(Income) Taxation – Fall 2011(Income) Taxation – Fall 2011Professor: Professor: Claudette AllardClaudette Allard

Summary:Summary: Michael Shortt Michael Shortt

Where you’ll learn that the textbook authors think the details of tax law don’t matter;Where you’ll learn that the textbook authors think the details of tax law don’t matter;that they’re wrong; that £10 tax cases go to the House of Lords; that they’re wrong; that £10 tax cases go to the House of Lords;

and that even in tax law, home is where the heart is.and that even in tax law, home is where the heart is.

Note: numbers in [brackets] refer to textbook pages. Also, I haven’t included any of the examples we worked out Note: numbers in [brackets] refer to textbook pages. Also, I haven’t included any of the examples we worked out in class, but they’re really important to understand what’s going on, especially in the later parts of the classin class, but they’re really important to understand what’s going on, especially in the later parts of the class

(capital gains, ECE, etc). Do them!(capital gains, ECE, etc). Do them!

Table of ContentsCHAPTER 1: INTRODUCTION.........................................2Section 1.1: Sources of Tax Law.............................................................2Section 1.2: Structure of Tax Law..........................................................2Section 1.3: Introduction to Canadian Income Tax..............................3Section 1.4: The (Federal) Income Tax Act............................................3Section 1.5: MNR’s Assumptions and the Evidentiary Burden...........4Section 1.6: Constitutional Issues in Tax Law.......................................4CCHAPTERHAPTER 2: S 2: STATUTORYTATUTORY I INTERPRETATIONNTERPRETATION................................................55Section 2.1: Summary of Text’s Materials on Tax Interpretation.......6

2.1.1 Historical Position...........................................................................62.1.2 The Modern Approach....................................................................72.1.3 Other Rules and Definitions............................................................7

CCHAPTERHAPTER 3: T 3: TAXATIONAXATION U UNITNIT................................................................................88Section 3.1: Subjects of Taxation............................................................8Section 3.2: Residency..............................................................................9

3.2.1 Statutory Provisions........................................................................93.2.2 Resident or Ordinarily Resident - Persons......................................93.2.3 Corporations..................................................................................123.2.4 Trusts.............................................................................................12

CCHAPTERHAPTER 4: T 4: THEHE S SOURCEOURCE C CONCEPTONCEPT OFOF I INCOMENCOME..............................1212Section 4.1: Introduction.......................................................................12

4.1.1 Statutory Provisions......................................................................134.1.2 General Cases and Materials on “Sources”..................................134.1.3 Nexus Between a Taxpayer and a Source of Income...................144.1.4 The Innominate Source Concept...................................................15

CCHAPTERHAPTER 5: I 5: INCOMENCOME FROMFROM O OFFICEFFICE OROR E EMPLOYMENTMPLOYMENT................1515Section 5.1: Introduction.......................................................................15Section 5.2: Employee or Independent Contractor?...........................15Section 5.3: Inclusions............................................................................18

5.3.1 Benefits.........................................................................................195.3.2 Valuation.......................................................................................215.3.3 Allowances....................................................................................22

Section 5.4: Deductions..........................................................................235.4.1 Travel Expenses............................................................................245.4.2 Legal Expenses.............................................................................245.4.3 Professional and Union Dues........................................................25

CCHAPTERHAPTER 6: I 6: INCOMENCOME FROMFROM B BUSINESSUSINESS OROR P PROPERTYROPERTY..................2525Section 6.1: Differences Between Business and Property Income.....25Section 6.2: Defining Business Income.................................................26Section 6.3: Inclusions in Income from Business.................................27Section 6.4: Property Income................................................................28

6.4.1 Interest Income..............................................................................286.4.2 Rent or Royalty Income................................................................296.4.3 Dividends......................................................................................29

Section 6.5: Deduction from Business/Property Income....................296.5.1 Introduction...................................................................................296.5.2 Legislative Provisions...................................................................29

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6.5.3 Business Purpose Test...................................................................306.5.4 Business Expenses vs Personal Expenses.....................................316.5.5 Some Specific Expense Types......................................................336.5.6 Public Policy.................................................................................336.5.7 Interest Expenses..........................................................................346.5.8 Reasonableness of Deductions......................................................36

CCHAPTERHAPTER 7: C 7: COMPUTATIONOMPUTATION OFOF P PROFITROFIT/T/TIMINGIMING P PRINCIPLESRINCIPLES..3737Section 7.1: Introduction to Timing Issues..........................................37

7.1.1 Timing: Recognition of Revenue..................................................387.1.2 Timing: Recognition of Expenses.................................................397.1.3 Special Cases for Recognition of Income/Expenses.....................40

Section 7.2: Inventory............................................................................41Section 7.3: Current Expense vs Capital Expenditures......................42Section 7.4: Capital Cost Allowance (Depreciation)...........................46

7.4.1 Calculation of CCA.......................................................................467.4.2 Terminal Losses and Recapture....................................................477.4.3 Other Legal Issues.........................................................................48

Section 7.5: Eligible Capital Expenditures...........................................497.5.1 Definition......................................................................................497.5.2 Calculation and Regime................................................................497.5.3 Classifying Eligible Capital Expenditures....................................49

CCHAPTERHAPTER 8: C 8: CAPITALAPITAL G GAINSAINS ANDAND L LOSSESOSSES..........................................5050Section 8.1: Overview and Solutions Map............................................50Section 8.2: Capital Gain or Adventure in the Nature of Trade?......50

8.2.1 Calculating Capital Gains.............................................................528.2.2 Adjusted Cost Base.......................................................................528.2.3 Disposition and Proceeds of Disposition......................................538.2.4 Capital Losses...............................................................................558.2.5 Non-recognized Capital Losses....................................................568.2.6 Intra-Family Transfers..................................................................568.2.7 The Principal Residence...............................................................56

CCHAPTERHAPTER 9: D 9: DEDUCTIONSEDUCTIONS....................................................................................5858Chapter 10: List of ITA Provisions Used in Class...............58

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Chapter 1: Chapter 1: IntroductionIntroductionTax is intellectually exciting because it constitutes the rules of a fast game played by dedicated people for high stakes. [3]

Section 1.1: Sources of Tax LawThe Income Tax Acts: Federal and Québec Acts are quite similar. We focus on Federal for obvious reasons. These acts are long, strangely drafted, and exceedingly complex. They are detailed, but the details change every six to twelve months, so that memorizing the details really isn’t worth it, even for practitioners. The Department of Finance is empowered to amend the ITA by regulation.

Case Law: Rendered by a small number of specialized courts and tribunals, such that jurisprudence has remained remarkably coherent over time.

Canada Revenue Agency: If a taxpayer and the CRA disagree about an assessment, the taxpayer can object to the Objection Branch of the CRA. Tax Court of Canada (formerly Tax Review Board): Created to handle tax matters instead of the Federal Court. Appeals from the Objection Branch are heard here.Federal Court of Appeal: Appeals from the TCC to the FCA are as of right, strangely enough.Supreme Court of Canada: Must grant leave to appeal. Tends to render wackier/less predictable judgments.

Occasionally provincial courts will hear tax cases, but generally only tangentially to other issues.

Administrative Documents: The Canada Revenue Agency issues Interpretation Bulletins, Information Circulars and other administrative documents in which it sets out its position on how the ITA should be interpreted, and how it intends to apply the ITA. These documents do not have force of law, but are considered by judges (see [254] for a judge rejecting IT Bulletin use). Note that these opinions are not binding on the CRA either. It can change its mind, even retroactively and without issuing new documents.

A special kind of administrative document is the tax ruling, which is like a pre-clearance or pre-assessment of the tax effects of a given transaction. The taxpayer tells the CRA what he or she plans to do and the CRA tells the taxpayer what the tax consequences will be. If the taxpayer carries out the plan exactly as documented in the tax ruling, the CRA is bound by its ruling. Any deviation and all bets are off.

Doctrine: Often written by practitioners. Few tax academics exist in Canada. I didn’t get the impression this was a very important source. Funnily enough, the textbook refers to practitioners making “indecent amounts of money” in tax law [3]!

Legislative Debates: The textbook deals with the use of Hansard and other parliamentary materials to interpret tax law at [763-764]. For a long time there was a common law prohibition on using this rule, but the rule was increasingly ignored over the course of the twentieth century and there plenty of examples in modern Canadian law.

Another source is, arguably, administrative practice and political expediency, since MNR has a fair amount of discretion to settle cases or otherwise make discretionary decisions about how to handle a particular tax lawsuit. Optical Recording Co v MNR (1990), (116 NR 200): MNR has authority to settle tax cases on whatever grounds seem to be in the public interest (ex: to avoid causing the bankruptcy of the taxpayer due to a sudden unpaid tax lawsuit, it might be best to accept 50% of the value, or to extend payment of back taxes over several years).

Section 1.2: Structure of Tax LawAll taxes have the following five characteristics:

Tax base: What is taxed?Tax filing unit: Who pays the tax?Tax rates: Method of calculating tax, typically a percentage.Tax period: Typically annual for income tax, but can be per-transaction (sales tax) or otherwise.Collection Structure: How is the tax collected?

Some specific taxes in Canada include payroll taxes (levied on corporations, and sometimes employees, in order to pay for programs like worker’s compensation, the Canada Pension Plan, etc), sales tax (single-stage vs value-added (HST)), federal Excise Tax (on

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tobacco, alcohol, gas, jewels, etc). Some taxes are on assets, like municipal property taxes and some special corporate taxes (although the latter are being phased out).

Two taxes that Canada does not have are estate (inheritance) and gift taxes. For historical reasons these have never been adopted here. Note that you need both to have an effective taxation system. Estate taxes alone would result in people giving away all of their property shortly before death.

Section 1.3: Introduction to Canadian Income TaxTax is defined as money collected by the government that is not matched with a particular quid pro quo or other government benefit . So it is not a payment to the government for a service (like tolls for a bridge). Income tax is a tax on the income of all physical and legal persons, as well as trusts, in Canada. It makes up half of the income of the Federal Government.

Tax base: Non-excluded income from a source.Tax filing unit: Physical persons, corporations, trusts.Tax rates: Progressive percentage rates [see handouts]. Some jurisdictions have surtaxes. This is a tax on your tax: suppose you pay $5000 in taxes on your income and there is a 20% surtax on all taxes over $4000. You pay $1000 in taxes above $4,000, so your surtax is: 20%*$1000= $200. Total taxes $5200. Tax period: Calendar year for individuals and trusts, with losses carrying over between years; corporations can choose their fiscal year.Collection Structure: CRA, plus appeals/judicial control via TCC, FCA, SCC.Special rule for Quebec: Taxpayers in Québec also get to take 16.5% off of the Federal taxes. So multiply fed taxes by 0.835.

The term “tax expenditure” means taxes forgone by the government due to tax breaks or rebates or exemptions. Most tax expenditures are calculated as deductions from tax, rather than deductions from income, because this is fairer. Most are also non-refundable, so that at best they reduce your taxes to zero and you cannot get money back. There are three exceptions to this: GST rebate, child tax credits, and a special medical expense tax credit.

Other concepts/principles of tax law: horizontal equity (tax payers in similar situations should be treated equally), vertical equity (taxpayers in unequal or different situations should be treated differently). Horizontal equity seems to be a very strong principle in many of the employment income cases; the judges are always asking: “Should this taxpayer be treated any differently from the millions of other working Canadians?” Marginal tax rate (“if I earn one more dollar, at what rate will it be taxed?” – note that your marginal rate increases as you make more money, because we have a progressive income tax). Average tax rate (“What percentage of my income goes to tax?” note that your average tax rate will be lower than your marginal rate, since you pay a lower rate on your initial income, then a progressively higher rate, so that the average is always behind, but catching up to, the marginal rate). Effective tax rate is a term used to reflect the fact that your taxable income may diverge from your real/accounting income.

Section 1.4: The (Federal) Income Tax ActThe Act consists of 17 Parts and about 40 subparts. This class will focus on Part 1 (Income Tax) and 17 (Interpretation).

Part 1: Income Tax. Consists of several divisions and subdivisions. Division B = computing taxes; this is the basic charging section. Section 2 establishes the taxing units. Section 3 establishes the tax base/income from a source concept. Section 4 deals with losses.

Subdivision A: Office or Employment Income. Sections 5-8.Subdivision B: Business or Property Income. Sections 9-37Subdivision C: Capital gains or losses. Sections 38-55.Subdivision D: Other sources. Sections 56-59.Subdivision E: Deductions in computing income. Sections 60-66.Subdivision F: Rules relating to the computation of income. Sections 67-80.Subdivision G: Amounts not included in computing income (exempt income). Sections 81.

Division C: Computation of Taxable Income…

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Section 149 exempt persons.…

Part 17: Interpretation. Dozens, maybe hundreds, of definitions are contained in section 248, the main definitional clause of the Act. But many parts and even some sections contain special definitions that only apply to that part/section/etc.

Allard Don’t take anything for granted. Many words are defined in strange ways in the ITA, that may be broader or narrower than their everyday meaning.

Non-tax Goals of the Income Tax Act The government publishes a list of over 100 provisions in the Tax Act which are “deliberately used as instruments to further specific social and economic policies” beyond merely raising revenue [3-4].

Referring to parts of the ITA 88 section88(1) subsection88(1)(c) paragraph88(1)(c)(vi) subparagraph88(1)(c)(vi)(B) clause88(1)(c)(vi)(B)(III) subclause88(1)(c)(vi)(B)(III)1. sub-subclause

Section 1.5: MNR’s Assumptions and the Evidentiary BurdenGeneral SchemaThis step-by-step procedure is taken from Hickman Motors v The Queen (an SCC case quoted in Maurice v The Queen para 19):

(1) The MNR is permitted to make assumptions about the taxpayer and the taxpayer’s circumstances.(2) The taxpayer has the burden of “demolishing” the MNR’s assumptions by making out a prima facie case against the exact assumptions made by the MNR.

(a) If the taxpayer cannot make out a prima facie case, the assumptions are upheld.(b) If the taxpayer succeeds in raising a prima facie case, continue.

(3) If the prima facie case is made out, the burden shifts to the MNR to rebut the taxpayer’s case and prove that the MNR’s assumptions are correct according to the civil standard of balance of probabilities.

(a) If the MNR adduces no evidence, the taxpayer succeeds by default.

The Queen v Bowens (quoted in Maurice para 20): “Unpleaded assumptions can have no effect on the burden of proof either way.”Youngman v Queen [282]: The taxpayer has to disprove the result reached by the Minister by providing a better answer. It is not enough to just show that the Minister’s method of calculation was arbitrary or based on shaky foundations. After all, the minister might be right for the wrong reasons, or there may not be any better answer than the one that the Minister came up with. Hence the taxpayer has to provide an alternative result, or at least prove that the Minister’s result is incorrect or unreasonable.

Section 1.6:Constitutional Issues in Tax Law

Constitution Act, 1867The book doesn’t really deal with the federalism aspects of tax law, which is too bad, because it’s actually fascinating. For example, did you know that provincial sales taxes stand on very shaky constitutional ground? The reason for this is the way in which taxation powers are allocated by the Constitution Act, 1867:

Federal: 91(3) The raising of money by any mode or system of taxation.Provincial: 92(2) Direct taxation within the Province in order to the raising of a revenue for provincial purposes.

There are effectively no limits on how the Federal Government can raise or spend money. By contrast there are three limitations on the way the provinces can tax: (1) It must be a direct tax; (2) it must be raised within the province; (3) the money must be used for provincial purposes.

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For this class we don’t care about restriction (3) (NB: since provincial taxation must be spent on “provincial purposes,” but there is no restriction of federal taxation to “federal purposes,” this is one of the strongest arguments in favour of the Federal Spending Power). The other two restrictions have been used successfully to defeat provincial taxes. Restriction (1), the “direct taxation” requirement, has been largely finessed by the Supreme Court so that it does not really apply in any meaningful way. The phrase “direct taxation” was interpreted by the Supreme Court and the Privy Council to mean a tax whose general effect falls upon the person who pays it, rather than being passed along to someone else (Bank of Toronto v Lambe, (1887) 12 AC 75). So income tax and property tax are direct, because it’s impossible to pass them on to someone else. But sales taxes and customs duties are normally thought of as indirect taxes, since the importer, manufacturer, or retailer can increase the price and effectively make the consumer pay. If this theory were strictly applied, provincial sales taxes would be illegal. To avoid this outcome, the provinces argue that their sales tax statutes empower the retailer to act as the province’s taxing agent and apply the tax “directly” to the consumer. The Supreme Court has accepted this argument, since it is unwilling to strike down an important source of provincial revenue, and thus provinces effectively can impose indirect taxation (British Columbia (AG) v Canadian Pacific Railway, [1927] AC 934; Cairns Construction v Government of Saskatchewan, [1960] SCR 619). Every once in a while though, provincial taxes are struck down as being indirect taxes, although these are typically newer taxes whose annulment that won’t threaten the provincial budget: Canadian Industrial Gas & Oil v Government of Saskatchewan, [1978] 2 SCR 545.

Restriction (2), the “within province” requirement, was used to strike down taxation of banks when the tax was imposed on Canada-wide assets as assets (e.g. when bonds located in Ontario via were taxed by Quebec’s succession tax (The Queen v National Trust Co, [1933] SCR 670)). However, it is permissible to tax a resident of the province as a person on his worldwide income: Kerr v Canada (Superintendant of Tax Income), [1942] SCR 435. One amusing case that struck down a provincial tax on this basis is Canadian Pacific Airlines v British Columbia, [1989] 1 SCR 1133: BC had tried to impose sales tax on sales made on airplanes while they were in flight; this was ruled to be taxation of transactions outside the province’s borders!

Since the Federal ITA is virtually immune from constitutional challenge, we don’t really need to worry about the Constitution Act, 1867. But if you ever go into tax practice, keep in mind that provincial and municipal tax statutes are more vulnerable.

Constitution Act, 1982The textbook notes that there hasn’t been a lot of Charter litigation related to the ITA [760-761], largely because economic interests are not protected by the Charter. However, information gathering by the CRA is constrained by the Charter’s section 8 search and seizure provisions [761]. Warantless auditing, for example, was struck down in The Queen v Norway Insulation Inc, [1995] 2 CTC 451 [761]. Evidence tainted by unreasonable search and seizure is routinely excluded from tax cases, because the state interest in using the evidence to obtain a marginal increase in the tax base is almost never a compelling reason to allow breach of Charter rights (Jurchison v MNR, [2000] 1 CTC 2762).

Attempts to invoke section 15(1) of the Charter to argue that certain provisions are invalid because they treat taxpayers unequally have had a mixed level of success. See Symes v The Queen at section 6.5.4 for an example of a failed equality argument about the deductibility of childcare expenses. However, in Re Rosenberge et al, [2000] 2 CTC 83, the Ontario Court of Appeal allowed a challenge of the definition of “spouse” under the ITA, ruling that the failure to include same-sex couples was discriminatory [762-763].

Chapter 2: Chapter 2: Statutory InterpretationStatutory InterpretationSince statutory interpretation seems to be so central to taxation, I decided to consolidate a lot of that subject in a separate chapter. It is supplemented with information from beyond the course.

Sullivan on the Construction of Statutes is cited (literally) every time the SCC interprets a law. Their favourite passage is the following:

Today there is only one principle or approach, namely, 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.

This is called the “Modern Approach” to statutory interpretation. Note that it doesn’t actually provide much guidance to judges about

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what any particular law means, but it does emphasize two things: the diversity of sources of evidence that must be considered, and the necessity of considering all of them, rather than prioritizing one over the others. As our text puts it “the modern approach leaves unclear what relative weight should be given to the ordinary meaning, context, and purpose.” [755]

Every jurisdiction has an Interpretation Act. Most of the Interpretation Acts’ provisions are technical in nature (whether holidays are counted in statutorily-prescribed time limits; references to the male gender include women unless the context indicates otherwise), or replicate common law interpretation rules (repeal of an act does not affect vested rights already conferred by that act), or are routinely ignored by the courts (most Interpretation Acts declare that all statutes are remedial statutes, as opposed to punitive ones, and thus deserve a large and liberal interpretation, but courts never apply these provisions in practice). Interpretation statues are almost never referred to by judges [all the above at 759]. The text also discusses bilingual legislation briefly [760].

Section 2.1: Summary of Text’s Materials on Tax Interpretation

2.1.1 Historical PositionThe common law was never particularly fond of income tax, leading to a historical position of strictly interpreting all tax statutes. The result of this was that ambiguities favoured taxpayers, since only taxpayers clearly within the letter of the provision were taxed. The ease with which the Income Tax Act can be amended may also have encouraged judges to adopt this approach, since loopholes were closed shortly after being exploited.

Partington v Attorney General (1869-1870) [750]: “If the person sought to be taxed comes within the letter of the law he must be taxed, however great the hardship may appear to the judicial mind to be. On the other than, if the Crown, seeking to recover the tax, cannot bring the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be. In other words, if there be admissible, in any statute, what is called an equitable construction, certainly such a construction is not admissible in taxing statutes, where you can simply adhere to the words of the statute.”

The Cape Brandy Syndicate v CIR (1920) [751]: “But it is often endeavoured to give that maxim [referring to Partington] a wide and fanciful construction. It does not mean that the words are to be unduly restricted against the Crown, or that there is to be any discrimination against the Crown in such Acts. It means this… in taxation you have to look simply at what is clearly said. There is no room for any intendment [intention? –Mike]; there is no equity about tax; there is no presumption as to tax; you read nothing in; you imply nothing, but you look fairly at what is said and what is said clearly and that is the tax.”

Commissioner of Inland Revenue v Duke of Westminster (1936) [757]: Case gave rise to the Duke of Westminster principle, namely that taxpayers are entitled to arrange their affairs so as to minimize the amount of tax payable.

The strict interpretation of taxation statutes also applied to tax exemptions and rebates. In Witthuhn v MNR (1957) [750] a sick woman was denied a tax credit available to sick persons who were confined by their disease “to bed or a wheelchair” because she spent several hours a day in a rocking chair built especially for her. The judge wrote: “However much one may consider that, in equity, a taxpayer should be entitled to a deduction in circumstances such as those present in this appeal, nevertheless if those circumstances do not coincide with the strict wording of the legislation, this Board has no jurisdiction to extend the provisions of the statute by granting the deduction claimed.”

However, in Johns-Manville Inc v The Queen (1985) [751] the Supreme Court of Canada stated that taxpayers should receive the benefit of the doubt for tax exemptions, as part of a general policy of interpreting taxation statutes in favour of the payer and against the government: “where the taxing statute is not explicit, reasonable uncertainty or factual ambiguity resulting from lack of explicitness in the statute should be resolved in favour of the taxpayer.”

Ransom v Higgs (1974) (quoted in Stubart) [754]: “It may seem hard that a cunningly advised taxpayer should be able to avoid what appears to be his equitable share of the general fiscal burden and cast it upon the shoulders of his fellow citizens. But for the Courts to try to stretch the law to meet hard cases (whether the hardship appears to bear on the individual taxpayer or on the general body of taxpayers as represented by the Inland Revenue) is not merely to make bad law but to runs the risk of subverting the rule of law itself.”

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Canada v Fries (SC 1990) [quoted at 87]: This is the strike pay case. In it the closest the SCC came to a legal argument was “the benefit of the doubt must go to the taxpayer.”

2.1.2 The Modern ApproachIntroduction of the Modern ApproachStubart Investments v The Queen (1984) [752]: The SCC noted that the historical common law position was based on the view of taxation statutes as punitive statutes, since there was no quid pro quo for the taxpayer. This has changed as the role of taxation and of the state has changed, so such an approach is no longer appropriate. Driegder’s Modern approach should be adopted). The Court then offered the following guidelines:

(1) When the facts reveal no bona fide business purpose for the transaction, section 137 [an early form of anti-avoidance rule] may be found to be applicable depending upon all the circumstances of the case.

(2) In those circumstances where section 137 does apply, the older rule of strict construction of a taxation statute, as modified by the courts in recent years, prevails, but will not assist the taxpayer where:

(a) the transaction is legally ineffective or incomplete; or (b) the transaction is a sham within the classical definition.

(3) Moreover, the formal validity of the transaction may also be insufficient where:(a) the setting the Act of the allowance, deduction, or benefit sought… clearly indicates a legislative intent to restrict such benefits to rights accrued prior to the establishment of the arrangement adopted by a taxpayer purely for tax purposes.(b) the provisions of the Act necessarily relate to an identified business function. [followed by a quotation to American doctrine that doesn’t help clarify what this actually means – Mike](c) the “object and spirit” of the allowance or benefit provision is defeated by the procedures blatantly adopted by the taxpayer…

The SCC noted that these guidelines fell well short of the generalized bona fide business purposes test advanced by the government’s lawyers. The SCC did criticize the “action and reaction” cycle between tax lawyers and tax collectors.

Nuancing The Modern ApproachThe SCC veered back and forth in its interpretation of taxation statutes in the years following Stubart [755-756].

Antosko v The Queen (SCC 1994) [755]: While acknowledging the importance of the Modern Approach, the Court noted that “such techniques cannot alter the result where the words of the statute are clear and plain and where the legal and practical effect of the transaction is undisputed.”

Canada Trustco Mortgage v The Queen (SCC 2005) [756]: First consideration of the General Anti-Avoidance Rule of section 245. Adopts the “textual, contextual, and purposive” approach, which will be cited by all other tax cases dealing with statutory interpretation issues from now on. Not clear to what extent this differs from the Modern Approach. Ratio: “When the words of a provision are precise and unequivocal, the ordinary meaning of the words plays a dominant role in the interpretative process. On the other hand, where the words can support more than one reasonable meaning [emphasis added], the ordinary meaning of the words plays a lesser role. The relative effects of ordinary meaning, context and purpose of the interpretative process may vary, but in all cases the court must seek to read the provisions of an Act as a harmonious whole.”

2.1.3 Other Rules and DefinitionsFreisen v The Queen, 1995 SCC [472]: “It is a basic principle of statutory interpretation that the court should not accept an interpretation which requires the insertion of extra wording where there is another acceptable interpretation which does not require any additional wording.”

Klotz v The Queen TCC (2004) [644]: “It is of course trite law that the court cannot increase the tax assessed.”

Nowegijick v The Queen, SCC 1983 (quoted in Savage ) [249]: “The words “in respect of” are, in my opinion, words of the widest possible scope. They import such meaning as “in relation to”, “with reference to” or “in connection with”. The phrase “in respect of” [is] probably the widest of any expression intended to convey some connection between two related subject matters.”

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Bronfman Trust v The Queen (SCC 1987) [412]: “the courts must deal with what the taxpayer actually did. And not what he might have done.”

Shell Canada v Canada (SCC 1999) [757]: “Absent a specific provision to the contrary, it is not court’s role to prevent taxpayers from relying on the sophisticated structure of their transactions, arranged in such a way that the particular provisions of the Act are met, on a basis that it would be inequitable to those taxpayers who have not chosen to structure their transactions that way.” [emphasis added by textbook… presumably this statement has less weight in the context of the General Anti-Avoidance Rule]

Will-Kare Paving & Construction v The Queen (SCC 2000) [758]: Issue: Is asphalt purchased for use in a paving business being used “primarily for the purpose of sale”? Majority says no, using common law definition of sale and also Sale of Goods Acts. Binnie in dissent says yes, based on the understanding that the “ordinary taxpayer” would have of the term “for the purpose of sale.”

Denison Mines v MNR (FCA 1972) [480]: “In our view the correctness of the appellant’s position must be determined by sound business or commercial principles and not by what would be of greatest advantage to the taxpayer having regards to the idiosyncrasies of the Income Tax Act.”

R v Sutherland (SCC 1980) [168]: “The purpose of any deeming clause is to impose a meaning, to cause something to be taken to be different from that which it might have been in the absence of the clause.”

Canderel v The Queen (SCC 1998) [431]: “The law of income tax is sufficiently complicated without unhelpful judicial incursions into the realm of lawmaking.”

Allard “For greater certainty” means that something redundant is coming, so courts shouldn’t try to read it as meaning something different from similar/identical statements elsewhere in the ITA.

Implied Exclusion Rule ( expressio unis est exclusio alterius ) This is a very important common law interpretation rule, one frequently used in tax cases. The Latin version means “to express one thing is to exclude all others.” The idea is that if Parliament has turned its mind to an issue and made a decision X, then Parliament has also implicitly decided not to go beyond X. So if a provision of the ITA says “A, B, C, are all deductible” and someone asks to deduct D, the answer is that if Parliament intended to D to be deductible, it would have said D was deductible at the same time that it was making A-C deductible. The omission of D was surely deliberate, and Parliament’s deliberate omissions should be respected. This is a broad rule, and over-application can lead to unfair results (see majority ruling in Symes).

Fair Market ValueSteen v The Queen [277]: “The price at which someone not obligation to buy would pay to someone who was not obligated to sell.”

General Anti-Avoidance Rule (GAAR)Lipson v The Queen [handout, para 21+]: “In brief, GAAR denies a tax benefit where three criteria are met: the benefit arises from a transaction (ss 245(1) and 245(2)); the transaction is an avoidance transaction as defined in s 245(3); and the transaction results in an abuse and misuse within the meaning of s 245(4). The taxpayer bears the burden of proving the first two of these criteria are not met, while the burden is on the Minister to prove, on the balance of probabilities, that the avoidance transaction results in abuse and misuse within the meaning of s 245(4).”

Steward v The Queen [323]: “… it has been established that in light of the specific anti-avoidance provisions of the Act, courts should not be quick to embellish provisions of the Act in response to tax avoidance concerns.”

Chapter 3: Chapter 3: Taxation UnitTaxation Unit

Section 3.1: Subjects of TaxationTaxation units in Canada are persons, corporations, and trusts. We’re only dealing with persons, although the occasional corporation or trust crops up in the readings. Importantly, this means families are not units of taxation. This creates opportunities to shift assets

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and income between spouses, and also spouses and children.

Some persons and sources of income are tax exempt. These are all set out in s 149, including among others: municipalities 149(1)(c); crown corporations 149(1)(d); agricultural organizations, boards of trade and chambers of commerce 149(1)(e); registered charities 149(1)(f); labour organizations 149(1)(k). Tax exemptions for first nations show up in 81(1)(a). See also s 125 Constitution Act, 1867: provinces and Canada and property held by either of them are all immune from taxation.

Section 3.2:Residency3.2.1 Statutory Provisions

2(1) … income tax shall be paid … on the taxable income for each taxation year of every person resident in Canada at any time in the year.

2(3) Taxation regime for non-residents. Triggered by Canadian employment, carrying on business in Canada, or disposing of taxable Canadian property. Applies to year and previous year. Payment determined according to section D.

250. (1) For the purposes of this Act, a person shall, subject to subsection 250(2), 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 more250(3) … a person resident in Canada includes a person who was at the relevant time ordinarily resident in Canada.250(4) … a corporation shall be deemed to have been resident in Canada throughout a taxation year if

(a) it was incorporated in Canada after April 26, 1965(b) Strange special rule for corporations incorporated before April 9, 1959, that were foreign business corporations under the 1971 Income Tax Act and which paid dividends to their shareholders.(c) in the case of a corporation incorporated before April 27, 1965 (other than a corporation falling under subsection b), it was incorporated in Canada and, at any time in the taxation year or at any time in any preceding taxation year of the corporation ending after April 26, 1965, it was resident in Canada or carried on business in Canada.

250(5) Exemption for persons covered by tax treaties. This overrides the other residency requirements.250(5.1)(b) Articles of continuance (i.e. switching the jurisdiction of incorporation of a company) changes its residence.

3.2.2 Resident or Ordinarily Resident - PersonsThe main test is from Thomson, and good lists of facts to consider are at [148-149],[156],[167]. Analysis:

(1) Use case law “ordinarily resident” test s 250(3); (2) If you aren’t resident under case law, check deemed residency/sojourning under s 250(1) and 250(2). Note that sojourning deems you resident for the entire year. (3) Part time residency rules are at s 114. Effectively you pay income tax on what you earned while you were resident in Canada, plus or minus special deductions/inclusions set out in ss 114/115.

The Queen v Reeder [167]: The judge in this case synthesized the vast array of facts used to prove residence in to five broad categories: (a) past and present habits of life; (b) regularity and length of visits in the jurisdiction asserting residence; (c) ties within that jurisdiction; (d) ties elsewhere; (e) permanence or otherwise of purposes of stay abroad.

Additional argument: If every taxpayer must be resident somewhere (Thompson), then until the taxpayer can show that he is resident somewhere other than Canada, he must remain ordinarily resident in Canada. This seems to be the thrust of Fisher v The Queen [150] “He had a right to come home whenever he chose. That can be said of no other country.”

Thomson v MNR, 1946 SCC [141]Facts: T is a wealthy businessman trying to avoid taxation in Canada. He has spent a lot of time in the US and is technically a citizen of Bermuda, although he spends no time there. He has a palatial home in North Carolina that is kept in constant readiness for him. He also rented a house in NB for several years, spending 134, 134 and 81 days there. He then built another expensive house in NB, claiming that he did this only to please his wife, and he himself had no attachment to Canada. From 1934-1942 he spent an average of 150 days a year in his NB home. He divides the rest of his time between North Carolina and Florida. Issue: Is T resident in Canada?

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Holding: Yes.Reasoning: “For the purpose of income tax legislation, it must be assumed that every person has at all times a residence.” Ordinarily resident means “resident in the course of the customary mode of life of the person concerned.” This doesn’t have any special technical meaning, but is a question of fact. It concerns the totality of human existence: physical residency, social relations, interests, conveniences, property, etc. Here T’s Bermuda residency is a sham. The real question is whether he is resident in Canada or in the United States. At best he spends as much time and energy in the US as in Canada, and so Canada must remain his ordinary residence. The sojourning provisions have no application here.Ratio: (1) Common sense, contextual definition of residency adopted; (2) “Sojourn” means “temporary residence or residence for a temporary purpose.”

Lee v MNR, 1990 TCC [146]Facts: L was an engineer who worked on an oil rig in the Atlantic. He was an English citizen who could not enter Canada for more than 27 days at a time. He deposited all his pay in a Canadian bank, got a Canadian driver’s license, but was not allowed to work in Canada, and was outside Canada 183 days a year. In 1981 he married a Canadian woman. He visited her “as often as I could” and guaranteed her mortgage (although he does not own land in Canada). Issue: Was L ordinarily resident in Canada? If so, when?Holding: Yes, following his marriage onwards.Reasoning: Residency is a question of fact and depends on the specific facts of the case. A good list of example facts is given at [148-149]. L’s denials that he lived in Canada are irrelevant because: “Intention, or free choice, is an essential element of domicile, but is entirely absent from residence.” Based on the facts, prior to meeting his wife he was not a resident. By 1982 at the latest, he had become a resident when he guaranteed his wife’s mortgage, since this required him to swear that he was not a non-resident. The tipping point for the trial judge is the marriage. That is when Lee became ordinarly resident in Canada.Ratio: (1) Home is where the heart is [based on the role of L’s marriage and the weight given to his testimony that he told people his home was Canada]; (2) Residence is not a question of intent.Comment: Section 128.1(1)(b) deals with the consequences of becoming a Canadian resident for capital gain purposes: all your property is deemed to be acquired at fair market value at that point in time.

Laurin v The Queen, 2007 TCC [Handout]Facts: M was a pilot for Air Canada. He has spent less than 183 days in Canada for the relevant tax years, although he worked out of Vancouver and Toronto. He has various weak ties to Canada and retains Canadian citizenship. MNR acknowledges that M is resident in the Turks and Caicos Islands, but claims he is also resident in Canada. The various ties to different jurisdictions are set out at paragraph 5. The assumptions made by the MNR are: that M was involved in a common-law relation with another Canadian, that he built a house with his common-law girlfriend, that this house remained available to him during the taxation period, that he spent more than 183 days in Canada, and that at no time did he sever his residential ties to Canada.Issue: (1) Were Revenue Canada’s assumptions demolished? (2) Was M ordinarily resident in Canada?Holding: (1) Yes (2) No.Reasoning: (1) All proof in taxation is according to the civil balance of probabilities. In preparing an assessment, the MNR may make assumptions, and the burden on the tax payer is to rebut these assumptions by providing a prima facie case against them. If the prima facie case is made out, the MNR is then forced to prove all assumptions on the balance of probabilities. In the case at hand, M succeeded in demolishing all of the MNR’s assumptions, most of which were clearly wrong. This leaves no significant ties to Canada. (2) “Residual friendships and employment connections do not create residency.” M’s only ties to Canada were his employment, his friends/family (and these weren’t even very strong ties), and thus there was no real connection with Canada after M sold his car, sold his house, broke up with his girlfriend, and cancelled various financial and administrative services. Ratio: (1) Sets out basic regime for the evidentiary burden with respect to assumptions; (2) Residual ties that remain after the taxpayer has severed the most important residential ties do not create or continue residency.Comment: Apparently “demolished” is a term of art in tax law. Not sure why they couldn’t say “rebutted” instead. A funny line from the judge with respect to the taxpayer’s contradictory testimony: “An individuals contradictory declarations of residency are not indicative of much when one considers that judges have difficulty with the concept of residency.”

Inland Revenue Commissioner v Lysaght (quoted in Thomson, quoted in Maurice at para 23): “If residence be once established ordinarily resident means in my opinion no more than that the residence is not casual and uncertain, but that the person held to reside

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does so in the ordinary course of his life.

Sojourning250(1)(a) [persons are deemed resident if they] sojourned in Canada in the year for … 183 days or more.CRA Bulletin IT-221R3 [158]: Their take on sojourning, which doesn’t really match with the jurisprudence.

Hauser v The Queen [quoted in Maurice v The Queen para 18]: The day of arrival of a person in a country is not counted for sojourning purposes.

R&L Food Distributors v MNR, 1977 TRB [151]Facts: R&L is a small business that hopes to qualify for a Canadian-controlled business tax exemption. To qualify it needs to show that its controlling shareholders are Canadian. The two shareholders are US citizens that commute to work in Canada. They spend more than 183 work days in Canada, but return home every evening after work. They have few social or other ties to Canada, their families are in the US, as is their real social life.Issue: Did the shareholders qualify as “sojourning” in Canada for more than 183 days?Holding: No.Reasoning: The OED defines “sojourn” as “to make a temporary stay in a place to remain or reside there.” This plus the case law suggest that coming into a country to work only, before returning to one’s real residence, is not enough to qualify as sojourning. The shareholders are not really sojourning in Canada, since they return home every night. They were not sojourning in Windsor.Ratio: (1) Sojourning means temporarily resident; (2) Working in a country but leaving each night is not sojourning.

Partial Residency

Schujahn v MNR, 1962 Ex Ct [159]Facts: S was an employee of a US multinational corporation and was transferred to Toronto in 1954. He moved with his family to Toronto and worked there until August 2, 1957, when he was recalled to the US. They had a house for the duration of their stay, and the wife and one child stayed behind to facilitate the sale of the house. S maintained a car and a small bank account for his wife in Toronto after he left. On leaving he resigned from his club in Toronto, and rejoined his Minneapolis club. He visited Toronto three times before the house was sold in February 1958 and the family returned to the US for good.Issue: When did S cease to reside in Canada?Holding: August 2, 1957.Reasoning: It is clear that the only reason the wife and child remained in Toronto was to sell the house, so it is clear that no weight can be attached to their presence there, or things necessitated by their presence, such as the car and bank account. The three trips were isolated stop-overs and did not indicate residency.Ratio: (1) Draw distinction between resident and ordinarily resident; (2) Illustration of partial residency.Comment: s 128.1(1)(4)(b) creates deemed disposition at fair market value when a taxpayer ceases to be resident in Canada.

Ordinarily ResidentResident v Ordinarily resident is dealt with at [163] where an influential 1978 academic article suggested that ordinarily resident should be understood more broadly than “resident.” In particular, it would cover cases where the taxpayer leaves Canada for a year or two, but has an intention to return. This wider reading follows from the sense of the words, but also from the way the two terms are defined in the act. Resident “includes ordinarily resident”… which means that “resident” must be narrower than “ordinarily resident” since otherwise there would be no need to specify that one includes the other.

Midyette v The Queen [168]: defined “ordinarily resident” as “the circumstantial concept of the person who has centralized his ordinary mode of living at some place in Canada or has maintained a sufficient nexus or connection therewith as to be logically regarded as being ordinary resident in Canada, even though physically absent therefrom.”

The Queen v Reeder, 1975 FC [164]Facts: R was hired by Michelin to work in their Nova Scotia plant. His training was to be in France. Michelin promised to pay his fare and that of his family. It was intended that after training he would move to Nova Scotia. While in France R bought a motorcycle but

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stayed in a hotel. In anticipation of his wife’s arrival he sold the bike and bought a car, and rented an apartment. He maintained a Canadian bank account, where Michelin deposited his pay. He spent about six months abroad.Issue: Was R resident in Canada or ordinarily resident in Canada while he was in France? [I realized that sounds silly – Mike]Holding: Yes.Reasoning: Begins by synthesizing the jurisprudence on various facts relevant to residency into 5 categories: (a) past and present habits of life; (b) regularity and length of visits in the jurisdiction asserting residence; (c) ties within that jurisdiction; (d) ties elsewhere; (e) permanence or otherwise of purposes of stay abroad. Weighing the evidence, and adding some common sense, the judge reiterates the “home is where the heart is” approach: “I am satisfied that had the defendant been asked, while in France, where he regularly, normally, or customarily lived, Canada must have been the answer.”Ratio: (1) Everyone must have a fiscal residence somewhere; (2) List of 5 broad groups of factors; (3) Seems to be based on the “ordinarily resident” interpretation of the article at [163].Comment: “The bulk of the judicial prose generated on the subject of fiscal residence has related to the peripatetic lifestyle of the leisurely wealthy…” Zing!

3.2.3 CorporationsTextbook deals with this as [171-174]. Corporations are units of taxation. Paragraph 250(4)(a) deems a corporation incorporated in Canada to be resident in Canada throughout a taxation year. The rule does not apply to corporations incorporated in Canada prior to April 27, 1965. These older corporations are deemed to be resident in Canada under 250(4)(c) only if resident under the case law principles or carrying on business in Canada.

Case law residency is relevant for older corporations and for corporations originally incorporated or continued outside of Canada, since foreign corporations can be considered resident in Canada (and thus owe tax on their world-wide operations in Canada) under case law principles separately from the statutory deeming regime.

De Beers Consolidated Mines v Howe, UKHL 1906 [171]Facts: DB is a South African company whose major mining operations are in South Africa. However, the directing minds of the company were located in London, and almost all important decisions were taken there.Issue: Where does DB reside?Holding: In England.Reasoning: Corporations, just like individuals, must have a residence. This residence is where it “keeps house and does business” or in legal terms “where its real business is carried on.” The rule to be followed is a simple one: find the country in which “the central management and control actually abides” and this is the residence of the corporation. Here all important decisions were taken in London and most of the meetings were held there. Only matters directly connected with the mines were taken in South Africa, and the South African directors had authority to spend only limited amounts.Ratio: Corporate residence is the country where “central management and control” is located.

3.2.4 TrustsTrusts are units of taxation. Determined according to case law principles. See [175] for details. I highly doubt we need to know this.

Chapter 4: Chapter 4: The Source Concept of IncomeThe Source Concept of Income

Section 4.1: IntroductionWhile various definitions of income could have been adopted in the ITA, most obviously any change in net wealth, the ITA leaves income undefined. Instead it states merely that income flows from “sources” while also leaving “source” undefined.

One important distinction is between income, and the source of the income, because this determines whether a transaction results in income or capital gains (since capital gains are taxed at half the income tax rate, this can be critical!). So stocks are sources of income (property), dividends paid under the stocks are income, and profits made on the sale of stocks are capital gains. “A capital asset which produces income is considered to be a sou0072ce of income; the recurring income which flows from the exploitation of the asset is

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income from a source. This approach results in the fundamental distinction, still operative in Canadian income tax law, between income and capital gains.” [82]

Eisner v Macomber (1919 SCOTUS) [82]: “The fundamental relation of ‘capital’ to ‘income’ has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time.”

4.1.1 Statutory Provisions3(a) determine the total of all amounts each of which is the taxpayer’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, “without restricting the generality of the foregoing, the taxpayer’s income for the year from each office, employment, business and property…”38-39 capital gains.56-59 deal with other statutory sources

Employment/Office, Business, Property, and Capital Gains/Losses are the four “nominate sources” of income.

4.1.2 General Cases and Materials on “Sources”While “source” is not defined in the ITA, various cases have grappled with the idea. The general approach is that only earned, recurrent, reasonably foreseen/expected, and purposefully achieved revenues are taxable. From an economic standpoint this seems a bit strange, since taxpayers who work hard towards rational goals can expect to incur taxation, whereas unforeseen and unexpected windfalls escape taxation. Why not tax windfalls? Surely if the taxpayer never expected to receive a windfall, he or she cannot complain if it is taxed, since even a smaller windfall is still additional, unearned income!

The role of purposefully achieved income is probably the most central. Gambling gains are not taxable, unless the taxpayer is in the business of gambling (i.e. both casinos and professional gamblers) [85]. Equally, a person who finds a sunken treasure ship while scuba diving for fun has found a windfall. But a professional salvaging company that searches for wrecks would have to treat any treasure that it recovers as income, since the company’s purpose is to locate wrecks.

Note that income from an “adventure in the nature of trade” will often be a one-off and non-recurring venture, so this shows that recurrence is not a necessary element for income to be “from a source.”

General StatementsBellingham v The Queen [82-83]: “The notion of what receipts constitute income for the purposes of taxation is central to the workings of the Act. Standing alone, the term income is susceptible to widely diverging interpretations. Narrowly constructed, income may be defined to include only those amounts received by taxpayers on a recurring basis. Broadly construed, income may be defined so as to capture all accretions to wealth.”

InclusionsMohawk Oil Co v Canada (FCA 1992) [87]: “… monies paid in exchange for discharge of even a questionable legal right may constitute income in the hands of the taxpayer.”

The Surrogatum Principle [89, Bellingham]: Monies paid as compensation for the loss or violation of a right are taxable if income from the underlying right would have been taxable. Also applies to settlements of lawsuits about those underlying rights.

Exclusions: Gambling, Gifts, Inheritances, WindfallsBellingham v The Queen [86]: “To qualify as a gift, there must be a voluntary and gratuitous transfer of property.” The gift also cannot emanate from a productive source (e.g. employment-related gifts are regarded as disguised wages).

The Queen v Cranswick (1982 FCA) [87]: C received a large and unsolicited payment from a fellow (majority) shareholder in the company, who hoped to appease the other shareholders after deciding to sell a division of the company below book value. The FCA held that the payment was not taxable because it “was of an unusual and unexpected kind that one could not set out to earn as income from shares.” The FCA set out the following indicia of windfall gains:

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(a) the taxpayer had no enforceable claim to the payment.(b) there was no organized effort on the part of the taxpayer to receive the payment.(c) the payment was not sought after or solicited by the taxpayer in any manner [not sure how this differs from (b) – Mike].(d) the payment was not expected by the taxpayer, either specifically or customarily.(e) the payment had no foreseeable element of recurrence.(f) the payor was not a customary source of income for the taxpayer.(g) the payment was not in consideration for or in recognition of property, services, or anything else provided or to be provided by the taxpayer, nor was it earned by the taxpayer, either as a result or any activity or in pursuit of gain carried on by the taxpayer, or otherwise.

Bellingham v The Queen, 1996 FCA [82]Facts: The taxpayer’s lands were expropriated at an unreasonably low price. In an expropriation tribunal judgment, the taxpayer was awarded fair value of her land, some six times the value originally offered by the municipality. Eventually they settled out of court. The taxpayer’s settlement included three components: $377,015 for the value of the land, $1181,319 in interest, and $114,272 in “additional interest”. Additional interest was awarded in cases where the municipality’s offer was 80% or less of the fair value of the land, basically as a deterrent to municipalities who might be tempted to make low-ball offers in the hopes that the expropriated party wouldn’t have the money or courage to go to court.Issue: Was the additional interest “income from a source”?Holding: No.Reasoning: The judge begins by noting that the source concept is difficult and complex, and susceptible to many interpretations. This is complicated by Parliament’s list of explicit inclusions and exclusions (ss 12 and 81) which violate the source rule in various ways. Hence the contextual and purposive approach to statutory interpretation becomes difficult: “The parameters of the source doctrine cannot b distilled from provisions intended to contradict the very precepts underlying the doctrine itself.” [85] There are nonetheless some clear exclusions: gambling gains (unless the taxpayer is in the business of gambling), gifts and inheritances, and windfalls, which is a residual category. The additional interest was awarded “for purposes of censuring and discouraging unacceptable conduct on the part of an expropriating party. It has no compensatory element, and, in my view, is tantamount to a punitive damage award.” Hence it cannot be income from a source, since the award is dependent on the municipality’s misbehaviour, rather than any aspect of the source itself.Ratio: (1) “Underlying the source doctrine is the understanding that income involves the creation of new wealth”; (2) Punitive damages, and other awards conditional on the egregious conduct of a third party, are not “income from a source”; (3) Non-compensatory awards or payments can be severed from compensatory awards or payments, even if both arise from the same set of facts [88].

4.1.3 Nexus Between a Taxpayer and a Source of IncomeThe four traditional sources of income are fairly easy to qualify: employment income has a nexus with the employee/office holder, business income has a nexus with the recipient of the business’s profits, property income has a nexus with the owner of the property, capital gains/losses have a nexus with the owner of the property at time of disposition.

Field v The Queen, 2001 TCC [106]Facts: F’s wife embezzled money from his RRSP after they divorced. She was his investment advisor and had the ability to access his investment funds. F was not in any way involved in the transaction, and yet MNR decided to tax him for the withdrawals by his wife.Issue: Were the withdrawn funds taxable in F’s hands?Holding: No, of course not.Reasoning: RRSP contributions are taxable when they are “received” by the contributor. It is hard to see how they have been received by F, since he was the victim of “defalcation” (aka fraud) by his wife. It would be illogical and unjust for the withdrawals to be taxed in F’s hands even though they passed straight into the hands of someone else. The fact that F obtained tax relief with respect to the RRSP contributions [because RRSP contributions are not taxed at the time of deposit, but rather at the time of withdrawal – Mike] does not change the basic fact that there was no nexus between him and the withdrawals.Ratio: Fraudulent takings of a taxpayer’s assets do not create a nexus between the wrongful income and the innocent taxpayer.Comment: I can’t believe the CRA would seriously pursue this file… Field should have asked for punitive damages.

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Buckman v MNR, 2001 TCC [106]Facts: B was a lawyer who embezzled money from his clients. MNR included this embezzled money in his income. B disputes this. First, because he admitted liability and will pay the money back, so it can’t be income. Second, if it is income, it must be from a recognized source, in this case the only logical source is his law practice, and income from business is profits only. And embezzled money can’t be profits of a business.Issue: Are the embezzled funds taxable in B’s hands?Holding: Yes.Reasoning: First, B was not planning to give the money back until he was caught, and engaged in elaborate deceptions to avoid getting caught. This distinguishes his case from genuinely remorseful thieves, who came forward on their own initiative. Thus B cannot raise his own fault as a defense to taxation. Second, the Poynton case [112] is the leading authority on embezzled funds, and states that funds which embezzled from a source are considered income from that source.Ratio: Embezzled funds are treated as income flowing from the same source that provided the opportunity for the criminal act.

4.1.4 The Innominate Source ConceptAllard For a very long time people have been acting like Act reads as if employment, business and property are the only sources. But remember that they are just given as examples of income from a source, and s 3 explicitly says that they do not reject the generality of the “source” concept. The generic/innominate source is gaining ground though.

Canada v Fries (1990 SCC) [87, CanLII]: SCC dismisses the idea that strike pay could be “income from a source.” Almost no reasoning is given in their decision. They seem to have been motivated mainly by policy concerns.

Chapter 5: Chapter 5: Income from Office or EmploymentIncome from Office or EmploymentSection 5.1: Introduction

Differences Between Employment and Business/Property Income1. Payment method: The employer withholds and remits income tax on behalf of employees to the government (known as deduction at source/payroll taxes because they are deducted straight from payroll). Independent contractors are responsible for paying their own taxes. This can lead to problems if a taxpayer has been treating its employees as independent contractors and thus not remitting payroll taxes for months or years. The government will arrive, impose large amounts of back taxes, and the employer will need to pay all of them. There is also personal liability of directors for unpaid payroll taxes. So this is a dangerous situation for small businesses.2. Income from employment is calculated on a cash basis, i.e. money is only counted when it is spent or received. This excludes the accrual method (see Chapter 8 for more details on timing).3. Taxation year is fixed according to section 249 for individuals to be a calendar year.4. Employee deductions are limited to section 8 of the Act, whereas business income gets 9 and 20 deductions which are much wider.

Taxing and Calculation Provisions5(1) Subject to this Part, a taxpayer’s income for a taxation year from an office or employment is the salary, wages and other remuneration, including gratuities, received by the taxpayer in the year.(2) A taxpayer’s loss for a taxation year from an office or employment is the amount of the taxpayer’s loss, if any, for the taxation year from that source computed by applying, with such modifications as the circumstances require, the provisions of this Act respecting the computation of income from that source.Section 6 then specifies inclusionsSection 8 specifies deductions

Section 5.2: Employee or Independent Contractor?Employees are dealt with in this section as earning income from office or employment. Independent contractors earn business income, and so face a very different tax position. In particular, contractors can deduct many more expenses, and so many workers have an incentive to characterize themselves as contractors. Equally, employers often prefer independent contractors over employees, since employers don’t have deduct payroll taxes for contractors. Many workplace regulations don’t apply to contractors either.

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Lang quoting Cook J in an unnamed case: “the fundamental test to be applied is this: ‘Is the person who has engaged himself to perform these services performing them as a person in business on his own account?’ If the answer to that question is ‘yes,’ then [he is an independent contractor]. If the answer is ‘no’ then contract is [one of employment].”

Traditional Method: The control test. R v Walker (1858) [220]: “It seems to me that the difference between the relations of master and servant and of principal and agent is this: A principal has the right to direct what the agent has to do, but a master has not only that right, but also a right to say how it is done.”

Di Francesco v MNR (1964): “A servant acts under the direct control and supervision of his master, and is bound to conform to all reasonable orders given to him in the course of his work; an independent contractor, on the other hand, is entirely independent of any control or interference, and merely undertakes to produce a specific result, employing his own means to produce that result.”

To characterize the degree of control, courts historically [220] looked to: (1) the power of selection of the servant; (2) the payment of wages, (3) control over the work method; (4) the master’s right of suspension and dismissal.

The control test has been abandoned as too simplistic, and unable to characterize the relationships of highly skilled professionals like doctors or lawyers, who may be employees, but whose work cannot be directed by their employers because of its technical nature.

Modern ApproachWiebe Door test, also known as the “four-in-one test.” It requires investigating the entire scheme of the working conditions. This is assessed through four factors: (1) control, (2) ownership of tools/materials, (3) chance of profit, (4) risk of loss. Wiebe Door was adopted by the SCC in the 2001 Sagaz case. Sagaz also put the focus on the intent of the parties.

Wiebe Door Services v MNR, 1986 FCA [221]Facts: W installs and repairs garage doors. W employs several installers and repairers. The mutual understanding of the parties is that the installers and repairers would be running their own businesses and were therefore responsible for paying their own taxes and contributions. The trial judge applied the integration test, stating that without the installers/repairmen, W would be out of business, so they must be employees.Issue: (1) What is the correct test? (2) Under that test are the installers/repairmen employees or contractors?Holding: (1) The four-in-one test; (2) Contractors.Reasoning: The control test is waning in importance, and a recent case has replaced control with a broader test. A recent Canadian case proposed the test should be whether “the party is carrying on the business…for himself or on his own behalf and not merely for a superior.” Another test is the organization/integration test: those whose work is an integral part of the business are employees. This test should be avoided, since it has a tendency to characterize everyone as an employee. The true test that should be used is the four-in-one test. Which seeks to asses “the combined force of the whole scheme of the operations.”Ratio: (1) Intent of the parties, even mutual intent, is not determinative [unclear if it’s even relevant – Mike]; (2) Integration test is not favoured in Canada; (3) Adoption of four-in-one test: (a) control, (b) ownership of tools/materials, (c) chance of profit, (d) risk of loss.

Cavanaugh v The Queen, 1997 TCC [231]Facts: C was a tutorial leader and grader at a university course. He did not have a formal, ongoing contract with the university. He could control the scheduling and number of tutorials as well as marking. Although the course outliner and solution manual were provided by the university, C provided his own supplies. He was not supervised by the university, and the prof exercised very limited supervision over his conduct of the tutorials. C wished to deduct his car/travel expenses to work. The MNR disallowed this, stating that C was an employee of the university. C’s payment intervals were also irregular.Issue: Was C an employee or contractor?Holding: Contractor.Reasoning: Applying Wiebe Door, the court finds: (a) no control over C; (b) C provided his own pens, floppy disks, marking materials (?) and briefcase; (c) C was able to schedule tutorials and marking, and could even have sub-contracted his marking to someone else and indeed he did do this from time to time; (d) there was an opportunity for loss depending on how C scheduled

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tutorials and the amount of resources he devoted to them [not sure I buy this… unless he went through several boxes of pens/chalk per tutorial/marking session I don’t see how you can lose money being a TA – Mike]. Nor is C estopped from denying that he earned employment income merely because this was written on his original T-4 form. York university characterized his income as employment income, but they were not empowered to make this decision [presumably if he had written this himself he would be estopped from denying it – Mike].Ratio: (1) Illustration of 4-in-1 test; (2) An employer’s admin or tax characterization of a job is not binding on a worker.Comment: When I TA’d Russian and Soviet Politics in the poli sci department, my prof gave me a green pen for marking (she felt green was a more soothing colour than red)… does that make me an employee?

Other Factors [234](1) Creating a new contract may help you shift the nature of a relationship, but it is far from binding on the courts.(2) Interposing a corporation or trust: textbook doesn’t comment on how effective this is… it refers to chapter 2, part III, but that doesn’t actually deal with the issue. Presumably like the contract approach, this isn’t binding on the courts.(3) Capitalizing employment benefits: this is an attempt to convert what would otherwise be a benefit (see inclusions section, below) in to a capital source, which produces income from property.(4) Location of work: if you work at home or away from the “employer’s” worksite, this suggests independent contractor.(5) Did you have an already-established business when you began working for your “employer”? If yes, strongly suggests IC.

Curran v MNR, 1959 SCC [235]Facts: C was a highly regarded middle-aged geologist. He was receiving a good salary for the time and would be entitled to receive a substantial retirement package at his current employment. C was induced to leave his current employment to work at a new company, in part by promises to pay him $250,000 as a lump sum to compensate for lost pension rights. C would also get stock options at his new company.Issue: Was the $250,000 income from employment?Holding: Yes.Reasoning: Martland (majority): C argues that the payment he received was capital in nature, since it compensated for the loss of a source of income. However, the essence of the payments was to make C available for employment with the new company. This payment may have been lump-sum, but it was paid to gain employment of C, and the corporation paying it did not acquire C’s pension rights, so it is difficult to characterize this as a capital transaction.Taschereau (dissenting): This income was partly a capital receipt and partly income. The sum of $250,000 is far too high to reflect purely compensation for lost pension income. It must also reflect other compensation and other motivations. Payment for these other motivations are capital receipts. The case should be returned to the Exchequer court so that it can divide the money between capital and income. Ratio: (1) Lump-sum or one-off payments are not automatically capital gains/losses; (2) Payments incurred to make an employee available for work, or to entice that employee into accepting an offer of employment, are payments on account of employment.

I ntent, and the Interplay of Civil Law and Common Law Lang shows civilian concepts bleeding into common law, whereas Grimard shows the reverse. The outcome is that intent becomes a tie-breaker in common law cases, and the Wiebe Door factors are used as supporting evidence of intention in Québec. There is also discussion of intent at [228-230].

CL – Lang v MNR, 2007 TCC [Handout]Facts: L owned a furnace and duct cleaning business and hired workers to service clients. These workers provided their own tools, while L provided vacuum equipment and vans if required. The workers received a percentage of the fees paid to L. MNR assessed L for unpaid pension and unemployment insurance contributions due on all employees. L claims the employees were actually contractors.Issue: Were the workers contractors or employees?Holding: Contractors.Reasoning: The legal framework to be applied in cases like this is confusing and the TCC is frequently reversed on appeal. The Weibe Door 4-in-1 test is the main test, with integration as a “substantially discredited” factor that cannot justify a decision. Intent may also be relevant. The circumstances of the business strongly favoured independent contractors. The workers were not supervised and L had

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no real control over them. Their profit and losses varied since L could rehire them on a job-by-job basis depending on how well L liked their performance. Both the workers and their employer considered themselves independent contractors, although the weight to attribute to this finding is unclear.Ratio: (1) Where intent is a factor in determining the nature of a relationship, it must be a shared intent between workers and their employer; (2) Intent’s relevance in common law cases is not clear.Comment: (1) This is a dubious judgment that inadvertently introduces civilian concepts into the common law, since the main “intent” judgment from the FCA on which the trial judge relies is a civil law judgment based heavily on the CCQ; (2) The list of assumptions at pages 4-5 is a good idea of (a) how many assumptions the MNR makes (see proof section, above), and (b) the kinds of factors the MNR considered relevant to contractors, like L’s role in finding clients and setting operating hours.

DC – Grimard v The Queen, 2009 FCA [Handout]Facts: G worked at a Québec administrative tribunal as a medical assessor 1995-1998. G resided in Sherbrooke and commuted to Montreal to work. G maintained an apartment in Montreal as an office. G deducted the apartment and travel expenses of his commute to Montreal as business expenses, claiming that he was an independent contractor. MNR characterized him as an employee and disallowed the deductions.Issue: Is G an employee or contractor?Holding: Employee.Reasoning: In light of s 8.1 of the Federal Interpretation Act, civilian concepts as embodied in the CCQ must be applied to determine the difference between an employment relationship and an independent contractor. That being said, the kinds of factors used in common law analysis (control, ownership of tools, profits/loss potential, integration into workplace, etc). Even though Québec contract law privileges the theory of the will, it is the actual behaviour of the parties which must guide the courts in assessing the common intention of the parties. This behavioural analysis opens the door to considering the common law factors if necessary. In the present case, G’s contract did not precisely state whether he was an independent contractor or employee. The trial judge correctly turned to the behaviour of the parties and assessed many common law-inspired factors to come to the decision that G was an employee. G’s tools were provided and he received pay on holidays and during vacations, which were strong indications of employment. Finally, G’s attempt to invoke the equitable remedy of laches is misplaced, as the court does not have the authority to reduce tax simply because it feels the MNR waited too long to reassess the taxpayer [as well, equitable remedies don’t exist in Québec! – Mike].Ratio: (1) Québec tax cases must use the CCQ and civilian concepts when the ITA refers to provincial-jurisdiction issues or ideas; (2) Common law criteria are helpful in qualifying the relationship; (3) To qualify a contract as either employment or independent contractor, a judge must always look to the conduct of the parties in addition to their declared intent; (4) the court cannot provide discretionary reduction in tax.

Section 5.3: Inclusions5 Basic charging provision. Income from office/employment is “salary, wages, and other remuneration (including tips)” received during the year.6(1)(a) must include the value of board, lodging, or other benefits of any kind whatsoever if they are “received or enjoyed in respect of, in the course of, or by virtue of” office or employment. Some exceptions to the benefit rule are then listed.6(1)(b) allowances for personal or living expenses or allowances for any other purpose. Some excepted allowances are then listed.6(3) Employment income can include amounts paid before or after the actual period of employment.

Richstone v The Queen: 6(3) was used to conclude that a non-compete payment was employment income.56(1)(a)(ii) “retiring allowances” are included as income.

IMPORTANT: 6(3) creates a presumption that payments (not benefits in kind) from an employer to an employee are employment income as long as (a) or (b) is fulfilled. The employee can rebut this presumption by showing that the payment is not (c), (d) or (e):6(3) An amount received by one person from another

(a) during a period while the payee was an officer of, or in the employment of, the payer, or(b) on account, in lieu of payment or in satisfaction of an obligation arising out of an agreement made by the payer with the payee immediately prior to, during or immediately after a period that the payee was an officer of, or in the employment of, the payer,

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shall be deemed, for the purposes of section 5, to be remuneration for the payee’s services rendered as an officer or during the period of employment, unless it is established that, irrespective of when the agreement, if any, under which the amount was received was made or the form or legal effect thereof, it cannot reasonably be regarded as having been received

(c) as consideration or partial consideration for accepting the office or entering into the contract of employment,(d) as remuneration or partial remuneration for services as an officer or under the contract of employment, or(e) in consideration or partial consideration for a covenant with reference to what the officer or employee is, or is not, to do before or after the termination of the employment.

5.3.1 BenefitsHistorically, only money or something convertible into money was considered to be a benefit [240-241]. This goes back to a ruling in a British tax case of Tennant v Smith [245]. However, that case was decided on the basis of a British statute which did not include language like that in 6(1)(a), so that rule has been abandoned in Canada [242]. Any benefit is liable to tax.

Sorin v MNR, 1964 TAB [243]Facts: S was a partner in a hotel business. S agreed to look after the bar and manage the rooms. S was assessed as having received a benefit of a free hotel room stay by MNR for $4/week at 52 weeks a year, half the hotel’s weekly rate. Because he managed the bar, S did not finish work until 3:30 am or 4:30 am four or five nights a week. His practice on such nights was to sleep at the hotel in a store room.Issue: Was the hotel room a “lodging” benefit?Holding: No.Reasoning: S clearly would have preferred to sleep at home. The store room was an expediency forced upon him by his work. It is difficult to think of a store room with a bed as “lodging” so there is no taxable benefit here.Ratio: A benefit must be more than an improvised solution that makes use of business property in a creative way to meet a human need.

The Queen v Savage, 1983 SCC [244]Facts: S was a research assistant at Excelsior. S received $300 from her employer for completing a series of training course on life insurance math and economics. S took these courses voluntarily. The courses were comparable in time and complexity to university courses. The pass rate for these courses on a North America-wide basis was 61%. Excelsior included the prize as a business expense on its income tax. S did not report the prize.Issue: Was the prize a benefit received in respect of employment?Holding: Yes.Reasoning: There’s a very long development at the start that distinguishes various cases. Eventually the court settles on the Phaneuf case as setting out the right rule: “I agree that the appropriate test [for a benefit] in Phaneuf was whether the benefit had been conferred on Phaneuf as an employee or simply as a person.” They add that this definition should not be restricted to payments in the character of remuneration for services. The language in 6(1)(a) is very wide, and this breadth must receive effect. S received the money in respect of her employment, since it was a payment made to her because she accomplished certain tasks as an employee.Ratio: (1) The test for an employment benefit is whether the benefit was received” as an employee or simply as a person”; (2) “in respect of” has a VERY wide scope; (3) “any benefit whatsoever” has a very wide scope; (4) Benefits are not restricted to those conferred “in exchange for services.”Comment: The SCC’s comment that prizes are taxed under 56(1)(n) is now incorrect, since the statute was amended to remove prizes based on income and employment from 56(1)(n).

Laidler v Perry, 1965 UKHL [250]Facts: L received a £10 voucher convertible to cash from his employer. These vouchers were given every Christmas by the employer to facilitate good relations with the staff, and letters received in reply show that the vouchers were much appreciated. Vouchers were given to ex-employees (pensioners).Issue: Can L be taxed on the vouchers as employment benefits?Holding: Yes.

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Reasoning: The question to be resolved here is whether, from the employer’s perspective, the gifts were intended as a business tool to promote harmonious labour relations, or rather were given merely as a personal goodwill gesture inspired by the holiday spirit. In the former case they are employment related benefits, in the latter case they are not employment related [because the true cause of the vouchers is holiday cheer? – Mike]. In the circumstances of this case, the fact that the payments were made every year, were in cash, and were for a non-nominal sum, all point to an employment-related motive. A gift of chocolates or whiskey or merely £2 would perhaps be justifiable as a Christmas-inspired gift, but repeated monetary payments are a different matter. Additionally, in the context of employment, the potential benefit for the employer must be taken in to account. Interestingly, the House of Lords ignores the pensioners in making their determination.Ratio: (1) Regularly made gifts are more likely to constitute employment benefits, particularly if they come to be expected by their recipients; (2) Monetary gifts are more likely to constitute employment income; (3) The existence of an employment-related benefit for the employer increases the likelihood the gifts will constitute an employment benefit.Comment: Whatever happened to de minimis non curat lex? Unless the leave for appeal to the House of Lords framed this case as a key battle in the War on Christmas, I can’t imagine why this was considered of national importance. [I may have to eat my words on that one, since when I checked the relative value of the £10 1965 payment, it came out to £151 in 2012 prices, or roughly $300 Canadian dollars per employee – Mike].

Lowe v The Queen, 1996 FCA [255]Facts: L was an account executive at an insurance company who got an expense-paid trip with his wife to New Orleans. This trip required him to go with clients and make sure those clients had a good time. His wife was equally expected to spend time with the client’s wives. L and his spouse had very little personal time apart from time spent with clients.Issue: Was the trip an employment benefit?Holding: No.Reasoning: Determining whether something is a benefit has two steps. First, using Krishna’s definition: is there a measurable economic advantage to the employee? Second, if there is such an advantage, is this employee advantage the primary and dominant purpose, or is it merely incidental? In the case at bar, L and his wife may have enjoyed their time in New Orleans, but the employer did not send them there to have a good time. In fact, they could have gotten in trouble if they placed their own enjoyment ahead of the client’s enjoyment. The enjoyment of L and his spouse was merely incidental to the trip’s dominant business purpose. Not a benefit.Ratio: (1) Adopts Professor V Krishna’s base criteria for a benefit as “an economic advantage that is measurable in monetary terms”; (2) In assessing whether something is an employment benefit, the court must determinant the predominant nature or purpose of the alleged benefit (i.e. mere incidental benefits to the employee do not make something a benefit).

The Queen v Huffman, 1990 FCA [261]Facts: A plain-clothes police investigator received a clothing allowance of $500 a year. Evidence showed that plain clothes officers often damaged their clothing at a very high rate. Regular police officers had their uniforms provided for them free of charge. Issue: Was the clothing allowance a benefit?Holding: No.Reasoning: H received the money to cover an expense that was imposed on him by his work, namely buying additional clothing due to damage caused by his work. Since he was required by his work to incur certain expenses, the reimbursement of these expenses is not a benefit.Ratio: Employer payments that merely compensate an employee for expenses incurred in the course of employment are not a benefit.Comment: There’s a case summarized at [264] about a hockey player’s agent being paid by the team. This was taxable. Presumably the difference is that having an agent is a consumption decision. A hockey player is free to represent himself or to engage an agent at various price and skill levels. H by contrast was required, whether he wanted to or not, to purchase additional clothing.

Ransom v MNR, 1967 Exch Ct [264]Facts: R was transferred from Sarnia to Montreal. He accordingly put his home on the market. However, a number of other Sarnia residents were transferred at the same time by another company, so there was a glut of houses on the market. Eventually R sold his house at a loss. His employer compensated him for the amount of the loss. MNR taxed him on the compensation as a benefit.Issue: Was the compensation a benefit?Holding: No.

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Reasoning: The presumption that payments to employees is employment income is rebutted here. The payment made by Dupont to S were to compensate his losses in the real estate market. These losses were caused by Dupont’s transfer of him to Montreal at a time when the real estate market was depressed in Sarnia. This loss is akin to moving expenses, which are generally considered to not be benefits if reimbursed. Because Dupont is merely returning the employee to his pre-move situation, and because they caused his losses, it is not a benefit.Ratio: (1) Reimbursement of an expense or of a loss are equivalent for tax purposes; (2) Reimbursement of a loss or expense is not a benefit if that loss or expense was created by the employee’s employment.

The Queen v Phillips, 1994 FCA [267]Facts: CNR moved P from Moncton to Winnipeg. P received a $10,000 from his employer to compensate him for higher real estate prices in Winnipeg compared to MonctonIssue: Was the housing price allowance a taxable employment benefit?Holding: Yes.Reasoning: Unlike Ransom, the taxpayer here has not suffered a loss because of his move. He has merely trade a low-priced home for a high-priced home. The difference in price is not a loss, since P acquired a more expensive asset with his money, whereas in Ransom, the taxpayer lost money selling his original home. There is no suggestion here that P lost money on his original home. P’s more expensive home can be resold at a high price. Thus CNR is merely giving him money to fund the purchase of a more expensive asset. This money is clearly a benefit. Furthermore, horizontal equity concerns and policy concerns point to the taxability of the housing allowance.Ratio: Payments by an employer to help an employee defray the cost of an asset purchase (rather than to avoid a loss) are taxable benefits.

Dimaria v The Queen, 2008 TCC [Handout]Facts: D was a senior tax specialist at Dupont [of all the taxpayers to bully with a shitty argument… – Mike]. His son got a $3,000 scholarship award paid through a Dupont program. The program required the student to apply, allocated scholarships to those with the highest marks, and was available to the children of retired, deceased, expatriated employees. The award could be renewed for up to four years, even if the parent stopped working at Dupont. Dupont could terminate the program at any time.Judicial History: The CRA issued a really stupid advance ruling to Dupont in which they claimed because the minimum requirement was only 70%, and this was the minimum to go to most universities, the program was a subsidy for all children. They overlooked the limited number of scholarships (100) and the fact that they were allocated to students with the highest marks, so clearly the students who received the money would not all have 70% averages. They also claimed that even if the parent stopped working at Dupont, they would continue to consider the benefit to be an employment benefit.Issue: Is the scholarship an employment benefit that should be included in D’s income?Holding: No.Reasoning: “Receiving” or “enjoyment” of benefits must be broadly interpreted. Physical receipt of monies is not required for money to be constructively received by a taxpayer for example. There is past case law holding that payments to family members, for example travel allowances to visit the employee when he is posted abroad, are benefits received by the employee. However, this case is different for seven reasons (final page of judgment), including: the payment was to the son and the father had no legal right to it, the scholarship was awarded to the son due to his scholastic achievement, and finally tax falls on individuals, not families. The CRA is improperly trying to shift income from the son to the father so that they can tax it at a higher rate.Ratio: Not sure… the list of seven reasons are all candidates for ratios. Allard Three requirements for an amount to be included in income from employment for 6(1)(a): (1) must be a benefit, (2) it must be had or received by the taxpayer; (3) must be received or enjoyed in the course of, in respect of, or by virtue of an office or employment.Comment: Note that the advance ruling was binding on Dupont, but not on its employees, since they weren’t privy to the ruling.

5.3.2 ValuationSome UK valuation cases are summarized at [277], but Canadian law differs. The question here is whether benefits are valued at the cost to provide them, or what they could be sold for in an open market. The Canadian approach is to assess at fair market value, according to the text, but this doesn’t answer the question of whether it means fair market value new (i.e. employer/employee cost) or fair market value used/re-sale (i.e. employee’s potential revenue). The answer generally seems to be fair market purchase cost.

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Giffen v The Queen, 1995 TCC [277]Facts: G and M were employees at HW and required to travel frequently. They earned frequent flyer points on their personal cards when travelling for business. G earned them on first class tickets, M on economy class. G and M redeemed their reward miles for reward tickets, and gave the tickets to their family members.Issue: (1) Were the reward tickets employment benefits? (2) How should the tickets be valued?Holding: (1) Yes (2) Discounted rates relative to the open market cost of regular tickets.Reasoning: The tickets were employment benefits [we don’t have the reasoning here –Mike] and were received by the employees when their family members received the tickets. “In my view the proper measure of the value of a benefit in the form of a reward ticket is the price the employee would have been obliged to pay for a revenue ticket entitling him to travel” on the same flight with the same restrictions as the reward ticket (since reward tickets weren’t as easy to exchange or cancel). This takes the employee’s perspective, and avoids the resale/revenue measure of value.Ratio: The value of a benefit is the cost to the employee of obtaining a similar benefit on the open market.Comment: This would be a good example of constructive receipt – even though the tickets went straight to family members, they were constructively received by the employees

Youngman v The Queen, 1990 TCC [279]Facts: Y and his family were all shareholders in a company. That company bought land to develop in to a subdivision. The subdivision plan was rejected by the municipality, so the land lost value for business. Instead, Y decided to have his company build a house for him. The house cost roughly $400,000 to build. $80,000 of this was borrowed from Canada Trust, and Y loaned $100,000 interest-free to his company in order to finance the construction. Y paid the company monthly rent of$ 1,100, including $300 for utilities. Experts testified that $1,100 a month is reasonably close to the market rate in the area, but admitted that since there were so few homes in the area rental at market rates bore no relation to real valueIssue: What is the true value of the house to Y?Holding: The case is returned to the MNR for reassessment.Reasoning: Assessing the value of a benefit is a two step process: first determine what the benefit is, second assess what the taxpayer would have had to pay in the open market to obtain a similar benefit. In the present case, the price Y would have had to pay to obtain a similar dwelling place was above the free market rent, since a company being asked to built a rental unit in an underdeveloped area would have ensured itself a decent rate of return. Thus the market rate of $1,100 is too low, since it does not take in to account the profit that an independent company would have demanded. However, this hypothetical independent company would have taken into account Y’s $100,000 interest-free loan and lowered prices accordingly. The MNR must reassess, taking the loan’s value into account.Ratio: (1) The MNR’s assumptions must be disproved directly, and merely criticizing the method by which they were arrived at is not enough; (2) Cost must be assessed at replacement cost from the perspective of the employee as a buyer (this may or may not be free market value in isolated locations); (3) The contribution of the employee to the acquisition of the asset must be reflected in its value for tax purposes.Comment: Technically Y is an officeholder, not an employee.

Rachfalowski v The Queen, 20009 TCC [284]Facts: R was given a very expensive golf club membership by his employer. R hated golf and could not golf. He tried to get the value of the membership in cash but his employer refused. He then tried to refuse the membership but was pressured into taking it by his employer. Because the membership was very expensive, it had serious tax consequences for R. R had visited the golf club a few times to entertain clients, and took his wife to dinner there once.Issue: What is the value of the golf club membership to R?Holding: Its value is subjective, and far below the actual cost.Reasoning: The golf club membership clearly has little to no value to R. It would be unfair to tax him for a “benefit” at its replacement cost where its actual use was minimal. Instead R should be taxed based on actual use of the golf club memberhip, not on the potential use [presumably its cost/fair market value reflects potential use –Mike]. Because R’s use was minimal, its benefit should be assessed as minimal as well.Ratio: Value must be determined based on actual use, not availability, as long as there is no indication of fraud or a sham on the taxpayer’s part.

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5.3.3 AllowancesThe main issue with allowances is distinguishing them from reimbursements. Reimbursements are not taxable.

Sherbaniuk, “The Taxation of Benefits and Allowances” (1967) [285]: Reimbursement of employees for expenses caused by their work is no different from employees paying for the employer’s expenses, then being reimbursed by the employer. Either way there is no taxable benefit.

The Queen v Pascoe (endorsed by FCA in Huffman) [290]: “An allowance is a [1] limited predetermined sum of money paid to enable the recipient to provide certain kinds of expense, [2] its amount is determined in advance, and, [3] once paid, it is at the complete discretion of the recipient, who is not required to account for it. A payment in satisfaction of an obligation to indemnify or reimburse someone or to defray his or her actual expenses is not an allowance.”

Campbell v MNR, 1955 TAB [287]Facts: C was the head nurse at a hospital. She was paid $50 (later $75 and $100) a month for the use of her car on hospital business. The hospital had rejected her suggestion that it should buy a hospital car. Her use of the car at work involved transporting patients from one institution to another, as well as picking up supplies and depositing cheques at the bank. C paid for gas, oil, and repairs. C said that the wear and tear on her car was considerable, since she often transported wheelchairs. The transport of patients by her car were not part of her ordinary duties, but were done voluntarily.Issue: Is the $50 an allowance?Holding: Yes.Reasoning: The amounts are not rental income, since the hospital recorded the expense as miscellaneous. C tried to claim that she was running a transportation business, but this is rejected out of hand. Thus we are left with a fixed lump-sum payment to an employee. This fits the definition of an allowance, since C was not required to actually transport patients, and did so voluntarily [presumably this is what disqualifies here from the “reimbursement” exemption – Mike].Ratio: Actions voluntarily undertaken for an employer that receive lump sum payments cannot qualify as exempt “reimbursement.”

The Queen v Huffman, 1990 FCA [289]Facts: see above. In 1979 the clothing reimbursement was increased from $400 to $500. An administrative decision was taken that the officers could claim the full $500 as long as they had submitted at least $400 worth of receipts. This was to avoid paperwork, and because officers had probably thrown away receipts over $400 that they didn’t think would be reimbursed.Issue: Is the $100 an allowance?Holding: No.Reasoning: The definition of allowance in Pascoe should be used (see above). Applying it to this case, it is clear that the extra $100 was a reimbursement, since the funds were contingent on showing $400 of clothing purchases and a good-faith presumption that the extra money was reimbursement for clothing expenses (i.e. that the police officer would not lie to get the extra $100). The police officers did not have an unlimited right to use the money freely.Ratio: Adoption of Pascoe definition/test for allowance.

Section 5.4: Deductions8 authorizes a number of deductions.8(2) only deductions authorized in section 8 may be deducted from employment income. Not others are deductible.8(4) deductions for meals are permitted only if the officer/employee are away from the work site for more than 12 hours. Other conditions are placed on the deduction of union dues by 8(5), and home offices 8(13)8(1)(i) These provision codify an important part of the reimbursement rules.

(i) annual professional membership dues the payment of which was necessary to maintain a professional status recognized by statute,(ii) office rent, or salary to an assistant or substitute, the payment of which by the officer or employee was required by the contract of employment,(iii) the cost of supplies that were consumed directly in the performance of the duties of the office or employment and that the officer or employee was required by the contract of employment to supply and pay for,

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5.4.1 Travel ExpensesIn general, employees can deduct the costs of travel once they are at work, i.e. when they travel from one work site to another, or from work to a client’s location. But they cannot deduct travel expenses to or from work.

Key Legislative Provisions8(h) is the main travel provision since it applies to all employees: (h) where the taxpayer, in the year,

(i) was ordinarily required to carry on the duties of the office or employment away from the employer’s place of business or in different places, and(ii) was required under the contract of employment to pay the travel expenses incurred by the taxpayer in the performance of the duties of the office or employment,

[the taxpayer may deduct] amounts expended by the taxpayer in the year (other than motor vehicle expenses) for travelling in the course of the office or employment, except where the taxpayer

(iii) received an allowance for travel expenses that was, because of subparagraph 6(1)(b)(v), 6(1)(b)(vi) or 6(1)(b)(vii), not included in computing the taxpayer’s income for the year, or(iv) claims a deduction for the year under paragraph 8(1)(e), 8(1)(f) or 8(1)(g);

8(h.1) Motor vehicle travel expenses: [this seems to deal with repairs only, since general costs would fall under (h)] (h.1) where the taxpayer, in the year,

(i) was ordinarily required to carry on the duties of the office or employment away from the employer’s place of business or in different places, and(ii) was required under the contract of employment to pay motor vehicle expenses incurred in the performance of the duties of the office or employment,

amounts expended by the taxpayer in the year in respect of motor vehicle expenses incurred for travelling in the course of the office or employment, except where the taxpayer

(iii) received an allowance for motor vehicle expenses that was, because of paragraph 6(1)(b), not included in computing the taxpayer’s income for the year, or(iv) claims a deduction for the year under paragraph 8(1)(f);

8(4) meals only if away from work site for 12 hours of more

Special Industry-restricted Provisions8(1)(e – railway company employees only), (f – travel as a salesperson or contract negotiator), (g – travel by transport employees), (h – general travel provision, all workers)

Martyn v MNR, 1962 TAB [293]Facts: M is a pilot who is on call 24 hours a day, 5 days a week. He commutes to work in his car. He deducted gas costs for all round trips to and from the airport. He claims that because he is on call, he is already “at work” so the trip to the airport is travel while at work.Issue: Can M deduct his travel costs to work?Holding: No.Reasoning: There is no reason to conclude that M’s employment began when he stepped into his car and ended when he got home from the airport. Instead the formula under which he was paid depended on the routes he flew, the type of aircraft, and the time in the air. None of these suggest that he was “working” while at home. Further, he had a guarantee of the equivalent of 60 hours of salary per month. Thus even if he was not called upon to work, or worked less than 60 hours, he could earn employment income.Ratio: (1) Travel expenses are deductible only once the employee is at work; (2) On-call employees do not count as “at work” if they are at home.

5.4.2 Legal Expenses8(1)(b) amounts paid by the taxpayer in the year as or on account of legal expenses incurred by the taxpayer to collect or establish a right to salary or wages owed to the taxpayer by the employer or former employer of the taxpayer.

This is like the Surrogatum principle in a way. It allows you to deduct the legal costs of forcing your employer to pay you wages and

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salary. Does not appear to cover lawsuits over benefits based on the wording. You need to win the court case to deduct the amount according to the CRA [300]. A lawsuit to preserve your right to work (at [300] a shipmaster litigating his competency to command a vessel, or a doctor litigating an attempt to remove his medical license) does not fall under 8(1)(b). Blagdon v The Queen, 2003 FCA.

5.4.3 Professional and Union Dues8(1)(i),(iv),(v) union dues, professional dues, payments under collective agreements for non-union members. Note that only annual payments are deductible, so one-shot entry fees are not deductible.

The Queen v Swingle, 1977 FC [301]Facts: S was a chemist who worked for the RCMP in their forensics lab and later at the department of fisheries. He is a designated analyst under several environmental Acts and the Canada Shipping Act. These designations allow him to provide certain types of evidence mandated under those acts. He is attempting to deduct learned society payments (list at [302]).Issue: Are these membership fees deductible?Holding: No.Reasoning: Based on the case law, the test for “necessary to maintain a professional status recognized by statute” in 8(1)(i)(i) means “necessary in order to preserve the taxpayer’s right to exercise the profession that allows him to earn employment income.” S remains a chemist whether or not he is a member of learned societies; nor is “chemist” a profession recognized by statute. As for his designated analyst status, this is not a “profession”, since the Acts in question speak of “a person” being designated or “any qualified person.” It is clear from such references that they are not to a profession. S has therefore not brought himself clearly within the exemption, thus he may not deduct the payments.Ratio: (1) “Profession” receives a restrictive definition under 8(1)(i)(i); (2) “Necessary” under 8(1)(i)(i) means “necessary in order to legally practice the profession.”

Chapter 6: Chapter 6: Income from Business or PropertyIncome from Business or PropertyThe ITA ousts general accounting principles where there is a conflict, but in the absence of guidance, GAAP is used.

Section 6.1: Differences Between Business and Property IncomeThe two are almost identical for tax purposes, with the following exceptions [310]. Based on what we covered in class, only 4, 5, and 6 look like they could reasonably come up.

1. Active business income of a Canadian-controlled private corporation is taxed as a special low tax rate because of a tax credit under section 125 for small businesses. This deduction is unavailable for property income.

2. A dividend refund available to private corporations under section 129 is calculated in a way that excludes income from active business.

3. The attribution rules in section 74.1 and 74.2 apply to income from property but not income from business.4. Special rules apply to rental and leasing property, but not rental or leasing business income. These rules are designed to close

a popular tax loophole from a few decades ago.5. **The deductions under 20(1)(b) for cumulative eligible capital is available only in respect of business income, not property

income.**6. Foreign resident taxpayers face a withholding tax on their Canadian property income, but not business income.7. Various complex provisions (ss 91-95) apply only to property income earned by foreign corporations owned by Canadian

residents, foreign trusts or foreign-based investment funds.8. The tax relief for international double taxation is different for foreign-source business income and foreign-source non-

business income.

Distinguishing Between ThemThe difference tends to be the degree of active work on the part of the owner. Property income is passive (letting interest accumulate on a bank account, or renting out buildings while doing nothing to maintain or service them). Business income is active (for a rental business you would need to be providing services of some kind in addition to just making the rental property available to tenants).

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Some criteria taken from Hollinger v MNR, 1972 FC [327]: (1) whether the income was the result of efforts made or time and labour devoted by the taxpayer; (2) whether there was a trading character to the income; (3) whether the income can fairly be described as income from a business in the meaning of the Act [this seems tautological – Mike]; (4) the nature and extent of the services render or activities performed.

Section 6.2: Defining Business Income248(1) Business is defined as “a professional, calling, trade, manufacture, or undertaking of any kind whatever and… an adventure or concern in the nature of trade but does not include an office or employment.”IT-459 Adventure or concern in the nature of trade [537]: This is the CRA’s position on the issue and it mirrors case law.

Defines business as “It is a general principle that when a person habitually does a thing that is capable of producing a profit, then he is carrying on a trade or business notwithstanding that these activities may be quite separate and apart from his ordinary occupation.”

Defines adventure or concern in the nature of trade as “Where such a thing is done only infrequently, or possibly only once, rather than habitually it is still possible to find that the person has engaged in a business transaction if…it can be shown that he has engaged in ‘an adventure or concern in the nature of trade.” The bulletin continues to say that just because you’re carrying on an adventure in the nature of trade doesn’t mean that you are “carrying on business” for the purpose of other parts of the ITA.

Traditional Case Law Definition, Gambling as IllustrationSmith v Anderson (1880) [111]: a business is “anything that occupier the time, attention and labour of a man for the purpose of profit” [our textbook puts “[sic]” after “man,” presumably to mark political incorrectness, since I can’t see a grammatical error –Mike]

Graham v Green (Inspector of Taxes), 1925 Brit KB [311]Facts: G bets on horses on a large and sustained scale and managed to make his living that way.Issue: Was G’s gambling winnings business income?Holding: No.Reasoning: Betting is an irrational transaction, in which transfers of property are based on arbitrary outcomes like whose horse ran fastest, or which way a coin flips. The betting activity does not produce the income, since the income is actually the result of chance. Bookmakers run businesses because they have the odds in their favour in the aggregate. Their clients are making irrational agreements. Nor is gambling, even habitually, an occupation. It is a mere pastime or hobby. For all these reasons gambling is not business income.Ratio: (1) Gifts or chance discovery of treasure are not profits; (2) Betting cannot generate business income.Comment: If the judge was talking about casino gambling, it would make more sense to call it an irrational agreement, since the games are rigged in the casion’s favour. But horse racing is a different story. It deals with unknown information, not a known and biased gaming system. And to say that a bet does not produce income for the winner is ridiculous!

Later cases would be far more likely to find gamblers liable to tax, although paying lip service to Graham v Green. See [313-314]. The decisions seem to turn on issues of risk management, organization, and professionalism.

The Pursuit of (Reasonably Expected?) ProfitsCurrent test in Canada is taken from Stewart: (i) is the activity of the taxpayer undertaken in pursuit of profit or is it a personal endeavour? (ii) If it is not a personal endeavour, is the source of income a business or property?

Moldowan v MNR SCC (1977) [315]: In this case, the Supreme Court had ruled that business income required “profit or a reasonable expectation of profit.” Reasonableness was assessed based on several factors: past profits/loss, taxpayer’s training, taxpayer’s intended course of action, the capability of the venture as capitalized to show a profit…” The list is non-exhaustive and varies by industries. Some businesses have higher start-up costs than others.

Moldowan was often used by the MNR to deny recognition of losses when taxpayers got involved in ill-advised business ventures and lost large sums of money. In 2002, the SCC reset the jurisprudence significantly.

Stewart v The Queen, 2002 SCC [316]27

Facts: S bought in to a tax-sheltered asset investment scheme. It involved buying rental units that were highly leveraged, so that interest payments would outweigh income for a long time. The tax-deductibility of interest incurred for business purposes made the plan tax-neutral, so that when it was over and the loans were paid off, S would have a valuable asset and have paid very little for it. S suffered a rough divorce and an even rougher real estate market so the plan was losing a lot of money. MNR disallowed his deductions of the interest on the ground that S’s business was so highly leverage that it was not showing a reasonable expectation of profit.Issue: (1) Should the reasonable expectation of profit test continue to be used? (2) What should replace it? (3) How does it apply to S?Holding: (1) No; (2) Two-stage Stewart test; (3) see below.Reasoning: (1) Applying the REOP test as the sole test to determine whether a business exists can lead to confusing and unjust results. It also involves second-guessing taxpayers and business people. Reasonable expectations are a sufficient, but not necessary, condition for a business to exist. (2) “There are a multitude of incidents which together make up the carrying on of a trade, but I know of no one distinguishing incident which makes a practice of carrying on a trade and another practice not carrying on a trade.” Business is “a compound fact made up of a variety of incidents…. Thus to equate ‘source of income’ with ‘reasonable expectation of profit’, at least in the instance of the business source [is not appropriate].” They then try to pretend that all along the 1977 judgment was being misinterpreted, and that really the supreme court then meant exactly what they’re about to tell you they mean now.(2) A two-stage approach should be adopted. In the first stage, the court asks (i) is the activity of the taxpayer undertaken in pursuit of profit or is it a personal endeavour? (ii) If it is not a personal endeavour, is the source of income a business or property? Stage 1 is designed to distinguish between commercial and personal activities, and will only fail if there is a significant personal or hobby aspect to the activity. Activities without a personal component should almost always be classified as businesses: “It is the commercial nature of the taxpayer’s activity which must be evaluated, not his or her business acumen.”(3) The MNR’s main contention was that because S’s business was so highly leveraged he should not be able to claim it as business income under the REOP test. Under the new test, it clearly is of a commercial character. Nor is S’s possible capital gain relevant. S managed his investment in a businesslike manner, and no personal motive can be found. He clearly had a source of income.Ratio: (1) Two-stage business test; (2) “Where the activity is clearly commercial there is no need to analyze the taxpayer’s business decisions. Such endeavours necessarily involve pursuit of profit.”Comment: Not sure I like this approach, since it legitimizes quasi-fraudulent transactions like the one mentioned at [324]. On the other hand I don’t know how else this issue could be determined without imposing unfair results on taxpayers like Stewart.

Harrison v The Queen, 2007 TCC [Handout]Facts: H was a high school math teacher who wrote a book about Biblical exegesis over the course of seven years. He then had the book published in small batches between 1994-1997. The book is no longer in print in English, but a Chinese publisher paid H $2,300 for the publication rights in Chinese and a translation will be available soon. H also anticipates that a second English edition will be launched. H attempted to deduct business expenses of writing, publishing, and promoting a book from his income, which the MNR disallowed.Issue: Did the book writing and promotion constitute a business?Holding: No.Reasoning: Sets out the test from Stewart. In the present case there are strong indicators that H has a hobby or personal interest in Biblical analysis, so it is incumbent on him to prove sufficiently indicia of commerciality or “badges of trade.” The fact that six publishers rejected H’s book for publication speaks strongly against its commercial viability, and the Chinese venture has not shown any profits despite seven years elapsing since the agreement was signed.Ratio: The following are indicia of commerciality: past commercial success of the project, likelihood of future success, interest shown by commercial investors in the project [here publishing houses], degree of personal interest in the project.Comment: Based on the judge’s reasoning, the burden flips to the taxpayer once personal interest is established… not sure that’s right.

Section 6.3: Inclusions in Income from BusinessStatutory Inclusions [309]The following must be included as business or property income if received by the taxpayer:12(1)(a) Amounts received for good and services to be rendered in the future12(1)(b) Amounts receivable for goods and services already rendered in the course of business12(1)(c) interest12(1)(d) amounts deducted in a previous year for doubtful debts12(1)(g) amounts received based on production or use of property, including but not limited to installment sales

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12(1)(j or k) dividends12(1)(l) income from partnerships12(1)(m) income from trusts12(1)(n) benefits from profit sharing plans between employees and employer12(1)(x) inducement or assistance payments [seems mostly targeted at government grants and subsidies –Mike]12.1 Cash bonus on Canada Savings Bonds

Section 6.4: Property Income12 Basic charging provision for property income, since it mentions things like interest on money, payments from various benefit plans or investment schemes, and a general “use of property” subsection at 12(1)(g).15(1) deeming provision for payments made to shareholders and in anticipation of someone becoming a shareholder.9(3) property income does not include capital gains/losse

248(1) defines property as “property of any kind whatsoever, whether real, personal, corporeal or incorporeal.” It also includes the following: (a) a right of any kind whatever, a share or a chose in action; (b) unless a contrary intention is evident, money; (c) a timber resource property; (d) the work in progress of a business that is a profession.”

6.4.1 Interest Income12(1)(c) interest income is bus/prop income.

Book’s Definition [332]: “Interest is compensation for the use of money belonging to another person; it must be referable to a principal amount and must either accrue daily or be allocable on a day-by-day basis.”

Timing of Interest [339]: According to 12(1)(c) interest income can be recorded at the time at which it was either received (paid in cash) or receivable (when the obligation to pay is created, regardless of when actual payment arrives). CRA allows the taxpayer to choose which method it pleases, even for different types of debt obligations, and this doesn’t have to be the same as the method used in the rest of the taxpayer’s business. 12(3) and 12(4) modify this rule in ways that I don’t fully understand.

Sales of Items with Accrued Interest [340]: Rules are at 20(14) issue is how to partition between transferor and recipient.

Discounts and Interest [333]: A discount refers to the difference between the price of a debt obligation and the amount it will eventually pay. Often debt obligations are sold in the format of “pay $20 now and I will pay you $30 in one year.” This is equivalent to a 50% interest rate, since the $20 increases by 50% to $30. The question that comes up from time to time is when discounted debt obligations should be considered interest. This is a question of fact, which the book explores in detail at [333].

Bonuses and Interest [334]: A bonus or penalty is an amount in addition to the interest that is payable on maturity of a debt obligation, or on early repayment, or in event of a default. Bonuses are not generally considered interest, unless the bonus is on a discounted loan and there is no interest rate, in which case it is treated as equivalent to an additional discount, and thus like interest.

Late Charges by Suppliers [335]: Many suppliers of goods and services stipulate that after X days from delivery, late payments are subject to interest. These charges are considered interest, even though no money is advanced to the buyer. The justification is that by delaying payment, the buyer is retaining use of money.

Blended Payments or Capitalized Interest: Rules are at [336]. Like most things in tax law, it’s a question of fact [if everything’s a fact, it makes you wonder why we even need an Income Tax Act – Mike]. See Groulx, below for more details.

Groulx v MNR, 1967 SCC [336]Facts: G sold his farm to T. Their negotiations began with G requesting $450,000 and T offering $350,000. G was willing to go as low at $395,000 but T still considered this too high. In order to close the sale, G agreed to not ask for interest on the sale of his farm, even though he would not see the bulk of the payments for a few years. Rather than treat the sale as a capital gain, MNR said that parts of it were disguised interest income.

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Issue: Was the combination of high sale price and no interest a disguised blended interest payment?Holding: Yes.Reasoning: G was a very sophisticated farmer, with impressive investment income even while he worked mainly on the farm. If he had received the interest payments this would have almost doubled his taxable income: “A taxpayer who is as involved in business as the respondent must quickly appreciate the pecuniary advantages of not doubling his taxable income.” The evidence at trial suggested that the farm was sold above fair market value, which leant weight to the MNR’s allegations of disguised income payments. Finally, by G’s own admission, the higher price was a trade-off for forgoing interest, which directly suggests capitalization of income.Ratio: None, really, the SCC affirms the trial judgment, from which they quoted at length, without commenting on the law.Comment: If G had sold at a lower price and asked for interest, he would have been taxed at the capital gain rate on the low price, and paid income tax on the interest payments. By building interest into the sale price, G initially paid the capital gain tax on the whole amount, and avoided paying any income tax at all.

6.4.2 Rent or Royalty Income12(1)(g) any amount received by the taxpayer in the year that was dependent on the use of or production from property whether or not that amount was an instalment of the sale price of the property…

Both rents and royalties represent payments for the use of property in the sense of 12(1)(g) Rents are given their intuitive meaning of periodic payments for use of physical property. [341] Royalty includes money paid to use a mineral property or for intellectual/intangible property. A definition of royalty used by the Federal Court is given at [341].

Note that 12(g) has an exception built in to it that converts certain capital gains into property income, namely where the sale price of the property is dependent on the use of or production from the property. So the sale of a mining or oil interest that was based on the amount of oil/minerals extracted would count as property income, and not a capital gain. Likewise, an exclusive license of a copyright which lead to a payment per book printed would also be property income. Computer software is mentioned at [343-344] in more detail than seems reasonably necessary.

6.4.3 DividendsA dividend is defined in the case law [344] as: any pro rata distribution from a corporation to its shareholders is a dividend unless that distribution is made during liquidation of the corporation (i.e. because it is bankrupt or being wound up). Section 84 deems a dividend to have occurred at various times and as a result of various corporate decisions. There is favourable tax treatment of dividends to prevent double taxation (this income has already been taxed once at the corporate level, so it seems unfair to also tax them in the hands of shareholders).

Section 6.5: Deduction from Business/Property Income6.5.1 IntroductionDaley v MNR 1950 Exch Ct [346]: The fact that profit is undefined shows that Parliament intended that it be a flexible concept grounded in the realities of business and accounting. “That being so, it follows that in some cases [really, he means all cases– Mike] the first enquiry whether a particular disbursement or expense is deductible should not be whether it is excluded from deduction by [18(1)(a)] but rather whether its deduction is permissible by ordinary principles of commercial trading or accepted business and accounting practice.” This approach was confirmed by the SCC in Canderel v Canada [347].

So first you ask if a business/accounting perspective would allow the deduction, and only if the answer is yes do you turn to the Act.

6.5.2 Legislative Provisions9(1) basic charging section: tax is assessed on business profits in a year. Profits are undefined in the act, so intuitive/accounting sense of profits as “revenue minus losses” is used. So the question of what losses can be deducted naturally arises.

Permitted Deductions20(1)(a) Capital cost allowance of property20(1)(b) Cumulative eligible capital

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20(1)(c) interest, 20(1)(d) Compound interest20(3) Money borrowed to repay an outstanding loan is deemed to have been borrowed for the same purpose as that outstanding loan.20(10) Pay attention future lawyers: deduction for the costs of attending up to 2 conventions a year connected to your business/ profession, as long as the city in which it is held is reasonably consistent with the geographical scope of the organization’s mandate [so no Hawaii conference deductions if the conference is for the Québec bar! – Mike].111 What losses are deductible?

(a) non-capital losses from the 20 years preceding and 3 years after the taxation year.(b) net capital losses from any preceding year, or 3 subsequent years.

Prohibited Deductions18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property; [basic prohibition on deducting non-business expenses – Mike](b) 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; [so only CCA allowed via s 20 can be deducted – Mike](c) an outlay or expense to the extent that it may reasonably be regarded as having been made or incurred for the purpose of gaining or producing exempt income or in connection with property the income from which would be exempt;(h) personal or living expenses of the taxpayer, other than travel expenses incurred by the taxpayer while away from home in the course of carrying on the taxpayer’s business;67 Unreasonably large deductions that are otherwise permitted will be reduced to reasonable amounts.67.5 Illegal payments67.6 Fines and penalties

Note that interest on account of capital outlays cannot be deducted 18(1)(b), unless specifically allowed by 20(1)(c).

6.5.3 Business Purpose Test18(1)(a) prohibits deductions that are not incurred for the purpose of earning income from business or property.

Imperial Oil v MNR, 1947 Exch Ct [348]Facts: IO had to pay half a million dollars to settle a lawsuit concerning a collision between one of its ships and another ship. IO deducted this amount from its profits. MNR opposes the deduction, arguing that the settlement money was not incurred for the purpose of earning business income.Issue: Was the settlement for alleged negligence barred by 18(1)(a)?Holding: No, it is fully deductible.Reasoning: There is already authority that if an employer is condemned through vicarious liability for the acts of his employees while they were performing their duties, this amount is deductible, since it was incurred in the process of earning income. From there it is a small step to the deductibility of settlement payments. After all, why should you have to wait until you lose to deduct the money if a settlement payment will discharge you from liability faster and at a lower cost? In this case collision is “a normal and ordinary hazard of marine operations generally” and thus IO would be justified deducting the settlement money from its business income. Various strange arguments raised by MNR are rejected [350-351].Ratio: Payments which compensate for “normal and ordinary hazards” of the trade are not prohibited under 18(1)(a).Comment: Counsel for MNR had the balls to argue that the SCC got Dominion Natural Gas wrong, and that he, counsel, had the correct interpretation, which also just happened to lead to IO not being able to deduct the money.

Royal Trust v MNR, 1957 Exch Ct [352]Facts: RT required some employees to join social clubs and other community organizations. The company paid all fees involved. In return the employees were expected to solicit clients. RT claimed $10,000 in these membership dues as business deductions. MNR disallowed the deductions as not being incurred for the purpose of earning business income.Issue: Were the social club dues deductible?Holding: Yes.

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Reasoning: Expenditures which are deducted according to standard business or trading practice (he deliberately omits “accounting” practice for some reason) and which are not barred by section 18(1)(a) of the ITA are deductible. In RT’s case it is consistent with good business practice to use social clubs as a venue to recruit new clients. RT’s actual experience showed that this policy worked out well and many new clients were recruited through this method. Hence it should be deductible.Ratio: (1) Deductibility of an expense requires commercial/trading deductibility and compliance with the ITA; (2) The fact that an expenditure “made business sense” or “was part of common business practice” is not sufficient reason to make it deductible, since the requirement that it be incurred for producing income is important. [this suggests that corporate social responsibility payments wouldn’t be deductible even if they became industry-standard, because they don’t contribute to earning income –Mike]Comment: This, Daley, and the preceding case are all by one pioneering judge, who basically created the modern income tax regime from his trial court. Reminds me of Justice Farley’s single-handed creation of Canadian restructuring law via the CCAA.

6.5.4 Business Expenses vs Personal Expenses18(h) personal or living expenses of the taxpayer, other than travel expenses incurred by the taxpayer while away from home in the course of carrying on the taxpayer’s business;248 “personal or living expenses” includes:

(a) 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,(b) the expenses, premiums or other costs of a policy of insurance, annuity contract or other like contract if the proceeds of the policy or contract are payable to or for the benefit of the taxpayer or a person connected with the taxpayer by blood relationship, marriage or common-law partnership or adoption, and(c) expenses of properties maintained by an estate or trust for the benefit of the taxpayer as one of the beneficiaries;

Benton v MNR, 1952 TAB [358]Facts: B is a farmer who is growing weaker with age and disease. He continues to farm his family farm without help. However he hired a housekeeper who does general household chores, freeing him up to do farmwork. She is also there to get help if he has another stroke or has a dizzy spell. B deducted his housekeeper’s wages as a business expense.Issue: Are the housekeeper’s wages a business or personal expense?Holding: Personal.Reasoning: The work done by the housekeeper is domestic and personal in nature. However helpful the may have been to the appellant, this does not make them business expenses.Ratio: Domestic/personal help is not an expense incurred to earn income, even if it frees the business person to earn income.Comment: This is a nonsensical holding, since if B had hired farm hands and done housework himself it would have been deductible. Thus begins the Canadian tax system’s less than proud tradition of considering domestic work (including child care) as invisible to the eyes of the tax system. I feel like a Surrogatum principle argument could have been invoked here: the payments to the housekeeper allowed B to preserve his farm business since he couldn’t run it alone.

Leduc v The Queen, 2005 TCC [359]Facts: L is a lawyer who was accused of sexual misconduct. He paid $140,000 to a law firm to defend him against the sexual misconduct charges. He claims this as a business expense, because he received a letter from the Ontario law society stating that if he was convicted he would be investigated by the society and could lose his license. L’s trial is ongoing due to procedural skirmishing.Issue: Was L’s legal defense a business or personal expense?Holding: Personal.Reasoning: While L may have believed that his license would be revoked if he was convicted, there is no evidence that this was the case. His legal practice is in fact thriving. Nor are these expenses of the kind normally incurred by others in his profession. L would have paid the expenses even if he was not engaged in business. Setting aside what the law society may ultimately do if L is found guilty, there is no indication that L’s income stream was threatened at the time he paid the legal fees. Hence L’s deduction is not justified. The cases relied on by L all concern professionals charged with criminal charges arising directly from their work and were decided under section 8 of the ITA. Sexual misconduct has no link with L’s profession.

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Ratio: “Where a business carries out activities in the normal course of its operations, and the cost of those activities is deductible in computing the income of the business, any expense incurred to defend those activities [in court] is a direct result of the activities themselves and is permitted by 18(1)(a).”[364] By implied exclusion, all other court battles are not deductible.

Symes v The Queen, 1994 SCC [366]Facts: S is a partner in a large Toronto law firm. She hired a full-time nanny to take care of her kids, allowing S to work full-time at the law firm.Issue: Are childcare expenses personal or business expenses?Holding: Trick question – they are a section 63 expense; anything not allowed there cannot be deducted.Reasoning: Majority: Starts off very encouragingly by acknowledging the importance of child care and women’s participation in the labour force. Even goes as far as to say that based only on section 9 and 18, childcare costs should be deductible. However, in section 63 of the ITA, Parliament has already considered the issue of childcare deductions and set out what can or cannot be deducted. In the face of this legislative decision, courts are not competent to made additions to the regime (expressio unius est exclusio alterius).Dissent: Mix of Charter arguments, criticism of the majority, and rejection of the section 63 argument (not clear why from the extract we have access to).Ratio: Childcare deductions are contained in section 63 of the ITA, and no other deductions apply.Comment: Of course they split on gender lines… I can’t believe that while the SCC was willing to issue a reason-less set of reasons about strike pay’s non-taxability, they weren’t willing to bend the law here to achieve a just result.

Scott v MNR, 1998 FCA [369]Facts: S is a foot and public transit courier who spends 12 hour days delivering packages in downtown Toronto. Due to the extra exercise this involves, he claimed the expense of an extra meal per day, plus one bottle of water per day.Issue: Is the additional food (his fourth meal, not the regular three) deductible as a business expense?Holding: Yes.Reasoning: Traditionally, food and beverages were considered personal expenses, since everyone needs to eat and drink regardless of their employment or business. However, S has shown that his business activities caused him to require additional food above and beyond the human norm. The bright line rule prohibiting food and drink from deductibility should not be a bar to this legitimate request. The FCA then analogizes food to car fuel, which is deductible to the extent that it is spent for business purposes, even though everyone also uses their cars for personal reasons. This analogy shows that MNR’s floodgates argument is misplaced.Ratio: Food and beverages beyond the human norm may be deducted if they are caused solely by a person’s employment.

Cumming v MNR, 1967 Exch Ct [375]Facts: C is an anesthesiologist who works at a hospital. However, since this is pre-medicare, he is paid directly by patients, and merely has practicing privileges at the hospital – it does not pay him. He does his administrative work (billing, collection of bills) at home, since the hospital does not provide him with an office. He is claiming travel expenses two and from his home office to the hospital as business expenses. To establish that the home office was a legitimate business environment evidence was adduced showing that he and his wife each worked about 12 hours a week in it, that it was well-equipped, that he kept business records and professional literature there, and that the office was strictly out of bounds to his children.Issue: (1) Can C deduct his travel costs to the hospital? (2) Capital costs related to his car?Holding: (1) Yes; (2) Yes.Reasoning: The traditional position has been that professionals who live at a distance from their office/chambers cannot deduct travel expenses to those offices/chambers. However, C’s home office was very much his base of operations, so that when he went to the hospital, he was going from one worksite to the other. The hospital provided him with no office, nor with any record space or billing apparatus, so by necessity he had to have an office off-site. The fact that this office was in his home does not change the nature of his travel to the hospital, since the home office was a bona fide work site. Thus they were legitimate business expenses and deductible. As for the capital costs related to the car, the judge fixes the work-related wear and tear at 50%.Ratio: (1) Travel from a worksite to another worksite is business-deductible; (2) Home offices constitute worksites.Comment: As far as I can tell, travel from a home office to a worksite is deductible even if you don’t qualify for the home office deduction (e.g. because you don’t meet clients at home). This is because you still meet the ratio in Cumming, while the home office deductions are purely statutory and relate to non-travel expenses.

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6.5.5 Some Specific Expense TypesHome Offices [383]18(12) Home office expenses are deductible as business expenses only if (1) it is the taxpayer’s principal place of business; or (2) it is used exclusively for business and on a regular and continuous basis for meeting clients, customers, or patients.

Deductions for home offices are limited to your business earnings for the year. You cannot create a loss by running a home office. Losses in excess of your business earnings can be carried forward indefinitely.

Business Entertainment Expenses [384]There’s a good doctrine article arguing that the current approach is inconsistent and unfair at [384-385].37.1(1) limits deduction of food and entertainment expenses to half of the lesser of either: the cost of the meal/entertainment, or a reasonable amount therefor.

Education Expenses [386]Typically considered a personal consumption decision. But refresher courses for professionals are allowed as deductible business expenses. Section 118.5 and 118.62 provide tax credits for those pursuing post-secondary education. See also s 56(1)(n) which deals with prizes and scholarships. See also conference expenses at 20(10)

6.5.6 Public PolicyThis section deals with “public policy” concerns that do expressly appear in the Act.

Illegal BusinessesMinister of Finance v Smith (quoted in Buckman [109]): “Nor does it seem…a natural construction of the Act to read it as permitting persons who come within its terms to defeat taxation by setting up their own wrong.”

Ex turpi non causa oritur actio: No one may benefit from their own wrongful conduct. This is a general maxim at common law that is invoked a couple of times in our textbook. The quote from Smith says essentially the same thing in English. The Latin maxim has been used by judges for hundreds of years. It seems particularly appropriate here.

MNR v Eldridge, 1964 Exch Ct [387]Facts: E ran a very successful callgirl operation in Vancouver for a long time. She began filing tax returns on her illegal business, presumably to avoid an Al Capone-style conviction. She kept no books of accounts, so all of her revenue and deduction statements were based solely on her word. Due to the poor record keeping most of her returns were on a net worth basis.Issue: Are various expenses (see reasoning) deductible?Holding: Depends, but largely, no.Reasoning: As a point of departure “it is abundantly clear from the decided cases that earnings from illegal operations or illicit businesses are subject to tax.” E’s attempt to allege that the state was living off the avails of prostitution is rejected out of hand [the judge should have quoted the Smith case, above – Mike]. Many of E’s expenses, such as rent payments, hotel payments, payments to thugs who protected the call girls, etc, where deductible if she could have proved them. Many were not proved, so they were denied. E’s (highly illegal) payments to a telephone company employee to check if her phones were bugged apparently would have been deductible, but she couldn’t prove the payments were ever made. Bribes paid to law enforcement would again be deductible, but without proof that they were paid, the judge states that police officers are presumed incorruptible. Since E refuses to say who the bribes were paid to, they are not deductible. Legal fees paid to defend one of the call girls in court are deductible, because they helped return the girl to income earning status, and because it was part of the call girl’s contract that she would be defended by E if arrested in the course of her business. To the extent that E can prove she paid thugs to act as enforcers, that money is deductible. Finally, E’s payment to buy up every edition of a local newspaper that was going to run a story on her business is not deductible, because the story would not clearly have been bad for business. Implicitly the judge seems to think E’s motivations in suppressing the story were largely personal, and in that sense similar to the lawyer in Leduc; E would have suppressed the story even if she wasn’t running a prostitution business.

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Ratio: (1) Illegal businesses are subject to tax in the same manner as legal business; (2) Even illegal or illegitimate payments, like bribes and protection money are deductible (unless specifically forbidden by the ITA), as long as sufficient proof of their recipients is provided [this is presumably to force the illegal business person to provide evidence that can then be used to prosecute the bribe-takers, which is a nice and publicly-beneficial catch-22 – Mike].Comment: The “net worth basis” is used by the Minister to assess taxpayers with poor record-keeping. It looks at your net worth in two years and takes the difference as your income.

Fines and Penalties67.6 Overrules the reasoning of the SCC in the case below. It makes all fines and penalties non-deductible if they were imposed by a public body.

65302 British Columbia ltd v The Queen, 2000 SCC [394]Facts: The taxpayer 65302 operated an egg farm. Egg farms in BC are subject to quotas. 65032 produced too many eggs in one year because it got a large order from an important client, and didn’t want to lose the client by refusing the order. 65032 was fined for producing over quota by the Egg Marketing Board. It attempted to deduct the fine as a business expense, MNR disallowed.Issue: Is the fine deductible?Holding: Yes.Reasoning: Majority: The deductibility of fines is a problematic decision for a court to make, because it is a public policy decision that ideally would be made by Parliament. Courts have shaky authority to decide this issue on their own. In particular, because Canada has a self-assessment system, if the court makes a nuanced ruling, this shifts a difficult burden on to taxpayers to determine whether their fines are deductible or not. All of this militates against a judicial policymaking role. Thus standard statutory interpretation rules apply. In the present case, Parliament has already dealt with deductibility of fines and some illegal payments. By prohibiting certain payments like bribes and any payment associated with certain criminal offenses, as well as penalties under the ITA itself, this shows that Parliament has considered the issue. Thus the decision not to include a general prohibition on deducting fines was a deliberate decision by Parliament and this must be respected by the courts. Thus fines are generally deductible unless explicitly prohibited.Minority (concurring): Look not just at the ITA, but also the statutes imposing the fine. Parliament clearly chose the size of fines imposed by other Acts carefully to fit their purpose. By allowing deductibility of the fines, their effective impact is reduced. Not all fines and penalties should be deductible. Fines with a punitive goal should not be deductible, while fines of a compensatory nature should be deductible. This harmonizes the ITA with the rest of the statute book.Ratio: Overruled by statute, specifically 67.6 ITA.

Illegal Payments [402]Illegal payments are deductible (see Eldridge) unless prohibited, such as by section 67.5(1) of the ITA. Because 67.5(1) is a limited provision prohibiting only some kinds of illegal payments, the courts have invoked the implied exclusion rule to conclude that Parliament did not intend to make all illegal payments non-deductible.

Theft, Burglary, and Embezzlement Losses [402]The case law draws a distinction between two kinds of theft/embezzlement losses. The textbook quotes a leading case at [403]: (1) losses caused by theft or embezzlement of low level employees are deductible as inevitable hazards of most businesses; (2) losses caused by theft or embezzlement of the owner, shareholders, high-level managers, or directors are not deductible. There are clearly policy reasons behind this distinction. See also Field v The Queen in section 4.1.3; that case dealt with non-business income, but the concept of “defalcation” was also in play.

6.5.7 Interest ExpensesDeduction of interest payments would normally be prohibited by 18(1)(b) as a payment on account of capital. However, 20(1)(c) and 20(1)(d) allow the deduction of interest and compound interest. Since interest is allowed as an exception to a general rule prohibiting its deduction, courts have insisted on strict compliance with the letter of the law [404]. See the Shell test in Singleton.

Example 1: if the source of business income for which the money was borrowed is destroyed or disappears, the interest payment matched with it is no longer deductible. This traditional position has been modified by 20.1 of the ITA, although I don’t understand what 20.1 actually does… the textbook implies that it would permit your deductions even if the source is destroyed, but I can’t see

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why that’s true from the text of the Act.

Purpose of Borrowed FundsCRA’s position after Bronfman is set out at [413]. Note that Bronfman and Singleton may seem contradictory. I think the difference between them is this: in Bronfman the trust was arguing that money directly used for purpose A was really being used indirectly for purpose B. This argument was rejected as false and self-serving. In Singleton there were a series of transactions all of which had a different purpose. So absent a finding of a sham or fraudulent intent, each transaction in Singleton was entitled to be treated with respect to its own original purpose.

The Queen v Bronfman Trust, 1987 SCC [405]Facts: The trust wanted to make a payment to a beneficiary, but due to market conditions, didn’t want to sell its assets to fund this distribution. Instead, it borrowed money and gave the borrowed money to the beneficiary. The trust then tried to deduct interest payments on the loan as payments that were made to preserve its asset base, and thus were made for the purpose of earning income from property.Issue: Is the interest on the loan deductible?Holding: No.Reasoning: B bears the burden of proving deductibility of the interest payments. This deductibility is assessed against the current use of funds, not the original use. Here the money was given to a beneficiary and so it is not available to the trust. Thus the trust cannot argue that the money was put to an income-earning use if it is not even in possession of the money anymore! Furthermore, by giving away the money, but incurring income charges, the trust has reduced its income earning potential, so it is hard to see how the loan “preserved” its income. The commercial and economic realities of the transaction was that the money was borrowed for the purpose of distribution to the beneficiary, and shall be treated as such for tax purposes. Furthermore, interest on the loans was $110,000 a year, whereas the same amount of money in trust property was producing only $10,000 per year, so the trust did not actually make a reasonable business decision. No deduction.Ratio: (1) “The onus is on the taxpayer to trace borrowed funds to an identifiable use which triggers deduction”; (2) Comingling funds used for a variety of purposes, only some of which are eligible for deduction will result in the loss of deductibility [406]; (3) Only the current use of borrowed funds is to be considered; (4) The purpose of a transaction should be assessed with an eye to commercial and economic realities [411].

Singleton v The Queen, 2002 SCC [414]Facts: S was a partner at a law firm. He withdrew $300,000 from his capital account with the law firm, and used that money to buy a house. He then borrowed $300,000 from a bank and put that borrowed money back into the firm’s capital account. S is attempting to deduct the money he borrowed from the bank as a business related interest expense. MNR disputes deduction.Judicial History: The trial judge found that the true purpose of the borrowed funds was to purchase a house and denied the deduction.Issue: Was the interest deductible as a business related expense?Holding: Yes.Reasoning: The trial judge incorrectly characterized S’s transactions by applying the wrong test. The correct test is the Shell test (see ratio). Tax payers are entitled to structure their affairs in a manner that reduces taxes. The focus of judicial inquiry must be the direct use of the borrowed funds. The shuffle of cheques that occurred in this case does not change the direct purpose of each transaction, since there was no finding of a sham or a fraud. It was thus an error by the trial judge to treat this as a single simultaneous transaction. The direct use of the borrowed funds was to refinance S’s partnership capital account. The direct use of the money he previously withdrew from that account was to buy a house. The two transactions had distinct purposes and these distinct purposes must be given effect.Ratio: (1) Four part Shell test for determining deductibility of interest payments: (a) the amount must be paid in the year or be payable in the year in which it is sought to be deducted, (b) the amount must be paid pursuant to a legal obligation to pay interest on the borrowed money, (c) borrowed money is used for the purpose of earning non-exempt income from a business or property; (d) the amount must be reasonable, as assessed with regards to a-c; (2) Absent a finding of sham or fraud, each transaction must be assessed individually to determine its direct purpose.

Lipson v The Queen, 2009 SCC [Handout]

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Facts: E Lipson sold shares of a family corporation to his wife, who paid for the shares using funds borrowed from a bank. E and his wife then bought a new house, which E purchased using the money from his share sales. They next got a mortgage from the bank, using this money to repay the share loan. E then invoked 74.1(1) and 73(1) to deem the dividend income from the shares and mortgage payments to accrue to him. Because he got both, this maximized deductibility. The MNR denied the deduction under the GAAR, claiming that they had abused the ITA deduction system.Issue: Should the deductions be allowed?Holding: No.Reasoning: GAAR applies whenever a taxpayer’s transactions frustrate the spirit, purpose or object of a provision of the ITA on which the taxpayer relies. Each transaction must be analysed separately under GAAR. There are two tax benefits at stake in the GAAR analysis: first, the interest deduction under ss 20(1)(c) and 20(3); and second the attribution rules which preserve the purpose of a loan when it is paid off by a new loan. E’s financing of his home with equity, and his wife’s financing of her share purchase with debt, were both legitimate. However, E’s deduction of mortgage interest against his dividend income is an abuse of 74.1(1). That provision exists to prevent spouses from redistributing income between each other in a way that improperly reduces tax. E has found a way to use 74.1(1) to reduce his tax burden, which is clearly abusive, since it violates the spirit and purpose of 74.1(1)Ratio: (1) Use of anti-avoidance rules to avoid tax justifies application of GAAR; (2) In general, the financing method chosen by taxpayers will rarely be held abusive.Comment: 74.1(1) deems income or losses for property transferred from one spouse to another to accrue to the transferor, and not the recipient, for the year in which the transfer takes place; 20(1)(c) deductibility of interest on business/property loans; 20(3) repaying borrowed money with newly borrowed money allows you to keep the tax consequences of the first loan.

6.5.8 Reasonableness of Deductions67 if the deduction is unreasonably large, regardless of whether it is for an allowable purpose, it will be disallowed for all amounts above a reasonable amount.

Mulder Bros v MNR, 1967 TAB [421]Facts: M paid a suspiciously-large salary of $13,000 (remember this is the 1960s… so it’s around $80-90,000 in 2011 dollars) to his wife for her assistance in his business. The MNR reassessed M for a salary half the level he had paid to his wife.Issue: (1) Was the wife’s salary reasonable? (2) If no, was the MNR’s reassessed value reasonable?Holding: (1) No, it was too high; (2) No, it was too low.Reasoning: Although the wife was being paid an excessive amount given her actual duties, the MNR did not take in to account her special knowledge and qualifications, which were high enough to justify a salary of $8,500 as reasonable. It is important to remember that section 67 is an anti-avoidance provision, so M’s attempt to shift too much income to his wife is against its spirit.Ratio: (1) In determining whether an expenditure was reasonable, the analysis needs to be in concreto, taking account of all factors; (2) specific provisions which are anti-avoidance provisions will be interpreted so as to prevent tax avoidance.

No 511 v MNR, 1958 TAB [422]Facts: No 511 sponsored a baseball team (whose name, oddly enough, is censored in the case) to the tune of $22,500 for that year. This is around $200,000 in 2011 dollars, and represents half of the company’s total revenues for the year! No 511 deducted this as a business expense, but MNR claimed it was unreasonably large.Issue: Is the expenditure unreasonable?Holding: Yes, only $5,000 should be deductible.Reasoning: The legitimacy of advertising does not make any particular advertising expenditure legitimate. In this case spending half the firm’s revenues on advertising is clearly ridiculous. Additionally, the advertising started later than it was contractually supposed to, and the actual publicity was for the name of the company, whereas its product was sold under a different name in the market. In all the circumstances, $5,000 is a reasonable figure.Ratio: (1) In determining whether an advertising expenditure is reasonable, courts should examine the size of the business, the “likely future patronage” (?), the locality where the advertising takes place, and the size of the market reached; (2) To come up with a more reasonable number, courts should look at the costs of alternative advertising campaigns.Comment: The judge should also have added: does the advertising reach the target market of the company? Because if No 511 is a wholesaler that sells to other merchants, there is no point in advertising directly to consumers.

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There’s a case at [425], Tonn v The Queen, that gives considerable deference to business judgment of the taxpayer, in contrast to the more hands-on approach in No 511.

Chapter 7: Chapter 7: Computation of Profit/Timing PrinciplesComputation of Profit/Timing Principles

Section 7.1: Introduction to Timing IssuesBusiness care about timing because of the time value of money. Money now is worth more than the same amount of money in the future, because current dollars can be invested and will earn income. Additionally, money now can be held in reserve in case of emergencies, or used to take advantage of a unexpected opportunity. For all these reasons, taxpayers prefer to shift recognition of revenues into the future (to delay tax on that revenue) and accelerate recognition of expenses (to diminish current income and hence lower current tax).

Taxation Year249 defines taxation year for corporations and individuals. For individuals it is the calendar year. For corporations it is their fiscal period.249.1(1) Defines fiscal period. This is any period not exceeding 53 weeks. Payment is due in the taxation year in which the fiscal period ends.

Method of AccountingThis is discussed in greater depth below. In general there are two possible accounting methods:

Cash Method: revenues and expenses are recognized when they are actually paid in cash. So if you skip an interest payment you don’t get to deduct it from your business income because you haven’t paid it. Equally, if you sell something but the purchaser pays late, you don’t have to recognize the income until payment is received. Payments received by a third person on the taxpayer’s behalf, such as an escrow agent, are considered received by the taxpayer. Cheques [and other negotiable instruments? Mike] are considered cash, regardless of when they are cashed.

o Income from office or employment uses the cash method. Business/property income typically cannot use the cash method due to section 12(1)(b). However there is an exception for farming and fishing businesses, per s 28.

Accrual Method: Revenues and expenses are recognized when a legal obligation to pay is created. Skipping an interest payment doesn’t change the fact that you legally owe the payment, so it is included as an expense on the day it became due. Equally, even if a purchaser delays payment, an obligation to pay exists, so that amount is added as income. The analysis is typically “at what time did an absolute requirement to pay crystallize in law?” Your right must be absolute, even if you don’t have an immediate right to posses. Suppose you were given $10,000 by your employer for moving expenses, but had to repay any extra; you don’t have an absolute right to the $10,000 since you might have to give back some or all of it, so not taxed until you spend it on moving expenses approved by your employer.

o Required for corporations [439] and most businesses (presumably via 12(1)(b)).

Allard For the accrual method, case law often jumps to “when is something receivable?” but keep in mind that you have to earn it first under section 9, only then do you ask “when is it receivable”!

Other Accounting/Timing IssuesThe ratios in Canderel are really important, as are the principles set out by the Court at [434[ of the textbook.

Canderel v The Queen, 1998 SCC [428]Facts: C had given a “tenant inducement payment” to a tenant who signed a lease with C. MNR and C debate how this payment should be deducted: immediately in full, or amortized over the length of the lease. Accounting practice would follow the “matching principle” and amortize the payment. Obviously amortization delays recognition of a deduction and is preferred by MNR.Judicial History: The trial judge and the FCA treated the matching principle as a binding rule of law.Issue: How should the payment be treated?Holding: Immediate deduction.

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Reasoning: The fact that profit remains undefined in the Act was a deliberate legislative choice, since the Act contains many exhaustive definitions of key concepts. The notion should therefore be kept somewhat flexible (one vague definition is given at [429]). The determination of profit is a question of law. The two main determinants are the Act’s specific inclusions/exclusions, and the case law that interprets and applies them. Any other source of guidance is just that – guidance. Even GAAP and trade practices are not binding, since they are designed for specific purposes that may or may not have anything to do with tax. Iacobucci then makes some very shaky claims about the differences between commercial accounting and the principles of accounting for tax law. Because C’s profit was accurately depicted by deducting the amounts immediately (after all, C had spent the money immediately, not parcelled it out over the length of the lease) and this was not against the ITA, C’s decision was permitted and MNR must accept it.Ratio: (1) “In seeking to ascertain profit, the goal is to obtain an accurate picture of the taxpayer’s profit for the given year”; (2) Taxpayers may adopt any method which is not inconsistent with the ITA, case law, or accepted business principles; (3) Business principles are not limited to accounting principles, nor is GAAP preferable to other commercially reasonable methods; (4) To impose a new method of calculation on the taxpayer, the MNR must either show that the taxpayer’s method was inaccurate, or that a more accurate method exists.

7.1.1 Timing: Recognition of RevenueFairly simple for the cash method: when you get the money. For the accrual method, income should be recognized when it becomes “earned” (in the intuitive sense?) or “receivable” (in the accounting sense). Allard: 12(1)(b) says that income is recognized when you sent the bill, or when you should [could? – Mike] have sent the bill.

12(1)(b) any amount receivable by the taxpayer in respect of property sold or services rendered in the course of a business in the year, notwithstanding that the amount or any part thereof is not due until a subsequent year, unless the method adopted by the taxpayer for computing income from the business and accepted for the purpose of this Part does not require the taxpayer to include any amount receivable in computing the taxpayer’s income for a taxation year unless it has been received in the year, and for the purposes of this paragraph, an amount shall be deemed to have become receivable in respect of services rendered in the course of a business on the day that is the earlier of

(i) the day on which the account in respect of the services was rendered, and(ii) the day on which the account in respect of those services would have been rendered had there been no undue delay in rendering the account in respect of the services;

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MNR v J Colford Contracting, 1960 Exch Ct [440]Facts: JCC is a contractor that does various construction work. In 1953, JCC didn’t recognize income from three jobs, which were ongoing at the time. JCC recognized this income in later years, so the issue is not whether the money was earned, but rather when it was earned. Some payments were actually paid over to JCC as the job progressed. Others, known as holdbacks, would be paid only after the job was done and an engineer had signed off on the quality of JCC’s job.Issue: Are the holdbacks received in 1953?Holding: Yes.Reasoning: Receivable is not defined in the act, so courts should seek the ordinary meaning of the word in the field in which it was used… but then the court rejects the dictionary meaning and comes up with its own! Receivable requires the recipient to “have a clearly legal, though not necessarily immediate, right to receive” which denotes entitlement. In the building trade, holdbacks are subject to a condition precedent [from common law property – Mike] so the contractor has no right to the money until the certificate is issued. So the holdbacks were not received until the certificate was issued. In this case, the certificate was issued in the taxpayer’s 1953 year. That JCC learned about the certificate only in 1954 does not change the date at which it became entitled to the money.Ratio: (1) Receivable means “legally entitled”; (2) Tax is triggered by the legal entitlement, not the taxpayer’s knowledge of the legal entitlement.

MNR v Benaby Realties, 1967 SCC [443]Facts: B’s land was expropriated during B’s 1954 fiscal period. The amount of compensation which B was entitled to was agreed with the municipality in B’s 1955 fiscal period. B conducted its business under the accrual method.Issue: When should the income be recognized?

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Holding: 1955.Reasoning: Until the amount of the claim is fixed, B didn’t really have a right to a sum of money. B had a right to compensation, but that right alone is not taxable. It is the amount which is taxed, and until that amount is determined there can be no tax.Ratio: (1) Expropriation funds are income; (2) Until the amount of money to which a tax payer is entitled, the taxable income has not been “received” nor is it “receivable.”

West Kootenay Power and Light Company v The Queen, 1992 FCA [1992]Facts: WKPL sells electricity and bills clients on a bi-monthly basis. At the end of both 1983 and 1984, there was unbilled power that had been sold to customers by year end, which WKPL did not include in its taxable income until the following year. WKPL had included this power in its income from 1979 to 1982, then stopped for 1983-84. MNR opposes the switch back to deferral.Issue: When should the power be included?Holding: In the year that it is delivered.Reasoning: The language of para 12(1)(b) itself makes a distinction between “receivable” and “due” [446, see also quote on that page]. So an amount may be receivable (legal entitlement exists) even though it is not yet due. Here, WKP was entitled to payment as soon as the electricity was delivered. The fact that it issued bills every 2 months does not change its basic legal entitlement to payment WKLP has shown itself easily capable of estimating how much this power is, and did so estimate in 1979-1982. So it has no excuses for not billing in the year of sale.Ratio: Only the legal entitlement, and not billing or collection practices, determines when an amount is “receivable.”Comment: “[insert home city name] Power and Light Company” would be a good band name.

Maritime Telegraph and Telephone Co v The Queen, 1992 FCA [447]Facts: MTT billed clients on a monthly basis, but this didn’t correspond with the calendar month (i.e. bills sent on the 15 th of every month or something). MTT would estimate earned but unbilled revenues at year end. In 1984, it switched to the “billed method” and didn’t include estimated revenues in its income. MNR reassessed, including estimated revenue in MTT’s income. This case was launched shortly after the deeming provision was added to 12(1)(b).Issue: When should MTT’s year-end revenues be included?Holding: In the year that they occur.Reasoning: MTT alleges that the deeming rules for 12(1)(b) enacted a large change in the law for all companies providing services. This is ridiculous and not supported by the scheme of the ITA or extrinsic evidence. “The purpose of paragraph 12(1)(b) is to ensure that income from a business is computed on an accrual basis, not a cash basis, with certain exceptions.” The trial judge found that the earned income method was the most appropriate for MTT, and its receivables are earned in law. MTT has even more information about its subscribers than WKPL, sinec it has client-specific call records. It must include income as it is earned.Ratio: None really, it rejected a silly interpretation of 12(1)(b), then applied the reasoning from WKPL.Comment: [insert home city] Telegraph and Telephone Co is a less-good band name.

7.1.2 Timing: Recognition of ExpensesAgain, the ITA uses words like paid, payable, incurred, etc, to describe expenses, but does not define any of these terms. The general case law approach is that “an expense is incurred when all the events occur that establish the taxpayer’s liability to make payments and the amount due can be determined with reasonable accuracy.” [450] This is the mirror image of the “receivable” rule discussed in section 7.1.1, above. The leading case for this proposition is Guay, below.

Guay Ltee v MNR, 1971 FC [450]Facts: G is a building contractor. G withholds 10% of its payments from the subcontractors it hires until the work has been completed. This holdback becomes payable 35 days after a certificate of acceptance is issued by the architect/engineer in charge of the project. In 1965, G deducted over $277,000 (millions today) in holdback payments. MNR disagreed that these expenses could be deducted in 1965.Issue: When are holdbacks incurred as expenses for the payor?Holding: When they are actually paid.

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Reasoning: Payment of the holdbacks was contingent on proper performance of the job by the subcontractor. If the job was poorly performed, the holdback was reduced or perhaps denied entirely. This case is the mirror of John Colford Contracting, and if the money is not received by subcontractors until the certificate is issued, then it is not spent by contractors until the same time. Ratio: (1) Costs are incurred when the person to whom they are owed acquires an absolute legal entitlement to them; (2) “As a general rule, if an expenditure is made which is deductible from income, it must be deducted by computing the profits for the period in which it was made, and not some other period.”

Collins and Collins v The Queen, 2010 FCA [Handout]Facts: C and C were equal partners in a project to construct low income housing. To finance their project they received large loans from the Alberta government. They later refinanced this loan on new terms. Although the new interest rate was theoretically 10% and required $150,000 per year in interest payments, the minimum payment was $20,000 per year, with the total unpaid balance being due after 16 years. C and C could pay more than $20,000, and up to $150,000 per year. And at any time until the 15 th year, they could pay off the entire mortgage if they paid the balance owing plus $100,000. C and C made their minimum $20,000 payments each year for several years. However, they deducted the upper amount that they could pay in a given year (roughly $150,000) as business interest not paid, but payable under section 20(1)(c). MNR argues they had no obligation to pay more than $20,000 so they can’t deduct sums in excess of that amount.Judicial History: Trial judge agreed with the government that C and C had no obligation to pay the amounts above $20,000 until the 16th year. Hence only $20,000 was deductible.Issue: How much can C and C deduct?Holding: The full amount accruing every year – $150,000.Reasoning: First, C and C had an absolute obligation to pay the interest every year. The fact that they could defer actual payment into the future did not make their obligation contingent. Second, the words “payable in respect of the year” have different meaning depending on whether the taxpayer uses the cash method or the accrual method of accounting. C and C use the accrual method, so their cash expenditures are irrelevant. They may deduct the full $150,000 per year since this is the amount of accrued debt. Their cash outlays of $20,000 do not affect this. The Crown’s last minute attempt to raise the reasonableness of the interest rate is rejected because it was raised as a surprise to C and C, which was unfair and procedurally improper.Ratio: For taxpayers who use the accrual method of accounting, deductions/inclusions depend on legal obligations, not actual outlays.Note: Leave to appeal to the SCC was refused. Which I can’t believe, because this is ridiculous. I think the correct approach would be to hold that C and C had a contingent obligation to pay an amount of between $20,000 and $150,000 every year, and that a precise amount only became “due” when they chose what amount to pay that year. By choosing $20,000 they excluded the possibility of $150,000 accruing. After all, the person they borrowed the money from could not have sued them for $150,000 in interest if they paid $20,000. But he could have sued them for $20,000 if they only paid $10,000.

7.1.3 Special Cases for Recognition of Income/ExpensesAdvance Payments for Unearned Income [453]: GAAP treats income very conservatively, so even if a customer pays ahead of time, the income isn’t recognized until the product is delivered. The assumption is that until delivery occurs, you might have to give the money back. The ITA obviously takes a very different view, since under 12(1)(a) as soon as you receive money you must include it as income. However, 20(1)(m) allows taxpayers to reduce their income by a reasonable reserve for various reasons related to delivery of goods/performance of services in the next tax year… which seems to completely undermine 12(1)(a)...

Prepaid Expenses [454]: Again, GAAP and the ITA diverge. Section 18(9) prohibits deductions in a year for prepayments made for certain items: (a) prepayments for services to be rendered after the end of the year, (b) interest, taxes, rent, etc, related to a period after the end of the year; (c) insurance with respect to a period after the end of the year. Presumably other prepayments are deductible in the year that they are spent.

Reserves [454]: A reserve is an accounting term for income owed but not included in revenue because its payment is questionable or risky, or it is otherwise unlikely to be received. The ITA permits a limited number of reserves:

Reserve for goods/services to be provided in the next tax year: 20(1)(m), discussed above. Reserve for deferred payments on property sold: 20(1)(n) for regular property and 40(1)(a) for sale of capital property.

Basically if you sell something in exchange for instalment payments, these reserves allow you to recognize the income as it comes due, rather than all at once. There are limitations on this (see ITA). There is also the overall reasonability requirement

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of section 67. The CRA believes that a reasonable reserve is (gross profit/gross selling price) x amount due = reserve. Reserve for doubtful debts: 20(1)(l) these are debts that are reasonably suspected as being difficult or impossible to collect.

Direct evidence is not needed [456]. The CRA won’t let you just deduct a percentage of all debts, you need to in some way justify why a particular debt is suspected. This contrasts with accounting practice, which allows you to say “historically I don’t collect 5% of my debts, so I will deduct that amount from my revenue reports this year.”

Reserve for bad debts: 20(1)(p) these are debts for which there is actual evidence that it will be uncollectible [456]

CCA and ECE [457]: Explored in Section 8.4, below.

Modified Accrual Basis Accounting for Professionals [458]: Section 34 allows certain professionals to elect to not include the value of work-in-progress in determining their income for tax purposes. This election is limited to doctors, lawyers, accountants, dentists, veterinarians, and chiropractors. This allows deferral of recognizing income until the actual bill is sent to the client. This is pretty important for law firms who work on big cases, and could ring up a lot of money before actually billing the client. Equally, contingency fee work would be practically impossible without this election.

Brock v MNR, 1991 TCC [459]Facts: B was a lawyer who had made the section 34 election. He sent interim statements of account which indicated that payment of the sums due was required within 10 days of receipt of the statement. B took the position that these statements were for work in progress, so they didn’t count as income until the file was closed, under the section 34 election.Issue: Did the bills for interim payment represent work in progress?Holding: No, they are not works in progress.Reasoning: B’s bills are worded as enforceable contracts, not reminders or notices. And in fact his clients treated them as bills and B received the money. A work in progress should be understood in its ordinary and natural sense – work underway that has not yet been billed. Because the services were actually billed for, B cannot claim the section 34 exception, since his services were no longer works in progress.Ratio: A professional who bills for services must include that income in the taxation year in which it was billed.Comment: I think the judge didn’t do enough research. Contracts for legal services have historically been treated very differently from other contracts. This is a common law issue, and he looked only at statutes. At common law, the traditional position was that a mandate with a lawyer was valuable only if it was completed in full, and a lawyer would have to return interim payments if the mandate was not completed for any reason. See Re Hall and Barker (1878), 9 Ch D 538, which is part of Canadian law. In that case Jessel MR analogized the value of an unfinished legal retainer as follows: “If a shoemaker agrees to make a pair of shoes, he cannot deliver one to you and ask for half the price.” All this to say that Brock should have argued that even if the client paid ahead of time, he as a lawyer had no absolute legal right to retain the payments until the mandate was completed. It’s a little bit like the holdback certificate cases in fact.

Section 7.2: Inventory248(1) Inventory is defined as “a description of property the cost or value of which is relevant in computing the taxpayer’s income from a business for a taxation year.” This is a far broader definition than accountants would use. It seems to include all costs! Our textbook provides the following, more useful, definition: “property acquired or produced by a taxpayer for the purpose of resale at a profit.” [461] What assets constitute inventory depends on the nature of the business. Works in progress are included in inventory.10(1) “property described in an inventory shall be valued as its cost to the taxpayer or its fair market value, whichever is lower” or in other methods allowed by regulation. This provision only applies to businesses that are not “adventures in the nature of trade”10(1.01) for adventures or concerns in the nature of trade, the value is cost the taxpayer paid for the property.10(1.1) rules for land10(2.1) limits on taxpayer’s ability to switch from one inventory valuation method to another10(4) definition of fair market value for advertising materials and works in progress of a “business that is a profession” (see 10(5))10(5) Special inventory rules:

(a) advertising, packaging, and works in progress of a “business that is a profession” is inventory (but see 34)(b) anything used for advertising is not included as inventory for sale under 10(4)(c) this is an oil and gas deduction provision

10(6)-(7) special inventory rules for “a business that is an individual’s artistic endeavour”

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34 six professions can opt out of the normal inventory valuation rules for businesses that are professions: accountants, dentists, lawyers, medical doctors, veterinarians, or chiropractors. If they do section 34 provides new valuations rules.

Canadian Institute of Chartered Accountants (quoted in Freisen [473]): Inventory means “items of tangible property which are held for sale in the ordinary course of business.”

Allard: If something is both a capital outlay and an inventory item, it is treated as an inventory item.

Inventory Accounting: “Timing and Income Taxation” (Arnold, 1983) Inventory is valued at the lesser of cost and fair market value [462]. Fair market value, according to the CRA, may be

calculated at either replacement cost or net realizable value [468]. Inventory value of works in progress should be the raw materials used so far, as well as direct labour and a reasonable share

of overhead expenses (i.e. if you pay $1000 in rent for your factory and make 100 cars that month, you apportion your rent among the cars at $10/car). [463]

Various timing methods exist: Specific item method, Average cost, FIFO, LIFO [465-467]. Specific item method provides the most accurate picture, but may not be practical for many businesses. The average cost method is used in some cases where specific cost is not possible. FIFO is the most common method. LIFO is not allowed [467].

Friesen v The Queen, 1995 SCC [470]Facts: F and other taxpayers had acquired land in 1982 as an adventure in the nature of trade. They borrowed money to do so. The property declined in value over several years and in 1986 the mortgagee foreclosed on the property. In 1983 and 1984, F had deducted the decline in fair market value of the land as a business loss. F argues this is justified because the land was “inventory.”Issue: Can F write down the value of inventory for an adventure in the nature of trade as the losses occur, or must they be claimed only in the year that the inventory is disposed of?Holding: F can write down the decrease in value as it occurs.Reasoning: Case law has already held that single pieces of real estate held as an adventure in the nature of trade meet the definition of inventory in the ITA. Furthermore, the plain meaning of section 10(1) is that write downs on inventory are not only permissible, but mandatory, when its fair market value falls below its cost. F was fully justified deducting the losses on his inventory as they occurred.Ratio: Inventory value can be written down as the losses occur, even without sale of the inventory or planned sale.

Section 7.3: Current Expense vs Capital ExpendituresRecall that capital expenditures are not deductible due to sections 18(b). Instead the ITA treats capital expenditures via the depreciation/CCA system and ECE system. Prior to 1972, such expenses were simply invisible for tax purposes. The classic definition of a capital outlay/expense is given in British Insulated, although other important factors are listed in the Johns Manville Canada decision at [485-486]. These other factors are good examples of the “special circumstances” that British Insulated listed as reasons to treat an expense that looks like capital as a current expense.

Canada Steamship Lines v MNR [498]: “Things used in a business to earn income – land, buildings, plant, machinery, motor vehicles, ships – are capital assets. Money laid out to acquire such assets constitutes an outlay of capital. By the same token, money laid out to upgrade such an asset – to make it something different in kind from what it was – is an outlay of capital.”

British Insulated and Helsby Cables v IRC, 1926 UKHL [477]Facts: The taxpayer set up a pension fund for its employees, and made a large lump-sum payment into the fund to start it off. The company attempted to deduct this as a current expenditure.Issue: Is the lump-sum payment a current expenditure or a capital expenditure?Holding: Capital.Reasoning: “When an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, there is very good reason (in the absence of special circumstances leading to the opposite conclusion) for treating such an expenditure as…capital.” Allard: Three main elements are underlined, enduring benefit is most important.Ratio: A capital expenditure is one which is (a) paid once and for all, and (b) creates an asset or procures an enduring benefit.

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Comment: This is the traditional/classic definition.

Denison Mines v MNR, 1972 FCA [479]Facts: DM owned a uranium mine. The mine was cut entirely though uranium ore veins, with no tunnels through pure rock. The mine consisted of “rooms” or large excavated areas where most of the mining was done, and “thoroughfares” which connected rooms to the extraction points and allowed air to circulate. The thoroughfares were cut through uranium ore too, and this ore was mined and sold in the same way as the ore mined in the rooms. DM is attempting to claim the costs of constructing the thoroughfares as capital costs.Issue: Are the thoroughfares capital costs or current expenses?Holding: Current expenses.Reasoning: The costs of removing ore from the rooms are clearly current expenses, since this is the normal business of a mine. The thoroughfares in this case are cut through ore veins, and the ore is mined and sold exactly like the rooms. There is no indication that DM spent additional money on the extraction of ore from the thoroughfares because of its claimed long-term use of them. Additionally, the extraction of ore from the rooms did not create a new asset for DM. The fact that it could reach other parts of the ore is part of its normal, current expenses. Ordinary business principles are that mining ore is part of the business of mining, not a capital outlay. Thus there was no “cost”, let alone a “capital cost” of making the thoroughfares.Ratio: Capital outlays should result in the creation or acquisition of a new assetComment: Although most taxpayers want to deduct expenses sooner rather than later, Denison benefitted from tax exemptions for the first three years of operation. Thus Denison had an incentive to shift as many expenses from these years into the future, where they could offset non-tax exempt profits.

Johns-Manville Canada Inc v The Queen, 1985 SCC [482]Facts: JMC operated a large open-pit asbestos mine. For almost 40 years it has been progressively acquiring land around the perimeter of its open pit mine, in order to maintain the slope of the outside of the mine at a safe grade. Roughly 100,000 tons of material were removed from the mine every day. Without constant and ongoing land purchases, the mine would become unusable. The land purchased was essentially “used up” to build ramps in and out of the mine, rather than as part of the mine itself, or for any other purpose. Purchase of land represent 3% of the cost of sales of the appellant during the tax years in question.Issue: Was the land capital account purchases or current account purchase?Holding: Current account.Reasoning: Because land purchases are not entitled to CCA, and capital purchases are not deductible, either JMC can deduct the full value of the land as a current expense, or it gets no tax deductibility at all. The expenditures on land were not really of a capital nature because of the ten factors listed at [485-486]. These include: the practical and business purpose of the expenditures, which was not to acquire an asset, the continual nature of the acquisitions over a 40 year period as an integral part of JMC’s operations, the steady and predictable level of cost, the fact that mining would be impossible without continual purchases. The purchase of land is a bit like buying platinum as a catalyst for petroleum operations. Although platinum is theoretically a valuable asset, if you use it as a catalyst, you’re really making a current expenditure, not “investing” in an asset. Ratio: (1) If a tax statute has two possible interpretations, one allowing deduction of a bona fide business expense, the other giving the taxpayer no relief at all, the interpretation providing relief should be adopted; (2) In the absence of an explicit statutory determination, characterization of an expense is a question of policy; (3) Recurring bona fide purchases closely connected to the business of a taxpayer may be current, rather than capital, outlays.

Algoma Central Railway: Sponsored a 5-year long geological survey of Northern Ontario. Normally that would be a capital expense since it adds value to land. But because Algoma was a railway, and the survey was intended to promote business by encouraging investment in areas served by Algoma’s railway, it was a current expense similar to advertising.

Legal Expenses

MNR v Dominion Natural Gas, 1940-1941 SCC [489]Facts: DNG was granted an exclusive license to provide natural gas to Barton Township by the municipal government. That township was later amalgamated with the city of Hamilton. DNG continued to provide gas to its clients. The exclusive supplier to the city of Hamilton then sued DNG and asked for an injunction to prevent them supplying gas to areas now part of Hamilton. DNG defended its case all the way to the privy council. It is now attempting to deduct $50,000 in legal expenses.

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Issue: Are the expenses capital or current expenses?Holding: Capital.Reasoning: For an expense to be deductible as a current business expense, it must be a working expense, an “expense incurred in the process of earning the income.” In this case, DNG defended a valuable intangible asset in a once-and-for-all legal battle. This suggests that it was a capital expense, particularly since the legal fees were not incurred in the process of earning business income.Ratio: (1) “Assets” procured by a capital outlay need not be material; (2) Assets or “enduring advantages” may be the removal of a disadvantage or disbenefit; (3) Normally, legal expenses are current expenses.

Kellogg Co of Canada v MNR, 1942 Exch Ct [491]Facts: K sold a product under the name “Shredded Wheat”, a name which was trade-marked by a competitor. That competitor sued Kellogg, who defended itself by arguing that the competitor’s trade-mark had become invalid due to its generic nature. Kellogg succeeded in having the trade-mark expunged and thereby won its lawsuit. During the lawsuit Kellogg earned no income from products using the name Shredded Wheat [presumably due to an interlocutory injunction –Mike]. Kellogg now is attempting to deduct the legal fees as current expenses.Issue: Are the legal fees current or capital outlays?Holding: Current.Reasoning: This case is very different from Dominion Natural Gas. There, DNG was defending an asset that it owned. Here Kellogg’s was asserting a right which, if it won, it would share with many others. Kellogg’s gained no special rights, but merely destroyed the competitor’s rights. Victory for Kellogg’s in this case would allow anyone to use the name “Shredded Wheat.” So it is hard to see how Kellogg’s acquired an asset or enduring advantage. Finally, Kellogg’s expense was an involuntary expense [although so too was DNG’s! –Mike] not a choice to acquire an asset or advantage.Ratio: Legal payments to attack a property right or an exclusive right of some kind are not capital outlays.Judicial Future [493]: The appeal to the SCC was dismissed with a very brief judgment, which noted that the right Kellogg was defending was not a property right or exclusive right of any kind. Rather Kellogg was asserting a right that was common to anyone, namely the right to describe a product using the name of the product in the popular mind. Dominion Natural Gas created a rule that legal expenses are current expenses unless proven otherwise, and the MNR has not successfully shown why Kellogg’s expenses are of a capital nature.

Canada Starch Co v MNR, 1968 Exch Ct [493]Facts: CSC spent $80,000 on marketing studies, container/label design, etc, to determine the best name for its new cooking oil product and then advertise that name. It settled on “Viva”. The registration of this name as a trade-mark was opposed by another company who had a similar registered trade-mark. CSC paid that company $15,000 to cease its opposition.Issue: Was the $15,000 payment to the company a capital or current expense?Holding: Current.Reasoning: The judge basically analogizes the case to Kellogg’s rather than DNG, although he doesn’t understand how registered trade-marks work, so his reasoning is completely wrong. Goodwill is like any other property used in a business. It is recognized for accounting purposes. Trade-marks are merely the vehicles used to acquire goodwill and deploy it in the marketplace. You can only register a trade-mark if it already has goodwill [false – Mike]. Registering a trade-mark merely confirms existing goodwill and adds little to common law protection [again, false – Mike]. Because CSC already had common law protection for its trade-mark, it wasn’t procuring an enduring advantage or new asset when it registered, so the payment to the competitor is not an outlay “on account of capital” because trade-mark registration is not a “capital outlay.”Ratio: (1) Advertising expenses are current expenses; (2) … I’m not sure how to characterize the judge’s main finding about deductibility of the payment to buy off the other firm’s opposition, since if it wasn’t a payment to protect or acquire an asset, it’s not clear what kind of business expense it actually is… a marketing expense perhaps?Comment: The trial judge’s understanding of trade-mark is a little shaky, so a lot of his reasoning doesn’t make a lot of sense. Registering a trade-mark gives a number of benefits that are above and beyond common law protection. So really, CSC was procuring an enduring advantage that it did not already have. And if one adopts the judge’s reasoning, registered trade-marks are kind of a waste of time, so paying someone $15,000 for them to cease opposition would not be a reasonable amount, running afoul of section 67!

Repairs and Upgrades/Improvements of Capital Assets

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Canada Steamship Lines v MNR, 1966 Exch Ct [497]Facts: CSL made repairs to a ship. These repairs fell into two classes: repairs to the hull/walls/floors, and a new boiler (powerplant).Issue: (1) Are the repairs capital or current expenses? (2) Is the new powerplant a capital or current expense?Holding: (1) Current; (2) Capital.Reasoning: (1) So long as the ship survives as a ship, the replacement of parts of the hull are repairs that are deductible as current expenses. Even extensive repairs are current expenses. The only exception is if the repairs effectively change the nature of the ship, in which case they would be an upgrade and thus a capital outlay. (2) Logically powerplants should follow the same rules, so that replacing a boiler with an equivalent model is a repair and thus a current expense, while replacing it with a superior boiler is an upgrade and therefore a capital expense. However, there are precedents holding that powerplants are separate capital assets, so buying a new boiler is not a repair or upgrade, but rather the acquisition of a new asset entirely.Ratio: (1) Repairs, even extensive repairs, are current expenses unless they also involve upgrades; (2) Upgrades (expenditures which change the nature of an asset) are capital expenses; (3) Equipment and machines are typically distinct assets, unless they are incorporated into a larger asset; (4) Boilers on ships are an exception to this rule, and count as individual assets.

The Queen v Shabro Investments, 1979 FCA [499]Facts: S bought a building that was built on shifting ground, and the first floor cracked when the ground settled. A new floor was needed that was built steel shafts sunk into the ground. This new, reinforced floor was constructed, and damaged pipes and wiring was replaced.Issue: (1) Are the repairs to pipes, wiring, etc, current or capital expenses? (2) What is the nature of the new, reinforced floor?Holding: (1) current; (2) capital.Reasoning: Additions or improvements to an asset are capital outlays. Repairs are current outlays. There is no single test which distinguishes one from the other. In this case, replacing the pipes and wiring were clearly repairs. However, the new and reinforced floor was a capital outlay. The elimination of an inherent defect like the shifting foundation problem was an improvement and change to the nature of the building. After all, if the floor was merely repaired, without the addition of the steel shafts, the building could and probably would have settled again. By installing steel shafts sunk into the ground, the building was transformed in nature.Ratio: (1) Permanent removal of an inherent defect in a building constitutes an upgrade and thus capital outlay; (2) Illustration of the “removing a disbenefit” type of capital outlay.

Gold Bar Developments v The Queen, 1987 FC [503]Facts: GB owned a building that was falling apart. Specifically, bricks were beginning to come lose from the face, and could have fallen on pedestrians. GB tore down the brick wall, and on the advice of engineers installed a metal surface instead. MNR claims this was a capital outlay, GB deducted it as a business expense.Issue: Was the metal cladding a repair or an improvement?Holding: Current.Reasoning: Adopts a more subjective test: what was in the mind of the taxpayer in formulating the decision to spend this money at this time? “Was it to improve the capital asset, to make it different, to make it better? That kind of decision involves a very important elective component…” Here GB had no choice. Furthermore, the expenditure was not substantial, representing only 3% of the cost of the building as a whole. MNR claims that because metal was used instead of more bricks, this made it an improvement and thus capital outlay. This is ridiculous: taxpayers should not be forced to ignore changes in technology, tastes, or their own needs when they decide to undertake repairs. So the mere fact that a repair does not restore the building identically to its former appearance does not make that repair an upgrade (and thus a capital expense). Nothing in the repair project attempted to change the nature of the building, so it is a repair.Ratio: Whatever it is, the ratio of this case flatly contradicts that of the FCA in Shabro… this case also involves the permanent removal of a defect, yet contrary to Shabro, the judge here decides that it is a current expense. I have no idea how the judge could not have found Shabro binding upon him.Comment: The subjective approach is silly. It also is inconsistent with some of the intangible asset cases, where the distinction between being sued (involuntary expense) versus suing someone (voluntary expense) was irrelevant.

Section 7.4: Capital Cost Allowance (Depreciation)Capital Cost Allowance (CCA) is the tax equivalent of depreciation. It is a slow annual deduction of the cost of a capital asset. This

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contrasts with current expenses, which can be deducted all at once. CCA is applied to classes of assets, which are lumped together and depreciated at the same rate over time.

Because the CCA applies to all assets in all industries, a lot of the actual depreciation rates are fairly arbitrary, so the statutory deductions may not match real-life depreciation. The drafters of the ITA knew this, but it would be too hard to try to accurately predict depreciation of all assets in all industries under all conditions. Any attempt to do so would lead to endless litigation. Additionally, the depreciation rates are often motivated by policy factors, like subsidizing certain industries by giving them faster depreciation/write-down rates. So instead of striving for perfection, the ITA picked arbitrary depreciation rates and corrects for errors through the terminal loss and recapture regimes.

Key Terms/EquationsUCC: Undepreciated Capital Cost = (A+B) – (E+F)

A: Purchase cost of all assets ever added to the classB: Total of all previous recaptureE: Total of all CCA previously claimedF: Proceeds of disposition up to cost (i.e. the lower of cost or proceeds of disposition)

CCA: Capital Cost Allowance. The amount you actually get to deduct off your income. This is the “depreciation” of your asset.

ITA /Regulation Provisions 18(1)(b) Capital outlays not deductible unless specifically allowed by the ITA.20(1)(a) CCA is deductible1102(1)(c) No CCA deduction is allowed on capital asset that is not used to earn income. No deductions for personal use capital asset. 1102(1)(a) Inventory cannot be used for CCA1102(1)(b) Assets whose cost is not currently deductible cannot be depreciated (e.g. works in progress?) 1102(2) Land cannot be depreciated under CCA, although buildings can.13(7)(c) Where property used both to earn income and for other purposes, apportionment of CCA is carried out.

7.4.1 Calculation of CCAClass-based Calculation: CCA is calculated on classes of assets. So the value of all your assets in a class is pooled together, then you depreciated the value of the pool as a whole. Classes are defined in Schedule II of the Income Tax Regulations.

Example classes: Class 2, 6% depreciation, applies to electrical generation and transmission equipment, oil and gas distribution equipment/buildings, etc. Class 5, 10% depreciation rate, pulp and paper plant and equipment. Class 10, 30% depreciation rate, applies to motor vehicles, self-propelled construction equipment that is used for rental purposes, general-purpose electronic equipment and some software, the floor of roller or skating rinks (!), Canadian film or video production equipment [this latter inclusion is a clear example of a subsidy, since the fast depreciation encourages foreign film studios to hire or buy local equipment rather than bring their own – Mike], etc. The example of Class 10 also shows how wide-ranging the classes are.

Important Classes: Class 8, which covers all tangible property not included elsewhere (there are a few exceptions to this catch-all class, like plans and animals, and mines… see 8(i)); Class 1, 4% all buildings that aren’t captured elsewhere.

Exceptions: There are a few exceptions to the class rule. Motor vehicles that cost more than a certain amount and that are used as passenger vehicles must be depreciated individually: regulation 7307, regulation 1101(1af). Rental properties that cost more than $50,000 must be treated separately: regulation 1101(1ac).

Calculation Method: CCA is generally calculated on a “declining balance” basis. This means you take 4% of the amount remaining in the class every year. So if you have a $100,000 asset, you take 4% in year one, reducing the amount to $96,000 (allowing you to deduct CCA of $4,000 that year). In year two you take 4% off $96,000, reducing the total to $92,160 (CCA $3,840). In the third year you take 4% off of $92,160, leaving you with $88,473 (CCA $3,687). The amount you deduct each year gets smaller, since you’re taking it off a progressively smaller number, hence the name “declining balance.”

Some assets (leasehold interests, patents, concessions, franchises, and license) use the straightline method (regulation 1100(1)(b) and 1100(1)(c) and Schedule III). Under this method you deduct the same amount ever year. So if there is a 4% deduction rate, and your patent cost you $100,000, you take $4,000 off every year: $100,000> $96,000>$92,000>$88,000. What all of these assets have in common is that they are intangible assets with a fixed lifetime, so it makes sense that their value is spread out equally over the lifetime.

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Taxpayers can claim up to CCA each year, but they don’t have to claim it if they don’t want to [507]. However this just delays the payment, since they can’t double up CCA in the next year, so you just skip a year and continue where you left off in the next.

Formula: For our purposes it’s only (A+B) – (E+F) where:A: Purchase cost of all assets ever added to the class.B: Total of all previous recaptureE: Total of all CCA previously claimedF: Proceeds of disposition up to cost (i.e. the lower of cost or proceeds of disposition)

I’ve included the technical definitions UCC and the variables at the end of this section. It’s too long to go here.

The bus example at 509-513 is super helpful. If you understand it, then you understand everything about CCA. Just keep in mind that your CCA is a running total, so you’re always carrying over the past values of A, B, E, and F.

Half-Year Rule: 1100(2) requires that the value of any asset acquired in a year be divided in half and deducted from the total UCC in the year. You still add the full value of the new asset to A, but then take out half that value as a special that-year-only reduction. The half year deduction amount is reduced by the value of dispositions in the year. If you have more dispositions than acquisitions, there is no half year deduction – it stop at zero and doesn’t go in to the negative. This results in what the textbook and Prof Allard call “notional UCC” for that year. NOTE: The half year rule is only applied if there are more acquisitions than dispositions.

Notional UCC: (A+B) – (E+F) – 1/2 (new acquisitions – new dispositions)**Only apply the half year rule if there are more acquisitions than dispositions. If dispositions are greater, nothing is deducted.

Technical Definitions Straight from the ITA “undepreciated capital cost” to a taxpayer of depreciable property of a prescribed class as of any time means the amount determined by the formula:

(A + B) - (E + F) where,A: is the total of all amounts each of which is the capital cost to the taxpayer of a depreciable property of the class acquired before that time,B: is the total of all amounts included in the taxpayer’s income under this section for a taxation year ending before that time, to the extent that those amounts relate to depreciable property of the class,E: is the total depreciation allowed to the taxpayer for property of the class before that time [i.e. CCA used to date –Mike]F: is the total of all amounts each of which is an amount in respect of a disposition before that time of [a] property…of the taxpayer of the class, and is the lesser of

(a) the proceeds of disposition of the property minus any outlays and expenses to the extent that they were made or incurred by the taxpayer for the purpose of making the disposition, and(b) the capital cost to the taxpayer of the property,

“total depreciation”…means the total of all amounts each of which is an amount deducted by the taxpayer under paragraph 20(1)(a) in respect of property of that class or an amount deducted under subsection 20(16), or that would have been so deducted but for subsection 20(16.1), in computing the taxpayer’s income for taxation years ending before that time.

7.4.2 Terminal Losses and Recapture13(21) Definition of total depreciation as: means the total of all amounts each of which is an amount deducted by the taxpayer under paragraph 20(1)(a) in respect of property of that class or an amount deducted under subsection 20(16), or that would have been so deducted but for subsection 20(16.1), in computing the taxpayer’s income for taxation years ending before that time;20(16) Terminal losses are deductible13(1) recapture must be included as income

When a taxpayer sells a depreciable asset, there’s a very good chance that it will be sold for a price that is either above or below its value for income tax purpose (i.e. after CCA was taken off). This means that the income picture generated by CCA is inaccurate and needs to be corrected for tax purposes. But because CCA applies to classes of assets, not individual assets (with a few exceptions) it is impossible to track whether a particular asset has been sold at the “wrong” price. Instead, the ITA triggers the assessment of

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recapture/terminal losses in the following two scenarios: Recapture: Applies when The UCC of a class is a negative number, regardless of whether there are assets in the class or not.

If this happens, you have to (1) add recapture to the class sufficient to return it to zero (term B in the UCC formula); and (2) add the same amount to your income under section 13(1). Allard: You will also have to pay for a capital gain on the item itself if you sell it for more than its original purchase price. Recapture applies to classes of items under the ITA, while capital gains apply to individual items.

Terminal Loss: Only triggered if (1) there are no more assets in the class, and if (2) at that time A+B is greater than E+F. If this occurs, you get to deduct the difference between (A+B) and (E+F)

o Suppose you never had any recapture on a class, so when you sold the last asset, your formula to check for recapture is A>E+F, or equivalently, A-E>F. A-E is the value of the assets after depreciation, F is your sale price. So if A-E>F, this means you sold for less than the depreciated value, and therefore made a terminal loss.

Note that you can defer recapture by adding more assets to the class (which increases A, so that A+B>E+F). This is a tax-planning strategy that Allard seems to like.

Replacement Rules [514]: 13(4) allows you to defer recapture if (1) your disposition of the property that triggered recapture was involuntary (fire, theft, etc), and the property disposed of was a “former business property” and you acquired a “replacement business property” within the meaning of section 13(4.1) within a specified amount of time.

Rental and Leasing Property Restrictions [515]: To block schemes like the one in Stewart v The Queen, rules exist to prevent using rental properties to create losses in some situations. See the textbook for details.

7.4.3 Other Legal IssuesDefining Cost/ “A” in the UCC formulaSee [517-518] for more details on cost. Generally cost is acquisition cost, unless there are non-arms length parties involved. Where property is not used entirely for earning income, an apportionment is made between its income- and non-income-producing uses.

13(7)(c) Apportionment if property is used in part to earn income and in part for other purposes (e.g. family residence/home office)

Ben’s Ltd v MNR, 1955 Exch Ct [516]Facts: B bought land surrounding its bakery in order to expand the bakery. B paid a total of $42,000. The land had buildings on it being used for a residential purpose. B told the tenants that their leases would not be removed and as soon as the last tenant left B sold the buildings for $1,200, and they were removed from the land [wtf…do they mean one of those house-moving trucks came by, or did B buy a trailer park or what? –Mike]. Once the buildings were removed, B expanded the bakery. B tried to deducted 10% depreciation on the buildings, claiming that they were worth $39,000 and the land was worth only $3,000. MNR was having none of that.Issue: What is the cost of the buildings for Ben’s (cost being relevant for determining “A” in the formula)?Holding: Irrelevant, because the buildings don’t even belong in the CCA system.Reasoning: Ben’s right to claim CCA is dependent on its having acquired the building for “the purpose of gaining or producing income.” Otherwise it did not acquire an asset to which CCA applies. Because Ben’s only purpose in acquiring the land and buildings was to demolish the buildings and use the land, the buildings were not acquired for the purpose of gaining or producing income. Thus no CCA can be deducted. [This neatly sidesteps the issue of how to apportion the purchase price between land and buildings –Mike]Ratio: CCA cannot be deducted from assets which are acquired for immediate destruction.

Timing [519-521]13(16)-13(27) Deeming provisions for when property becomes available. The earliest date of (among others): when it is available for use, when it is first used for producing income, when it is disposed of by the taxpayer (if you buy and then sell it almost immediately), the time a building is completed… the list goes on. The case law principles are that property is acquired when title passes, or when all the incidents to title (use, possession, risk) pass, even if legal title is retained as security for the purchase price [520].

Section 7.5: Eligible Capital ExpendituresThis is a special kind of capital cost allowance system for intangible assets like goodwill.

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7.5.1 DefinitionITA Definition This consists of a open ended definition “any outlay or expense made or incurred by the taxpayer, as a result of a transaction occurring after 1971, on account of capital for the purpose of gaining or producing income from the business” followed by a list of exceptions that are NOT qualified as ECE:(a) Any amount that would otherwise be deductible under the ITA from business income, or which is specifically prohibited as a deduction from business income. This ensures there are no double deductions (once as ECE, one somewhere else) and also that ECE doesn’t let you get around a prohibition elsewhere.(b) ECE can’t be deducted if the transaction giving rise to it generated exempt income.(c) ECE can’t be deducted with respect to tangible property, depreciable intangible property, property which gives deductions in any other manner. (d) debts related to shares or bonds; (e) payments to shareholders of any kind; (f) shares, bonds, interests in corporations or trusts.Nor can ECE be deducted for a interest in any of the above, or a right to acquire any of the above.

According to the textbook the main thing that is included in ECE is purchase of goodwill.

7.5.2 Calculation and RegimeECE is like a combination of CCA and the capital gains system. Three quarters of the value of ECE purchases are added to the taxpayer’s ECE total. Three quarters of the value of a sale of ECE is removed and added to the tax payer’s income when a sale occurs. ECE can be depreciated at up to 7% a year on a declining balance basis under 20(1)(b). There’s an example at [522]. There’s some deep questions about EEC at [524].

7.5.3 Classifying Eligible Capital ExpendituresSubsection 14(5) defines ECE as nearly all expenses incurred after 1971 for the purpose of gaining or producing income from a business that are capital in nature, and are not otherwise prohibited or deductible. This normally includes: goodwill, customer lists [trade secrets in general? Or are those property? –Mike], some franchises, and the expenses of incorporation or reorganization.

Royal Trust Co of Canada v The Queen, 1982 FC [525]Facts: A corporate predecessor of RT sold shares of its capital stock to a broker (Pitman) for resale to the public. It granted the broker a commission on the selling price and claimed deductions for the commission as ECE. MNR disallowed.Issue: Is the brokerage fee an ECE?Holding: Yes.Reasoning: MNR claimed that RT never actually made a payment of the commission, and that the commission wasn’t so much an expenditure as a reduction of the selling price of its shares. This was an improper decision for MNR to make. The evidence shows that both the share price and the commission were separately negotiated by RT with various brokers before settling on Pitman. RT also had a goal of selling the shares as widely as possible, ideally to financial institutions that might later become clients. This shows that the brokerage commission was not merely a deduction from the selling price.Ratio: (1) [narrow] where a taxpayer can show that the commission of a broker was negotiated separately from the selling price, the commission will be deductible via ECE; (2) [broad] all brokerage commissions are deductible.Comment: I don’t know if the ratio should be narrow or broad, but the broad ratio is now part of the ITA at 20(1)(e).

The Queen v Saskatoon Drug and Stationery Co, 1978 FC [527]Facts: SDS bought seven drugstores in [somewhat ironically] Regina. SDS acquired inventory, buildings, and other tangible assets, plus a number of intangible assets. These intangibles included a number of leases, rights of first refusal, and the option to buy some of the land that was being leased. There was also a clause specifying that if any of the store burned down, the vendor would pay the purchaser liquidated damages. No portion of the sale was specifically attributed to these intangible. After the sale, SDS carried

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$207,500 in goodwill on its books, which was recorded as “premiums on lease purchased.” SDS attempted to deduct CCA on this $207,500, claiming it as part of the leasehold interest. This extra money is over and above the value of the lease itself.Issue: Is the locational goodwill of the leases deductible?Holding: Most of it is deductible via CCA as part of the leasehold interest.Reasoning: While the leases were fairly generous ones, there was no proof that a prospective tenant would pay anything over and above the cost of the lease itself. So if SDS can deduct anything, it is locational goodwill. This goodwill is evaluated at $187,500 by the trial judge. “I am unable to divorce the goodwill for a location from the other advantages accruing to a person entitled to possession of that location.” So the $187,500 is imputed to the leases and deducted through their CCA. There is no proof of where the remaining $20,000 came from, so it is not deductible.Ratio: Goodwill for a rented location is included in the value of the leasehold interestComment: Unanswered question after reading this: if SDS owned the building, would locational goodwill go to the building? Or would it be part of the land and thus not be deductible? Or would it be deductible under ECE if it was attached to the land?

Chapter 8: Chapter 8: Capital Gains and LossesCapital Gains and LossesCapital gains have only been taxable in Canada since 1972. The history of why they became taxable is related at [531-534]. Interestingly, one of the reasons given by the commission was that taxing capital gains “would render obsolete the many guidelines that have been established over the years for determining what was in the taxpayer’s mind, an exercise which was at its best unsatisfactory, and at its worst arbitrary.” [532] This show an appreciation of the need for certainty in tax law, and the traditional common law distrust of subjective tests.

Textbook [82]: “A capital gain or loss is realized on the sale (or other disposition) of a capital asset… it results from the disposition of the source itself.”

Allard: The courts in the pre-1972 cases are well aware that if something is found to be a capital gain/loss, it will not be taxable/deductible at all

9(3) property income does not include capital gains or capital losses.

Section 8.1: Overview and Solutions Map(1) Is the property in question intangible (go to 2) or tangible (go to 3)?(2) If intangible, does it qualify for as an eligible capital expenditure?

(a) If yes, apply ECE regime.(b) If not, it may be either a standard capital transaction or an adventure or concern in the nature of trade (go to 5).

(3) If tangible, is it personal use property (go to 4) or business use property (go to 5)?(4) If personal use tangible property, is it listed personal property?

(a) If it is LPP you can claim capital losses and gains.(b) If it is not LPP, then only capital gains are counted, and capital losses are not recognized for tax purposes.(c) Recall that all personal use property is subject to the $1000 deeming rule from 46(1).

(5) The transaction is either: an adventure in the nature of trade or a capital account transaction.(a) Adventure in the nature of trade is a current revenue/expense.(b) Capital gain rules are below. Note that some capital losses will be ABILs (deductible against all sources of income).

(6) There is a lifetime capital gain exemption of up to $750,000 of capital gains (so before the 50% reduction for taxation purposes). This deduction only applies to qualifying farming businesses, fishing businesses, and small business corporations under 110.6(1).(7) Only 50% of a capital gain is included in income.

Section 8.2: Capital Gain or Adventure in the Nature of Trade?Book [325]: Where a taxpayer enters in to an isolated transaction, if the transaction is speculative and intended to yield a profit, [then even if] the taxpayer is not a trader, the profit is taxable as business income.”

CRA’s administrative position and the factors they look at is set out at [357].

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39(4) Election for gains and losses of disposition of Canadian securities as capital gains or income.39(5) Those who deal in securities professionally cannot make this election. [“professionally” defined flexibly see cases at 550-551]Text: A debt owing to a taxpayer for disposition of capital property is itself a capital property [581].

California Copper Syndicate v Harris, 1904 Scot Ct of Sess [540]Facts: CSC acquired began developing, then sold, a copper field.Issue: Was this a capital gain or business income?Holding: An adventure in the nature of trade, so business income.Reasoning: Even a single transaction can be an adventure in the nature of trade – this is clear from the use of a new term instead of merely “trade,” and from the singular/one-off sense of the word “adventure.” Speculative buying and selling is a business. Selling an income producing property may thus produce either a capital gain or business income. The judge says that the dividing line is “is the sum of the gain that has been made a mere enhancement of the value by realising a security, or is it a gain made in an operation of business in carrying out a scheme of profit making.” Based on the nature of the syndicate’s trade it seems highly speculative in general. Based on the capital available to the syndicate and the way that it spent the money, it never had any intention to actually develop the field. So the field could not have been an income producing property. So it was acquired on a speculative basis. So it was an adventure or concern in the nature of trade.Ratio: The distinction between capital gains and an adventure in the nature of trade is a subjective one based on the purpose of the acquisition and sale.Comment: I used some modern terms for clarity even though that’s not the language the Scottish Court of Session adopted.

Canadian Marconi Corporation v The Queen, 1986 SCC [542]: Where income is received or generated in an activity that is one of the objectives listed in the articles of incorporation of a corporation, there is a rebuttable presumption that this activity was business income/expenses.

MNR v Taylor, 1956 Exch Ct [552]Facts: T bought lead in bulk and sold it to a company he worked for, after getting clearance to do so. He made unexpectedly large profits due to a lead shortage.Issue: Was T’s profits on the lead a capital gain or income in the nature of trade?Holding: Business income because the lead purchase was an adventure in the nature of trade.Reasoning: The judge begins with a long review of the case law, concluding that (a) even one transaction is enough to qualify as an adventure in the nature of trade, (b) that the nature of the taxpayer’s conduct is critical, (c) “adventure in the nature of trade” is a much broader concept than “trade” which is one of the justifications for finding (a) above. T’s main motivation was to make a profit buying and selling the lead, and even if it benefitted him in his employment (he made up for a bad decision previously by ensuring the company’s lead supply) that is not enough to change his overall intent.Ratio: (1) Even a single transaction can qualify as an adventure in the nature of trade; (2) Mix of objective and subjective factors used to assess whether it is an adventure in the nature of trade.Comment: This was the first case in which “adventure and concern in the nature of trade” was defined by the federal courts.

Regal Heights Ltd v MNR, 1960 SCC [542]Facts: RH bought land bordering the trans-Canada highway with the goal of building a shopping centre. Various purchases, studies, negotiations, etc, were carried out. Generally there was enough interest in RH’s project for it to move forward. Then another company announced that they would open a shopping centre 2 miles from RH’s proposed site, and RH realized that their centre was no longer feasible. RH sold the land at a profit. The nature of that profit is now disputed.Issue: Did the sale product a capital gain, or was RH involved in an adventure in the nature of trade?Holding: Adventure in the nature of trade.Reasoning: While RH’s primary intention was to build a shopping centre, it always had a secondary intent that the land would be sold at a profit if the shopping mall idea fell through for any reason. RH’s sincerity in promoting the shopping centre was less than convincing, which reinforces the idea that they had a well-developed fallback plan of selling the land for a gain. “They failed to promote a shopping centre and they then disposed of their speculative property at a profit. This was a venture in the nature of trade and is taxable [as such].”

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Ratio: (1) Creation of “secondary intent” approach to capital gains/adventure in the nature of trade; (2) Secondary intentions must be assessed at the moment of acquisition; (3) Secondary intentions will be more easily found where the venture is speculative in nature.Comment: The case law which follows at [544-545] is worth reading since it illustrates the scope of the ratio in RH. Allard dislikes the reasoning in Regal Heights.

Allard: The secondary intent doctrine is alive and kicking, even if Irrigation Industries criticized it severely. She also noted that the more unrealistic/speculative your primary intent is, the greater the chance a secondary intent will be found. Vacant land often gets found to be acquired on a speculative basis, and thus it’s an adventure in the nature of trade and thus business income. Which makes sense, because it’s tough to earn income from bare land. The similarity of a transaction to the kind of transaction you already do will influence the likelihood of finding a business purpose for a given transaction.

Irrigation Industries v MNR, 1962 SCC [546]Facts: II was incorporated to purchase farm properties and create an Alfalfa mill. The project was never carried out and the company remained dormant for many years. Then II purchased 4,000 shares of a NB mining company. This purchase was funded by an overdraft at the bank of almost $40,000, since the company had no assets. The bank called upon II to pay off the overdraft in 2-3 weeks, which was done by selling off some of the shares. The remaining shares were sold later for a handsome profit.Issue: Was the share purchase a capital gain/loss or an adventure in the nature of trade.Holding: Capital gain.Reasoning: Majority: Rejects a purely subjective test, since guessing what is in the minds of the purchaser at the time of purchase is a futile task. Furthermore, it is difficult to conceive of anyone buying shares without having at least some intent to sell them if the price is right… and yet there are no cases in which a person who did not trade in shares for a living was found to have been a trader due to one isolated transaction. Instead, the courts should look to objective factors like the manner in which the taxpayer dealt with the property, and the nature of the purchase/sale transactions. Here these factors point to a capital transaction.Dissent: Applies Regal Heights. The share sale was a venture in the nature of trade.Ratio: (1) Objective factors should be preferred to subjective ones in assessing capital gains vs adventure in the nature of trade; (2) Two important objective factors are: (a) did the person deal with the property purchased by him as a dealer [i.e. trader] ordinarily would, and (b) whether the nature and quantity of the subject-matter of the transactions were suggestive of a trading purchase or a capital purchase.Comment: This is 1962, so if the transaction was not an adventure in the nature of trade, it was not taxable

8.2.1 Calculating Capital GainsA capital gain is the (1) proceeds of disposition minus both (2) the adjusted cost base of the property and (3) the costs of disposition.

54 “adjusted cost base” (a) and (b) capital cost of depreciable property.53 and 54 “adjusted cost base” (b) definition of cost of undepreciable property.38(a) capital gains count at 50% in your income38-39 definition of capital gain/loss and basics of the regime

8.2.2 Adjusted Cost Base53 too long to reproduce here. Sets out calculation methods for various kinds of property (shares in corp, interest in partnership)54 “adjusted cost base” to a taxpayer of any property at any time means, except as otherwise provided,

(a) where the property is depreciable property of the taxpayer, the capital cost to the taxpayer of the property as of that time, (b) in any other case, the cost to the taxpayer of the property adjusted, as of that time, in accordance with section 53,(c) [complex exception for property you dispose of then reacquire(d) in no case shall the adjusted cost base to a taxpayer of any property at any time be less than nil;

The adjusted cost base of depreciable property at any given time is its “capital cost” to the taxpayer at that time (s 54 “adjusted cost base” para (a)). The ACB of undepreciable property is its “cost”, given at s 54 para (b) and section 53. These terms are not defined in the Act.

Capital Cost (ACB of Depreciable Property)

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According to the CRA [559], capital cost is the original purchase price plus the legal, accounting, engineering, brokerage, etc, costs that had to be paid to acquire the property. It can also include debts incurred to buy the capital asset. Interest and taxes paid in relation to land must be capitalized like this and their value added to that of the land: ITA 18(2), 18(3), 53(1)(h).

Capital expenditures: Money spent improving capital (but not repairing it!) are included in its cost [560]. Certain construction costs of a building and some land ownership costs must be added to its value 18(3.1)-(3.7). Because these are deductible at the 50% rate, and only when sold or via CCA, they are not as valuable as immediate business income deductions.

If there is a barter transaction between arms-length parties, the value of the things exchange can be difficult to measure. If one asset has an uncertain value (a disputed legal claim) but the other is easy to measure (money), there is a presumption that the two assets have the same value

There’s a complex set of rules for pre-1972 property at [561-563]. Not sure we actually need to know this, so I won’t expand on it.26(3)26(7) election for individuals

Cost (ACB of Non-depreciable Property)It seems like shares and corporations are the typical non-depreciable property. Adjustments for this kind of property are largely set out in section 53. See textbook at [564-565 for some details about inclusions/exclusions from cost].

8.2.3 Disposition and Proceeds of DispositionSCC has ruled that Disposition and Proceeds of Disposition bear both their ordinary and grammatical meanings, and also the expanded ITA definitions that add things to them via the “X includes Y, Z, etc” definitions [565]. The text notes that if as part of a sale the buyer assumes any encumbrance or liability (like a mortgage) the value of this assumption is added to the seller’s proceeds of disposition and to the buyer’s cost [566]. Sale price also includes other non-cash consideration like goods or services. An interesting tort-contract issue is raised at [566-567].

RCI Environment v The Queen, 2009 FCA [565]: “In principle, any right that is convertible into cash is likely to result in a disposition when it is converted.”

“disposition” includes any transaction or event entitling a taxpayer to proceeds of disposition of property. “proceeds of disposition” of property includes

(a) the sale price of property that has been sold,(b) compensation for property unlawfully taken,(c) compensation for property destroyed and any amount payable under a policy of insurance in respect of loss or destruction of property,(d) compensation for property taken under statutory authority or the sale price of property sold to a person by whom notice of an intention to take it under statutory authority was given,(e) compensation for property injuriously affected, whether lawfully or unlawfully or under statutory authority or otherwise,(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 within a reasonable time after the damage been expended on repairing the damage,(g) an amount by which the liability of a taxpayer to a mortgagee or hypothecary creditor is reduced as a result of the sale of mortgaged or hypothecated property under a provision of the mortgage or hypothec, plus any amount received by the taxpayer out of the proceeds of the sale, and(h) any amount included because of section 79 in computing a taxpayer’s proceeds of disposition of the property;

DispositionThe Queen v Compagnie Immobilière BCN, SCC [567]: Disposition also includes events that do not produce proceeds, such as the owner knocking down the building, or an uninsured building burning down.

CRA [567-568]: disposition is “any event or transaction where possession, control, and all other aspects of property ownership are 54

relinquished.” The CRA is also prepared to treat some kind of changes to the nature of property as dispositions, such as the terms to a security obligation changing so radically as to alter the nature or identity of the security. Finally, if property changes uses, such as from inventory to capital, this counts as a disposition, so that an ultimate sale will generate a mix of capital and trading income.

General Electric Capital Equipment Finance Scheme case (Allard): “When it can be said that substantial changes have been made to the fundamental terms of the obligation, which materially alter the terms of that obligation, it can be said that a new obligation has been created and the old one disposed.” Examples: interest, maturity date, principal amount, identity of debtor [probably not identify of the creditot – Mike]

Some things that are not dispositions [568-570]: Transfers securing a loan or debt, or returning the security to borrowers. This is deemed in the definition of disposition at

paragraph h. So granting or redeeming mortgages does not trigger capital gains or losses. Transfers of bare legal title are not general dispositions, so trusts are generally not dispositions (para e and f). Transfers to

agents are also not dispositions without any change in the beneficial ownership. However transfers to trusts may trigger dispositions.

Bailment is not a disposition, since there is no change of legal or beneficial ownership. Partition of jointly-owned property is not a disposition: 248(20) and 248(21). Granting an option is not a disposition of the property over which the option is granted. Corporations do not dispose of anything when they issue their own stock or other securities.

Deemed Dispositions [570]To prevent lock-in effect of too much capital gains accruing, and to combat tax avoidance, certain events create deemed dispositions of all property. These include:

change of use of assets from business to non-business purposes or vice versa 45(1), but see elections to avoid at 45(2)-(3); death of the taxpayer 70(5), but see spousal rollover to avoid this deemed disposition at 70(6); giving up Canadian residence 128.1(4)(b); deemed dispositions of trust property every 21 years 104(4)(b),(c)

Deemed Prices/Cost Provisions69 Non arms length transfers52(4) prizes acquired in lotteries are deemed to have been acquired at fair market value70(5)(c) death disposition, prices thereof

Timing of Dispositions [572]It seems like this follows the same rules as business income: absolute right to be paid is the time at which a capital gain/loss is recognized to have occurred. CRA lists the following as “strong indicators of the passing of ownership”: (a) physical or constructive possession, (b) entitlement to income from the property, (c) assumption of responsibility for insurance coverage, (d) commencement of liability for interest on the purchaser’s debt that forms a part of the sale price [?]. Allard: Tax authorities tend to ignore the built-in retroactivity of Qc conditions precedent.

Partial Dispositions [573]When a taxpayer disposes of part of a larger asset, the taxpayer must allocate a reasonable amount of the ACB to the part sold 43(1). After this allocation to the part disposed of, the remainder is allocated to the unsold part of the property 53(2)(d).

Combined Proceeds from More than One Property [574]68. Where 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 taxpayer or as being in part consideration for the provision of particular services by a taxpayer:

(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 irrespective of the form or legal effect of the contract 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; and(b) the part of the amount that can reasonably be regarded as being consideration for the provision of particular services shall be deemed to be an amount received or receivable by the taxpayer in respect of those services irrespective of the form or

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legal effect of the contract or agreement, and that part shall be deemed to be an amount paid or payable to the taxpayer by the person to whom the services were rendered in respect of those services.

The Queen v Golden, 1986 SCC [574]Facts: The taxpayer sold land and a building for 5.85 million, allocating 5.1 million to the land and $750,000 to the building. Expert evidence showed that 2.3 million was a reasonable amount to pay for the land. MRN reassessed at 2.3 for the land and 3.5 for the building.Issue: Can MNR reassess the allocation as unreasonable?Holding: No.Reasoning: The SCC endorsed the FCA’s position on section 68 reassessments [574]. The procedure endorsed by the FCA was to figure out the reasonable value of the transaction from the perspective of both buyer and seller. The trial judge had ruled that 5.1 million was reasonable payments for the land at the time. Thus the MNR was not justified in reassessing the transaction merely because MNR preferred a different, equally reasonable, allocation.Ratio: Where arms length parties reach an allocation, it can be interfered with only in exceptional circumstances.

Section 68 cannot apply where the parties allocate all of the proceeds of a transaction to a single asset. [575]

Where a building is demolished shortly after or before a sale of the underlying land, the proceeds can be allocated entirely to the land, because only bare land is being paid for: The Queen v Malloney’s Studio, 1979 SCC [575].

Rollover and Replacement Transactions [575]Note that destruction or theft of property can result in disposition if the owner receives insurance payments, since these are proceeds of disposition. There are rules for this given at [567] and [575-576].

Rollovers for Non-recognition of Transaction [577]Various examples given in this section of transactions that allow you to preserve the capital gains. Mandatory or elective.

Reserve for Future Proceeds [577]This section covers installment payments on capital sales, using the regime at 40(1)(a)(ii),(iii). You can take a reserve for the future payments (presumably to reflect the possibility you won’t be paid and to defer recognition of payments that haven’t happened yet). This allows you to effectively spread out your original capital gain over up to five years. The CRA requires you to take the lesser of two amounts: a “reasonable amount” and a mathematical formula. The CRA helpfully provides a formula they believe is reasonable. The mathematical formula reaches zero by design in the fifth year, which means that any remaining reserve payments are due in the third year.

Reasonable Rate: Capital gain x (amount not due until after the end of this year/proceeds of disposition)Mathematical formula: (4/5 capital gain in year of disposition, 3/5 of cg in year 2, 2/5 of cg in year 3, 1/5 of cg in year 4, 0 in year 5)

Expenses/Costs of Disposition [579]The taxpayer may add to the ACB any costs incurred for the purpose of making the disposition. This includes surveying fees, notary fees, legal fees from due diligence, commissions, finder’s fees, even fixing-up expenses. Fixing-up expenses include minor repairs and cleaning expenses to put the car in a sellable state. More expensive improvements or renovations would be added to the cost. Repairs that don’t qualify as fixing-up costs would be current expenses, not capital-expenses.

8.2.4 Capital LossesLosses are also deductible at only 50% of their actual value 38(b). Capital losses are deductible only against capital gains, not against all sources of income. The exception to this is Allowable Business Investment Losses (ABILs), which may be deducted against all sources of income. ABILs are available for designated kinds of property like Canadian small businesses. Capital losses existing and unapplied at death may be deducted against all income in the year of death. [579-580]

Capital losses may be carried back 3 years, or forward up indefinitely from the year in which it occurs. A taxpayer’s earliest capital

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losses must be used up first: 111(3)(b).

8.2.5 Non-recognized Capital LossesDepreciable Property [580]Losses relative to an asset’s depreciated value are covered by terminal losses, and do not give rise to a capital loss under 39(1)(b)

Personal use property[580]“personal-use property” of a taxpayer includes:(a) property owned by the taxpayer that is used primarily for the personal use or enjoyment of the taxpayer or for the personal use or enjoyment of one or more individuals each of whom is

(i) the taxpayer,(ii) a person related to the taxpayer, or(iii) where the taxpayer is a trust, a beneficiary under the trust or any person related to the beneficiary,

(b) debts owed to the taxpayer due to disposition the taxpayer’s personal-use property, and (c) options to acquire personal use property

Capital losses on personal use property are deemed to be nil 40(2)(g)(iii) and so are not deductible. However, section 41 permits capital losses on certain kinds of personal property, called Listed Personal Property, to be deducted.

Note that all personal property, including listed personal property, is subject to a deeming clause at 46(1) that deems personal property to have been acquired and sold for $1000 if either price is less than $1000. As a result, if both cost and sale price are less than $1000 then this section deems away any possible capital gain or loss. If only one is below $1000, the amount of the loss/gain will be altered. And if both are above $1000, the section doesn’t apply. If you dispose of a set of LPP, the deeming rule applies to the set, not each piece.

Superficial Losses [583]A superficial loss occurs when a taxpayer sells a capital property at a loss, then repurchases a similar or identical property soon thereafter. These losses are disallowed to prevent gaming the system and to reduce paperwork. Denied by 40(2)(g)(i).

54 “superficial loss” of a taxpayer means the taxpayer’s loss from the disposition of a particular property where(a) during the period that begins 30 days before and ends 30 days after the disposition, the taxpayer or a person affiliated with the taxpayer acquires a property (in this definition referred to as the “substituted property”) that is, or is identical to, the particular property, and(b) at the end of that period, the taxpayer or a person affiliated with the taxpayer owns or had a right to acquire the substituted property,

8.2.6 Intra-Family TransfersSee also other rollovers 577

For tax purposes, a gift is a gratuitous transfer of property. A sale at undervaluation is not a gift: The Queen v Littler, FCA 1978 [587].

69(1)(b)(ii) donor rules.69(1)(c) recipient rules73(1) inter vivos transfers70(6) transfer on death251 Relatives are deemed to not deal at arms length.

8.2.7 The Principal ResidenceThis is a special regime allowing people to avoid paying capital gains from the sale of their family home in certain circumstances [590-594]. If you qualify under the principal residence exception, you accumulate zero capital gains. The statutory provisions for this regime are hideously complex, so I haven’t copy-pasted them here. Most are found at the definition of “principal residence” in section 54.

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Also note that you cannot claim CCA on the family home, because it is not being used to earn income (except for the home office rules under 18(12)). Nor under Canadian rules can you deduct mortgage payments or other household-related interest charges from your income (in contrast to the American approach). The exception to this is if you borrow for business purposes, but use your home as security [591].

Definition of a Principal ResidenceThe definition is composed of two parts, and both must be met in a given year.(1) Physical/legal definition: “a particular property that is a housing unit, a leasehold interest in a housing unit or [a co-op housing unit] and that is owned, whether jointly with another person or otherwise…by the taxpayer.” Housing unit has been held to include trailers and houseboats [591].(2) Residence requirement: You, your spouse, or one of your children must be ordinarily resident in your principal residence. This means that it must be “in most cases, usually or commonly occupied as an abode” [591]. If you are a child under 18, your mother or father must live with you (this is to prevent a four person family having four “principal residences” as a tax dodge). There is an exception to this residence requirement created by 54.1 (see below).

Other RequirementsYou must make the required election if you have multiple housing units at the time that you sell one of them (subsection (c) of the definition of principal residence). You are only allowed a single residence, and spouses living together may only claim one residence between them.

What is Covered by the Exception(1) The housing unit itself. To the extent that you aren’t using part of the housing unit as a residence (e.g. it’s a duplex and you rent out the other half) that part doesn’t count as your residence. See section 45 of the ITA to this effect.(2) Land adjacent to the house itself is included, but only the land under the house and any adjacent land “reasonably necessary to the use and enjoyment” of the residence. The ITA is written so that you can claim up to one half hectare without proving reasonable necessity to use and enjoyment (all this is at subsection (e) of the definition at s 54). So you get 1/2 hectare for free (unless you are using the land to use income [591]), and as much additional land as you can prove is reasonably necessary. Reasonably necessary in this context is generally considered an objective test, so you’ll need to show municipal bylaws forbidding the subdivision of lots, or a physical impossibility of reaching the house without additional land [591-592]. At one point the FCA favoured a subjective test in addition to the objective test, but the SCC has criticized approach [592]. See the cases at [591-592] for more info.

Section 45(1) Deemed Disposition with Change of Use [594-595]If you switch your home to income earning purposes, or alter the percentage of your home used to earn income (e.g. you go from renting out the basement to renting the basement and the upper floor), this triggers a deemed disposition and possible capital gains under section 45(1). You can avoid this in some cases by making an election under 45(2) and 45(3).

Section 45(2) and 45(3) Elections [595-596]Recall that section 45(1) creates a deemed disposition when property is switched from business to personal use.

Section 45(2) : If you use property for personal purposes, then start using it to collect income, you can avoid the deemed disposition of 45(1) by making an election under this section. The benefit is that you avoid a deemed disposition, but on the other hand you can’t claim CCA or other business deductions. Generally you would use this section if you’re renting your house out for a short period of time, since you want to avoid the deemed disposition and any associated capital gains, but you won’t be renting it out long enough to need CCA or other business deductions. You can cancel this election later, but it has retroactive effects.Section 45(3): If you own a property and use it to gain income, then later start living there, you can make a section 45(3) election to avoid capital gains that would normally occur from the deemed disposition triggered by section 45(1). This switches your primary residence to the new property, and you lose the primary residence designation on the old one. You must notify the MNR in writing on the earlier of (a) 90 days from receiving a request by the Minister to make such an election, or (b) the filing date of your income tax for the year in which you sold the home.

Exception: Moving Temporarily for Work Purposes

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54.1 creates an exception to the rule that once you The exceptions to the principal residence regime that once you stop living in a house it is no longer your principal residence, as long as: (1) you cease living in your principal residence only because either you or your spouse got transferred to another location as a result of your employment [54.1(1)]; (2) neither you nor your spouse are related to your employer [54.1(1)]; (3) you die while away from your residence, or you subsequently return to your principal residence during the course of the employment mentioned in (1)-(2) or within one year of the end of your employment mentioned in (1)-(2)[54.1(1)(a)]. Also the new place of employment must be at least 40 kilometers from your original home [54.1(end of section)].

Chapter 9: Chapter 9: DeductionsDeductionsTax credits are amounts you deduct from the tax otherwise payable. They are not to be confused with deductions from your income. You pay tax on your net income (what you earn minus what it costs you to earn it). Tax credits are deductions from your tax. On taxable income, you assess the rate of tax and you come up with a tax payable. From that, you deduct any tax credits to which you may be entitled. Tax credits are calculated at the federal level at 15%, with two exceptions.

Example: everyone gets to deduct $1,557 from their taxes since it’s 15% of $10,382 (which is now the basic tax credit). Because everyone gets this basic tax credit, you know that the first $10,382 of income you get is in effect not going to be taxed. Let’s say you make $10,382 – you have to pay $1,557 in taxes, but you get that back as a tax credit automatically so you’re in effect paying no taxes.

The first 200$ of charitable donations you make entitle you to a 15% tax credit, and anything above $200 entitles you to a 29% tax credit.

Chapter 10: Chapter 10: List of Key List of Key ITAITA Provisions ProvisionsThis list is probably incomplete, but it could be useful if you didn’t buy the ITA and are wondering what to print out from CanLII, or in case you need a quick-reference guide to the ITA for exams. This list is general and intended to refresh one’s memory. Like I said, it should probably be extended.

GENERAL PROVISIONS248(3) Special Québec-only rules251 arms length dealings: who is deemed not to deal at arms length

DEFINITIONS248 all general definitions here. Some specific definitions sprinkled throughout act for specific provisions only.54 all capital gains/losses definitions are found here.

RESIDENCY250(1)(a) Sojourning/deemed residency.250(3) Resident includes ordinarily resident.250(4) Residency for corporations

EMPLOYMENT AND OFFICE INCOME5 Basic charging provision. Income from office/employment is “salary, wages, and other remuneration (including tips)” received during the year.6(3) Creates a presumption in favour of the government that payments from employers to employees are employment income in most circumstances. Employment income can include amounts paid before or after the actual period of employment.

INCLUSIONS6(1)(a) must include the value of board, lodging, or other benefits of any kind whatsoever

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6(1)(b) Allowances56(1)(a)(ii) “retiring allowances” are included as income

DEDUCTIONS8 General inclusion regime8(2) only deduction in 8 are permitted.8(1) (e),(f),(g),(h),(h.1),(j);8(4) Travel related deductions, including meals.8(13) home office rules

BUSINESS INCOMEINCLUSIONS IN BUSINESS INCOME

12(1)(a) Amounts received for good and services to be rendered in the future12(1)(b) Amounts receivable for goods and services already rendered in the course of business12(1)(c) interest12(1)(d) amounts deducted in a previous year for doubtful debts12(1)(g) amounts received based on production or use of property12(1)(j or k) dividends12(1)(l) income from partnerships12(1)(m) income from trusts12(1)(n) benefits from profit sharing plans between employees and employer12(1)(x) inducement or assistance payments [mostly targeted at government grants and subsidies –Mike]12.1 Cash bonus on Canada Savings Bonds13(1) Recapture under UCC/CCA18(12) rules for home offices

IMPERMISSIBLE/DISALLOWED DEDUCTIONS18(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;18(b) 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;18(c) an outlay or expense to the extent that it may reasonably be regarded as having been made or incurred for the purpose of gaining or producing exempt income or in connection with property the income from which would be exempt;18(h) personal or living expenses of the taxpayer, other than travel expenses incurred by the taxpayer while away from home in the course of carrying on the taxpayer’s business67 Only reasonable amounts of any deduction are allowed67.5(1) Bribes and some Criminal Code offense-related payments67.6 Fines and penalties

ALLOWABLE DEDUCTIONS FROM BUSINESS INCOME20(1)(a) Capital cost allowance of property20(1)(b) Cumulative eligible capital20(1)(c) Interest, and via 20(1)(d) Compound interest20(3) Money borrowed to repay an outstanding loan is deemed to have been borrowed for the same purpose as that outstanding loan.20(16) Terminal loss under UCC/CCA18(12) Home office expenses are deductible as business expenses only if (1) it is the taxpayer’s principal

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place of business; or (2) it is used exclusively for business and on a regular and continuous basis for meeting clients, customers, or patients.37.1(1) deductibility of food and entertainment expenses111 What losses are deductible? ABILS dealt with here too

(a) non-capital losses from the 20 years preceding and 3 years after the taxation year.(b) net capital losses from any preceding year, or 3 subsequent years.

111.1 something weird about (b) deductibility.PROPERTY INCOME

248(1) defines property as “property of any kind whatsoever, whether real, personal, corporeal or incorporeal.” It also includes the following: (a) a right of any kind whatever, a share or a chose in action; (b) unless a contrary intention is evident, money; (c) a timber resource property; (d) the work in progress of a business that is a profession.12(1)(c) interest income is bus/prop income12(1)(g) any amount received by the taxpayer in the year that was dependent on the use of or production from property whether or not that amount was an instalment of the sale price of the property…

TIMING ISSUES12(1)(b) requires inclusion of receivables, which puts most businesses on the accrual method.12(1)(a) income must be included as soon as it is received, even if it’s a pre-payment for a service/good not yet rendered.18(9) Prohibition on deducting certain pre-payments ahead of the year in which they should have been made

RESERVES20(1)(m) a reserve for money paid for services/goods to be provided in the next year.20(1)(n): Reserve for installment payments on property sales. See also 40(1)(a) for sale of capital assets/deferred payment of capital gains.20(1)(l): Doubtful debt reserve20(1)(p): Bad debt reserve

INVENTORY248(1) Inventory is defined as “a description of property the cost or value of which is relevant in computing the taxpayer’s income from a business for a taxation year.”10(1) “property described in an inventory shall be valued as its cost to the taxpayer or its fair market value, whichever is lower” or in other methods allowed by regulation.

SPECIAL TREATMENT OF CERTAIN BUSINESSES28 Fishing/farming businesses can use the cash method34 Professional election for treatment of inventory costs

ELIGIBLE CAPITAL EXPENDITURE14(5) Definition of ECE

CAPITAL GAINS AND LOSSES39 Definition of capital gain and capital loss, calculation formulas, ABIL40(1)(a)(i),(b) More detailed basic calculation rules for capital gains40(1)(a)(ii),(iii) Installment sale provisions.40(2)(g) non-inclusion of capital losses from superficial losses, personal use property44 Rollover for involuntary loss of asset if you buy a replacement asset.

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46(1) $1000 deeming rule for personal property sales.54 “adjusted cost base” (a) and (b) capital cost of depreciable property.53 and 54 “adjusted cost base” (b) definition of cost of undepreciable property.54 definition of personal use property.68 Allocation for sale of multiple capital properties, or a mix of capital and non-capital properties.69 Capital gains resulting from non-arm’s length transactions and deeming for prices.

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