Federal Court of Appeal Decisions

     A-671-96

CORAM:      STONE J.A.

         STRAYER J.A.

         MacGUIGAN J.A.

IN THE MATTER OF an Application under Section 28 of the Federal Court Act

AND IN THE MATTER OF a Decision of the Tax Court of Canada made pursuant to the provisions of the Income Tax Act

BETWEEN:

     THE ATTORNEY GENERAL OF CANADA

     Applicant

     - and -

     WILLIAM F. KUBICEK III, EXECUTOR

     FOR THE ESTATE OF THE LATE

     WILLIAM F. KUBICEK JR.

     Respondent

     REASONS FOR JUDGMENT

MacGUIGAN J.A.

The issue in this s. 28 application is the interpretation of Art. XIII (9) of the Canada-United States Income Tax Convention ("the Convention"). On the facts, William Kubicek Jr. and his wife, U.S. residents, purchased a cottage on an Ontario Lake in 1967. With his wife's death in 1981, Kubicek became the sole owner of the property, being deemed to have acquired her one-half interest. On his own death in 1992 he was deemed to have disposed of the cottage for its face market value. The disagreement between the parties is solely over the correct date to start the time frame for the calculation of tax. The respondent starts with the 19 September 1967 date on which the cottage was purchased, the Minister of National Revenue on 31 December 1971, since a capital gains system was instituted for the first time in Canada on 1 January 1972 and 31 December 1971 was fixed as Valuation Day for all future capital gains in Canada.

     The question is which is the correct date under the Convention. The relevant part of the Convention is as follows:

Art. III(2):      As regards the application of the Convention by a Contracting State any term not defined therein shall, unless the context otherwise requires . . . have the meaning which it has under the law of the State concerning the taxes to which the Convention applies.

Art. XIII(1):      Gains derived by a resident of a Contracting State from the alienation of real property situated in the other Contracting State may be taxed in that other State.

Art. XIII(9):      Where a person who is a resident of a Contracting State alienates a capital asset which may in accordance with this Article be taxed in the other Contracting State and

(a)      That person owned the asset on September 26, 1980 and was resident in the first-mentioned State on that date;

(b)      . . .

the amount of the gain which is liable to tax in that other State in accordance with this Article shall be reduced by the proportion of the gain attributable on a monthly basis to the period ending on December 31 of the year in which the Convention enters into force, or such greater portion of the gain as is shown to the satisfaction of the competent authority of the other State to be reasonably attributable to that period.

     The leading authority on the interpretation of treaties is the unanimous decision of the Supreme Court of Canada in The Queen v. Crown Forest Industries Limited (1995), 95 D.T.C. 538-539, where Iacobucci J. wrote for the Court:

In interpreting a treaty, the paramount goal is to find the meaning of the words in question. This process involves looking to the language used and to the intentions of the parties.

The Court in that case therefore proceeded to examine the plain language reading of the provision there in question and the goals and purposes of the Convention.

     In following this decision in Coblentz v. The Queen (1996), 96 D.T.C. 6531, 6534, Robertson J.A., significantly observed for this Court that "literalism has no role to play in the interpretation of treaties."

     Double taxation is not an issue in the present case because Art. XXIV of the Convention obliges the United States to grant the respondent a credit for any Canadian tax paid on the capital gain. The only issue, then, is as to the appropriate allocation of tax as between Canada and the United States.

     One of the governing principles of Canada's domestic capital gains tax system is that 31 December 1971 is the reference point for determining the Canadian tax consequences of the disposition of capital property owned as of the date, since, as I have said, Canadian domestic capital gain legislation came into effect for the first time at the beginning of 1972. Of course under the former double taxation convention between Canada and the United States, Canada could not impose capital gains on U.S. residents on Canadian-source property between 1972 and 1984 (until the Convention was amended as of 1984).

     The Tax Court, relying on an earlier decision made under its informal procedure in Kaplan Estate v. The Queen (1992), 94 D.T.C. 1816 that "gain" is defined in neither the Convention nor the Income Tax Act, held that the time period which should be used in calculating the deductions to the capital gain should run from the date of the original purchase of the property on 19 September 1967.

     However, Art. III (2) of the Convention and s. 3 of the Income Tax Conventions Interpretation Act clearly state that when a term is not defined in the Convention, as "gain" is not, it should be given "the meaning it has in the tax legislation of the taxing state." In my view, the applicant was correct in his contention that meaning is not the same as definition. The Convention does not require that there be a definition in the domestic legislation but only that the meaning of the term in question can be derived from it. In this sense the meaning of the word "gain" can be drawn from s. 40(1) of the Income Tax Act , which sets out the method to be used by a taxpayer for calculating a capital gain for Canadian income tax purposes. Given the breadth of the gains allowed to be taxed by the contracting party in Art. XIII (1), I do not read the concept of gain in Art. XIII (9) as further limited, but to fall to be determined by domestic Canadian law.

     The counter-indication urged by the respondents is the Technical Explanation of the Convention produced by the United States Treasury Department and endorsed by the Canadian Minister of Finance, which states that paragraph 9 of the Convention provides that:

... where a resident of Canada or the United States is subject to tax pursuant to Article XIII in the other Contracting State on gains from the alienation of a capital asset, the amount of the gain shall be reduced for tax purposes in that other State by the amount of the gain attributable to the period during which the property was held up to and including December 31 of the year in which the documents of ratification are exchanged. (Emphasis added.)

The Tax Court Judge relied on the phrase "during which the property was held" in order to find that the date the property was purchased was the appropriate start date for the pre-1984 deduction.

     There is no international tradition or procedure for an exchange of subsequently bargained documents as determinative of treaty interpretation. The Technical Explanation is a domestic American document. True, it is stated to have the endorsation of the Canadian Minister of Finance, but in order to bind Canada it would have to amount to another convention, which it does not. From the Canadian viewpoint, it has about the same status as a Revenue Canada interpretation bulletin, of interest to a Court but not necessarily decisive of an issue.

     In any event, the document should not be interpreted as if it were a treaty or statute dealing in detail with every possible application to particular facts. The term "held" would be literally accurate in general, but is not qualified to deal with the particular situation of property held in Canada by a U.S. resident prior to 1992.

     I believe the Tax Court's interpretation of the Explanation is erroneous. The Tax Court's reliance on a single phrase ignores the context of the Explanation, i.e. that the only "gains" referenced are those which are "subject to tax". In the Canadian context, this would only be gains which accrued after December 31, 1971, when Canada began taxing capital gains.

     The ordinary meaning of "gain" for the purposes of Art. XIII of the Convention is the gain which is subject to tax. Given both the language and the otherwise apparent intention of the parties, this Court should find that the calculation of the reduction in the capital gain tax begins when the gain first began to accrue for Canadian income tax purposes. In this case, that is the December 31, 1971 starting date, not the date on which the respondent acquired the property. This interpretation is more consistent with the purposes behind the Convention, the avoidance of double taxation and the proper allocation of tax between Canada and the U.S., than is the literal meaning advanced by the Tax Court Judge. We find ourselves in agreement with the words of Professor Brian Arnold:¹

The Tax Court of Canada rejected [the Applicant's] arguments because, according to it, section 40 of the Income Tax Act does not provide a definition of "gain," but a process for determining capital gain. There is no basis for this distinction. The Tax Court appears not to understand the purpose and effect of section 3 of the Income Tax Interpretations Act or article III(2) of the treaty.... Of course, the fundamental purpose of tax treaties is to eliminate double taxation. Since Canada does not tax a capital gain to the extent that it accrued before 1972, there is no justification for taking the ownership of property before that time into account for purposes of the transitional rule in article XIII(9).

     As a result the applicant was correct in its reassessment of the respondent.

---

     The application for judicial review should be allowed, the judgment of the Tax Court of 29 July 1996 set aside and the matter referred back to that Court for reconsideration on the basis that the reduction in the capital gain is to be calculated from 31 December 1971 and not from 19 September 1967.

     (Mark R. MacGuigan)

     J.A.

I agree

A.J. Stone

J.A.

I agree

B.L. Strayer J.A.

     A-671-96

IN THE MATTER OF an Application under Section 28 of the Federal Court Act

AND IN THE MATTER OF a Decision of the Tax Court of Canada made pursuant to the provisions of the Income Tax Act

BETWEEN:

     THE ATTORNEY GENERAL OF CANADA

     Applicant

     - and -

     WILLIAM F. KUBICEK III, EXECUTOR

     FOR THE ESTATE OF THE LATE

     WILLIAM F. KUBICEK JR.

     Respondent

     REASONS FOR JUDGMENT

     A-671-96

CORAM:      STONE J.A.

     STRAYER J.A.

     MacGUIGAN J.A.

IN THE MATTER OF an Application under Section 28 of the Federal Court Act

AND IN THE MATTER OF a Decision of the Tax Court of Canada made pursuant to the provisions of the Income Tax Act

BETWEEN:

     THE ATTORNEY GENERAL OF CANADA

     Applicant

     - and -

     WILLIAM F. KUBICEK III, EXECUTOR

     FOR THE ESTATE OF THE LATE

     WILLIAM F. KUBICEK JR.

     Respondent

Heard at Toronto, Ontario, on Friday, September 5, 1997.

Judgment rendered at Ottawa, Ontario, on Friday, September 26, 1997.

REASONS FOR JUDGMENT BY:      MacGUIGAN J.A.

CONCURRED IN BY:      STONE J.A.

     STRAYER J.A.

     A-671-96

OTTAWA, ONTARIO, 26TH DAY OF SEPTEMBER 1997

CORAM:      STONE J.A.

     STRAYER J.A.

     MacGUIGAN J.A.

IN THE MATTER OF an Application under Section 28 of the Federal Court Act

AND IN THE MATTER OF a Decision of the Tax Court of Canada made pursuant to the provisions of the Income Tax Act

BETWEEN:

     THE ATTORNEY GENERAL OF CANADA

     Applicant

     - and -

     WILLIAM F. KUBICEK III, EXECUTOR

     FOR THE ESTATE OF THE LATE

     WILLIAM F. KUBICEK JR.

     Respondent

     JUDGMENT

     The application is allowed, the judgment of the Tax Court of 29 July 1996 is set aside and the matter is referred back to that Court for reconsideration on the basis that the reduction in the capital gain is to be calculated from 31 December 1971 and not from 19 September 1967.

     (A.J. Stone)

     J.A.

__________________

     ¹ Brian J. Arnold, "Canadian Court Interprets Article XIII(9) of the Canada-U.S. Tax Treaty", Tax Notes International , Nov. 4, 1996, 1513.