Federal Court of Appeal Decisions

Date: 20070514

Docket: A-237-06

Citation: 2007 FCA 185

 

CORAM:       NADON J.A.

                        SHARLOW J.A.

                        PELLETIER J.A.

 

BETWEEN:

CCLI (1994) INC.

Appellant

and

HER MAJESTY THE QUEEN

Respondent

 

 

 

Heard at Vancouver, British Columbia, on March 29, 2007.

Judgment delivered at Ottawa, Ontario, on May 14, 2007.

 

REASONS FOR JUDGMENT BY:                                                                          SHARLOW J.A.

CONCURRED IN BY:                                                                                                  NADON J.A.

                                                                                                                                 PELLETIER J.A.

 

Date: 20070514

Docket: A-237-06

Citation: 2007 FCA 185

 

CORAM:       NADON J.A.

                        SHARLOW J.A.

                        PELLETIER J.A.

 

BETWEEN:

CCLI (1994) INC.

Appellant

and

HER MAJESTY THE QUEEN

Respondent

 

 

REASONS FOR JUDGMENT

SHARLOW J.A.

[1]               This is an appeal by CCLI (1994) Inc. of a judgment of the Tax Court of Canada (2006 TCC 240) dismissing income tax appeals relating to assessments for 1989, 1990 and 1993 and loss determinations for 1991 and 1992. One issue is whether foreign exchange gains and losses incurred in respect of money borrowed to finance CCLI’s equipment leasing transactions are to be treated for income tax purposes as income or capital. The other issue is whether, in the circumstances of this case, the Income Tax Act, R.S.C. 1985, c. 1 (5^th Supp.) requires CCLI to deduct more of its 1991 non-capital loss in 1989 than it has chosen to deduct.

Foreign exchange gains and losses

[2]               During the years under appeal, CCLI was a wholly owned subsidiary of Citibank Canada, a Canadian chartered bank. Citibank Canada is subject to the Bank Act, S.C. 1991, c. 46. Prior to 1992, Citibank Canada was precluded by the Bank Act from providing financing to its customers through leasing transactions. Citibank Canada could, however, own a subsidiary corporation that could provide such financing as long as the leases met the conditions set out in the Financial Leasing Regulations, SOR/82-705.

[3]               In 1992, the Bank Act was amended to remove the prohibition on lease financing transactions. Citibank Canada was then free to provide lease financing on its own account. In 1994, proceedings were commenced to wind up CCLI into Citibank Canada.

[4]               During the years under appeal, CCLI entered into a number of leasing transactions involving the purchase by CCLI of aircraft or railcars which were then leased to an operating company for terms of ten years or more. For each leasing transaction, CCLI borrowed from Citibank Canada the money required to complete the equipment purchase. The loans were in U.S. dollars or other foreign currencies, depending upon the currency of the lease transactions. (The details of the transactions are set out in the reasons for the judgment under appeal, and need not be repeated here.) The leases met the conditions in the Financial Leasing Regulations.

[5]               For financial statement purposes, CCLI consistently and correctly reported the financial results of its leases on the basis that they were “financial leases” (or “direct financing leases” as they are sometimes called). For commercial accounting purposes, a lease is classified as either a financial lease or an operating lease, depending upon a practical assessment of the incidents of ownership of the leased property. If substantially all of the benefits and risk of the ownership of the leased property are in the hands of the lessee, the lease is classified as a financial lease. Generally, a lease that meets the conditions of the Financial Leasing Regulations would be classified as a financial lease under commercial accounting principles.

[6]               In a financial lease, the lessor has the financial benefit of an income stream from the user of the leased property, and bears the risk of financial default by the lessee, a risk that is mitigated by the fact that the lessor holds legal title to the leased property. Because that is the functional equivalent of a secured loan, the transaction is presented in the lessor’s financial statements in the same manner as a secured loan (see, for example, section 3065.09 of the Handbook of the Canadian Institute of Chartered Accountants, quoted in paragraph 8 of the reasons for judgment of the Tax Court Judge). Specifically, the lessor’s asset is described as a loan receivable, and the amounts received by the lessor are treated in part as interest income and in part as a return of capital. By contrast, the financial statements of the lessor under an operating lease will reflect the fact that the lessor is the owner of the leased property who receives income in the form of rent and incurs the expenses of an owner of property, including the cost of the equipment which is amortized over the number of years of its estimated useful life.

[7]               As mentioned above, CCLI treated its equipment leases as financial leases in preparing its financial statements for commercial purposes. However, in filing its income tax returns, CCLI consistently claimed capital cost allowance on the leased equipment, as it was entitled to do.

[8]               For financial statement purposes and for income tax purposes, CCLI included in its income accrued but unrealized foreign exchange gains and losses relating to its Citibank Canada loans. On that basis, CCLI reported foreign exchange gains in the years 1988 to 1991 and foreign exchange losses in the years 1992 to 1994. The position of the Crown is that all foreign exchange gains and losses of CCLI should have been treated as capital gains and losses, and reported when realized. On that basis, CCLI was reassessed for 1989, 1990 and 1993, and its losses for 1991 and 1992 were redetermined. The appeal of CCLI to the Tax Court of Canada was unsuccessful. It now appeals to this Court.

[9]               The tax treatment of income differs from the tax treatment of capital in a number of respects. One difference relates to the timing of the recognition of gains or losses. For income tax purposes, most revenue and most expenses of a business are required to be reported on an accrual basis, while capital gains and losses are reported when realized. That means, generally, that revenue is included in income in the year in which it becomes receivable and expenses are deducted in the year in which they become payable. However, capital gains and losses are reported for income tax purposes in the year the gain is made or the loss is sustained.

[10]           Another difference relates to the inclusion rate. For income tax purposes, capital gains and capital losses are only partly reflected in income. The amount of a capital gain or loss that is included in income depends upon the capital gain inclusion rate for the year. For example, in a year with a 50% inclusion rate (1972 to 1987), only 50% of a capital gain is included in income and only 50% of a capital loss is deductible. (The capital gain inclusion rate was increased to 66 2/3% for 1988 and 1989 and to 75% for 1990 through 1999, and reduced to 50% in 2000.)

[11]           Finally, there is a difference in terms of how losses may be deducted for income tax purposes. A loss on income account can be deducted from all other income in the year. The deductible portion of a capital loss can be deducted only from the taxable portion of capital gains in the year. If in a particular year a taxpayer has losses on income account that exceed income for that year, the excess (called a “non-capital loss”) can be carried back 3 years and forward 7 years, and deducted in computing taxable income in those other years (a 2006 amendment increases the carry-forward period to 20 years). If a taxpayer has deductible capital losses in a year that exceed taxable capital gains in that year, the excess can be carried back 3 years and forward indefinitely, and deducted against taxable capital gains in those other years.

[12]           It is not necessary to recount in detail how these differences affected the tax position of CCLI when its returns were reassessed to treat its foreign exchange gains and losses as capital rather than income. It is enough to say that CCLI was entitled to object to the changes and, when not satisfied of the result of the objection, to appeal to the Tax Court of Canada.

[13]           For income tax purposes, the classification of a foreign exchange gain or loss as income or capital depends on the nature of the transaction in relation to which the gain or loss occurred. In this case, the transactions are the loans from Citibank Canada to CCLI. The question is whether, to CCLI, those loans are capital transactions or income transactions.

[14]           The position of the Crown is that the Citibank Canada loans are capital transactions to CCLI because the borrowed money was used to acquire equipment that was capital property. CCLI was entitled to deduct and did deduct the cost of the equipment over number of years as capital cost allowance pursuant to Part XI of the Income Tax Regulations, C.R.C. c. 945. Property in respect of which capital cost allowance is claimed falls into the definition of “capital property” in subsection 248(1) of the Income Tax Act (see also the definition of “capital property” in section 54 and the definition of “depreciable property” in subsection 13(21) of the Income Tax Act). The Tax Court Judge agreed with the Crown.

[15]           CCLI argues that the Citibank Canada loans are income transactions because CCLI carries on a financing business, which consists of acquiring equipment that is leased to its customers under financial leases. CCLI argues that in commercial terms a financial lease is exactly the same as a secured loan, and so the tax character of the loan should be the same as if the borrowed money was used to finance a money lending transaction by a financial institution.

[16]           The argument of CCLI is based on Gifford v. Canada, [2004] 1 S.C.R. 411. The issue in that case was whether a financial adviser was entitled to a deduction for the cost of a client list, and for interest on money borrowed to make the purchase. Because the expenditures were incurred for the purpose of earning income from employment rather than income from a business or property, the availability of a deduction depended on paragraph 8(1)(f) of the Income Tax Act. That provision precluded any deduction for a “payment on account of capital” (subject to certain exceptions that did not apply). Justice Major, writing for the Court, concluded that the client list was a capital asset to the financial adviser, and therefore the cost of the client list was a payment on account of capital, as was the interest on the money borrowed to make the purchase.

[17]           CCLI relies on certain statements made by Justice Major in discussing whether, as a matter of law, a payment of interest is always a capital outlay, and if not, what test ought to be applied in determining in a particular case whether interest is a capital outlay. Justice Major found no support in the jurisprudence for the general proposition that a payment of interest is always a capital outlay. He concluded that interest on borrowed money is a capital outlay if the loan proceeds are added to the financial capital of the borrower, but not if the loan proceeds constitute part of the stock in trade of the borrower, as may be the case if the loan is made to a moneylender, such as a bank or a similar financial institution. In the case before him, the borrowed money was used to pay for the client list, which was a capital asset, indicating that the loan proceeds increased the financial capital of the taxpayer. It followed that the interest payments on the loan were capital outlays.

[18]           I do not read Gifford as authority for the proposition that either the characterization of the leases as financial leases, or the characterization of the business of CCLI as a “financing business”, determines conclusively that the loan proceeds received by CCLI from Citibank Canada comprise part of the stock in trade of a moneylender. It seems to me that, although the business of CCLI may be described as a financing business, it could with equal accuracy be described as an equipment leasing business.

[19]           CCLI used the money borrowed from Citibank Canada to acquire equipment that CCLI then leased to its customers for relatively long terms. The leases are treated for commercial accounting purposes as financial leases because they entail business risks that are the functional equivalent of secured loans, but on the specific facts of this case, that is not a sufficient basis to justify treating the leases for income tax purposes as though they actually were loans. As the Tax Court Judge correctly noted, each loan to CCLI was earmarked for a particular equipment acquisition and in each case, the purchased equipment was the subject of capital cost allowance claims which caused the equipment to fall within the definition of “capital property” in the Income Tax Act. In my view, that leads inescapably to the conclusion that each equipment acquisition was a capital transaction, and that each loan entered into to finance an equipment acquisition was also a capital transaction.

[20]           I conclude that the Tax Court Judge was correct to find that the foreign exchange gains and losses of CCLI arising from the Citibank Canada loans were capital gains and losses. That makes it necessary to consider the other point on appeal, relating to CCLI’s 1993 claim for a deduction of part of its 1991 non-capital loss.

[21]           I note parenthetically that one issue that was not debated in this case is whether it would have been open to CCLI to determine its income for income tax purposes on the same basis as its income for financial statement purposes, foregoing any claim for capital cost allowance. In my view, it is an open question whether the income of CCLI as determined for financial statement purposes would have been sufficiently accurate for income tax purposes, and consistent with all of the provisions of the Income Tax Act and established legal principles (see Canderel Ltd. v. Canada, [1998] 1 S.C.R. 147 at paragraph 53).

Is CCLI entitled to a deduction in 1993 for part of its 1991 non-capital loss?

[22]           If the Minister was correct on the foreign exchange issue, the resulting determination of the income and losses of CCLI for the years under appeal is agreed to be correct, except for one remaining issue relating to 1993. By way of summary, the 1991 non-capital loss of CCLI has been determined conclusively to be $25,824,050. CCLI has asked for $19,984,499 of that 1991 non-capital loss to be deducted in 1993, and the Minister has refused. The entitlement of CCLI to that deduction was one of the issues in its appeal to the Tax Court for 1993. The Tax Court Judge agreed with the Minister.

[23]           To understand this issue, it is necessary to consider paragraph 111(1)(a) of the Income Tax Act, which reads as follows:

 

[24]           The term “non-capital loss” is defined in subsection 111(8) by means of a complex statutory formula. For the purposes of this case, a non-capital loss is synonymous with a business loss.

[25]           For 1987 and 1988, CCLI had non-capital losses of $19,895,182 and $31,636,822 respectively. Those amounts have not changed. They were deducted in 1989 under paragraph 111(1)(a), resulting in a 1989 taxable income of $29,259,177.

[26]           In filing its income tax returns for 1991 and 1992, CCLI initially reported further non-capital losses. CCLI requested that those non-capital losses be deducted in 1989. That request resulted in a reassessment dated May 4, 1995 reducing the 1989 taxable income of CCLI to nil, calculated as follows:

 

[27]           By 1997, the Minister had reached its current position that the foreign exchange losses and gains of CCLI should have been reported as capital gains and losses. It was apparent that this would result in changes to the non-capital losses of CCLI for 1991 and 1992.

[28]           In 1997, the revised amounts of the non-capital losses of CCLI for 1991 and 1992 were calculated by the Minister as $21,481,249 and $7,085,367, respectively. Those amounts were the subject of loss determinations under subsection 152(1.1) of the Income Tax Act. A taxpayer has the right to object to a subsection 152(1.1) loss determination, and appeal it, in the same manner as an assessment. CCLI objected to those loss determinations.

[29]           Meanwhile, on June 11, 1997, the Minister reassessed CCLI for 1989 to change the deductions for the 1991 and 1992 non-capital losses, resulting in taxable income for 1989, determined as follows:

 

[30]           CCLI objected to this reassessment on the basis that it was made outside the statutory time limit (see subsection 152(4) of the Income Tax Act). The Minister considered that objection and agreed that the reassessment was out of time.

[31]           The 1989 objection was under consideration at the same time as the objections to the 1991 and 1992 loss determinations. The major issue for 1991 and 1992 was the characterization of the foreign exchanges gains and losses of CCLI.

[32]           One result of the objections for 1991 and 1992 was that the non-capital losses of CCLI for those years were redetermined to reflect a number of changes, none of which are relevant for present purposes. The revised amounts of the 1991 and 1992 non-capital losses, $25,824,050 and $8,122,335 respectively, were the subject of notices of loss determination dated April 19, 2002. Those loss determinations were appealed to the Tax Court.

[33]           On April 18, 2002, the Minister reassessed CCLI for 1989 to acknowledge that the 1997 reassessment was out of time. In that reassessment, the Minister also purported to change the amounts of the 1989 deductions for the 1991 and 1992 non-capital losses, based on the April 19, 2002 loss determinations. The result was as follows:

 

[34]           At the same time, the Minister reassessed CCLI for 1990 by permitting a deduction of $4,587,208 for part of the 1992 non-capital loss as finally determined (previously, there was no deduction in 1990 for any part of the 1992 non-capital loss). CCLI does not take issue with that adjustment. Nor does CCLI take issue with revised amount of the 1989 deduction for the 1992 non-capital loss, which the Minister changed from $23,519,626 to $3,535,127. Both of those changes favour CCLI.

[35]           However, CCLI does take issue with the change in the amount of the 1989 deduction for the 1991 non-capital loss. CCLI argued in the Tax Court and in this Court that the Minister had no legal authority to increase the 1989 deduction for the 1991 non-capital loss from the amount originally deducted in 1995, which was $5,839,626. CCLI claims that, of its 1991 non-capital loss as finally determined ($25,824,050), $5,839,626 was properly deducted in 1989, and it is entitled to deduct the remainder, $19,984,499, in 1993. The Tax Court Judge did not agree.

[36]           The statutory provisions read in relevant part as follows:

 

Neither party has suggested that there is any relevant difference between the English and French versions.

[37]           In my view, paragraph 111(1)(a) entitles CCLI to the deduction as requested, subject only to the restrictions in subparagraphs 111(3)(a)(i) and 111(3)(b)(i).

[38]           I will consider those two restrictions in reverse order. Subparagraph 111(3)(b)(i) says that CCLI cannot deduct, in 1993, any part of its 1991 non-capital loss until all of its non-capital losses for 1990 and prior years are deducted. The Minister does not allege that CCLI has any undeducted non-capital losses for 1990 or any year prior to 1990.

[39]           Subparagraph 111(3)(a)(i) says that CCLI cannot deduct, in 1993, its 1991 non-capital loss to the extent it was deducted in a year prior to 1993. The Minister argues that the entire amount of the 1991 non-capital loss was deducted in 1989 and that none is available for deduction in 1993. That is true only if the Minister can point to some legal authority for increasing the 1989 deduction, as indicated in the disputed 1989 reassessment dated April 18, 2002.

[40]           The Minister does not suggest that it has express legal authority for increasing the 1989 deduction, but argues that such authority is implicit in the scheme of section 111. The Minister argues that section 111 should be understood as establishing a pool of available non-capital losses, with adjustments being made by the Minister as the need arises, until there is some final determination (such as, in this case, a loss determination under subsection 152(1.1)). Under that interpretation, the Minister takes the initiative, as changes are made to the computation of taxpayer’s income and losses from time to time (whether reflected in a reassessment or not), to allocate and re-allocate non-capital losses of a particular year within the prior 3 and following 7 years, essentially on a first in-first out basis. (I assume that the Minister would acknowledge that authority to allocate and re-allocate, if it exists, would be exercisable only if the taxpayer has first elected to deduct at least $1 of its non-capital losses in computing the income of another year, although that point was not addressed in argument.)

[41]           One problem with this interpretation is that section 111 says nothing about pooling non-capital losses. The drafters of the Income Tax Act are familiar with the notion of pools for deductions. Examples may be found in the statutory schemes for capital cost allowance, and Canadian exploration expenses. Section 111 bears no resemblance to those schemes.

[42]           A more important problem with this interpretation is that it fails to respect the choice that Parliament has given to taxpayers in the first line of subsection 111(1). As I read subsection 111(1), only the taxpayer has the right to choose how to allocate the non-capital loss of a particular year between the 3 prior years and the 7 subsequent years, subject only to the restrictions in subparagraphs 111(3)(a)(i) and 111(3)(b)(i). Although in a given situation a taxpayer may be content to allow the Minister to choose how its losses may be applied, nothing in section 111, except subparagraphs 111(3)(a)(i) and 111(3)(b)(i), gives the Minister any legal basis for imposing on a taxpayer a particular allocation.

[43]           The Minister argues that in this case, subparagraph 111(3)(b)(i) would be violated if CCLI is permitted to deduct part of its 1991 non-capital loss in 1993, because CCLI’s 1992 non-capital loss was deducted in computing CCLI’s taxable income for 1989 and 1990. The Minister may well have been wrong to permit CCLI’s 1992 non-capital loss to be deducted in 1989 and 1990. However, in this appeal CCLI has not challenged the propriety of those deductions, and the Minister is not entitled to do so.

[44]           The Minister points out that CCLI is getting an unfair advantage, because it will be allowed a 1993 deduction for 1991 non-capital losses that should have been deducted in 1989, and would have been deducted in 1989 but for the statutory limitation period. It is to be expected that the statutory limitation period will sometimes work to the advantage of taxpayers. That result is tolerated in the interest of finality in tax matters.

[45]           The Minister argues that if this proposed interpretation is not adopted, the result will be “administrative chaos”, because the Minister will refrain from allowing non-capital loss deductions until after the losses have been finally determined, which could potentially take so long that the years available for deduction will become statute barred. As the record contains no evidence in support of this argument, there is no factual basis upon which to determine whether the Minister’s practices will change as a result of this decision, and if so in what way and with what consequences. The only guidance available on this point is the Income Tax Act itself.

[46]           The normal reassessment period is either three or four years from the date of initial assessment, depending upon the status of the taxpayer (paragraphs 152(3.1)(a) and (b) of the Income Tax Act). The reassessment period is automatically extended by three years to permit extra time to reassess losses carried back from future years (subparagraph 152(4)(b)(i)). There is a more generous limitation period of ten years in the case of a taxpayer who has requested a reassessment to reduce tax payable (subsection 152(4.2)). If these provisions do not give the Minister enough time in a particular case, taxpayers may be asked to waive the time limitations (subparagraph 152(4)(a)(ii)), assuming they are alerted to the issue on a timely basis. Perhaps the Minister will still run out of time in some cases. If so, the remedy lies with Parliament. The remedy is not for this Court to give section 111 an interpretation it cannot reasonably bear.

[47]           I conclude that CCLI is entitled to deduct $19,984,499 of its 1991 non-capital loss in 1993. I would allow this part of the appeal.

Conclusion

[48]           I would dismiss the appeal in relation to 1989, 1990, 1991 and 1992, allow the appeal in relation to 1993, set aside the judgment of the Tax Court of Canada in relation to 1993, and replace it with a judgment allowing the appeal of CCLI for that year and referring the reassessment for that year back to the Minister for reconsideration and reassessment in accordance with these reasons. In light of the mixed success, the parties should bear their own costs.

 

“K. Sharlow”

 

“I agree

            M. Nadon J.A.”

 

“I agree

            J.D. Denis Pelletier J.A.”

 

 

 

FEDERAL COURT OF APPEAL

 

NAMES OF COUNSEL AND SOLICITORS OF RECORD

 

 

 

DOCKET:                                                                              A-237-06

 

STYLE OF CAUSE:                                                              CCLI (1994) INC v. HER MAJESTY THE QUEEN

 

PLACE OF HEARING:                                                        Vancouver, British Columbia

 

DATE OF HEARING:                                                          March 29, 2007

 

REASONS FOR JUDGMENT BY:                                     Sharlow J.A.

 

CONCURRED IN BY:                                                         Nadon J.A.

                                                                                                Pelletier J.A.

 

DATED:                                                                                 May 14, 2007

 

 

APPEARANCES:

 

Warren Mitchell Douglas Mathew   John Shipley Jagmohan Gill	FOR THE APPELLANT     FOR THE RESPONDENT

 

SOLICITORS OF RECORD:

 

Thorsteinssons, Tax Lawyers Toronto, Ontario   John H. Sims, Q.C. Deputy Attorney General of Canada	FOR THE APPELLANT     FOR THE RESPONDENT