?

248(1) “Disposition” of any property includes (a) any transaction or event entitling a taxpayer to proceeds of disposition of the property and (b) other transactions involving the redemption, cancellation, settlement, conversion or expiry of shares, debt obligations, options and other kinds of intangible property.

But does not include

(l) issue of bond, debenture, note, etc., and (m) issue by corporation of capital stock

54 “Proceeds of disposition” of property includes (a) sale price of property sold, (b)-(f) compensation for property destroyed, unlawfully taken, taken under statutory authority, injuriously affected, damaged (includes insurance proceeds), (g) amt by which mortgage reduced as result of sale

BCN Immobilieres : “disposition of property” should be given broadest possible meaning, including destruction of tangible property and extinction of item of intangible property (e.g. patent).

Can have disposition where no proceeds (see s. 69 – gift, destroyed property + no insurance) Can have disposition where no change in ownership (property dmgd or destroyed for e.g.) Can have voluntary and involuntary disposition (e.g. compensation for property lost/stolen)

Changes to debt instruments of shares may = disposition Where the fundamental terms of a share or debt instrument are materially altered, that share/debt has

been disposed of and new debt/share (with new characteristics) acquired in its place. Novation (i.e. debt, under private commercial/corporate law, ceases to exist and is replaced by new debt) is not necessary. [ GE Capital Finance ]

Fundamental terms of debt instrument = ID of debtor, term, principal, rate of interest. In GE Capital, 3 of 4 were materially altered [ID of debtor remained the same]

Fundamental changes to shares (IT-Bulletin, no cases): change in voting rights, change in defined entitlement (e.g. what get to share in upon dissolution), giving up or addition of priority right to share in assets upon dissolution, addition or deletion of dividend right, change from cumulative to non-cumulative right to dividends or vice versa

Barter/exchange transaction Exchange one type of property/service for another = one or both parties might make capital gain on

disposition. Proceeds of disposition = value of what received. What if difficult to value? D’Auteuil : if easier to value one side of transaction, and assuming that parties are dealing at arm’s length, then value of that one side will be value of transaction (i.e. PofD or biz income) for both sides.

When does disposition occur? There is disposal of property as soon as a TP is entitled to the sale price of the property sold

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Property may be disposed of even though TP retains legal title (e.g. in a financing lease). Question is whether incidents of ownership have been transferred (i.e. risk, use and possession) [Wardean Drilling ]

What are ‘proceeds of disposition’?

P of D = entire consideration (not just cash)

Robert et al v. MNR, [1990] TCC p. 959

Facts:- TP bought condo units by writing promissory note to seller- TP later sold units back to seller for $1 + assumption of mortgage liability by transferee +

cancellation of promissory note (i.e. no more amts owed thereunder) + agreement on part of transferee to drop certain claims it had made against the TP (for operating deficits)

Issue: Which of these amts is part of the proceeds of disposition?

Held: all but agreement to drop claim [Proceeds of disposition = $1 plus reduction of mortgage liability plus debt forgiveness]

Ratio:- TP tried to argue that the remission of debt doesn’t come under def’n of ‘proceeds of disposition’- Court rejected: (1) def’n of ‘proceeds of disposition’ is not exhaustive; and (2) the remission of the

debt, which is one of the conditions for the transfer of ownership must be calculated in the sale price. - In order to determine sale price, must look for the true consideration for the transfer of ownership .

To find what this consideration was, must examine the sequence of events which led to transfer of ownership.

- Agreement to release claims held not to form part of consideration b/c there was proof that transferor owed the amt in the first place.

RULE: Def’n of ‘proceeds of disposition’ not exhaustive. Look for the true consideration for the transfer of ownership by examining the sequence of events which led to this transfer.

Fradet v. The Queen, [1986] FCA p. 961

Facts:- TP owned 100% of stock in company and sold it for $7.8 million, pursuant to agreement whereby TP

was required to purchase $1.4 million account receivable (worth only $600,000)

Issue:What are proceeds of disposition of stock?

Held:- Proceeds of disposition = $7.8 million – $1.4 million + $600,000 (value of A/R)- [Concurring]: $800,000 is an expense of the disposition (rather than direct reduction of P of D)

Inadequate consideration (gifts and sale at < or >FMV)

69(1): Inadequate Consideration

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(a) Acquire at > FMV – Where TP acquires anything from person with whom not dealing at arm’s length for amt > FMV at time of acquisition, TP will be deemed to have acquired at FMV

*Transferee acquires at FMV (=ACB)*Transferor disposes at stipulated price (i.e. > FMV)*Result = difference btwn FMV and price is taxed twice (once when transferor disposes of it and once when transferee disposes of it)

(b) Where TP disposes of anything(i) to non-arm’s length person for no proceeds or proceeds < FMV(ii) to any person by way of inter vivos gift

TP deemed to receive P of D equal to FMV

*Transferor disposes at FMV *Transferee acquires at stipulated price (< FMV)*Result = difference btwn FMV and price is taxed twice

(c) TP acquires by way of gift or inheritance – TP deemed to acquire at FMV

SumTransfer to non-arm’s length person at < FMV [69(b)]**Deemed to receive P of D = FMV**Recipient’s ACB = price paid

Transfer to non arm’s length person at > FMV [69(a)]**Deemed to acquire for FMV (= ACB)**Transferor’s P of D = price paid

Inter vivos gift to anyone [69(b) and (c)]**Recipient deemed to acquire at FMV (c)**Donor deemed to receive P of D = FMV (b)

Warranties

42 In computing P of D, must include all amounts received as consideration for warranties, covenants or other conditional or contingent obligations given or incurred by TP in respect of disposition. Any outlay or expense made or incurred by TP in any year pursuant to or by reason of any such obligation shall be deemed to be a loss of the TP for that year from a disposition of capital property

*Amt received in respect of warranty must be included in P of D. If, in subsequent year, must pay money to honor the warranty – it is a capital loss

Allocations

- Where get consideration for more than one thing (e.g. land and building, property and services), must do reasonable allocation of proceeds

68 Allocation of amounts in consideration for disposition of property – If an amount received or receivable from a person can reasonably be regarded as being in part the consideration for the disposition of a particular property of a TP…(a) the part of the amount that can reasonably be regarded as being the consideration for the disposition shall be deemed to be proceeds of disposition of the particular property

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irrespective of the form or legal effect of the K or agreement, and the person to whom the property was disposed of shall be deemed to have acquired it for an amount equal to that part

- Golden : great deal of weight will be given to allocation of parties provided that dealing at arm’s length and there are no other reasons to suspect that allocation might be unreasonable (e.g. if one of the parties had no interest in the allocation b/c was tax exempt entity)

Foreign exchange gains and losses

Gaynor: Proceeds and cost must first be converted to Cdn currency before computing the amount of the gain. [Result = gains and losses on property acquired with and disposed of for another currency include both changes in the value of the property and changes in the value of the other currency relative to the Cdn dollar].

What is ‘adjusted cost base’?

S. 54: “adjusted cost base” to a TP of any property at any time means(a) where property is depreciable property, the CC to the TP of the property [Duff: case law says this is actual, factual or historical cost to TP](b) in any other case, the cost to the TP of the property adjusted in accordance with s. 53

Stirling v. The Queen, [1985] FCTD, FCA p. 965

Facts:- TP purchased gold bullion and disposed of it several years later- He declared capital gain upon disposition, and included as part of ACB interest (i.e. paid on money

owed to vendor) and safekeeping charges.

Issue: Can charges related to financing and safekeeping of capital property be added to ACB? [i.e. effectively deducted from P of D / gain]

Held:No

Ratio:- Per s. 54, interest and safe keeping charges could be deductible only if part of cost of bullion- The word ‘cost’ means the price that TP gave up in order to get the asset; it does not include any

expense that he may have incurred in order to put himself in a position to pay that price or to keep the property afterwards.

RULE: Cost (s. 54) of capital property means costs directly related to acquisition. ACB does not include costs of ownership, i.e. costs incurred to keep the property after acquisition (financing and safekeeping charges for e.g.).

Allard:- costs directly related to acquisition might include legal fees, delivery fees, accounting fees, and

survey and engineering costs- Problem here is that transaction characterized as giving rise to capital gain. More sensible

interpretation? Purchase and sale of gold as adventure in nature of trade, i.e. proceeds of sale fully taxable business income and interest deductible per 20(1)(c). Only property that can earn income while you own it should be characterized as capital property giving rise to cap gain/loss

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What is ACB?

1. s. 54 def’n of “adjusted cost base.” Sub 53(1) – amts added to CB. Sub 53(2) – amts subtracted from CB

2. Costs of acquisition but not costs of ownership , i.e. costs incurred in order to keep property after acquired (e.g. interest or safe keeping charges) (Stirling). Costs of acquisition include legal fees, delivery fees, accounting fees and survey and engineering costs)

3. If acquired from non-arm’s length person for > FMV, ACB = FMV [s. 69(a)]

4. Add to ACB any improvements to capital property (i.e. capital expenditures as opposed to current outlays for mere repairs or maintenance charges) [SH: note effect of this personal use property – cost of improvements recognized b/c added to ACB. Cost of repairs not recognized b/c can only deduct those expenses incurred in order to gain or produce income from biz or property [18(1)(a), 9(1)]]

5. Property acquired before 1972 (or acquired from spouse who owned it since before 1972 and died or rolled it over to you). Per ITAR sub 26(3), ACB = median of:

a. Proceeds of disposition when dispose of propertyb. “V-day value” (i.e. FMV of property on Dec. 31, 1971)c. Original cost of property**Effect of this = not taxed on any pre-1972 increase (though if value decreases from date of purchase to V-day and then increases above both, will get advantage of using original cost). **Note that pre-1972 re-capture will be taxable (b/c CCA system existed pre-1972)

6. Add amount of capital gain where ACB becomes negative [40(3) + 53(1)(a)]a. Sub 40(3): Where amts to be deducted from ACB exceed cost plus amounts to be added to

ACB amount of excess shall be deemed to be a capital gain [1/2 of which is taxable per 38(a)]

b. 53(1)(a): this capital gain added back to ACB to restore it to zero

7. ACB of identical property (e.g. identical shares bought at different periods for different prices): Per s. 47, ACB = weighted average of costs. Note that weighted average only changes when shares are added, not when shares are sold!

10 for $5 = 505 for $7 = 3510 for $10 = 100

Sell 5 for $15 each = $75

ACB = 185/25Gain = 75 – 185/25

8. ACB of property received as a prize [sub 52(4)]: Where TP acquires prize in connection with lottery scheme, TP shall be deemed to have acquired at cost = FMV.

9. ACB of property received as a gift [69(c)]: deemed to have acquired at cost = FMV.

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10. ACB of dividends in kind [sub 52(2)]: Where TP receives dividend payable in kind (other than stock dividend) in respect of share owned, he shall be deemed to have acquired at cost = FMV and corporation shall be deemed to have disposed of it for P of D = FMV.

11. Property received upon death of another (spouse or otherwise): a. 70(5) : (a) Where TP dies in tax year, shall be deemed to have disposed of capital property

before death and to have received proceeds of disposition = FMV of property immediately before death. (b) person who as consequence of TP death acquires property that is deemed to have been disposed of per (a) is deemed to acquire at cost = FMV.

b. 70(6) : deemed disposition on death under 70(5) can be deferred by leaving property to spouse. Where property to which sub (5) would otherwise apply is, as result of death, transferred to spouse or common law partner, TP shall be deemed to have disposed of property for P of D = ACB and spouse or cml law partner shall be deemed to have acquired at cost = ACB (of spouse). [i.e. tax liability for accrued gain merely transferred to spouse]

12. Inter-vivos transfer of property to spouse [73(1) and 73(1.01)]: Where TP transfers property to spouse or common law partner, and unless he elects not to have this section apply, he is deemed to have disposed of it for P of D = ACB and spouse / cml partner is deemed to have acquired it cost = ACB (of spouse).

“Bad” capital debts- What if dispose of capital property for $100 and only receive $50?- Per 50(1), when debt goes bad, TP is deemed to have disposed of it for proceeds = 0 (cost = face

value of bad debt), triggering capital loss per 39(1)(c) which can be carried back to year in which tax paid on capital gain. TP is then deemed to have reacquired the same debt at cost = 0. If subsequent payment on debt – dispose of it at P of D = amt of payment

P of D = 100ACB = 20Cap Gain = 80Receive 50Taxable capital gain = 40

Year in which $50 becomes bad debt – dispose of it0 – 50 = capital loss

What are expenses?

Avis Immobilien GMBH v. The Queen, [1997] FCA p. 973

Facts:- TP was non-resident corporation- Borrowed German DM and converted them into Cdn dollars to buy real properties. Bank took

security on real properties. Loan provided for penalty for advance repayment. - TP decided to dispose before term of loan and bank wouldn’t allow it to transfer mortgage to

purchaser. Therefore had to repay loan, and repayment resulted in (1) penalty; (2) foreign exchange

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loss (b/c Cdn $ fell relative to DM so he needed more Cdn $ to repay the DM loan)

Issue:Are the penalty and foreign exchange loss “outlays and expenses…incurred by the TP for the purpose of making the disposition” per 40(1)(a)?

Held:Penalty yes, foreign exchange loss noRatio:- Penalty is direct result of the repayment in advance of the loan, and that advance repayment was

made directly “for the purpose of” the disposition of the property- Loss suffered as result of dollar-mark conversions was indeed an ‘outlay’ but was not made for the

purpose of making the disposition of the properties but rather for the purpose of making the payment of TP’s debt. If profit had been made on dollar sale, it would not have been added to aplt’s taxable capital gain; same applies to loss.

RULE: “for the purpose of making” disposition means expenses incurred directly for purpose of making disposition and not merely expenses that facilitated the disposition or were made in course of disposition. Foreign exchange/gain or loss too remote.

Allard: - This issue only arose b/c TP was non-resident – loss on foreign exchange transaction occurred outside

Cda and thus not recognized for tax purposes. If the foreign exchange loss had occurred inside Canada, would have been capital loss (b/c characterized same way as transaction that attached to) and deductible against capital losses.

Reserves for capital property

1. Where part of proceeds of disposition is not due until subsequent year(s), can deduct reserve per 40(1)(a)(iii)

2. Amount of reserve: can deduct (from CG) amt not exceeding the lesser of a. Reasonable amount as a reserve in respect of proceeds of disposition payable to TP after the

end of the yearb. 1/5 of capital gain (i.e. profit) * amt, if any, by which 4 exceeds the number of preceding

taxation years ending after the disposition of the property

(Total CG) * (amt payable after end of year) (TOTAL amount payable)

OR1/5 (CG) * (4 - # preceding tax years ending after disp)

3. In calculating CG for any taxation year, add in any reserve taken in previous years [40(1)(a)(ii)] (SH: for a particular property, could be calculating capital gains from it for up to 5 years)

Result of this formulaa) Must recognize at least 1/5 of capital gain each yearb) Limits total number of years over which can take reserve to 4. In year 5, must recognize balance of

CG, irrespective of when proceeds are due

ExampleP of D = 100,000ACB = 70,000

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CG = 30,000Payable: 25K, 15K, 15K, 15K, 15K, 15K

Year 1 Year 2 Year 3 Year 4 Year 5CG 30,000 22,500 18,000 12,000 6000Reserve 22,500 18,000 12,000 6,000 0CG 7500 4500 6000 6000 0Taxable CG ½(7500) ½(4500) ½(6000) ½(6000) ½(6000)

Year 1:a. 30 * (75/100) = 22, 500b. 1/5(30) * (4-0) = 24,000

Year 2:a. 30 * (60/100) = 18,000b. 1/5(30) * (4-1) = 18,000

Year 3:a. 30 * (45/100) = 13,500b. 1/5(30) * (4-2) = 12,000

Year 4:a. xb. 1/5(30) * (4-3) =

Year 5:a. xb. 1/5(30) * (4-4) = 0

*Note that if balance of sale is due on demand, it is due this year, not after the year. Fact that you choose not to demand doesn’t make proceeds due after the end of the year. Cannot take reserve – must recognize entire capital gain in year property sold pursuant to demand loan.

Special Rules

Personal Use Property

S. 54 “personal use property” includes (a) property owned by TP that is used primarily for personal use or enjoyment of TP or for personal use or enjoyment of one or more individuals each of whom is (i) the TP, (ii) person related to TP

Personal Use PropertyCapital gains taxable (exception for principal residence)Allowable capital losses – none allowed unless listed PP (but only deductible against LPP gains)

Capital gains on personal use property are taxable to extent of ½ gain (per s. 3, 38, and 39)

Exceptions / special rules:

46(1) De minimis rule: ACB deemed greater of $1000 and actual ACB. P of D deemed greater of $1000 and actual P of D. **Where either or both of ACB and P of D < $1000, bump up to $1000. Reduces or eliminates capital gain on personal use property

46(3) Set rule: If multiple personal use properties (worth in aggregate > $1000) that would ordinarily be disposed of as a set are disposed of by multiple dispositions so that one person or group of non arm’s length persons has acquired all the properties, properties shall be deemed to have been sold together. **If sell set in pieces to one person or group of non arm’s length persons – deemed sold together**If sell in pieces to multiple arm’s length persons – set rule doesn’t apply.

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Any loss from disposition of personal use property deemed nil [40(2)(g)(iii)]

40(2)(g)(iii) TP’s loss from disposition of any personal use property other than listed personal property or a debt referred to in sub 50(2) is nil. i.e. disallows deduction of losses that result from disposition of personal use property

S. 54 “listed personal property” means TP’s personal-use property that is all or any portion of, or any interest in or right to, any(a) paint, etching, drawing, painting, sculpture or other similar work of art(b) jewellery (c) rare folio, rare manuscript, or rare book, (d) stamp, or(e) coin

41(1) TP’s taxable net gain for year from dispositions of listed personal property = ½ of amt determined to be TP’s net gain for the year from dispositions of such property

Can deduct losses from LPP only against gains from LPP [3(b)(i)(B)] BUT if make losses in year in which no gain, can carry those losses back 3 years and forward 7 years to offset LPP gains in other years [41(2)(b)]. I.e. if have gain, look forward 3 years and back 7 years to look for losses if there are any, can deduct from LPP gains but only to extent that gains exceed loss (can’t go below zero) and provided that deduct earliest losses before more recent ones. [i.e. “no amount is deductible in respect of the LPP loss of any year until the deductible LPP losses for previous years have been deducted.”]

Burnet (K.P.) v. Canada, [1995] TCC p. 982

Facts:- TP owned house in West Van and lived there with his family- In 1978 inherited house from father- In 1979 and 80, there was boom in real estate market and TP planned to take advantage of it by

demolishing West Van home and building (and then selling) a new luxury home- Between 1981 and 1987, TP and his family moved in and out of the new home.- In 1987 TP sold the house at a significant loss and sought to deduct the loss as a loss incurred in

carrying out an adventure in the nature of trade

Issue: Was the house the TP’s personal residence or inventory in an adventure in nature of trade?

Held:Inventory in adventure in nature of trade

Ratio:- There is evidence which suggests that the house was personal property, not inventory: family lived in

house off and on, did not list it for sale until 1985, and participated in design (bedrooms were designated by the children’s names). Clearly the house was the TP’s principal residence. But this doesn’t determine the manner. The exclusion from a TP’s income of the gain or loss on the disposition of a principal residence occurs only if the property, in addition to being a principal residence, is also capital property. Gain or loss on house in which TP ordinarily resides falls entirely outside of capital gains subdivision if that property was not capital property in the TP’s hands, i.e. if it is inventory in the TP’s hands.

- In this case, TP had intention to resell at a profit, i.e. a consistent speculative intent that goes well

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beyond the normal hope that everyone has that he or she can sell his or her principal residence at a profit. (evidence of this: stated intention, fact that house was too large for the family, market that prevailed in 1979).

RULE: Rules that apply to personal use property (notably that loss on disposition of PUP not deductible) only apply where that personal use property is capital property, i.e. and not inventory in the TP’s hands. [First step: characterize – capital property or adventure in nature of trade?]

SH: I think that there would be a deemed disposition, per 45(1)(a)(i) at point where property went from personal use property (i.e. principal residence) to income-earning property (i.e. inventory), likely on the day in which TP decided to take advantage of the rising market and demolish the house

Principal Residence

- Sub-cat of personal use property so above rules apply, i.e. loss not recognized, de min and set rules- Also special rules for principal residence b/c, for policy reasons, CG on principal res is tax-exempt

40(2)(b) Formula for calculating taxable portion of capital gain on principal residence

Where TP is individual (or trust), the TP’s capital gain from the disposition of property that was TP’s principal residence at any time after the acquisition date = A-(A*B/C)

Capital gain on PR = A – (A*B/C)

A = Capital gain that would have otherwise realizedB = 1 + # of years that property qualified as principal residence and TP was res in CdaC = # of years that TP owned the property

S. 54 def’n of “principal residence.” Criteria which must be met to qualify as PR in given yr

Qualifying as PR for given year

1) housing unit (see Flanagan)2) owned by a particular TPAND EITHER, 3) ordinarily inhabited by certain eligible persons [para (a)]

a. TPb. TP’s spouse or cml partner or former spouse or cml partnerc. TP’s child

OR4) 45(2) or 45(3) election [para (b)]

a. TP made 45(2) election in tax return for year or preceding year b. TP made 45(2) election that relates to a change in use of property in subsequent tax year

EXCEPT THAT, a particular property shall, subject to 54.1, not be considered PR for tax year 5) Unless designated as PR in prescribed form and manner (only do this when dispose of PR) [para (c)]6) Unless no other property has been designated for the same year as PR by TP, spouse or common law

partner of spouse (not separated one though), or unmarried child under 18 [para (c)] Bottom line = can only have one principal residence w/in a nuclear family

7) If PR is only PR because of para (b), i.e. one of the elections, and has so qualified for 4 years (i.e.

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election only good for 4 years) [para (d)] [keeping in mind 54.1 which could extend the 4 years]

Surrounding land included if reasonably contributes to use and enjoyment

Principal residence includes land under the housing unit and any portion of land beside the housing unit that reasonably contributes to use and enjoyment of housing unit as a residence.

BUT, where immediately contiguous land > ½ hectare, excess will only be part of PR if TP can show that it is necessary to such use and enjoyment. [para (e) of PR def’n] (see Yates)

45(2) and (3) elections

45(1) Where TP (a)(i) acquires property at time 1 for some purpose and starts using it at time 2 for the purpose of gaining or producing income OR (a)(ii) vice-versa (income-earning purpose to other purpose), deemed disposition and acquisition at FMV

45(2) Election where change of use - For purposes of this sub and s. 13, where subpara (1)(a)(i) would otherwise apply [i.e. property goes from other purpose to income-earning purpose], and TP so elects, TP shall be deemed not to have changed use (i.e. not to have started to use property for income-earning purpose). Election applies until rescinded (when rescinded, TP shall be deemed to have changed use)**Effects of 45(2)1. prevents 45(1)(a)(i) deemed disposition (and immediate realization of capital gain) where go

from personal use to income-earning use (defers CG recognition)2. can be used to qualify income-earning property as PR for each of the four years after the

election is made [for max 4 years subject to 54.1] (= more of gain will be tax exempt)3. Election is for purposes of this subdivision only so TP must report income from the property

(minus applicable expenses) but cannot claim CCA. **Election must be filed in the year in which change of use occurred.

45(3) Election concerning principal residence – Where property acquired for purpose of gaining or producing income becomes principal residence of TP, sub (1) will not apply to deem disposal/reacquisition if TP so elects. Note that need not elect until filing due-date for tax year in which property is actually disposed of by the TP**Effects of 45(3)1. advantage is that can be made after property is disposed of2. prevents 45(1)(a)(ii) deemed disposition (and immediate realization of capital gain) where go

from income-earning use to principal residence (defers CG recognition)3. Can be used to qualify income-earning property as PR for each of the four years before the

election is made. (= more of gain will be tax exempt)4. Can use 45(3) to ‘wait and see,’ i.e. if property decreases in value, would want to max out on

the years in which was used for income-earning (b/c then could deduct loss – terminal if depreciable property and capital if non-depreciable). If property increases in value, would want to use 45(3) to max out on tax-exempt years.

5. Per 45(4), cannot make election if TP or TP’s spouse has claimed CCA in respect of the property on or before the change in use.

54.1 Taxation year in which TP doesn’t ordinarily inhabit TP’s property as consequence of relocation of TP or spouse’s employment is deemed not to be a previous taxation year referred to in para (d)

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of def’n “principal residence” if (a) move back into property before end of tax year immediately following year in which employment ceases

**Extends 4-year period during which principal res can qualify as such under 45(2) or (3) indefinitely where TP or spouse is relocated by employer and TP moves back into house before end of year immediately following year in which employment ceases.

Property with dual use (income-earning and principal residence)- for purposes of capital gains, treat part as principal residence (gain exempt) and part as income-

earning property (CG taxable and CCA and other expenses deductible in respect of it)- If relatively small part is used for income-earning purpose and TP is not taking CCA on it, TP could

probably qualify the entire property as principal residence and thereby exempt the entire gain. - Note 45(1)(c) which provides for deemed disposition and reacquisition (at FMV) of portion of

property converted from principal residence to income-producing use and vice-versa (i.e. converted back to principal residence). An election under 45(2) or (3) cannot be made where there is a partial change in use of a property. [This rule only applies where the partial change in the use of the property is substantial and of a more permanent nature, i.e. where there is structural change]

Cases:

R v. Yates, [1983] FCTD p 1005

Facts:- TP bought 10 acres of vacant land and built house on it. Under zoning bylaws, could not build house

on any parcel less 10 acres- 14 years later, TP sold 9.3 acres of the land to the municipality under threat of expropriation

Issue: was the disposition of 9.3 acres of land a disposition of a principal residence?

Held: Yes

Ratio:- para (e) of def’n of “principal residence” includes as part of principal residence land immediately

contiguous to housing unit, provided that any excess over ½ hectare is reasonably necessary to use and enjoyment of land

- Critical time to examine this requirement is moment before disposition- Here, the excess over ½ hectare was necessary b/c TP could not have legally occupied his housing

unit on less than 10 acres

RULE: When is excess over ½ hectare reasonably necessary to use and enjoyment of land? When cannot occupy housing legally without it. IT-Bulletin: the excess land must be necessary for housing unit to properly fulfill fn as residence and not simply be desirable. Might be necessary where excess required to provide access to public roads. Excess over ½ hectare definitely not necessary if used for income-earning purposes. [Lifestyle arguments not likely to be successful]

Flanagan v. MNR, [1989] TCC p. 994

Facts:- TP purchased vacant lakefront land from his mother. He planned to build a cottage on it but couldn’t

get the necessary approvals.

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- Every summer (for one to four months), he would park his trailer on the lot and enjoy the property. - 9 years after he purchased the property, he sold it at a gain but did not include any of the gain in his

income on the grounds that the property was his principal residence

Issue: Was the property his principal residence?

Held: Yes

Ratio:Is a mobile home without services a ‘housing unit’?- Yes. Housing unit need not be a building or structure, just something equipped to provide shelter. - Lack of services to the trailer not fatal – many buildings that Cdns use as homes are w/o servicesIs the land part of the principal residence?- YES. Per para (e), “principal residence” includes land subjacent provided that it may reasonably be

regarded as contributing to the TP’s use and enjoyment of the unit as a residence. “land subjacent” includes land under a trailer – it is obvious that a van, trailer and tent must rest on something! The land contributed to his use and enjoyment of the unit – he did not stay inside the van all the time; the purpose in acquiring the land was because of its lake frontage and surroundings

Did TP ‘ordinarily inhabit’?- Yes. Court cites Thomson. Ordinary means that inhabit in the course of the customary mode of life;

need not inhabit all year as long as inhabit for some period every year. Principal residence need not be your primary residence. A seasonal residence may be a TP’s ordinary residence. As long as can establish routine of living in the housing unit and can show that primary purpose of property was not to earn income, will qualify as ordinarily inhabited.

RULE: Housing unit doesn’t have to be a building, just something that provides shelter. “Ordinarily inhabited” means that inhabit as part of routine/customary mode of life; need not live there every day (1-4 months per year is sufficient) and need not be primary residence.

Other Deemed Dispositions

45(1)(a) – deemed disposition where change in use(i) other purpose to income earning purpose(ii) income earning purpose to other purpose

70(5) – deemed disposition of all capital property upon death

128.1 – deemed disposition and reacquisition (at FMV) upon becoming resident of Canada or ceasing to be resident of Canada

Rollovers

Rollovers allow a TP to defer the realization of capital gains upon certain actual or deemed dispositions. Most work the same way – disposition and acquisition at amount equal to ACB. Accrued capital gains are thereby transferred to the transferee (or, in case of s. 44, to the new property) and realization deferred.

Some mandatory [73(3)], some elective [s. 44], some apply unless you elect out of them [70(6), 73(1)]

Rollovers include- 73(3) – farm property going to child [mandatory]- 70(6) – property rolls over to spouse upon death [applies unless elect out]

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- 73(1) – inter vivos transfer of property between spouses [applies unless elect out]- 44 – replacement property rollover [elective]

Replacement property rollover (s. 44)

44(1) Applies (if TP elects) where TP acquires replacement property with either of

(a) proceeds of disposition from an involuntary disposition (i.e. compensation for property lost, stolen, destroyed or expropriated) OR(b) proceeds of disposition of capital property that, immediately before disposition, was former business property.

(e) the gain on the disposition of property involuntarily disposed or former business property is the lesser of (A) actual gain (P of D – ACB) and (B) P of D – ACB of new property**Effect – can shelter that portion of the gain which is used to acquire/make replacement property (some or all of accrued gains thereby rollover onto new property)

(f) the deferred part of the gain is subtracted from the cost of the replacement property, i.e. ACB = cost of property minus gain deferred .

(c) When must replace? Involuntary disposition – must replace before the end of the second taxation year following the year of disposition. Voluntary disposition of former business property – before the end of the first taxation year following the year of disposition

41(5) Replacement property – a particular capital property is a replacement property for a former property of the TP if (a) reasonable to conclude that property was acquired by TP to replace the former property;(a.1) it was acquired and used by the TP or a related person for a use that is the same or similar to the use to which the TP or related person put the former property(b) where former property used in a business, the property was acquired for the purpose of gaining or producing income from that or a similar business

248(1) “former business property” means a capital property used by TP or related person primarily for the purpose of gaining or producing income from a business , and that was real property of the TP or an interest in a real property. Doesn’t include(a) rental property(b) land subjacent to a rental property(c) land contiguous to land referred to in (b)(d) a leasehold interest in any land referred to in (a) to (c)

Superficial Loss Rules

General rules re capital loss- can deduct capital loss against capital gains- cannot deduct capital losses on personal use property. Exception: losses on listed personal property,

which are deductible against gains on listed personal property. - Also stop loss rules – e.g. superficial loss

40(2)(g)(i) A superficial loss from the disposition of a property is deemed nil.

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s. 54 “superficial loss” means loss from disposition of property where, during period that begins 30 days before and 30 days after the disposition, the TP or an affiliated person acquires identical property (or right to acquire it) and, at the end of the period, the TP or affiliated person still owns or has a right to acquire the identical property.

250.1(1) “affiliated person” includes spouse or common law partner of the TP

53(1)(f) In computing cost base of identical substituted property, add the amount of the superficial loss.

So, superficial might occur where

Dispose of property to spouse, elect out of 73(1), non-arm’s length transaction therefore deemed to receive proceeds equal to FMV per s. 69(b), trigger loss, if spouse or you continues to hold property at end of 30 day period, then loss is superficial (per s. 54 def’n), deemed nil (per 40(2)(g)(i)) and superficial loss can be added to cost base of property

OR sell property at FMV and trigger loss. W/in period 30 days before and after, acquire identical property. If continue to hold property at end of 30 day period, loss superficial (per s. 54 def’n), deemed nil (per 40(2)(g)(i)) and superficial loss must be added to cost base of new property

Carryovers

Listed Personal property losses- can be used to offset LPP gains- if no gains, can carry loss forward 7 years and back 3 and use to offset gains in calculating net gains

from LPP [per 41(3)], i.e. in calculating income for tax purposes.1

Other losses can be carried over and deducted in calculating taxable income s. 111

111(1)(a) non capital losses can be carried forward 7 and back 3 (i.e. can deduct non-capital losses from preceding 7 years and following 3 years) **can be deducted from all kinds of income

111(1)(b) net capital losses can be carried back three years and forward indefinitely (i.e. can deduct net capital losses from any preceding years and following 3 years)*Can only be deducted against taxable capital gains in any of those years**BUT, in year of death, per 111(2), can deduct any remaining net capital losses against all sources of income

Allowable business investment losses- i.e. loss realized on disposition of shares of small business corporation- Losses are 50% deductible against all sources- Can carry back 3 years and forward seven years - If don’t deduct w/in seven years, reverts to capital loss – can carry forward indefinitely but is only

deductible against taxable capital gains

1 SH: carry over LPP loss, not net loss.

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Chapter Seven: Other Income and Deductions

Introduction

- per 3(a), include “other” non-source specific inclusions- per 3(c), deduct “other” non-source specific deductions to extent those not already taken into account

in determining total in (a)- find these “other” inclusions at ss 56-59 and deductions at 60-66- Since non-source specific, any TP, regardless of the type of income he is required to include / entitled

to deductInclusions

Prizes for achievement

56(1)(n) When computing income of TP, must include total of all amounts (other than amounts received in course of business and amts received in respect of, in course of or by virtue of an office or employment) received by TP in the year, each of which is an amount received by the TP as a scholarship, fellowship or bursary, or a prize for achievement in a field of endeavour ordinarily carried on by the TP**Note exemption of $500 at 56(3)**BUT, as result of bracketed portion above, work and business related prizes do not qualify for the $500 exemption.

R v. Savage, [1983] SCC p. 1116- TP received $300 from employer after successfully completing life insurance courses- Held: payment was benefit received “in respect of, in the course of, or by virtue of an office or

employment,” per 6(1)(a)- Court also considered meaning of prize for achievement in a field of endeavour ordinarily carried on

by the TP- “Prize for achievement” does not (as Crown contended) necessarily connote an award for victory in a

competition or contest with others. Merely means an award for something accomplished. Must be in field of endeavour ordinarily carried on by the TP, which rules out, for example, prizes won in games of chance or at a costume party or for athletic achievement.

Deductions

Support payments

Child support payments (i.e. any support payment not exclusively for the support of a spouse) are not recognized for tax purposes (recipient cannot include and payor cannot deduct)

Spousal support payments (i.e. support payments exclusively for the support of a spouse) must be deducted in computing income of payer [per 60(b)] and included in computing income of recipient [per 56(1)(b)] provided the payment meets the following criteria [i.e. in def’n of “support amount” at 56.1(4)]

1. amt payable as an allowance and recipient has discretion as to use of the amti. fixed, predetermined amt over which recipient has full discretion (Pascoe)

ii. Curative provisions at 56.1(1) and (2) [latter only if court order or written agreement provides that it shall apply to any payment made pursuant thereto]

iii. Armstrong re. 56.1(1)/60.1(1)

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2. amount payable on a periodic basis for the maintenance of the recipienti. McKimmon

3. recipient must be spouse or former spouse [i.e. not third party]i. [but see 56.1(1)/60.1(1) and 56.1(2)/60.1(2)]

4. must be paid pursuant to written agreement or court order [Note that must be agreement effective April 1997 or later; if before that date, old rules apply, i.e. child support payments also deducted/included if meet these criteria]

i. but see 56.1(3)/60.1(3): recognizes that might not be agreement for some time; provides that payments made in year of agreement/court order and in previous years will be deemed to have been made pursuant to the agreement/court order

Allowance and discretionary use- Pascoe: allowance (in empl context) = fixed, predetermined amount over which recipient has full

discretion (need not acct for use). This creates problems where spouse/former spouse wants to (1) pay third party (bank for mortgage) or (2) have control over use (must use money to go to school, medical payments, etc.). Curative provisions introduced

56.1(1) If an amount is paid to third person for benefit of spouse or former spouse, it will be deemed to have been received by spouse or former spouse**This doesn’t solve problem b/c payment is not allowance over which spouse has discretionArmstrong: this section does not operate to make payments made by spouse to third party (in this case mortgage payments) deductible b/c spouse has no discretionary use.

56.1(2) Payments made to third persons for medical or education expense or in respect of acquisition, improvement or maintenance of a self-contained domestic establishing in which spouse/former spouse resides will be deemed to have been received by spouse as an allowance and spouse will be deemed to have discretion as to use of the amount. **Note that court order/written agreement must stipulate that this s. applies

Periodic payments for maintenanceMust distinguish between periodic maintenance payments and periodic payments made as instalments of a lump or capital sum (latter not deductible). Factors (McKimmon):1. Intervals at which payments made (greater than year suggests capital)2. Amt of payments relative to income and std of living of payer and recipient (if substantial portion of

income and exceeds what is necessary to live, suggests capital)3. Whether payments bear interest (suggests capital)4. Whether payments can be paid by anticipation or accelerated as a penalty (suggests capital)5. Whether payments allow significant amt of capital accumulation6. Whether payments are for indefinite period or fixed term (latter suggests capital) 7. Whether payments can be assigned and whether obligation to pay survives payer and recipient

(suggests capital; maintenance payments normally personal, i.e. unassignable and terminate at death)8. Whether payments purport to release payer from future obligations to pay maintenance.

Moving Expenses

s. 62 allows for deduction of personal moving expenses where TP makes an ‘eligible relocation’ [see 248(1). There is limit on amount deductible.

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Child-care expenses

s. 63 permits TPs to, subject to certain limitations, deduct amounts paid “as or on account of child care expenses incurred for services rendered.” Per 63(3), i.e. def’n of “child care expense,” these services include babysitting services, day nursery services or services provided at a boarding school or camp. These services must be provided to enable the TP to perform duties of office/employment, carry on business or go to school [63(3)]*Limit on amt can deduct per year per child*Amt deducted cannot exceed 2/3 TP’s earned income for the year*Deduction must be claimed by the parent with the lower income

Symes v. The Queen, [1994] SCC p. 1193

Facts:- TP was lawyer and sought to deduct nanny’s salary in computing business income- She argued that when a TP has expenses which exceed an amt made deductible by a specific

provision (here s. 63), the TP can have recourse to a more general provision in order to deduct the full amount.

Issue:Can child care expenses be deducted in computing business income?

Held:Don’t need to decide b/c s. 63 is a “complete code”

Ratio:Relationship between 9(1), 18(1)(a) and 18(1)(h)- 9(1) authorizes deduction of biz expenses; provisions of 18(1) are limiting only- Under 9(1), an expense is deductible if its deduction is consistent with well accepted principles of

business practice- Such practices operate to prohibit expenses which lack an income earning purpose or which are

personal expenses [18(1)(h) and (a) are explicit in this regard)Personal expenses and para 18(1)(h)- Traditionally, child-care expenses characterized as personal expenses. But shouldn’t slavishly follow

these cases. WHY? B/c social foundation has changed, i.e. women in the workforce. Tax law can’t be static – must take into account changing social fabric.

Business expenses and para 18(1)(a)- Expenses cannot be deducted unless incurred for the purpose of gaining or producing income from

biz. Factors that should be taken into consideration1. whether deduction is ordinarily allowed as a biz expense by accountants (suggests it is widely

accepted)2. whether the expense is one normally incurred by others involved in the TP’s business3. But for the gaining of or producing of income, would these expenses still need to be incurred?

[Allard: court in this case rejects this simple but-for test]4. Iac prefers a needs-based but-for test, i.e. but for the business, would the need exist (irrespective of

whether the need was satisfied by third party or by opportunity cost of personal labour). If yes, personal expense. Such expenses are incurred by the TP in order to relieve him or her from personal duties and make him/her available to the business .

5. Expenses that simply make TP available to the business are not business expenses . 6. Prevent deductions which represent personal consumption choices. - Iac applies these factors to the facts at bar; emphasizes that, for policy reasons, the choice to have

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kids shouldn’t be considered a personal consumption choice. While a ‘needs-based’ analysis carried the day in the FCA (i.e. the need to take care of the kids exists irregardless), Iac suggested that the “changing composition of the business class and changing social structure demand a reconceptualization”

- No need to decide whether this reconceptualization is appropriate however b/c s. 63 was intended by Parliament to address comprehensively child care expenses. Allowing TP to deduct additional child care expenses in computing income from business would undermine balance struck in that section.

Chapter Eight: Rules Relating to Computation of Income

Introduction 1213

Limitations on deductions 1213-1214

Deemed proceeds 1235

Non-arm’s length transactions 1256-1263

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PART I – INTRODUCTION - LSA McGill - AÉD McGill...

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