Judgments

[1995] 2 F.C. 433

A-664-93

Her Majesty the Queen (Appellant)

v.

Mara Properties Limited (Respondent)

Indexed as: Canada v. Mara Properties Ltd. (C.A.)

Court of Appeal, Marceau, Stone and McDonald JJ.A.—Vancouver, January 12; Ottawa, February 22, 1995.

Income tax — Corporations — Subsidiary wound up — Appeal from T.C.C. decision permitting deduction of loss, being difference between actual proceeds of disposition and deemed cost of acquisition under Income Tax Act, s. 88(1) of land acquired as result of purchase, winding-up of subsidiary — Parent, subsidiary land developers — S. 88(1) providing on winding-up, properties deemed disposed of by subsidiary, acquired by parent at cost to subsidiary — Whether land part of inventory so as to allow notional loss incurred on disposal to be considered business loss used in calculating profit from business — Applicability of s. 245(1), precluding deductions unduly or artificially reducing income.

This was an appeal from a Tax Court decision permitting the deduction of a loss, being the difference between the actual proceeds of disposition and the deemed cost of acquisition under Income Tax Act, subsection 88(1) of a parcel of land. On November 30, 1982, the taxpayer, Mara Properties Limited, acquired all of the outstanding shares of Fraserview Development Ltd., the sole asset of which was a parcel of land originally purchased for $6 million, but the fair market value of which at the time of winding-up was only $3 million. Both the taxpayer and Fraserview were in the business of real estate development. Fraserview was wound-up the same day and the land sold to an arm’s length purchaser. Income Tax Act, subsection 88(1) deems the proceeds of disposition of a subsidiary’s property to the parent to be the cost to the subsidiary immediately before the winding-up, and the cost of acquisition to the parent to be the amount deemed to be the proceeds of disposition. Mara deducted the loss on the sale from its revenues for 1982 and subsequent years, resulting in a total avoidance of tax for those years. The transactions were motivated solely to avoid tax. The Minister disallowed the claim.

The Tax Court Judge held that subsection 9(1) (defining business income for a taxation year as the profit therefrom) and paragraph 18(1)(a) (prohibiting a deduction for an expense except to the extent that it was made to produce income from the business) did not preclude deductibility of the loss simply because Mara had not acquired the land for the purpose of profit from a business. She held that the land was inventory in the hands of both companies, and that subsection 88(1) operates “notwithstanding” any other provision. She held that subsection 245(1) (precluding deduction of disbursements or expenses made or incurred in respect of a transaction that, if allowed, would unduly or artificially reduce income) only applied to “deductions” or “disbursements” and that the deemed cost was not a deduction or a disbursement “made or incurred.” The loss was the product of a statutory deeming provision to which effect had to be given. Finally she stated that until 1987, Parliament, by way of subparagraph 88(1)(a)(iii) had a policy whereby a parent company could utilize a subsidiary’s unrealized non-capital losses following its wind-up into the parent. In 1987 subsection 249(4) was added to the Act and section 1801 to the Income Tax Regulations. The amendments were not merely a codification of existing law but were intended to block the transfer of losses so as to preclude a situation such as that at bar.

The appellant submitted that the land was not inventory, and that the sale of Fraserview to the taxpayer did not meet a “business purpose test” because the taxpayer had not purchased Fraserview to produce income, and had no reasonable expectation of profit therefrom. Alternatively, the appellant argued that subsection 245(1) precluded deduction of the deemed cost of the land in calculating the taxpayer’s business income.

The issue was whether the land became part of the taxpayer’s inventory so as to allow the notional loss incurred on its disposal to be considered a business loss, used in calculating the profit from the respondent’s business.

Held (McDonald J.A. dissenting), the appeal should be allowed.

Per Marceau J.A.: The rule enacted in subsection 88(1) was that on the winding-up of a subsidiary, there shall be a deemed disposition by the subsidiary of its properties at the cost amount to it and a deemed acquisition of the property at the same cost. Subsection 88(1) does not determine whether the deemed cost of acquisition and the actual proceeds of sale of the property will enter into the calculation of the parent’s business income. That determination must be made according to section 9. In order to satisfy the requirements of that provision, the parent must demonstrate that the property has become part of its own inventory.

That the parent and subsidiary were in the same business did not impose a finding that the property became part of the parent’s inventory unless the transaction by which the land was acquired by the parent was entered into in the course of or for the purposes of its business. A transaction which is devoid of the ordinary characteristics of trade, especially if devoid of any possibility of yielding some profit, is not a trading transaction and any property so acquired cannot be regarded as stock-in-trade. The mere seeking of a fiscal benefit does not give a non-trading transaction the character of a trading one. The transaction herein was devoid of the ordinary characteristics of trade. That the taxpayer assumed all of Fraserview’s debts was irrelevant to the determination of the nature of the transaction. The land so acquired did not become part of the respondent’s inventory.

Subsection 245(1) did not apply. The series of operations by which the respondent acquired the land was not a sham. Even if subsection 88(1) allowed the respondent to consider the difference between the deemed cost and the actual proceeds of sale as a business loss, such loss would not be “artificial” or “undue” as it would arise by specific operation of the Act.

Per Stone J.A.: It was not necessary to construe the 1987 amendments to the Income Tax Act and Income Tax Regulations, but they did not necessarily alter the previous state of the law. Interpretation Act, subsection 45(2) provides that the amendment of an enactment shall not be deemed to involve a declaration that the law under that enactment was different from the law as it is under the enactment as amended.

Per McDonald J.A. (dissenting): The loss on the sale of the land was a business loss because the land was inventory in the taxpayer’s hands. Upon winding-up a subsidiary automatically distributes its assets to its parent (subsection 88(1)), and those assets should be grouped with assets of the parent of the same character. Both companies were in the same business and considered land as inventory. On the winding-up of Fraserview, its inventory should have merged with Mara’s inventory for income tax purposes.

Subsection 9(1) did not preclude inclusion of the taxpayer’s loss on the sale of the inventory in the calculation of business income just because the purpose of the purchase of Fraserview was not to produce income i.e. did not meet a “business purpose test.” A transaction may be effectual and not in any sense a sham, but may have no business purpose other than the tax purpose.

The deemed cost was not in respect of a “disbursement or expense made or incurred.” The claimed loss on the sale of the land could not be artificial because the loss was the product of a statutory deeming provision to which effect must be given.

The Tax Court Judge correctly held that the 1987 amendments were substantive and went beyond clarification or codification of the existing state of the law by materially changing its impact on the subsidiary and on the parent. They prevent the transfer of accrued trading losses such as the one herein.

STATUTES AND REGULATIONS JUDICIALLY CONSIDERED

Income Tax Act, S.C. 1970-71-72, c. 63, ss. 4(1), 9(1), 18(1)(a), 88(1) (as am. by S.C. 1973-74, c. 14, s. 27; 1974-75, c. 26, s. 52; 1977-78, c. 1, s. 43; 1980-81-82-83, c. 48, s. 48), 245(1), 248(1) “inventory” (as am. by S.C. 1991, c. 49, s. 192), 249(4) (as enacted by S.C. 1987, c. 46, s. 70).

Income Tax Regulations, C.R.C., c. 945, s. 1801 (as am. by SOR/89-419, s. 1).

Interpretation Act, R.S.C., 1985, c. I-21, s. 45(2).

CASES JUDICIALLY CONSIDERED

DISTINGUISHED:

Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536; (1984), 10 D.L.R. (4th) 1; [1984] CTC 294; 84 DTC 6305; 53 N.R. 241.

CONSIDERED:

Inland Revenue Commissioners v. Westminster (Duke of), [1936] A.C. 1 (H.L.); Québec (Communauté urbaine) v. Corp. Notre-Dame de Bon-Secours, [1994] 3 S.C.R. 3; (1994), 171 N.R. 225; Macdonald & Sons Ltd. v. M.N.R., [1970] Ex. C.R. 230; (1970), 70 DTC 6032; Canada v. Loewen, [1994] 3 F.C. 83(C.A.); Deputy Minister of Revenue (Que.) v. Lipson, [1979] 1 S.C.R. 833; (1979), 29 N.R. 335; Moloney (M.) v. Canada, [1992] 2 C.T.C. 227; 92 DTC 6570 (F.C.A.); C of IR v Challenge Corporation Ltd (1986), 8 NZTC 5219 (P.C.); Ensign Tankers (Leasing) Ltd v Stokes (HMIT), [1992] BTC 110 (H.L.).

REFERRED TO:

Bishop (Inspector of Taxes) v. Finsbury Securities, Ltd., [1966] 3 All E.R. 105 (H.L.); FA & AB Ltd v Lupton (Inspector of Taxes), [1971] 3 All E.R. 948 (H.L.).

APPEAL from Tax Court decision (Mara Properties Ltd. v. Canada, [1993] 2 C.T.C. 3189; (1993), 93 DTC 1449 (T.C.C.)) permitting the taxpayer to deduct a loss, being the difference between the actual proceeds of disposition and the deemed cost of acquisition under Income Tax Act, subsection 88(1) of land acquired as a result of a purchase and winding-up of a subsidiary company. Appeal allowed.

COUNSEL:

Brent Paris for appellant.

Warren J. A. Mitchell, Q.C. for respondent.

SOLICITORS:

Deputy Attorney General of Canada for appellant.

Thorsteinssons, Vancouver, for respondent.

The following are the reasons for judgment rendered in English by

Marceau J.A.: I have had the advantage of reading the reasons for judgment prepared by my brother McDonald J.A. Unfortunately, my analysis of the legal principles applicable to the facts of this case does not lead me to the conclusion which he has reached. I cannot, therefore, share his view and must respectfully disagree with him.

I have no doubt that subsection 88(1) of the Income Tax Act [S.C. 1970-71-72, c. 63 (as am. by S.C. 1973-74, c. 14, s. 27; 1974-75, c. 26, s. 52; 1977-78, c. 1, s. 43; 1980-81-82-83, c. 48, s. 48)] (the Act) contains a rule which is meant to apply automatically. It is even expressed to operate notwithstanding any other provision of the Act. The conditions for application of the provision are clearly set out and have been met. Subsection 88(1) is certainly applicable here.

I also accept that subsection 245(1) of the Act, concerning artificial transactions, has no role to play in the factual context of this case. The series of operations by which the respondent acquired the Maple Ridge property does not constitute a sham, whatever may be the ulterior economic motive of the scheme. The transactions were real and nothing was hidden behind them. Even if subsection 88(1) operates to allow the respondent to consider the difference between the deemed cost and the actual proceeds of sale as a loss sustained in the course of its business, this loss could not be said to be “artificial” or “undue” as it would arise by specific operation of the Act.

Where I respectfully disagree with my colleague is in my reading of subsection 88(1) and the view I take of the limited effect of the rule it establishes.

For convenience, I reproduce again the relevant and significant words of subsection 88(1):

88. (1) Where a taxable Canadian corporation (in this subsection referred to as the “subsidiary”) has been wound up after May 6, 1974 … , notwithstanding any other provision of this Act, the following rules apply:

(a) … each property of the subsidiary that was distributed to the parent on the winding-up shall be deemed to have been disposed of by the subsidiary for proceeds equal to,

…

(iii) … the cost amount to the subsidiary of the property immediately before the winding-up;

…

(c) the cost to the parent of each property of the subsidiary distributed to the parent on the winding-up shall be deemed to be the amount deemed by paragraph (a) to be the proceeds of disposition of the property ….

As I understand the rule enacted in that provision, it is to the effect that on the winding-up of a subsidiary, there shall be a deemed disposition by the subsidiary of each of its properties at the cost amount to it and a deemed acquisition of the property by the parent at the same cost. I cannot read anything else in that provision. More particularly, I cannot read the provision as saying that, if the property was part of the inventory of the subsidiary, it will become part of the inventory of the parent; nor does it specify that unrealized losses of the subsidiary become business losses for the parent. It does not say that the parent will be considered for tax purposes to be in the same situation as the subsidiary was with regard to the property. It determines a deemed cost of acquisition but it does not determine, as I read it, whether that deemed cost and the actual proceeds of sale of the property will enter into the calculation of the parent’s income from its business. That determination must be made according to section 9 of the Act which defines business income. In order to satisfy the requirements of that provision, the parent must demonstrate that the property has become part of its own inventory.

It is true that the parent’s business in our case is the development and sale of real property, the same as that carried on by the subsidiary. It is this feature of the case which renders the analysis so difficult. Had the respondent’s business been different than what it is, the scheme would have been unthinkable, as the acquisition of the land would obviously not be a transaction done in the course of business, nor could it ever have been considered, in the circumstances, an adventure in the nature of trade (cf. the decision of this Court in Canada v. Loewen, [1994] 3 F.C. 83(C.A.)). But does the fact that both parent and subsidiary were in the same business, in itself, impose a finding that the property necessarily became part of the inventory of the parent since it was part of the inventory of the subsidiary? In my view, it could be so only if the transaction or series of transactions by which the land was acquired was entered into by the parent in the course of, within the ambit of, or for the purposes of its business. It is well established, in the jurisprudence, that a transaction which is devoid of the ordinary characteristics of trade, especially if devoid of any possibility of yielding some direct or indirect, immediate or eventual profit, is not a trading transaction and any property so acquired cannot be regarded as stock-in-trade (see: Bishop (Inspector of Taxes) v. Finsbury Securities, Ltd., [1966] 3 All E.R. 105 (H.L.); FA & AB Ltd v Lupton (Inspector of Taxes), [1971] 3 All E.R. 948 (H.L.); Deputy Minister of Revenue (Que.) v. Lipson, [1979] 1 S.C.R. 833). It is well established also that the mere seeking of a fiscal benefit does not give a non-trading transaction the character of a trading one (Moloney (M.) v. Canada, [1992] 2 C.T.C. 227 (F.C.A.); Canada v. Loewen, supra).[1]

That the transaction here was devoid of the ordinary characteristics of trade is indisputable. This is made clear in the following passage from the judgment of the learned Trial Judge [[1993] 2 C.T.C. 3189 (T.C.C.), at pages 3191-3192]:

These series of transactions were motivated solely for the purpose of reducing tax. Appellant’s counsel’s words cut to the core:

Now let’s be clear, Your Honour. We make no bones about the fact that this was an entirely tax-motivated transaction. We make no bones about the fact that there was no reasonable expectation of profit in property where we acquired it at noon and sold it by dusk for a loss of four and a half million dollars.

That this was factually correct was elicited from Mr. Ralph Schmidtke, an officer of the appellant. He also confirmed that although the land had in the past been considered for acquisition and development as part of the appellant’s regular business, it was only an idea which was dropped.

It is true also that, by winding-up its subsidiary, the respondent was assuming all of Fraserview’s debts. One may try to see there a compelling indication that the respondent intended to blend the subsidiary’s business with its own and carry on the subsidiary’s business with no change whatsoever. I do not see it this way. For the scheme to be carried out, it was of course necessary that the respondent take this route, and this it did wilfully, and very wisely, only after having “parked” the debts in the hands of a partnership controlled by its principal shareholder. But I do not see how that fact alone could have any bearing on the determination of the nature of the transaction and the status of the land during the short time while it was owned by the respondent before being transferred pursuant to a prearranged sale.

Counsel for the respondent tried to dispute the appellant’s position by characterizing it as the latest version of the “business purpose test” discredited in Canadian law since the Supreme Court decision in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536. I do not agree. The question is not whether the transaction or series of transactions should be ignored as in Stubart. It is a real transaction, as I said, which produced ostensible legal effects and to which, undoubtedly, the rule established by subsection 88(1) applied. The question, again, is whether the land acquired became part of the respondent’s inventory so as to allow the notional loss incurred on its disposal to be considered a business loss and used in calculating the profit from the respondent’s business. With the greatest respect for the contrary opinion of the learned Trial Judge and my brother, I believe that, according to the provisions of the Act, the answer to the question must be no.

I would allow the appeal, set aside the decision of the Tax Court of Canada dated October 27, 1993, and reinstate the assessments of the Minister as set out in notices of reassessment dated July 16, 1991 with respect to the appellant’s taxation years ended November 30, 1982, November 30, 1983, November 30, 1987 and November 30, 1988.

* * *

The following are the reasons for judgment rendered in English by

Stone J.A.: I have had the advantage of reading in draft the reasons for judgment of both of my colleagues. In my view the appeal should be allowed for the reasons proposed by Marceau J.A. and for those which follow.

One of the arguments before the learned Trial Judge was the significance to be attributed to certain amendments to the Income Tax Act and Regulations [Income Tax Regulations, C.R.C., c. 945] adopted in 1987.[2] The argument was advanced at trial and in this Court that the adoption of these amendments signified an intention by Parliament to alter the previous state of the law. It was explained that these amendments had the effect of preventing an accrued and unrealized loss on inventory from being passed up to a parent on a winding-up of a subsidiary without tax consequences. The Trial Judge [at page 3196] described the 1987 amendments as “substantive,” that they had worked more than a “mere clarification or codification of the existing state of the law” and had the effect of precluding “the results of the very situation at hand.” My colleague, McDonald J.A., adopts that reasoning.

In my opinion, the 1987 amendments should not be viewed with such facility. We are not required to construe them. I merely wish to state that in my view those amendments are not necessarily to be taken as altering the previous state of the law. That this is so is evident from the provisions of subsection 45(2) of the Interpretation Act, R.S.C., 1985, c. I-21, which read:

45. …

(2) The amendment of an enactment shall not be deemed to be or to involve a declaration that the law under that enactment was or was considered by Parliament or other body of person by whom the enactment was enacted to have been different from the law as it is under the enactment as amended.

I would dispose of the appeal in the manner proposed by Marceau J.A.

* * *

The following are the reasons for judgment rendered in English by

McDonald J.A. (dissenting): This is an appeal from the Tax Court of Canada decision dated October 27, 1993 in which the Trial Judge decided that the respondent could claim a loss arising from the sale of a property that had been acquired as a result of a purchase and winding-up of a subsidiary company. The sole issue before the Tax Court was whether that loss could be claimed against the respondent’s income.

The acquired loss from the subsidiary was claimed against revenues of the respondent for the 1982 taxation year and for subsequent years resulting in a total avoidance of tax payable for these years.

The Facts

The respondent, Mara Properties Ltd. (Mara) is a taxable Canadian corporation having its principal place of business in Vancouver, British Columbia. The respondent’s business was managed by its principal shareholder, Mr. Werner Paulus, a resident of the United States. Mara is in the business of locating, developing and selling real property and any profits from property sales were reported as business income and not as capital gains.

The transaction which is the subject of this appeal began on November 30, 1982 when Mara acquired all of the outstanding shares of another taxable Canadian corporation, Fraserview Development Ltd. (Fraserview). The purchase price of these shares was $69,998. Fraserview thus became a wholly-owned subsidiary of Mara. Fraserview’s sole asset at the time of acquisition was a parcel of land (land) originally purchased for approximately $6 million and partially developed by Fraserview for an additional $1.577 million.

On the same day that Mara acquired control of Fraserview it proceeded to wind up the company which resulted in Fraserview’s land “rolling over” to Mara pursuant to subsection 88(1) of the Income Tax Act (the Act).

88. (1) Where a taxable Canadian corporation (in this subsection referred to as the “subsidiary”) has been wound up after May 6, 1974 … notwithstanding any other provision of this Act, the following rules apply:

(a) … each property of the subsidiary that was distributed to the parent on the winding-up shall be deemed to have been disposed of by the subsidiary for proceeds equal to,

…

(iii) … the cost amount to the subsidiary of the property immediately before the winding-up;

…

(c) the cost to the parent of each property of the subsidiary distributed to the parent on the winding-up shall be deemed to be the amount deemed by paragraph (a) to be the proceeds of disposition of the property.

At the time of the winding-up the fair market value of Fraserview’s land had dropped to $3 million. The loss in land value was described by witnesses before the Trial Judge as a “pregnant loss” which is a vernacular term to depict the failure to give birth to the loss by way of sale or otherwise, while in the hands of the subsidiary. To continue in the vernacular, the birth of the loss took place when the land was sold by the parent Mara to an arm’s length third party purchaser. Mara then claimed the loss from this disposition of land against its revenues but the claim was disallowed by the Minister giving rise to the appeal to the Tax Court of Canada.

It is important to note that all of these transactions were motivated solely for the purpose of avoiding tax. The Trial Judge quoted [at page 3192] the appellant’s counsel as follows:

Now let’s be clear, Your Honour. We make no bones about the fact that this was an entirely tax-motivated transaction. We make no bones about the fact that there was no reasonable expectation of profit in property where we acquired it at noon and sold it by dusk for a loss of four and a half million dollars.

The Decision Under Appeal

The Trial Judge described subsection 88(1) as a rollover provision which deems a disposition and acquisition of a subsidiary’s property to have accrued at the subsidiary’s cost, and to defer its fiscal consequences until the parent actually disposes of the property by sale or otherwise. She found that this provision operates automatically upon all of its conditions being met, which is the situation here. She also ventured the opinion that the rationale behind subsection 88(1) is a recognition that before being wound up a subsidiary may have accrued unrealized losses on non-capital property.

The Trial Judge rejected the Minister’s argument that subsection 9(1)[3] and paragraph 18(1)(a)[4] of the Act precluded deductibility of the cost of the land because the respondent did not acquire the land for the purpose of profit from a business that it intended to carry on. Specifically she rejected the paragraph 18(1)(a) argument by finding that the land in question was inventory in the hands of both companies and not an “outlay or expense” made or incurred that is a “deduction in the computation of income.” She found that the respondent did not make or incur any outlay or expense, it simply inherited the deemed cost of the land.

With respect to subsection 9(1) the Minister argued that the deemed cost amount is fallacious since the income therefrom could not conceivably produce a profit when the pre-arranged sale took place. Again the Trial Judge rejected this argument when she held that the definition of income in subsection 9(1) does not affect a deduction based on subsection 88(1) because, by its own terms, subsection 88(1) operates “notwithstanding” any other provision of the Act.

Finally the Trial Judge also rejected the Minister’s claim that the purchase of Fraserview was an artificial transaction that was caught by subsection 245(1) of the Act. This she said was a similar provision to paragraph 18(1)(a) in that it only applies to “deductions” or “disbursements or expenses made or incurred.” She stated that the deemed cost of the land here is not a “deduction” or a “disbursement or expense made or incurred.” In fact, far from being artificial, the amount of loss is the product of a statutory deeming provision to which effect must be given.

In her conclusion the Trial Judge stated that until 1987 Parliament, by way of subparagraph 88(1)(a)(iii) presumably had a policy whereby a parent company had the ability to utilize a subsidiary’s unrealized non-capital losses following its wind up into the parent. The purpose of the 1987 amendments discussed below was clearly to block the transfer of losses and thus preclude the very situation that existed here.

Issues Under Appeal

The following issues arise.

1. Did the Trial Judge err in holding that the difference between the cost of the land deemed by subsection 88(1), and the proceeds of disposition from the sale of the land constituted a result which properly entered into the computation of the respondent’s profits for the 1982 taxation year?

2. Did the Trial Judge err in holding that the cost of the land deemed by subsection 88(1) was relevant in computing the respondent’s income from business for the 1982 taxation year even though the respondent did not use the land in its business nor acquire it with the intention of using it in the business?

3. Did the Trial Judge err in holding that subsection 88(1) itself operates to produce a loss from the business being the difference between the cost of the land deemed by subsection 88(1) and the proceeds from the sale of the land?

4. Did the Trial Judge err in holding that the cost of land deemed by subsection 88(1) does not constitute an outlay or expense within the meaning of paragraph 18(1)(a) or a disbursement or expense within the meaning of subsection 245(1)?

Analysis

I begin this analysis by repeating that the respondent’s sole motivation to engage in these transactions was for the purpose of reducing tax. That fundamental concept may initially strike the judicial mind as unpalatable and contrary to the general anti-avoidance rule that abusive tax avoidance, contrary to the goal of equity in the modern Income Tax Act, is no longer tolerable. This aversion however must be tempered in consideration of Lord Tomlin’s fundamental dictum that “Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it would otherwise be” (Inland Revenue Commissioners v. Westminster (Duke of), [1936] A.C. 1 (H.L.), at page 19) and Wilson J.’s finding in Stubart Investments Ltd. v. The Queen [1984] 1 S.C.R. 536, at page 540 (Stubart): “A transaction may be effectual and not in any sense a sham (as in this case) but may have no business purpose other than the tax purpose.” Additionally, this Court must assess the loss on the sale of the land with an “eye to commercial and economic realities, rather than juristic classification of form” (Québec (Communauté urbaine) v. Corp. Notre-Dame de Bon-Secours, [1994] 3 S.C.R. 3, at page 17 (Bon-Secours).

Before proceeding further I feel it would be wise to clarify the terminology to be used in the present case. Here, the respondent acquired the shares of Fraserview at a time when the cost of the land exceeded its fair market value by approximately $4,500,000. By specific operation of subsection 88(1) of the Act, the respondent did not realize any loss on the land when Fraserview was liquidated. Conversely, Fraserview’s cost of the land became the respondent’s cost of the land.

The respondent, not Fraserview, realized the loss when the land was sold. I have specifically emphasized the word “loss” to remove any doubt that the amount in question here is indeed a loss on the sale of the land. This loss is not an “outlay,” “expense” or “disbursement.”

The appellant’s objection to the claimed loss begins at the most fundamental level of the Income Tax Act. Consequently, I begin my analysis by investigating whether the respondent has a source of income (or loss) under which this loss can be claimed. Under subsection 4(1) of the Act, a taxpayer’s income or loss is computed on a source-by-source basis. The section reads:

4. (1) …

(a) a taxpayer’s income or loss for a taxation year from an office, employment, business property or other source, or from sources in a particular place, is the taxpayer’s income or loss, as the case may be …

Again, the appellant correctly asserts that a taxpayer’s income from a business is the profit from that business and, in accordance with generally accepted accounting principles (GAAP), the profit comprises the revenues earned in a taxation year less the expenses incurred for the purpose of earning such revenues. One of the established reductions in the Act is non-capital losses and it is widely accepted that a business loss is a non-capital loss. I find that the loss on the sale of the land is a business loss because the land is an item of inventory in the hands of the respondent.

At this juncture I will address the appellant’s contention that the land in question cannot be inventory. Subsection 248(1) [as am by S.C. 1991, c. 49, s. 192] of the Act reads:

248. …

“inventory” means a description of property the cost or value of which is relevant in computing a taxpayer’s income from a business for a taxation year …

The appellant claims the respondent did not acquire Fraserview for use in its ordinary course of business and therefore the land that rolled over to the respondent under subsection 88(1) is not inventory and ought not to form a part of the computation of profit from that business. Furthermore, since the respondent never intended to gain or produce income on the Fraserview purchase and the subsequent sale of the land, and knowing that the whole undertaking had no reasonable expectation of profit, the land is not a source of income and does not constitute inventory in the respondent’s business.

To simplify these claims, I consider the appellant to mean that the loss on the land is not relevant in computing the respondent’s income.

To address the first claim, the respondent is a corporation in the business of buying, developing and selling real estate. Consequently the respondent reports profits or losses realized from this activity as income (or loss) for tax purposes. Here the respondent purchased all of the shares of Fraserview, a corporation in the business of developing and selling real estate that claims its land holdings as inventory.

There is no dispute that the parties here were at arm’s length and that the price paid for the shares was at fair market value. I emphasis these points in order to distinguish this situation from that of Macdonald & Sons Ltd. v. M.N.R., [1970] Ex. C.R. 230. There the appellant company claimed a $3,000 per acre cost of acquiring land that consisted of $1,000 per acre paid in cash plus a gift of $2,000 per acre made by the principal shareholder. The fair market value of the land at the time of sale was $2,200 per acre. The appellant company quickly sold the land for $3,000 per acre and claimed no profit on the basis that the cost to them was $3,000. Thurlow J. [at page 258] found that the appellant did not acquire land in the course of trade because the original transaction “was not carried out in the same way, as transactions that are characteristic of ordinary trading in land.” Specifically, the original transaction was a non-arm’s length transaction that established an acquisition cost of the land at cost price higher then the fair market value of the land at the time. Without question, the acquisition of the land in Macdonald was not in the ordinary course of trading in land. However, as I stated above, the sale of all the shares of Fraserview was at arm’s length and in a manner that is characteristic of an ordinary acquisition of corporations. Consequently, on the winding-up of Fraserview, its inventory rolled over to the respondent’s inventory.

Although counsel for the appellant urged this Court not to deem the rolled over property as inventory, he could not assist the Court in determining how this land should be defined for income tax purposes. I believe that the land did roll over into the inventory of the respondent. Fraserview was in the business of developing and selling land and the land in question was a part of its inventory. Upon winding-up, a subsidiary automatically distributes its assets to its parent (subsection 88(1)) and those assets should be grouped with assets of the parent of the same character. Here, both companies are in the same business and consider land as an item of inventory. Consequently, on the winding-up of Fraserview, its inventory should have merged with Mara’s inventory for income tax purposes.

The second prong of the appellant’s argument is that since the purpose of respondent’s purchase of Fraserview was not to gain or produce income and because the purchase had no reasonable expectation of profit, the land did not create a source of income and it therefore cannot constitute inventory in the respondent’s business.[5] In essence, the appellant claims that the sale of Fraserview to the respondent fails to meet a “business purpose test.” This leads the Court to another question. Is it relevant that the taxpayer’s sole purpose for entering the transaction was to obtain a tax advantage? The following quote from Wilson J.’s concurring decision in Stubart best answers this question [at page 540]:

I am also of the view that the business purpose test and the sham test are two distinct tests. A transaction may be effectual and not in any sense a sham (as in this case) but may have no business purpose other than the tax purpose. The question then is whether the Minister is entitled to ignore it on that ground alone. If he is, then a massive inroad is made into Lord Tomlin’s dictum that “Every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate Acts is less than it would otherwise be”: Inland Revenue Commissioners v. Duke of Westminster, [1936] A.C. 1, at 19. Indeed, it seems to me that the business purpose test is a complete rejection of Lord Tomlin’s principle.

I believe this quote is as applicable to transactions that fall within Division B, as it is to transactions that fall within Division C of the Act. Therefore, I find that subsection 9(1) of the Act does not block the inclusion of the respondent’s loss on the sale of the inventory in the calculation of business income. Consequently, I see no need to comment on whether subsection 88(1)’s “notwithstanding clause” overrides the operation of subsection 9(1).

Application of Subsection 245(1)

The appellant’s alternative argument claims that the Trial Judge erred in holding that subsection 245(1) does not preclude the respondent from deducting the deemed cost of the land in calculating its income from business. The applicable part of subsection 245(1) reads:

245. (1) In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

In my view the Trial Judge was correct when she states that the inherited deemed cost amount here is not in respect of a “disbursement or expense made or incurred.” Furthermore I agree that the claimed loss on the sale of the land cannot be artificial because the loss is the product of a statutory deeming provision (subsection 88(1)) to which effect must be given.

I have read and considered with interest the following quote from C of IR v Challenge Corporation Ltd (1986), 8 NZTC 5219 (P.C.), at pages 5225-5226 (and cited with approval in Ensign Tankers (Leasing) Ltd v Stokes (HMIT), [1992] BTC 110 (H.L.), at page 123):

Income Tax is mitigated by a taxpayer who reduces his income or incurs expenditures in circumstances which reduce his assessable income or entitle him to reduction in his tax liability …

Income tax is avoided … when the taxpayer reduces his liability to tax without involving him in the loss or expenditure which entitles him to that deduction. The taxpayer engaged in tax avoidance does not reduce his income or suffer a loss or incur expenditure but nevertheless obtains a reduction in his liability to tax as if he had.

I believe this quote should be read in conjunction with the following statement by Estey J. in Stubart, at pages 575-576:

Income tax legislation, such as the federal Act in our country, is no longer a simple device to raise revenue to meet the cost of governing the community. Income taxation is also employed by government to attain selected economic policy objectives. Thus, the statute is a mix of fiscal and economic policy. The economic policy element of the Act sometimes takes the form of an inducement to the taxpayer to undertake or redirect a specific activity. Without the inducement offered by the statute, the activity may not be undertaken by the taxpayer for whom the induced action would otherwise have no bona fide business purpose.

Intention of Parliament

The Supreme Court of Canada in Bon-Secours emphasized the need for courts to review Parliament’s intent in creating and amending sections of the Income Tax Act. In 1971 Parliament amended section 88 which deems assets of a liquidated wholly-owned subsidiary corporation to be sold at cost and acquired by the parent at cost. The result is to defer any gain or loss on those assets until they are disposed of by the parent. In 1981 Parliament amended the Act so that on the change of control of a corporation the undepreciated capital cost of the corporation’s depreciable property was reduced to one-half of the fair market value of the corporation’s eligible capital property. In 1987 Parliament again amended the Act to add subsection 249(4), and in 1989 amended section 1801 of the Regulations as part of the measures announced in 1987.

These new additions effectively compelled recognition of accrued losses on inventory at the time of a change of control. These 1987 amendments prevent the transfer of accrued trading losses such as the one claimed by the respondent here.

For convenience and simplicity I adopt as my own reasons the words of the Trial Judge in the decision below at page 3196:

I do not agree that the 1987 amendments merely clarified what was otherwise the state of the law in 1982 as argued by respondent’s [appellant’s] counsel. They go much farther in that if the subject transactions had occurred thereafter the subsidiary’s inventory must be valued at fair market value. Accordingly after 1987, accrued and unrealized losses on inventory could not pass up to the parent on wind up but rather remained with the subsidiary. The 1987 amendments were substantive. They went beyond mere clarification or codification of the existing state of the law by materially changing its impact on the subsidiary and on the parent. These were known as the new stop-loss or anti-avoidance rules and were publicly touted to preclude the results of the very situation at hand.

Conclusion

Subparagraph 88(1)(a)(iii) of the Act entitled the respondent to deduct the deemed cost amount of $7,577,175 respecting the land from its proceeds on disposition of $3,022,970. Such a result is not repugnant or inconsistent with the object and spirit of the Act as a whole nor with Parliament’s intent. I would dismiss this appeal with costs.

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