A-782-82
The Queen (Appellant)
v.
Canada Southern Railway Company (Respondent)
INDEXED AS: CANADA SOUTHERN RAILWAY CO. V. R. (RCA.)
Court of Appeal, Heald, Ryan and Stone JJ.—
Ottawa, October 17 and 18, 1985 and February 5,
1986.
Income tax — Non-residents — Whether amounts credited
as dividends by Canadian company to non-resident company
exempt from non-resident tax — Whether amounts could
reasonably be attributed to business — Income Tax Act, S.C.
1970-71-72, c. 63, ss. 2(3), 115(1)(a)(i),(ii), 212(2), 215(1)
Income Tax Act, R.S.C. 1952, c. 148, ss. 2(1),(2), 31(1) (as am.
by S.C. 1960, c. 43, s. 6(1)), 106(1) — Income Tax Regula
tions, SOR/54-682, s. 805(1) (as am. by SOR/57-4;
SOR/69-631).
The respondent, a corporation resident in Canada, owned
railway property ("the system") in Canada, including connec
tions with U.S. lines. The respondent's system was operated by
The Penn Central Transportation Company ("Penn Central")
pursuant to a lease, acquired by a merger and previous leases,
which provided that the yearly rental was to be the amount of
money necessary to insure that the respondent could declare
and pay a dividend of $3 a share on its issued stock. However,
since Penn Central directly or indirectly owned a substantial
amount of the respondent's outstanding shares, more than half
of the dividends were payable to it. In recognition of that fact, a
waiver agreement, entered into between Penn Central's prede
cessors in title and the respondent, provided, in effect, that
Penn Central would only pay the difference between the rent
owed to the respondent and the dividends payable, directly or
indirectly, to itself. This difference would be an amount suffi
cient to enable the respondent to pay the dividends payable to
outside shareholders.
The Minister considered, for the purposes of the respondent's
1972 and 1973 taxation years, that the amounts that the
respondent credited to Penn Central on account of dividends
were taxable pursuant to subsection 212(2) of the Income Tax
Act and that the respondent therefore should have withheld and
remitted the appropriate amounts of tax owed by Penn Central.
The Minister assessed the respondent accordingly.
On appeal from that assessment, the Trial Judge found that
the dividends could reasonably be attributed to the business
carried on by Penn Central in Canada and were amounts
taxable under Part I, rather than Part XIII of the Act. He
consequently vacated the Minister's assessments.
This is an appeal from that judgment.
Held, the appeal should be allowed.
The issue is whether the amounts credited as dividends by
Canada Southern to Penn Central are exempt from non-resi
dent tax under Part XIII of the Act by virtue of the exemption
provided by subsection 805(1) of the Regulations.
The words in Regulation 805(1) "except those amounts that
may reasonably be attributed to the business carried on by him
in Canada" are not so clear as not to require interpretation:
"reasonably attributed" in what sense? The respondent argues
that the critical issue is not whether, as a matter of law, the
source of the dividends was "business" or "property", but
whether, as a matter of fact, the dividends could reasonably be
attributed to the business. This argument is rejected because it
is essential to determine the purpose and meaning of Regula
tion 805(1). A review of the legislative history of Regulation
805(1) leads to the conclusion that it was intended to exempt
only income from the business carried on by a non-resident
person in Canada, and not income from property even if it
could be attributed to the business in a broad sense. And even
apart from that legislative history, subsection 2(3), section 115,
and Part XIII of the Act, and Regulation 805(1), when con
sidered together, indicate an intention to exempt from taxation
amounts that would otherwise fall within Part XIII if they
would also be subject to taxation under Part I by virtue of
falling within subparagraph 115(1)(a)(ii) of the Act.
There remains the question of whether the dividends could be
regarded as income from Penn Central's railroad business in
Canada. Penn Central carried on its own railway business in
Canada, using the railroad property owned by the respondent.
The respondent did not carry on business at all during 1972 and
1973; its income came from property rentals. For the purposes
of the Act, therefore, the source of the dividends was the
respondent's shares, and the shares were property.
And it is not possible, on the facts, to hold that the shares
themselves constituted a fund employed and risked in a
business.
CASES JUDICIALLY CONSIDERED
APPLIED:
Canada Safeway Limited v. The Minister of National
Revenue, [1957] S.C.R. 717; Bank Line Ltd. v. Commis
sioners of Inland Revenue (1974), 49 T.C. 307 (Sess.).
DISTINGUISHED:
Liverpool and London and Globe Insurance Company v.
Bennett, [1913] A.C. 610 (H.L.).
REFERRED TO:
Wertman, Henry v. Minister of National Revenue,
[1965] 1 Ex.C.R. 629; R. v. Marsh & McLennan, Lim
ited, [1984] 1 F.C. 609 (C.A.); The Queen v. Ensile
Limited, (No. 1) (1983), 83 DTC 5315 (F.C.A.).
COUNSEL:
Deen C. Olsen and Bonnie F. Moon for
appellant.
Franklyn E. Cappell for respondent.
SOLICITORS:
Deputy Attorney General of Canada for
appellant.
Kingsmill, Jennings, Toronto, for respondent.
The following are the reasons for judgment
rendered in English by
RYAN J.: This is an appeal by the Crown from a
judgment of the Trial Division [ [ 1982] CTC 278]
allowing an appeal by the respondent, The Canada
Southern Railway Company ("Canada Southern")
from assessments made by the Minister of Nation
al Revenue ("the Minister") under the Income
Tax Act [R.S.C. 1952, c. 148 (as am. by S.C.
1970-71-72, c. 63, s. 1)] ("the Act") with respect
to Canada Southern's 1972 and 1973 taxation
years.
During those years Canada Southern, a corpora
tion resident in Canada, credited to The Penn
Central Transportation Company ("Penn Cen
tral"), a non-resident person, amounts on account
of dividends. The position taken by the Minister,
in making the assessments, was that Penn Central,
as a non-resident person, was liable under subsec
tion 212(2) of the Act to pay an income tax on
those amounts, and that Canada Southern was
under a duty, by virtue of subsection 215 (1) of the
Act, to deduct or withhold the amounts of tax and
to remit them to the Receiver General of Canada
on behalf of Penn Central. Subsections 212(2) and
215(1) fall within Part XIII of the Act which is
headed: "TAX ON INCOME FROM CANADA OF
NON-RESIDENT PERSONS". The Minister assessed
Canada Southern for the amounts it ought, in the
Minister's view, to have withheld and remitted,
together with interest and penalties. Canada
Southern appealed to the Trial Division.
Canada Southern submitted that Penn Central
was not liable to pay income tax under subsection
212(2) of the Act because Penn Central carried on
business in Canada during the taxation years in
question, and the amounts credited to it could
reasonably be attributed to that business; the
amounts in question, it was submitted, were thus
within the exemption provided by subsection
805(1) of the Income Tax Regulations [SOR/
54-682 (as am. by SOR/69-631, s. 1)]. Regulation
805 (1) provided:
805. (1) Where a non-resident person carries on business in
Canada he shall be taxable under Part III [Part XIII] of the
Act on all amounts otherwise taxable under that Part except
those amounts that may reasonably be attributed to the busi
ness carried on by him in Canada.
As noted above, Canada Southern succeeded
before the Trial Division. The issue in this appeal
is whether the amounts credited as dividends by
Canada Southern to Penn Central are exempt
from non-resident income tax under Part XIII of
the Act by virtue of the exemption provided by
subsection 805(1) of the Income Tax Regulations.
It may be as well to quote subsection 212(2) and
subsection 215 (1) of the Act, the subsections on
which the Minister relied.
Subsection 212(2) provides:
212... .
(2) Every non-resident person shall pay an income tax of
25% on every amount that a corporation resident in Canada
pays or credits, or is deemed by Part I to pay or credit, to him
as, on account or in lieu of payment of, or in satisfaction of a
taxable dividend (other than a capital gains dividend within the
meaning assigned by subsection 131(1) or 133(7.1)) or a
capital dividend.
Subsection 215 (1) provides:
215. (1) When a person pays or credits or is deemed to have
paid or credited an amount on which an income tax is payable
under this Part, he shall, notwithstanding any agreement or any
law to the contrary, deduct or withhold therefrom the amount
of the tax and forthwith remit that amount to the Receiver
General of Canada on behalf of the non-resident person on
account of the tax and shall submit therewith a statement in
prescribed form.
It is not in issue that the effective rate for the
1972 and 1973 taxation years was 15 per cent. The
reason for this need not be examined.
Canada Southern owned railway property in
Canada at all times material to this appeal. The
Trial Judge describes the property in this way [at
page 279]:
... a railway line running north of Lake Erie between the
Detroit River and the Niagara River along with a number of
branch lines in Canada and appurtenant facilities including
most notably, connections with US lines at or near Detroit,
Niagara Falls and Buffalo, a railway tunnel under the Detroit
River and a bridge across the Niagara River....
I will refer to this property as the "railroad
property".
The Michigan Central Railroad Company
("Michigan Central") operated the railroad prop
erty for some 21 years from 1882 to 1903 under an
agreement with Canada Southern. In 1903,
Canada Southern leased the railroad property to
Michigan Central for a term of 999 years, effec
tive January 1, 1904 ("the 1903 lease"). A rail
road lease is very different from a conventional
lease. Under the 1903 lease, the management of
the railroad property was effectively transferred to
Michigan Central: the business of the line became
the business of Michigan Central. The rental was
to be the amount of money necessary to insure that
Canada Southern could declare and pay a dividend
of $3 a share on its issued stock. There were
150,000 shares outstanding so that the annual rent
was in effect $450,000. Michigan Central owned
some of the Canada Southern shares; others were
held by outsiders. Michigan Central was itself a
subsidiary of The New York Central Railroad
Company ("New York Central"). By 1930, New
York Central owned about 99 per cent of Michi-
gan Central stock outstanding.
Effective February 1, 1930, Michigan Central
leased—more accurately subleased—the railroad
property, along with other properties, to New
York Central for a term of 99 years ("the 1930
lease"). Under the lease, Michigan Central also
"leased"—again more accurately, I think
assigned—to New York Central the Canada
Southern shares owned by it; Michigan Central
appears, however, to have remained the sharehold-
er of record of these shares. New York Central
agreed in the 1930 lease to pay Michigan Central
each year a sum of money that would enable
Michigan Central to pay to Canada Southern the
rent owing under the 1903 lease. By 1930, Michi-
gan Central had acquired 83,449 shares, 55.6 per
cent of the outstanding shares of Canada Southern
stock.
Until 1959, Canada Southern declared and paid
dividends in the amount of $450,000 per year to its
shareholders. More than half of this amount was
payable to New York Central because of the
"rental" of the stock and dividends under the 1930
lease; such dividends were paid by cheque by
Canada Southern to New York Central. The
rental of $450,000 per year payable by Michigan
Central to Canada Southern under the 1903 lease
was in fact paid by cheque directly to Canada
Southern by New York Central.
On June 26, 1959, New York Central, Michigan
Central and Canada Southern entered into an
agreement ("the waiver agreement"). By the
agreement Canada Southern "waived" payment of
part of the cash rental owed it by Michigan Cen
tral, and New York Central "waived" payment of
the part of the cash dividends declared by Canada
Southern payable to New York Central. From
then on New York Central paid Canada Southern
in cash an amount equal to the difference between
the rent of the $450,000 payable by Michigan
Central to Canada Southern and the dividends
declared by Canada Southern and payable to New
York Central; this difference would be an amount
sufficient to enable Canada Southern to pay divi
dends declared in favour of and payable to outside
shareholders. The waiver agreement provided that
the agreement should be deemed to be in compli
ance with the 1903 lease. The agreement could be
terminated on short notice. The waiver agreement
is set out in a letter which New York Central
wrote to Canada Southern and Michigan Central,
a letter quoted by the learned Trial Judge in his
reasons [at pages 280-281]. I quote this passage
from the letter (New York Central is "the Cen
tral" referred to in the letter):
Pursuant to the provisions of the Michigan Central Lease,
the Central has paid to the Canada Southern as part of the
rental under the Canada Southern Lease the amount of
$450,000 annually (since 1910), being the amount equal to
three per cent per annum upon the 150,000 shares of capital
stock of the Canada Southern outstanding. From these pay
ments of rent, the Canada Southern has declared and paid
dividends on its stock, which (since 1910) have amounted to
$1.50 per share semi-annually, or an aggregate of $450,000
annually, equal in other words to the amount of the annual
rental payment. Such semi-annual dividends have in the past
been made payable during the month following the month in
which the semi-annual rental payment is made and it is under
stood that this practice is expected to continue in the future.
Of the total of 150,000 shares of Canada Southern stock
outstanding, 89,163 shares are owned by the Michigan Central,
and that company's right, title and interest in and to such stock
is held by the Central under the Michigan Central Lease. The
Central has accordingly received the dividends declared and
paid by the Canada Southern on such stock since the effective
date of the Michigan Central Lease.
The result is that the Central is, in effect, paying rent to
itself in respect of the portion of rent paid back as dividends the
next month.
In order to eliminate such unnecessary circuity of payments
and in order to reflect the true situation more accurately, we
propose that, commencing with the rental payment of July 1,
1959, and at each semi-annual payment date thereafter, the
Central shall pay, by means of a waive of dividend as below set
forth, that portion of the semi-annual rent expressed to be
payable under the Canada Southern Lease as shall amount to
the product of the number of shares of stock of the Canada
Southern owned on the dividend record date by the Michigan
Central [and held by the Central under the Michigan Central]
Lease times the per share rate (but not in excess of $1.50) of
any semi-annual dividend declared on Canada Southern stock
and unpaid, it being understood that appropriate accounting
adjustments will be made by the Central, the Michigan Central
and the Canada Southern to reflect the transactions in the
accounts on this basis effective as of January 1, 1959.
During the period when such portion of the rent is paid by
waiver as aforesaid, the Central shall and does hereby waive its
right to receive semi-annual dividends (up to $1.50 per share)
which, in each semi-annual period, would otherwise be paid
from such rent on the stock of the Canada Southern then
owned by the Michigan Central and held by the Central under
the Michigan Central Lease.
This arrangement shall be deemed to be in compliance with
the provisions of the Canada Southern Lease with respect to
the payment of rent thereunder and shall not constitute an
amendment or modification of the terms, provisions and condi
tions of that lease in any way. The arrangement shall continue
until terminated by any company party hereto giving to the
other parties at least 30 days' written notice prior to the end of
any such semi-annual period.
Please signify your concurrences in the foregoing by signing
the enclosed copy of this letter in the space provided therefor
and return such copy to us.
The Trial Judge states [at page 2811:
The Plaintiff and Michigan Central concurred. That arrange
ment was in effect in 1972 and 1973 and, it appears, was
applied, in practice, to the shares owned by Penn Central as
well as those leased from Michigan Central.
As I read the waiver agreement, the 1903 lease
and the 1930 lease remained unaltered by it except
as they might relate to the actual payment of sums
that would become owing under them. And after
the agreement, as before it, New York Central
held the Canada Southern shares assigned to it by
Michigan Central. I would note that as of 1968
New York Central acquired Canada Southern
shares in its own right as well. The effect of the
waiver agreement was that the obligation of New
York Central to make payments to Michigan Cen
tral under the 1930 lease, the obligation of Michi-
gan Central to pay rent to Canada Southern under
the 1903 lease, and the obligation of Canada
Southern to pay declared dividends to New York
Central were all to be satisfied by payment by
New York Central to Canada Southern of the
sums calculated in the manner specified in the
waiver agreement. The purpose of the waiver
agreement was to eliminate "unnecessary circuity
of payments" and "to reflect the true situation
more accurately".
Mr. Norman Hull testified at the trial. He had
been an assistant comptroller of New York Cen
tral, and had later served as comptroller and vice-
president of Penn Central. There was also exten
sive documentary evidence. With respect to the
effect of the evidence, the Trial Judge said [at
page 281 ] :
The evidence is that neither Michigan Central nor New York
Central would have had any interest in acquiring the plaintiff's
shares if they had not been renting its system. They acquired
shares in the market when the price was such that the reduction
in outflow of cash by way of dividends advantageously offset
the cost of the purchase money. The primary motivation was
reduction of payments to third parties. A secondary motivation
was the desire eventually to eliminate all third party interests
and to make the plaintiff a wholly owned subsidiary as, in
effect, Michigan Central was. The trend to consolidation of
ownership into large corporate organizations, as well as the
consolidation of operations, through the medium of long term
leases, had been a characteristic of the railroad industry in the
northeastern United States for about a century and applied in
Canada to American operated systems.
The Trial Judge's conclusions, as stated in the
above quotation, are supported by the evidence,
particularly that of Mr. Hull. The Trial Judge
concluded his reasons in these words [at page
282]:
It was reasonable for Penn Central to regard the dividends
credited to it as de facto payment to itself of rent it was obliged
to pay to carry on its railway business in Canada. It follows
that they were amounts that may reasonably be attributed to
the business carried on by Penn Central in Canada and were
amounts taxable under Part I, rather than Part XIII of the Act.
In his judgment, he vacated the assessments in
issue and awarded costs. This is the judgment
under appeal.
Before moving to the legal issues, I would add
this observation:
On February 1, 1968, New York Central
merged with The Pennsylvania Railroad Company
to form The Penn Central Transportation Com
pany ("Penn Central"). After the merger, Penn
Central was, as the Trial Judge states, in the
position that New York Central had previously
occupied for purposes relevant to this appeal. In
June 1970, pursuant to United States bankruptcy
laws, trustees were appointed to take possession of
the assets of Penn Central. It would thus, I sup
pose, be more accurate to refer to the trustees of
Penn Central rather than to Penn Central itself
when describing events that happened after the
appointment of the trustees, but for present pur
poses nothing turns on this and it is simpler to
refer to "Penn Central".
Counsel for the appellant submitted that the
Trial Judge erred in holding that the amounts
credited by way of dividends by Canada Southern
to Penn Central could reasonably be attributed to
the business carried on in Canada by Penn Cen
tral. Counsel also submitted that the Trial Judge
erred in finding, as counsel submitted he had
found, that Penn Central was not taxable under
Part XIII of the Act, but was taxable under Part I.
Counsel for the respondent submitted that the
Trial Judge had not erred in holding that the
dividends could reasonably be attributed to the
business carried on in Canada by Penn Central.
The meaning of the words in issue in this appeal,
the words in Regulation 805(1) "except those
amounts that may reasonably be attributed to the
business carried on by him in Canada", is not, to
my mind, so clear as not to require interpretation.
The words almost suggest the question: "reason-
ably attributed" in what sense?
Counsel for the Crown submitted that the
answer to this question could best be sought by
having regard to the purpose of the exemption
provided by Regulation 805(1) as revealed by its
legislative history. Counsel submitted that the pur
pose of Regulation 805 (1) is to avoid double taxa
tion or at least to avoid the potential of double
taxation. She argued that the amounts made sub
ject to taxation by Part XIII of the Act are,
generally speaking, amounts which have their
source in property, not in business; they are, there
fore, not amounts that would be rendered taxable
under Part I by operation of subsection 2(3) of the
Act; non-residents are made taxable by subsection
2(3) if they earn income in Canada from being
employed in Canada or from carrying on business
in Canada; they are not, however, made taxable by
the subsection on income from property. It is
conceivable, however, that an amount falling
within Part XIII, interest or rent, for example,
might have its source in business carried on in
Canada by a non-resident; in such a case the
non-resident would be subject to the possibility of
being taxed under both Part I and Part XIII were
it not for Regulation 805(1). It is avoidance of this
possibility that is the purpose of Regulation
805(1).
Counsel argued that the dividends credited by
Canada Southern to Penn Central had their source
in property; their source was the Canada Southern
shares owned by Penn Central or held by it under
assignment, not the railway business carried on by
Penn Central in Canada. Not having their source
in the business being carried on in Canada, the
dividends could not reasonably be attributed to it,
however closely they might be associated with it.
Counsel for Canada Southern, on the other
hand, submitted in effect that the meaning of the
words used in Regulation 805 (1) really created
little difficulty. He submitted that the test of
whether the dividends were made exempt by Regu
lation 805 (1) is simply this: could they reasonably
be attributed to the railway business that was
unquestionably being carried on by Penn Central
in Canada? The Trial Judge found that they could
be and were. There is abundant evidence to sup
port his finding. That really is the end of the
matter. The critical issue is not whether, as a
matter of law, the source of the dividends was
"business" or "property", but whether, as a matter
of fact, the dividends could reasonably be attribut
ed to the business.
Counsel for the Crown relied to a considerable
extent on the legislative history of pertinent sec
tions of the Act and of the Regulations in support
of her submission that the purpose of Regulation
805(1) is to avoid double taxation.
In the Income Tax Act, R.S.C. 1952, c. 148
("the 1952 Act"), subsections 2(1) and (2)
provided:
2. (1) An income tax shall be paid as hereinafter required
upon the taxable income for each taxation year of every person
resident in Canada at any time in the year.
(2) Where a person who is not taxable under subsection (1)
for a taxation year
(a) was employed in Canada at any time in the year, or
(b) carried on business in Canada at any time in the year,
an income tax shall be paid as hereinafter required upon his
taxable income earned in Canada for the year determined in
accordance with Division D.
Subsection (2) is now numbered subsection (3);
it is worded somewhat differently, but the differ
ence is not significant for present purposes.
Division D, as it appeared in the 1952 Act, was
headed: "TAXABLE INCOME EARNED IN CANADA
BY NON-RESIDENTS". It consisted of one section,
section 31. Subsection 31(1) read:
31. (1) For the purposes of this Act, a non-resident person's
taxable income earned in Canada for a taxation year is
(a) the part of his income for the year that may reasonably
be attributed to the duties performed by him in Canada or
the business carried on by him in Canada,
minus
(b) the aggregate of such of the deductions from income
permitted for determining taxable income as may reasonably
be considered wholly applicable and of such part of any other
of the said deductions as may reasonably be considered
applicable.
Part III of the 1952 Act was headed: "TAX ON
INCOME FROM CANADA OF NON-RESIDENT PER
SONS", the same heading as now applies to Part
XIII. Subsection 106(1) provided that " Every
non-resident person shall pay an income tax of
15% on every amount that a person resident in
Canada pays or credits ... on account or in lieu of
payment of, or in satisfication of " certain items,
including among others, dividends, interest, and
rents and royalties, subject, however, to specified
limitations.
Subsection 805 (1) of the Regulations was first
enacted by SOR/54-682, effective January 12,
1955. It provided:
805. (1) Where a non-resident person, other than a registered
non-resident insurance company, carries on business in Canada
he shall be taxable under Part III of the Act on all amounts
otherwise taxable under that Part except such amounts as are
included in computing his income for the purpose of Part I of
the Act.
Under this Regulation it is clear that an amount
that would otherwise fall within Part III as being,
for example, a dividend or an interest payment
would be exempt from taxation under Part III if it
were included in computing his income for the
purpose of Part I. Double taxation, at least to this
extent, would have been avoided. At this time, a
non-resident taxpayer was subject to tax under
either Part I or Part III, but not both. I would
note, however, that a non-resident might nonethe
less, by virtue of deductions or exemptions, escape
tax entirely.
The wording of Regulation 805 (1) was changed,
effective in 1957, by SOR/57-4. As amended, the
Regulation read:
805. (1) Where a non-resident person, other than a registered
non-resident insurance company, carries on business in Canada
he shall be taxable under Part III of the Act on all amounts
otherwise taxable under that Part except that part of his
income that may reasonably be attributed to the business
carried on by him in Canada.
A consequence of the change in wording was
that the exemption provided by Regulation 805(1),
so far as it related to carrying on business in
Canada, was expressed in exactly the same words
as those used in paragraph 31(1)(a) of the Act. I
do not think that a substantive change was intend
ed by this change in the wording of the Regula
tion. Rather, it appears to me that the intent was
to make the purpose of avoiding double taxation
even more clear by using the very wording of
paragraph 31(1)(a) in the exemption provided by
Regulation 805(1).
Section 31 of the Act was amended in 1960 by
"An Act to amend the Income Tax Act", S.C.
1960, c. 43. Subsection 6(1) of the amending Act
repealed paragraph 31(1) (a) and substituted:
31. (1) ...
(a) his income for the year from all duties performed by
him in Canada and all businesses carried on by him in
Canada,
It may be worthy to note once again that, before
the 1960 amendment, paragraph 31(1) (a) of the
Act, as it related to business carried on in Canada,
provided that a non-resident's taxable income
earned in Canada for a taxation year " is the part
of his income for the year that may reasonably be
attributed ... to the business carried on by him in
Canada ". The 1960 amendment replaced these
words by the substituted paragraph 31(1)(a), but
the words were left unchanged in the Regulation.
The very problem central to this appeal lurks in
the continuing use of these words in the Regula
tion: can an amount credited to a non-resident that
has its source in property be considered to be an
amount that may reasonably be attributed to the
business which the non-resident carried on in
Canada?
Regulation 805 (1) was revoked and replaced in
1969 by SOR/69-631. The substituted Regulation
was the one in effect during the taxation years in
question in this appeal. I have quoted it earlier in
these reasons. I will, however, repeat it here for
convenience of reference:
805. (1) Where a non-resident person carries on business in
Canada he shall be taxable under Part III [Part XIII] of the
Act on all amounts otherwise taxable under that Part except
those amounts that may reasonably be attributed to the busi
ness carried on by him in Canada.
The amounts which are exempted from the
amounts that otherwise would be taxable under
Part III are "those amounts that may reasonably
be attributed to the business carried on by him in
Canada" whereas, before the amendment, what
was exempted was "that part of his income that
may reasonably be attributed to the business car
ried on by him in Canada".
This was the situation when what is sometimes
referred to as "the new Income Tax Act" came
into force in 1971, the Act which appears as
chapter 63, S.C. 1970-71-72. The new Act sub
stituted a newly worded Division D for the former
Division D. The relevant provisions of the new
Division D appear in section 115 of the Act. I will
quote subparagraphs 115(1)(a)(i) and (ii).
115. (1) For the purposes of this Act, a non-resident person's
taxable income earned in Canada for a taxation year is the
amount of his income for the year that would be determined
under section 3 if
(a) he had no income other than
(i) incomes from the duties of offices and employments
performed by him in Canada,
(ii) incomes from businesses carried on by him in Canada,
minus the aggregate of such of the deductions from income
permitted for the purpose of computing taxable income as
may reasonably be considered wholly applicable and of such
part of any other of the said deductions as may reasonably be
considered applicable.
My examination of the legislative history of
Regulation 805(1) leads me to the conclusion that
there has been and remains a close link between
the exemption it provides in respect of amounts
taxable to non-residents under Part XIII of the
Act and the tax imposed on non-residents in
respect of income they receive from businesses
they carry on in Canada. From 1955 to 1957, the
exemption in Regulation 805(1) applied only to
amounts, received by or credited to non-residents,
which would be included in their income for the
purpose of computing their taxable income under
Part I. From 1957 to 1960, the exemption in
Regulation 805(1) was defined in the same words
as those used in paragraph 31(1)(a) of the Act to
impose a Part I tax on non-residents receiving
income from Canada which could reasonably be
attributed to business carried on by them in
Canada. The 1960 amendment to paragraph
31(1) (a), which made taxable income received by
non-residents from business carried on by them in
Canada, did not in my opinion change in substance
the law as it was before the amendment: if any
thing, it simply made quite clear that to be taxable
by virtue of subsection 2(3) of the Act income
would have to be income from a business carried
on by a non-resident in Canada; income properly
classifiable as income from property would thus
not be caught by subsection 2(3). I am also of the
view that the words used in Regulation 805(1)
between 1957 and 1960, "that part of his income
that may reasonably be attributed to the business
carried on by him in Canada", were intended to
exempt only income from the business carried on
by him in Canada, and not income from property
even if it could be attributed to the business in a
broad sense.
It follows that the 1960 amendment to para
graph 31(1)(a) of the Act did not create a gap
between the amounts that would be exempted by
Regulation 805 (1) and the amounts that would be
included in income for purposes of paragraph
31(1)(a). The avoidance of double taxation
remained the intent throughout, and it was never
the intention to create a gap in which there would
be no taxation at all. The 1960 amendment was
not, as I read it, designed to exclude from para
graph 31(1)(a) income which, before the amend
ment, would have been caught by the paragraph.
Nor, in my view, did the 1969 amendment to
Regulation 805(1) have the effect of broadening
the scope of the exemption provided by the Regu
lation. The substitution of the words "except those
amounts" for the words "except that part of his
income" results in a wording of the Regulation
805(1) exemption that fits more comfortably with
the wording of Part XIII; Part XIII taxes specified
"amounts"; section 115 has the effect of taxing
"income".
The legislative history persuades me that, for
purposes of Regulation 805(1), the only amounts,
otherwise taxable under Part XIII, that can be
said to be reasonably attributable to the business
carried on in Canada by a non-resident person are
amounts which can properly be classified as
income from that business. The words in issue, the
words used in Regulation 805(1), may be open to
either of the views put forward by counsel, but the
history of the regulations persuades me that this is
the reading which is in accordance with the legis
lative purpose of the exemption.
Even apart, however, from the legislative histo
ry, subsection 2(3), section 115, and Part XIII of
the Act, and Regulation 805(1), when considered
together, would appear to me to indicate an inten
tion to exempt from taxation amounts that other
wise would fall within Part XIII if they would be
subject to taxation under Part I by virtue of falling
within subparagraph 115(1)(a)(ii) of the Act. It is
by virtue of subsection 2(3) and Part XIII of the
Act that non-residents are made subject to
Canadian income tax. It makes good sense to
recognize that the amounts specified in Part XIII
may occasionally attract tax under Part I, as they
would if they were properly classifiable as income
from business, and in such cases to exempt them
from taxation under Part XIII.
My conclusion that, to be exempt by virtue of
Regulation 805(1), an amount must be attributed
to the business carried on in Canada in the sense
of being an amount earned from that business does
not, however, in itself resolve this appeal. A dif
ficulty remains. Income which, at first sight, may
appear to be income from property may, on closer
analysis, turn out to be income from business.
Rental income is an obvious example. Rents from
property are generally considered to be income
from property, but not if the owner so manages the
renting as to make a business of it. For an analysis
of the problems involved see Wertman, Henry v.
Minister of National Revenue, [1965] 1 Ex.C.R.
629, particularly at pages 644-646.
Could then the dividends in question be regard
ed as income from Penn Central's railroad busi
ness carried on in Canada?
It may be useful to keep in mind that the
business carried on in Canada by Penn Central
was railway transportation. It is true that Michi-
gan Central was to all intents and purposes a
wholly owned subsidiary of Penn Central and that,
by virtue of the shares of Canada Southern owned
by Penn Central in its own right or under assign
ment, Penn Central controlled Canada Southern.
It remains, however, that each of these corpora
tions was a separate legal person. It remains, too,
that Penn Central had a sublease, a contract, with
Michigan Central and that Michigan Central had
a lease with Canada Southern; each year sums
became owing to Michigan Central by Penn Cen
tral and by Michigan Central to Canada Southern.
The railway business which Penn Central carried
on in Canada, using the railroad property owned
by Canada Southern, was the business of Penn
Central, not of Michigan Central or of Canada
Southern. Canada Southern did not carry on busi
ness at all during 1972 and 1973; it received what
income it did receive from its property, including
the railroad property it rented to Michigan Cen
tral. All three corporations were parties to the
waiver agreement, but this agreement was essen
tially designed as a means of settling the accounts
periodically accruing in respect of rentals and
dividends. The dividends credited by Canada
Southern to Penn Central were dividends, and the
rentals and sums which became owing periodically
by Penn Central to Michigan Central and by
Michigan Central to Canada Southern were sums
owed in respect of "rentals".
In my opinion, for purposes of the Income Tax
Act, the source of the dividends was the Canada
Southern shares. The moneys used by Canada
Southern to pay the dividends were funds available
to the directors of Canada Southern for dividend
declaration. These funds were the proceeds of the
rental of the railroad property, property owned by
Canada Southern, and, I gather, from other invest
ments owned by Canada Southern. It is true that,
had it not been for the rental of the railroad
property, Canada Southern might not have been
able to declare and pay dividends, and that the
rentals were so calculated as to ensure that, so far
as possible, a $3 dividend would be paid each year
on each share outstanding. It is also clear that
Penn Central was in effective control of Canada
Southern. It remains, however, that the source of
the dividends was the shares and that the shares
were property: see Canada Safeway Limited v.
The Minister of National Revenue, [1957] S.C.R.
717, particularly per Mr. Justice Rand at pages
725 and 726.
On the facts of the present case, it could not be
seriously argued that Penn Central was in the
business of dealing in stock, and no such submis
sion was made. There may, however, be another
possibility. There is some authority for the proposi
tion that income from property that is being used
in a business may, in appropriate circumstances,
be income from the business itself; an example
might possibly be income in the form of interest
from a bank account, the bank account being used
in the day-to-day operation of the business. This
proposition was applied in Liverpool and London
and Globe Insurance Company v. Bennett, [1913]
A.C. 610 (H.L.). Its scope and limitations were,
however, carefully examined in Bank Line Ltd. v.
Commissioners of Inland Revenue (1974), 49 T.C.
307 (Sess.). In Bank Line, a company engaged in
the trade of owning and operating ships estab
lished a ship replacement fund. The company
invested sums not required for immediate use in
government and short term securities so as to have
funds available to meet requirements for replace
ment of its fleet. The company sought to treat the
interest it received from these investments as
income from its business or trade, but failed in
that attempt. The Lord President said at pages 316
and 317:
Before us it was common ground between the parties to the
appeal that the test to be applied is the test which was
formulated by Buckley L.J. in the insurance company cases
reported as Liverpool and London and Globe Insurance Co. v.
Bennett 6 T.C. 327. That test, under reference to the opinion of
Buckley L.J., at page 374, is whether the interest represented
profits of the business as fruit derived from a fund employed
and risked in the business. The business, and indeed the only
business, of this Company was the business of owning and
operating ships, and the question accordingly comes to be
whether their ship replacement fund can properly be said to
have been "employed and risked" in that business in each of the
accounting periods.
Also in Bank Line, Lord Avonside said at page
333:
As has already been said, it is found as a fact that the
Appellants carry on no activity other than that of owning and
operating ships. It is plain, in my opinion, that this fact does not
in any way lead to the conclusion that the income from capital
funds owned by the Appellants must be looked on as trading
receipts. Income becomes a trading receipt when it arises from
capital actively employed and at risk in the business, capital
which is employed in the business because it is required for its
support or, perhaps, to attract customers looking to the credit
of the business. Trading income is "the fruit" of the capital
employed in the business in a present and active sense. The
classic example is the insurance company. Apart from special
contracts, the capital of such a company is at immediate risk
when a policy is issued and remains at constant risk during the
continuance of that policy.
I would observe that the learned Trial Judge in
the present case did say, of the dividends credited
to Penn Central by Canada Southern, that they
"were amounts taxable under Part I, rather than
Part XIII of the Act." The dividends, however,
would be taxable to Penn Central under Part I,
only if they fell within subparagraph 115(1)(a)(ii)
of the Act, only if they were income from the
business carried on by Penn Central in Canada. I
have no doubt that, if the dividends did constitute
such income, they would be exempted from Part
XIII by Regulation 805(1).
I did not, however, understand counsel for the
respondent to argue that the dividends were
income from the business carried on by Penn
Central in Canada and thus subject to tax under
Part I. Possibly this was because, on his submis
sion, the dividends, even if income from property,
were, as the learned Trial Judge found, reasonably
attributable to the business carried on by Penn
Central in Canada. Counsel suggested in oral
argument that, having found that the dividends
were reasonably attributable to the Canadian busi
ness, the Trial Judge merely meant to indicate that
the dividends would be taxable under Part I if they
were taxable at all. It remains, however, that the
Trial Judge did say that the dividends were tax
able under Part I.
The critical question in determining whether the
dividends from the Canada Southern shares may
be considered to be income from Penn Central's
business carried on in Canada is not whether the
dividends were used in the business. The question
is rather whether the shares themselves constituted
a fund "employed and risked" in the business. I
simply do not find it possible on the facts to hold
that they were. On this point I have found helpful
the judgments of this Court in R. v. Marsh &
McLennan, Limited, [1984] 1 F.C. 609, and The
Queen v. Ensite Limited, (No. I) (1983), 83 DTC
5315, although in both cases the essential issue
was whether the income in question was income
from property used in the business rather than
whether it was income from the business.
For all of these reasons, I would allow the
appeal with costs. I would set aside the judgment
of the Trial Division and substitute a judgment
dismissing with costs the appeal to the Trial
Division.
HEALD J.: I concur.
STONE J.: I concur.
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