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Minister off National Revenue (Appellant) v.
Bessemer Trust Company and Ogden Phipps as Trustee (1959 Trust) (Respondent)
Court of Appeal, Jackett C.J., Sheppard and Bastin D.J.T.---Vancouver, December 20, 1972.
Income tax—Canada-U.S. Tax Convention Art. XIII A 2-Recaptured capital cost allowances made taxable after Convention came into force—U.S. resident electing to pay tax under Part I of the Income Tax Act—Recaptured capital cost allowances taxable—Income Tax Act, R.S.C. 1952, c. 148, s. 110(1), 110(5), am. 1955.
United States trustee off rental property in Canada elected to pay tax on the rentals therefrom for 1965 and 1969 under Part I of the Income Tax Act, R.S.C. 1952, c. 148, as permitted by section 110(1). The property was sold in 1969 after some rents had been received and the trust was assessed to income tax for that year on recaptured capital cost allowances pursuant to section 110(5), which was enacted in 1955. The trust contended that the assessment violated Article XIII A 2 of the Canada-U.S. Tax Conven tion (which came into force in 1951), viz.,
Rentals from real property derived from sources within Canada by an individual or corporation resident in the United States off America shall receive tax treatment by Canada not less favorable than that accorded under Sec tion 99 of The Income Tax Act [section 106 of the Income Tax Act, R.S.C. 1952, c. 148], as in effect on the date on which this Article goes into effect.
Under section 3 of the Canada-U.S. Tax Convention Act, 1943, 1943-44, c. 21, the Convention prevails if there is an inconsistency with any other law.
Held, reversing Collier J., while section 110(5) of the Income Tax Act was excluded from application by the Tax Convention so that the U.S. trustee was not required to elect thereunder, it had the right to do so under section 110(1) and having done so was liable to pay tax on recap tured cost allowances under section 20.
APPEAL from judgment of Collier J. ([1972] F.C. 1176).
M. R. V. Storrow for appellant.
P. N. Thorsteinsson for respondent.
JACKETT C.J. (orally)—This is an appeal from a decision of the Trial Division allowing an appeal by the respondent from its assessment under Part I of the Income Tax Act for the 1969 taxation year.
The respondent became liable to pay tax under Part I of the Income Tax Act for the 1969 taxation year because it elected to file a return of income under that Part for that year under section 110 of the Income Tax Act.
To understand the questions raised by the appeal, it is helpful to examine the historical development of the law touching the matters in question.
Thé problem arises concerning a taxpayer resident in the United States whose only liabili ty under the Income Tax Act is as a non-resi dent person to whom amounts have been paid as rent on real property in Canada.
Looking only at the Income Tax Act, and setting to one side the Canada-United States of America Tax Convention, there were, prior to 1955, two alternatives with reference to the liability of such a person under the Income Tax Act. In the first place, if he did not otherwise elect, he was liable to pay as income tax 15 per cent. of the gross amount of the rental pay ments under section 106(1)(d) of the Income Tax Act. Alternatively, he might have elected to pay ordinary income tax under Part I of the Income Tax Act as though
(a) he were resident in Canada,
(b) his interest in real property in Canada were his only source of income, and
(c) he were not entitled to any deduction from income to determine taxable income,
as provided by section 110 of the Income Tax Act as it appeared in the Revised Statutes of
1952, which section is, for present purposes, to the same effect as section 99 of the 1948 Income Tax Act. If a non-resident person made such an election, the effect was that, instead of paying 15 per cent. on the gross amount of the rents received in a year, tax would be computed on the net profit from the real property at the graduated rates for an individual, if the taxpay er were an individual, and at corporate rates, if the taxpayer were a corporation. As can readily be seen, it would be a matter of calculation in each year for each taxpayer to determine which alternative was preferable.
Under the second option, in the computation of "income" from the real property in the manner provided by Part I of the Income Tax Act, one of the deductions permitted was a deduction in respect of the capital cost of the property as allowed by regulation under section 11(1)(a) of the Act, which deduction is com monly referred to as "capital cost allowance".
The scheme of capital cost allowance, as it was originally enacted in 1948 for residents of Canada and persons carrying on business in Canada was twofold. In the first place, annual allowances in respect of capital cost were per mitted by regulation under section 11(1)(a) each year during which the taxpayer continued to own property acquired for use as, or in, a source of income. In the second place, when the taxpayer disposed of the property, if the pro ceeds of disposition exceeded the portion of the capital cost that had not been written off under section 11(1)(a), the excess (or the amount of the capital cost that had been written off, if it were smaller) had to be included in computing income for the year of disposition. See section 20(1) of the Income Tax Act.
This second feature of the capital cost allow ance scheme is commonly referred to as "re- capture" and that name conveys accurately enough, for practical purposes, the scheme of the matter. If one conceives of the allowance under section 11(1)(a) as intended to permit the capital cost of property that has been used as,
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or in, a source of income to be written off in computing the income of which it was a source, then, if the property is disposed of for an amount in excess of the portion of the capital cost that was not written off, it becomes appar ent that more has been written off than was consumed in the income earning function and, to that extent, what has been so written off is "recaptured".
Returning now to the position of a non-resi dent recipient of rent from real property in Canada prior to 1955, it is clear that the first branch of the capital cost allowance scheme applied to him in a year in respect of which he elected to pay tax under Part I of the Income Tax Act. He could deduct capital cost allow ance under section 11(1)(a) for such a year because that was one of the deductions allowed in computing the "income" for the year on which he had elected to pay tax. However, there was nothing in the Act at that time to require him to pay tax under Part I for a year in which he disposed of the property in respect of which he had previously taken capital cost allowance and he was not therefore bound to pay tax resulting from the recapture provision. (As will be seen later, the question that arises in this case is whether, that tax becomes payable, if he chooses to elect to pay tax under Part I in the year of disposition on rental payments received in the year of disposition.)
I turn now to the relevant provision of the Canada-United States of America Tax Conven tion. While the Canadian income tax provisions were in the state that I have described, a provi sion was introduced into that Convention read ing as follows:
2. Rentals from real property derived from sources within Canada by an individual or corporation resident in the United States of America shall receive tax treatment by Canada not less favorable than that accorded under Section 99, The Income Tax Act, as in effect on the date on which this Article goes into effect.
(As already indicated section 99 was substan tially the same as section 110 of the 1952 Income Tax Act as it was before 1955.)
It is common ground that, if this provision in the tax convention is inconsistent with the provisions of the Income Tax Act that would otherwise apply in a particular case, the tax convention provision must prevail.
In 1955, certain subsections were added to section 110 of the Income Tax Act of which it will be sufficient to refer to subsection (5), which reads in part as follows:
(5) Where a non-resident person has filed a return of income under Part I for a taxation year as permitted by this section and has, in computing his income under Part I for that year, deducted an amount under paragraph (a) of subsection (1) of section 11 in respect of real property in Canada ... he shall ... file a return of income under Part I ... for any subsequent taxation year in which that real property ... is disposed of, within the meaning of section 20, by him, and he shall ... thereupon be liable ... to pay tax under Part I for that subsequent taxation year ..
In this case, the facts are simple, the respond ent was a resident of the United States who received rent from property in Canada until some time in 1969. In 1965, it elected to pay tax under Part I with reference thereto. In 1969, after receiving some payments of rent from the property, it disposed of the property and, subse quently, it filed a return of income under Part I for the 1969 taxation year. The sole question is whether section 20 applies to bring the "recap- ture" amount into the calculation of the respondent's "income" for 1969.
In the first place, it is common ground that, if section 110(5) as enacted in 1955 is applicable, then section 20 does apply. I agree with the learned trial judge that section 110(5) does not apply in this case because the provision from the Tax Convention quoted above excludes it.
Apart from the Convention, as it appears to me, the situation is that, at the time of the Tax Convention, a non-resident could elect, in respect of a year when he was paid an amount as rent on real property in Canada, to file a return under Part I, in which event he became liable to pay tax under Part I as though the real property in Canada were his only source of income and he was not bound to file such a return in respect of a subsequent year when he disposed of the property so as to become liable to "recapture", but, after 1955, if a non-resi dent so elected to pay tax under Part I in respect of a year when he was paid such an amount as rent, it carried with it a liability, by virtue of the new section 110(5), to file a return in respect of the year of disposition and to pay any tax arising from the "recapture" provision in section 20(1). In my view the application of section 110, including subsection (5), involves "tax treatment" of "rentals from real property derived from sources within Canada" less favourable than that accorded by the old sec tion 99 and is excluded in the case of persons resident in the United States by the Canada- United States of America Tax Convention.
The question remains as to whether, on the facts of this case, the recapture provision was properly invoked by the appellant in assessing the respondent. On this question, I have the misfortune to disagree with the learned trial judge.
In my view, while the respondent was not required to elect to pay tax under Part I for 1969, as it received rental payments from real property in Canada in 1969, it was authorized by section 110(1) to elect to do so, and, having done so, it becomes liable to pay tax computed in accordance with the provisions of Part I "as though ... his interest in real property in Canada ... were his only source of income". While, normally, the only amounts included in
computing the income of a taxpayer for a year during which his only source of income was real property are the amounts of rent received in respect of the property for the year, section 20 requires that, where such property was "depre- ciable property", as this property was, and was disposed of in the year, the amount determined thereby "shall be included in computing his income for the year". I cannot escape the con clusion that, having elected to pay tax for the 1969 taxation year as though its sole source of income for that year was its real property in Canada, section 20 operates to require that the "recapture" amount be included in computing the respondent's income for the year.
Counsel for the respondent endeavoured to find something in section 110(3) inconsistent with this conclusion but, not only was it not clear to me how that provision led to any such conclusion, but, when it is read with section 110(4), there is an obvious reason for including it in the section even though, taken by itself it was probably unnecessary.
I am of the view that the appeal should be allowed with costs in this Court and in the Trial Division, that the judgment of the Trial Division should be set aside and that the assessment of the respondent under Part I of the Income Tax Act for the 1969 taxation year should be restored.
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SHEPPARD AND BASTIN D.JJ. concurred.
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