canadian tax journal / revue fiscale canadienne (2008) vol. 56, no 4, 870 - 92
870
Tax Implications of Expropriation
Adam Scherer and Shane Rayman*
P r é c i s
La justice et l’équité représentent des éléments fondamentaux de la législation et de la politique fiscale. Il est juste d’imposer les gens à l’égard des décisions qu’ils prennent relativement aux biens, dans la mesure où leurs décisions représentent des événements volontaires. On ne peut en dire autant de l’expropriation, qui n’est pas volontaire et qui ne touche pas la totalité des contribuables. Elle touche en effet une petite partie de la population et elle n’est habituellement pas demandée ni voulue. Le présent article porte sur les différentes questions qui se posent relativement à l’imposition du produit tiré d’une expropriation et sur la façon dont la Loi de l’impôt sur le revenu s’efforce d’aboutir à un traitement fiscal équitable pour les propriétaires expropriés.
A b s t r A c t
Fairness and equity are cornerstones of tax legislation and policy. It is fair to tax people on income resulting from their decisions about property, because those decisions represent voluntary events. Such is not the case with the expropriation of property. For the property owner, expropriation is an involuntary event; it is not ordinarily requested or desired; and it generally affects only a small portion of the population. This article examines various issues relating to the taxation of proceeds from an expropriation and how the Income Tax Act endeavours to create a fair result for property owners whose property has been expropriated.
Keywords: Expropriation n involuntary convErsions n capital gains n dispositions n
rollovErs n propErty
* AdamSchererisofSobermanLLP,Toronto.ShaneRaymanisofRueterScargallBennettLLP,Toronto.TheauthorswishtothankStacieScherer,ofPassItOnCommunications,Toronto,foreditorialassistance,andDoreteAstroffandAdamRubinoffofSobermanLLP,fortheirinsightfulcommentsduringthedevelopmentofthisarticle.
c o n t e n t s
Introduction 871Policy 872Application of Policy 872
Entitlement to Proceeds of Disposition 873Requirements for Expropriations or Involuntary Dispositions 874Disposition of the Former Property 875
tax implications of expropriation n 871
intro duc tio n
TheIncomeTaxAct1containsprovisionsintendedtomitigateoreliminatetheim-mediatetaxburdencreatedasaresultofexpropriation.CertainrulesintheActallowanexpropriatedownertopotentiallydeferthetaxburden.Thisarticledescribesthedeferral mechanisms, including the underlying policy and the administration oftheserulesbytheCanadaRevenueAgency(CRA).Italsoexploreshowthecourtshavedeterminedtheappropriatetaxtreatmentofawardsofcompensationresultingfromexpropriation—inparticular,thebasisfordeterminingwhethersuchcompen-sationconstitutes“income,”“capital,”ora“windfall.”Finally,thearticlereviewsthetreatmentoftaxationinthedeterminationofawardsofcompensation,andthecircumstancesinwhichanownercanrecoverthecostoftaxadvicerequiredasare-sultofanexpropriation.
Thediscussionthatfollowsaddressesvarioustaxissuesarisinginthecontextofexpropriation. One significant area of concern is the treatment of replacement
Replacement Property Requirements 878Property Acquired To Replace the Former Property 878Same or Similar Use 879Gaining or Producing Income from a Business 880Acquisition of the Replacement Property 880
Elections 881Rules for a Valid Rollover Election 881Elections for Capital Losses 882
Determining Taxation 882Income Versus Capital 883Business Losses and Other Related Expenses 884Interest 885
Ordinary Interest 885Additional Interest 885
Eligible Capital Property 886Other Issues 887
Non-Residents 887Principal Residence 888Easements 888Professional Fees 888Voluntary Dispositions 889
Treatment of Taxation in Determining Compensation 889Reimbursement for Tax Advice 891Conclusion 892
1 RSC1985,c.1(5thSupp.),asamended(hereinreferredtoas“theAct”).Unlessotherwisestated,statutoryreferencesinthisarticlearetotheAct.
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property.Althoughotherarticlesandpapershavediscussedthistopic,2thisarticleexpandsontheissues.
P o lic y
Expropriationsandotherinvoluntarypropertydispositionsareusuallyunforeseen,andtheyoftencreateanunexpectedburdenforanexpropriatedpropertyowner.Theexpropriatedownermayhavetoimmediatelyrebuildorreplacehispropertyinordertocontinuehisbusinessoperationsorsupporthislifestyle.Hewilllikelyalsofaceadministrativedealingswithgovernmentagencies,insurancecompanies,law-yers,appraisers,andaccountantstodeterminethesettlementamountandtiming.Withoutrulestothecontrary,theownermayalsobesaddledwiththeimmediatetaxationofthecompensationreceivedforthepropertylost.
Infairnesstotaxpayerswhomustinvoluntarilydisposeofproperty,Parliamentpassedlegislationaimedatprovidingrelieffromtheimmediatetaxeventthatmightotherwiseresult.Whenthislegislationwasfirstintroduced,thenMinisterofFinanceJohnTurnerspokeofthefairnessandtimingissuesasfollows:
Ithas...cometomyattentionthatthetaxsystemdoesnotapplyfairlywherepropertyhasbeenexpropriated,lostordestroyed.Quiteoftenataxpayermaybefacedwithasignificanttaxliabilitylongbeforeasettlementdatehasbeenagreeduponandfundsareavailable.Thisseemsquiteunfair,andIamintroducingarelievingamendmentwhichwillensurethatundercertaincircumstancesnotaxispayableuntilthecompen-sationhasbeenfinallydetermined.3
A PPlic Atio n o f P o lic y
Whenataxpayerdisposesofcertaincapitalproperty,4suchaslandorabuilding,forcashorotherproceedsinexcessofitstaxcost,aliabilityfortaxmayarise.Thisusu-allytakestheformofacapitalgainor,inthecaseofdepreciableproperty,5recapture
2 See,forexample,AdamShapiro,“TheReplacementPropertyRules:ABitMoreThanBefore,”PersonalTaxPlanningfeature(2002)vol.50,no.6Canadian Tax Journal2141-66;andEdwinG.Kroft,“AnUpdateonSelectedIssuesRelatingtoDispositionsandExchangesofProperty,”inReal Estate Transactions: Tax Planning for the Second Half of the 1990s,1995CorporateManagementTaxConference(Toronto:CanadianTaxFoundation,1996),10:1-45.SeealsoLarissaV.Tkachenko,“Expropriations:TheIncomeTaxAspects”(1985)vol.33,no.1Canadian Tax Journal1-35.
3 Canada,DepartmentofFinance,1974Budget,BudgetSpeech,May6,1974,25.
4 “Capitalproperty”generallymeanspropertythedispositionofwhichgivesrisetoacapitalgain,andisdefinedinsection54oftheActasfollows:
(a) anydepreciablepropertyofthetaxpayerand(b)anyproperty(otherthandepreciableproperty),anygainorlossfromthe
dispositionofwhichwould,ifthepropertyweredisposedof,beacapitalgainoracapitalloss,asthecasemaybe,ofthetaxpayer.
5 “Depreciableproperty”isdefinedinsubsection13(21)aspropertyinrespectofwhichthetaxpayerhasbeenallowedtoclaimcapitalcostallowance.
tax implications of expropriation n 873
ofthecapitalcostallowance(CCA).Capitalgainsandrecapturearegenerallytaxableintheyearsinwhichtheyarerealized.
Incasesofinvoluntarydispositions,suchasexpropriations,thetypicaltaxliabil-itymaybedeferred.TheActsetsoutrulesondeferringcapitalgains(section44)orrecapture(subsection13(4))resultingfromthedispositionofcertaincapitalprop-erty.6Italsoprovidesaframeworkfordeterminingthetaxationyearinwhichthetaxpayermustreportthedispositionandpayanytaxesarisingfromit.
Thebasicpremiseoftheseprovisionsisthatifataxpayerdisposesofcertaincap-ital (depreciable)propertyandacquiresa suitablereplacementpropertywithinaspecificperiodoftime,shemaydeferthetaxfromthedispositionoftheoriginal(or“former”)property.Thegainthatwouldhavebeenrealizedatthetimeofthedis-positionisnow“rolled”intothepurchasepriceofthereplacementproperty.Asaresultofthisrollover,someorallofthetaxisdeferreduntilthetaxpayerdisposesofthenew(orreplacement)property.
Whilesubsection44(1)dealswiththeparametersofsuchrollovers,subsection44(2)dealsspecificallywiththetimingissues,andsubsection44(5)outlineswhatconsti-tutesavalidreplacementproperty.Eachsubsectionwillbeexaminedingreaterdetailbelow.TheActsetsoutparallelrulesforthedeferralofrecaptureinsubsection13(4).
Forarollovertooccur,thefollowingeventsmusttakeplace:7
1. thetaxpayerbecomesentitledtoproceedsofdisposition; 2. the taxpayeracquirescapitalproperty that isa replacementof the former
property; 3. thetaxpayeracquiresthereplacementpropertywithinaspecifiedtimeperiod; 4. thetaxpayerdoesnotdisposeofthereplacementpropertybeforethedateof
dispositionoftheformerproperty;and 5. thetaxpayermakesavalidelection.
Therulesassociatedwitheachoftheseeventsarediscussedbelow.
Entitlement to Proceeds of Disposition
Therearemanytransactionsoreventsthatmaycauseataxpayertobecomeentitledtoproceedsofdisposition.Forthepurposesofthisdiscussion,proceedsofdisposi-tionmayinclude
(a) thesalepriceofpropertythathasbeensold,(b) compensationforpropertyunlawfullytaken,(c) compensationforpropertydestroyed,andanyamountpayableunderapolicy
ofinsuranceinrespectoflossordestructionofproperty,
6 Gainson“eligiblecapitalproperty”mayalsobedeferredpursuanttosubsection14(6).
7 Subsection44(1).
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(d) compensationforpropertytakenunderstatutoryauthorityorthesalepriceofpropertysoldtoapersonbywhomnoticeofanintentiontotakeitunderstatutoryauthoritywasgiven,
(e) compensationforpropertyinjuriouslyaffected,whetherlawfullyorunlawfullyorunderstatutoryauthorityorotherwise.8
Absentanyrulestothecontrary,whenataxpayer isconsideredtohavereceivedproceedsofdispositionasaconsequenceofanyoftheeventsabove,ataxliabilitymayresult.
Requirements for Expropriations or Involuntary DispositionsThecircumstancesdescribedinparagraphs(b),(c),and(d)ofthedefinitionabovearecommonlyreferredtoas“involuntarydispositions.”9Onlyproceedsfromthesetypesofdispositionsqualifyforthesection44rollover.10Accordingly,proceedsofdispositionthatfallunderparagraphs(a)and(e)(amongothers)arenoteligiblefortherollover.
Proceedsofdispositionforexpropriatedpropertygenerallyfallwithintheparam-etersofparagraph(d)above.Therefore,itisimportanttoexaminetheelementsofthisdefinition:eithercompensationmustbereceivedforpropertythathasbeenex-propriated,orcompensationmustbereceivedforpropertythathasbeensoldtoaperson(thestatutoryauthority)whoprovidednoticeofanintentiontoexpropriate.
Becausethesecondpartofthedefinitionrequiresnoticeofanintentiontoex-propriate,anunsolicitedsaleofthepropertytotheexpropriatingauthoritydoesnotqualifyfortherolloverprovisions.Nordotherolloverprovisionsapplyif,afterpro-vidingnoticeofintentiontoexpropriate,thestatutoryauthoritynotifiestheownerthatithasabandonedthatintention,andthereisasubsequentsaletotheauthor-ity.11Similarly,therolloverprovisionsapplyonlywhenthetransferoccursbetweentheexpropriatingauthorityandthetaxpayer.Ifthetaxpayerreceivesanoticeofin-tentiontoexpropriatebutsellsthepropertytoathirdparty,theproceedsreceivedarenoteligibletoberolledintoareplacementproperty,andthereforethetaxesarisingfromthemcannotbedeferred.
Afterreceivinganoticeofintentiontoexpropriate,thepropertyownermaybeginnegotiatingthesaletotheexpropriatingauthority.Anoticeofintentioncanincludeanyofthefollowing:
8 Section54,thedefinitionof“proceedsofdisposition.”Notethatthisisapartiallistingoftheitemsincludedinthedefinition.
9 Interpretation BulletinIT-259R4,“ExchangeofProperty,”September23,2003,paragraph1.
10 Paragraph44(1)(a).
11 Interpretation BulletinIT-271R,“Expropriations—TimeandProceedsofDisposition,”May16,1980,paragraph5.ThisbulletinwasarchivedbytheCRAin2004.
tax implications of expropriation n 875
n Aformalnoticeof intentiontoexpropriate(NoticeofApplicationforAp-provaltoExpropriateLand)giventotheownerundertherequirementsoftheapplicableexpropriationlegislation.12
n Anynoticeprovidedormadeavailabletothepropertyownerbytheexpro-priatingauthority,indicatingitsintentiontoexpropriateifnegotiationsforthesaleofthepropertyarenotfruitful,anddescribingthepropertyinvolved.Examplesincludeaninformationcircularorletterpublishedbytheexpropri-atingauthorityandsenttotheownersoftheproperty.13
n Verbal notice given to the owner by a representative of the expropriatingauthority.14
Thecourtshaveconsideredtheprinciplesunderlyingthenoticerequirementinordertodeterminewhetherataxpayerqualifiesforthereplacementpropertyprovi-sionsundertheAct.AnexampleisthedecisioninDamka Lumber & Development Ltd. v. The Queen.15Inthatcase,thetaxpayerdisposedofpropertytotheUrbanTransitAuthorityofBritishColumbia,eventhoughnoformalnoticeofaninten-tiontoexpropriatewaseverprovided.Thetaxpayersoldthepropertyonthebasisofverbalnotificationsandrumoursofanimpendingexpropriation.Thecourtheldthatthereplacementpropertyrulesdidnotapplybecausetherewasnoevidencethattheproceedsactuallyconstituted“the salepriceofproperty sold toapersonbywhomnoticeofintentiontotakeitunderstatutoryauthoritywasgiven.”16
AlthoughthecourtreferencedInterpretation BulletinIT-271R,17itacceptedtheevidenceofapolicyspecialistwhostatedthattheintentionoftherolloverprovisionswasnotjustthata“verbalnoticeofexpropriation”mustbegivenbytheexpropriat-ingauthority,butthatverbalnoticemustalsobefollowedbyawrittennoticeofanintentiontocommence,ortheactualcommencementof,expropriationproceedings.Inlightofthecourt’sfindinginthiscase,itappearsthatverbalnotificationfromanexpropriatingauthoritymustbefollowedbywrittennoticeinorderforthereplace-mentpropertyprovisionsinsection44toapply.
Disposition of the Former PropertyIncasesofexpropriation,orotherinvoluntarydispositions,theprincipalproblemforthetaxpayerisoneoftiming.Althoughataxpayermayhave“disposed”ofhisproperty,hemaynotreceivealloranypartoftheproceedsofdispositionforalong
12 Ibid.,atparagraph4(a).InOntario,givingthisnoticerepresentstheformalinitiationoftheexpropriationprocessinaccordancewithsection6oftheExpropriationsAct,RSO1990,c.E.26,asamended(hereinreferredtoas“theExpropriationsAct”).
13 Ibid.,atparagraph4(b).
14 Ibid.,atparagraph4(c).
15 90DTC6101(FCTD).
16 Ibid.,at6104.
17 Supranote11.
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time(sometimesevenyears)afterthedisposition.18Forthisreason,therearerulesforidentifyingtheyearinwhichadispositionisconsideredtotakeplace—thatis,theyearinwhichtheformerpropertyownermustaccountfortheproceedsfortaxpurposes.
Inthemajorityofexpropriations,anexpropriatedownerreceives“withoutpreju-dice”advancesorinterimpaymentsofcompensationfromtheexpropriatingauthoritybeforethefinalamountofcompensationisdetermined.19Theseadvancepaymentsgenerallyneednotbetakenintoincomefortaxpurposesuntilthefullamountofthecompensationisdetermined.20
OnthebasisoftheSupremeCourtofCanadadecisioninMinister of National Revenue v. Benaby Realties Ltd.,21adispositionofacapitalpropertydoesnottakeplaceuntilthefinaldeterminationofcompensationismade.Thisdecisionsetsaparameterforrecognizingthetimingofadispositionandavoidstheprejudicetoataxpayerofhavingtopaytaxoncompensationbeforeitisdeterminedwithfinality.Attimes,itmayalsoprovideanincentivefortaxpayerstoextendthenegotiationorlitigationprocess,therebydelayingtherecognitionofandconsequentialtaxationontheproceedsofcompensation.
Inthecontextofexpropriationsorotherinvoluntarydispositions,thetaxpayermustacquireareplacementpropertybeforetheendofthesecondtaxationyearfollowingtheyear inwhichthedispositionisdeemedtooccur.22Otherwise,shecannotreapthebenefitsoftherolloverprovisions.23
Subsection44(2)oftheActgovernswhenthetwo-yearperiodstarts.Underthisprovision,involuntarydispositionsaredeemedtooccurattheearliestofthefollow-ingevents:
1. thedaythetaxpayerhasagreedtoanamountasfullcompensationforthepropertytakenorsold;24
18 SeeJ.G.Ware,“InvoluntaryDispositionsandthe1974Budget,”inReport of Proceedings of the Twenty-Sixth Tax Conference,1974ConferenceReport(Toronto:CanadianTaxFoundation,1975),542-54.
19 See,forexample,theExpropriationsAct,supranote12,section25(1).
20 Paragraph44(2)(a)oftheAct,andIT-271R,supranote11,atparagraph18.
21 [1968]SCR12.
22 DraftamendmentstotheActproposetochangethisperiodtothelateroftheendofthesecondtaxationyearfollowingthefinaldeterminationand24monthsaftertheendoftheyearinwhichthefinaldeterminationtookplace.SeeBillC-10,AnActToAmendtheIncomeTaxAct,IncludingAmendmentsinRelationtoForeignInvestmentEntitiesandNon-ResidentTrusts,andToProvidefortheBijuralExpressionoftheProvisionsofThatAct,aspassedbytheHouseofCommonsonOctober29,2007.TheamendmentisapplicabletodispositionsthatoccurintaxationyearsendingonorafterDecember20,2000.
23 Paragraph44(1)(c).
24 Paragraph44(2)(a).
tax implications of expropriation n 877
2. whereaclaim,suit,appeal,orotherproceedinghasgonebeforeanytribu-nalsorcourts,thedayonwhichthetaxpayer’scompensationforthepropertyisfinallydeterminedbythetribunalorcourt;25
3. whereaclaimreferredtoin2abovehasnotgonebeforeatribunalorcourtwithintwoyearsoftheloss,destruction,ortakingoftheproperty,thedaythatistwoyearsfollowingthedayoftheloss,destruction,ortaking;26
4. thedayonwhichthetaxpayerdiesorceasestobearesidentofCanada;27and 5. wherethetaxpayerisacorporation,otherthancertainsubsidiarycorpora-
tions,thetimeimmediatelybeforeitiswoundup.28
Ataxpayerisdeemedtoownthepropertycontinuouslyuntilthedateofdisposi-tionisdetermined.29Accordingly,thetaxpayercancontinuetoclaimCCAinrespectoftheproperty,providedthatthetaxpayercontinuestousethepropertytoearnbusinessincome.30
ThedecisioninLoukras v. MNR31illustratesthetimelinefortheapplicationofsubsection44(2).InLoukras,thefollowingeventshadtakenplace:
n InMarch1972,anoticeof intentionwasregisteredbythegovernmentofCanadatoexpropriatetheappellant’sportionofa100-acrefarminPickering,Ontario.
n OnApril24,1973,aformalofferwasmadetotheappellantfortheproperty.n OnAugust15,1973,theappellantcommencedanactionintheFederalCourt
claimingcompensationinrespectoftheexpropriationoftheproperty.n Theappellantreceivedamounts,onvariousdatesin1973and1974,without
prejudicetohisrighttoappealthequantumofthecompensation.n AjudgmentwassignedonSeptember20,1974.n OnOctober17,1974,theappellantfiledanoticeofappealtotheFederal
CourtofAppeal.n OnFebruary19,1976,theappellantdroppedtheappeal.
TheTaxCourtofCanadaheldthatpartialadvancepaymentsarisingfromtheexpropriationwerenottaxable,pursuanttosubsection44(2),untilthefullamount
25 Paragraph44(2)(b).
26 Paragraph44(2)(c).Itappearsthataclaimisconsideredtogobeforeatribunalorcourtwhenthejurisdictionofthetribunalorcourtisinvoked.UndertheExpropriationsAct,thejurisdictionoftheOntarioMunicipalBoardisinvokedwhenanoticeofarbitrationforthedeterminationofcompensationbytheboardisserved.Seesection26(b)oftheExpropriationsAct,supranote12,andMarshall v. Ontario (MoT)(2005),87LCR177,at179(OMB).
27 Paragraph44(2)(d)oftheAct.
28 Paragraph44(2)(e).
29 Subsection44(2).
30 Paragraph20(1)(a).
31 90DTC1557(TCC).
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ofthecompensationhadbeenfullydeterminedbythecourtbeforewhichtheclaimwasbrought.ThatdatewasdeterminedtobeSeptember20,1974.Adiscontinuedappealdidnotaffecttheyearoftaxability.Hadtheappealproceeded,andhadtheFederalCourtofAppeal awardedadifferent amountof compensation than thatcontainedintheinitialjudgment,theeffectivedatewouldlikelyhavebeenthedateonwhichtheappellatedecisionwasrendered.
Replacement Property Requirements
Subsection44(5)outlineswhatconstitutesareplacementproperty.32Aparticularcapitalpropertyqualifiesasareplacementpropertyforthetaxpayer’sformerprop-ertyifitmeetsallofthefollowingconditions:
n Itisreasonabletoconcludethatthenewpropertywasacquiredbythetax-payertoreplaceherformerproperty.33
n Thenewpropertywasacquiredbythetaxpayerandtheuseofthepropertybythetaxpayer(orarelatedperson)isthesameasorsimilartotheuseoftheformerproperty.34
n Wherethetaxpayer(orarelatedperson)usedtheformerpropertyforthepurposeofgainingorproducingincomefromabusiness,thetaxpayer(orarelatedperson)acquiredthenewpropertyforthesamepurposeinthesameorasimilarbusiness.35
n WheretheformerpropertywasataxableCanadianpropertyofthetaxpayer,thenewpropertyisalsoataxableCanadianpropertyofthetaxpayer.36
n WheretheformerpropertywasataxableCanadianpropertyofthetaxpayerthatwasnot treaty-protected, thenewproperty isalsoa taxableCanadianpropertythatisnottreaty-protected.37
TheCRAprovidessomeguidanceonitsadministrativeinterpretationofthereplace-mentpropertyrulesinInterpretation BulletinIT-259R4,38asdiscussedabove.
Property Acquired To Replace the Former PropertyWithrespecttotherequirementthatthenewpropertywasacquiredtoreplacetheformerproperty(paragraph44(5)(a)),IT-259R4states,inpart:
32 Theparallelprovisionoutliningtheconditionsnecessaryforthedeferralofrecaptureiscontainedinsubsection13(4.1).
33 Paragraph44(5)(a).
34 Paragraph44(5)(a.1).“Relatedpersons”isdefinedinsubsection251(2).
35 Paragraph44(5)(b).
36 Paragraph44(5)(c).“TaxableCanadianproperty”isdefinedinsubsection248(1).
37 Paragraph44(5)(d).“Treaty-protectedproperty”isdefinedinsubsection248(1).
38 Supranote9.
tax implications of expropriation n 879
[T]heremustbesomecorrelationordirectsubstitution,thatis,acausalrelationshipbetweenthedispositionofaformerpropertyandtheacquisitionofthenewpropertyorproperties.Whereitcannotreadilybedeterminedwhetheronepropertyisactuallybeingreplacedbyanother,thenewlyacquiredpropertywillnotbeconsideredare-placementpropertyfortheformerproperty....Generally,thegeographicallocationof the “replacementproperty” isnotdeterminativewhenconsideringwhetheronepropertyisareplacementforanother.39
Same or Similar UseIT259-R4alsoprovidesguidancefordeterminingwhetherthenewpropertycanbeconsidered to have the same or a similar use as the former property (para-graph44(5)(a.1)).Tomeettherequirements,theformerpropertymusthavebeen“used.”Thus,landthathasneverbeenusedbythetaxpayer(orarelatedperson)cannotqualifyasaformerproperty.Landoranyothercapitalpropertythatisusedfornon-income-earningpurposes(suchasapersonal-usecottage)canqualifyasareplacementpropertyprovidedthatitreplacesapropertythatwasusedbythetax-payer(orarelatedperson)forthesameorasimilarpurpose.Landthatisacquiredforthepurposeofresalecannotqualifyunderparagraph44(5)(a.1)becauseitisnotconsideredtobeacapitalpropertyforthepurposesofsection44.40
The“usetest”wasadjudicatedinDepaoli et al. v. The Queen,41wherethetaxpayers(Depaoli) owned 33.47 acres of vacant, unsevered land in Milton, Ontario. Thepropertywasexpropriated,andDepaolipurchasedtwonewpropertiesinCaledon,Ontario.Eachofthenewpropertiesconsistedofapproximately10acresofvacant,unseveredland.
Depaoliarguedthathehadpurchasedtheformerpropertywiththeintentiontoeventually build a house and operate a farm upon his retirement. Every yearthroughouthisownershipoftheproperty,hehadarrangedforlocalfarmerstocul-tivatethelandandplantandharvestcrops.Aftertheexpropriationoftheformerproperty,Depaoli entered into the same farming arrangements for the twonewproperties.Thecourtruledthatthisarrangementpassedthesameorsimilarusetest,andthereforethenewpropertieswereconsideredreplacementproperties.
IT-259R4alsonotesthatalthoughareplacementpropertygenerallybearsthesamephysicaldescriptionas the formerproperty (forexample, land replacedbylandorabuildingreplacedbyabuilding),theremaybecaseswhereadifferenttypeofpropertyservesthesame(orasimilar)functionorisappliedtothesame(orasimilar)useastheformerproperty.42
39 Ibid.,atparagraph15.
40 Ibid.,atparagraph16(a).
41 96DTC1820(TCC);aff ’d.99DTC5727(FCA).
42 IT-259R4,supranote9,atparagraph16(b).
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Gaining or Producing Income from a BusinessWithrespecttotherequirementinparagraph44(5)(b),whereataxpayer(orarelatedperson)usedtheformerpropertyforthepurposeofgainingorproducingincomefromabusinessandthenewpropertyisusedforthesamepurposeinthesameorasimilarbusiness,theCRAwillconsiderthenewpropertytobeareplacementpropertyifitgenerallybearsthesamephysicaldescriptionastheformerproperty.IT-259R4providestheexampleofabusinessthatreplacesawarehousewithamanufacturingbuilding.IntheCRA’sview,themanufacturingbuildingqualifiesasareplacementproperty“becausebothpropertiesarebuildingsandthetwousesare ‘similar’ inthattheyarebothpartoftheoverallprocessofprovidingproductsfromthesameorasimilarbusinesstotheconsumer.”43
However,thesameorsimilarusetestisnotoutweighedbythesameorsimilarbusiness test. For example, a corporate automobile cannot replace a corporatebuilding,eveniftheyarebothusedinthesamebusiness.IT-259R4alsonotesthatapropertynormallycannotbeareplacementpropertywhenitisacquiredforthesameorasimilarusebutalsoservessubstantialotherusesatthesametime.Anin-significantsecondaryusewillnotdisqualifythenewproperty.44
TheCRAinterpretsthesameorsimilarbusinesstestinareasonablybroadmanner.Itwillconsidertwobusinessestobesimilariftheybothfallintooneofthefollow-ingcategories,listedinIT-259R4:
(a) merchandising—retailingandwholesaling;(b) farming;(c) fishing;(d) forestryandforestproducts;(e) extractiveindustries,includingrefining;(f ) financialservices;(g) communications;(h) transportation;(i) construction,includingsubcontracting;and(j) manufacturingandprocessing.45
Acquisition of the Replacement PropertyTheCRAstatesthatforthereplacementpropertyprovisionstoapplyincasesofex-propriation,thepropertymustbeacquiredafterthetaxpayerreceivesanoticeofintentiontoexpropriatethepropertyunderstatutoryauthorityandbeforetheendofthetwo-yearperiodafterthedispositionoftheformerpropertyisconsideredtohavetakenplace(seethediscussionabove).46
43 Ibid.,atparagraph17.
44 Ibid.
45 Ibid.,atparagraph18.
46 Ibid.,atparagraph2(b).
tax implications of expropriation n 881
Ataxpayercanacquireareplacementpropertyeitherbeforeorafterhedisposesofhisformerproperty.Giventhelengthoftimethatcanelapsebetweenanoticeofintentionandtheactualdisposition,itiscommonforataxpayertopurchaseare-placementpropertybeforehedisposesoftheformerproperty.Inordertoqualifyforthedeferralrules,thetaxpayermustbemindfulnottodisposeofthereplace-mentpropertybeforethedispositionoftheformerproperty;forthereplacementprovisionstoapply,hemustownthereplacementpropertyatthetimehereceivestheproceedsfortheformerproperty.47
Whenthetaxpayerdoesnotacquireareplacementpropertyuntilasubsequentyear,hemustreportanyrecapturedCCAortaxablecapitalgainsfromthedispositiononhisincometaxreturn.Onceheacquiresthereplacementproperty,hemayrequestareassessmentofhisincometaxreturnfortheyearofthedispositionoftheformerproperty.Inthisway,hemaygeneratearefundofthetaxeshepaidontheproceedsofdisposition.48Inordertoalleviatethefinancialburdenthatmayfollow,theCRAmayacceptsecurityinlieuofpaymentoftaxesowing,untilthefinaltaxesaredeter-minedorthetimeforacquiringareplacementpropertylapses.49
Elections
Rules for a Valid Rollover ElectionThereplacementpropertyanddeferralrulesdonotapplyautomatically;ataxpayermustelecttousetherolloverprovisions.50Thetimingandnatureoftheelectionvaries,dependingonthecircumstancesofthedispositionandtheacquisitionofre-placementproperty.
Therearethreesituationsthatdeterminehowanelectionismade:
1. Ifthedispositionandreplacementtakeplaceinthesametaxationyear,thetaxpayer’scalculationoftherecapturedCCAandcapitalgainsontheincometaxreturnforthatyearconstitutesanelection.51
2. Whereapropertyisnotreplaceduntilasubsequentyear,theelectionmusttaketheformofaletterattachedtotheincometaxreturnfortheyearinwhichthereplacementpropertyisacquired.Thelettershouldincludeade-scriptionofboththeformerandthereplacementproperties,arequestforanadjustmenttotherecaptureofCCAandtaxablecapitalgainspreviouslyre-ported,andacalculationoftherevisedrecaptureandtaxablecapitalgains.52
3. Similarly,wherethereplacementpropertyisacquiredinataxationyearpriortothedispositionoftheformerproperty,theelectionmusttaketheformof
47 Subsection44(1). 48 IT-259R4,supranote9,atparagraph3. 49 Ibid. 50 Subsections44(1)and13(4). 51 IT-259R4,supranote9,atparagraph7(a). 52 Ibid.,atparagraph7(b).
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aletterattachedtotheincometaxreturnfortheyearofacquisitionofthereplacementproperty,andthelettershouldincludeadescriptionofboththeformerandthereplacementproperties.
Ifthetaxpayerelectstorollovertheproceedsanddeferthecapitalgainsonadepreciableproperty,anelectionisautomaticallyappliedtothecorrespondingrecap-tureaswell(andviceversa).53ThisensuresthatthecapitalcostofthereplacementpropertyisconsistentforthepurposesofboththeCCAandcapitalgainsprovisionsoftheAct.
Theelectionisanessentialcomponentofthereplacementpropertydeferral.TheCRAwillacceptlate-filedelectionsincertaincircumstances.54TheCRA’sguidelinesforacceptinglate,amended,orrevokedelectionsareoutlinedinInformation Circu-lar07-1.55In2004,thelegislationwasamendedtoadda10-yearlimitationperiodforapplicationsmadeafter2004.56Ifthetaxpayerlate-filesthereplacementprop-ertyelection,itwillstillbeaccepted,providedthatitisfiledwiththeincometaxreturnfortheyearinwhichtheformerpropertyisdisposedof.57
Elections for Capital LossesBecause the rollover provisions are elective, a taxpayer can choose not to applythemwhensheincursothercapitalornon-capitallossesthatwouldnototherwisebe absorbed. In certain circumstances, not using the rollover provisions can bebeneficial,sincethetaxpayercanrecognizethelossesimmediately.
de ter mining tA x Atio n
Onceataxpayerreceivescompensationforapropertythathasbeenexpropriated,thenextstepistodeterminehowthatcompensationistobetreatedfortaxpurposes—inthecurrentyeariftheproceedscannotberolledover,orinalateryeariftheycan.
Ataxpayermayreceivevariouscomponentsofcompensationwhenhispropertyisexpropriated.InOntario(andotherprovinceswithsimilarlegislation),variousheadsofcompensationareitemized.58TheExpropriationsActdividescompensationintothefollowingheadsofdamages:
n marketvalueforthelandacquired;59
n injuriousaffectiontotheremaininglands;60
53 Subsection44(4). 54 Subsection220(3.2)andregulation600. 55 Information Circular07-1,“TaxpayerReliefProvisions,”May31,2007,paragraphs45-63. 56 Paragraph220(3.2)(b). 57 IT-259R4,supranote9,atparagraph7(c). 58 ExpropriationsAct,supranote12,section13(2). 59 Ibid.,section13(2)(a). 60 Ibid.,section13(2)(c).
tax implications of expropriation n 883
n disturbancedamages,includingbusinesslosses,relocationexpenses,andotherareasofcompensationtomaketheownerwhole;61
n specialdifficultiesinrelocating;62
n interestoncompensationoutstanding,includingadditionalinterestwhenap-propriate;63and
n reimbursementofreasonablelegal,appraisal,andothercostsincurredbytheownerinthedeterminationofcompensation.64
Insomecases,thequantificationofmarketvalueandinjuriousaffectionisblendedusingthebeforeandafterapproach.65
Howthecompensation ischaracterizedcanhave importantconsequences forincometaxpurposes.Eachcategoryhasavaryingdegreeoftaxability.Onthebasisofincometaxpostulations,anawardfromexpropriationcanfallunderoneormoreofthefollowingcategories:
n areceiptonaccountofincome(whichisordinarilytaxedasincome);n areceiptresultingfromthedispositionofcapitalproperty(whichisordinarily
taxedasacapitalgain);66
n anon-taxablereceipt;n an eligible capital amount, or goodwill (which is taxed similarly to capital
gains);67andn reimbursementofexpenses(whichispresumedtohavenotaxeffect).
Itisnotuncommonforawardsofcompensationfromexpropriationtofallintomultiplecategories.Often,thereisnoclearanswerastowhichcategoryaparticularreceiptfallsinto.Individualresultsvaryaccordingtothefactsandcircumstancesoftheparticularcase.Consequently,itisimportanttoexaminejurisprudenceinthisareaforguidanceonthetaxabilityofaparticularreceipt.
Income Versus Capital
Thefirststepinestablishingthetaxtreatmentofaparticularreceiptistodeterminewhetherthepropertytowhichthereceiptrelatesisacapitalassetorheldonaccountofincome.Apropertyisconsideredtobeheldonaccountofincomeifitisheldfor
61 Ibid.,sections13(2)(b)and19. 62 Ibid.,section13(2)(d). 63 Ibid.,sections33(1)and33(4). 64 Ibid.,section32(1). 65 Ibid.,section14(3). 66 Thetaxtreatmentofcapitalgainsisgovernedbysection39oftheAct.Currently(September
2008),50percentofthenetgainisincludedinincome. 67 Thetaxtreatmentofthedispositionofgoodwillandothereligiblecapitalamountsisgoverned
bysection14oftheAct.Currently,thedispositionofgoodwilliseffectivelytaxedatthesamerateascapitalgains—thatis,50percentofthenetproceedsisincludedinincome.
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thepurposeofresaleandthetaxpayercanbeconsideredtobe“inthebusiness”ofsellingit(or,putdifferently,ifthetaxpayeracquiredthepropertyasanadventureinthenatureoftrade).Whenataxpayerdisposesofpropertyheldonaccountofin-comeandrealizesagain,thegainisnottreatedascapital,buttaxedasordinaryincome.
Thesameappliesinthecaseofexpropriatedproperty:acapitalgaindoesnotapplyifthepropertywasheldforresale.Itistheunderlyinguseofthepropertythatdeterminesthetaxtreatment,notthemannerofitsdisposition.TheFederalCourtofAppealsupportedthisnotioninBellingham v. The Queen.68Itheldthatsincethetaxpayer’spropertywasacquiredasanadventureinthenatureoftrade,anyprofitonthedispositionwastaxableonaccountofincome,whetherthepropertywasdis-posedofbysaleorbyexpropriation.ThejudgestatedthatnowheredoestheActdeemadispositionbywayofexpropriationtobeeligiblefortreatmentasacapitalproperty.69GiventhatthetaxpayerinBellinghamadmittedthatthepropertywasacquiredinthecourseofanadventureinthenatureoftrade,andfiledherreturnreportingtheproceedsasderivedtherefrom,theproceedsofdispositionweretax-ableasincomeandnottreatedasacapitalgain.
Business Losses and Other Related Expenses
Usually,compensationforbusinesslossesandotherrelatedexpensesistreatedonaccountofincome.Iftheawardisareimbursementforcurrentexpenses,itislikelytaxableasincome,butpresumablyoffsetwhentheactualexpendituretakesplace.Inthecaseofanexpropriation,abusinesslossisintendedtoreplacetaxableincomethatwouldhavebeenenjoyedbutfortheexpropriation.Generally,thecompensationwouldbetaxedonaccountof income;however, incertain instances,courtshavecometoadifferentconclusion.Specifically,wherethebusinesslossescouldbeinter-pretedas“permanent,”theyappeartohavebeentreatedascapital.ExamplesofthischaracterizationoccurinthedecisionsinSani Sport Inc. v. The Queen70andFarrell et al. v. MNR.71
InSani Sport,thetaxpayerownedandoperatedasportcentreinQuebec.Thecompanyintendedtousepartofitslandtobuildatenniscourt.However,HydroQuebecexpropriatedpartofthatlandandsettledforapaymentof$350,000,whichincluded$286,000forpermanentbusinesslosses.Thecourtruledthattheindemnitypaidontheexpropriationwasawholeamountthatcouldnotbesplitintovariousheadings.72Becausethecompensationwasconsideredaunitarysum,thefullamountwastreatedascapital.
68 96DTC6075(FCA).
69 Ibid.,at6078.
70 90DTC6230(FCA).
71 85DTC706(TCC).
72 QuebecdoesnothavelegislationsimilartoOntario’sExpropriationsAct,whichbreaksdowncompensationintodistinctheadsofdamages.
tax implications of expropriation n 885
InFarrell,thetaxpayerownedaparceloflandforwhichheenteredintogravelremovalcontracts.OntarioHydroexpropriatedthelandandcompensatedtheownerfor“granulardeposits”onthebasisoftherevenuethatheexpectedtoderivefromthesaleofgravel.Thecourtruledthatthepaymentforthebusinesslosswastobetreatedasacapitalgain.TremblayJ,writingforthecourt,statedthatdeterminingcompensationonthebasisofanticipatedrevenueswasmerelyayardstickincalculat-ingthevalueoftheproperty,anddidnotchangethecapitalnatureofthereceipt.73
Interest
Ordinary InterestOrdinaryinterestpaidonanawardisnotincludedinthedefinitionof“proceedsofdisposition”andistaxedseparately.74TherationaleforthistreatmentcanbefoundinthecommentsofWestonJinThe Queen v. Elliott,wheretheFederalCourtTrialDivision,onanappealfromtheTaxCourtofCanada,concludedthattheinterestoncompensationarosenotfromthedispositionofproperty,butfromadelayinthepaymentofacapitalsum.75Accordingly,theinterestelementofanexpropriationawardshouldproperlybecharacterizedas“interest”andtaxedassuch.
Itshouldalsobenotedthattheportionofproceedsfromanexpropriationthatisconsideredtobeinterestcannotberolledintoanewproperty,andthetax,ifap-plicable,cannotbedeferredtoalaterdate.
Additional InterestAdditionalinterest—interestthatexceedsastatutorilyprescribedrate76—istreateddifferentlythanordinaryinterest.TheBellinghamdecisionnotedthisdistinction.Inthatdecision,thetaxpayerreceivedexpropriationproceedsasfollows:
n $377,015ascompensationforthepropertylost;n $181,319asordinaryinterest;andn $114,272as“additionalinterest.”
Theamountsawardedforpropertylostandordinaryinterestweretreatedasbusi-nessandinterestincome,respectively.However,theFederalCourtofAppealheldthatadditionalinterestdoesnotconstitutecompensationforlandspreviouslytaken,nordoesitcompensateforthelossoruseofmoney;rather,inthecourt’sview,theadditionalinterestwastantamounttoanawardofpunitivedamages.77
73 Farrell,supranote71,at717.
74 Paragraph12(1)(c).SeeWideman v. MNR,83DTC531(TCC);The Queen v. Shaw,93DTC5121(FCA);The Queen v. Elliott,96DTC6189(FCTD);andBellingham,supranote68.
75 Elliott,supranote74,at15.
76 InOntario,“additionalinterest”referstointerestinexcessof6percentperannum,awardedpursuanttosection33(4)oftheExpropriationsAct.
77 Supranote68,at6083.
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Thecourtconcluded:
[T]hesourceoftheadditionalinterestawardisnottheexpropriatingauthority.Thatbodyismerelythepayor.ThetruesourceoftheawardistheExpropriation Actwhichdictatesasamatterofpublicpolicy,thatexpropriatingauthoritiesareobligatedtopayapenalsumincircumstanceswheretheirbehaviourfallsbelowaprescribedstandard.78
Theawarddidnotflowfromanagreementbetweenthetwoparties,andtherewasnoelementofbargainorexchange.Sinceadditionalinterest(likeotherformsofexemplarydamages) ismeant topunishthewrongdoerandnotcompensate thevictim,thecourtconcludedthattheawardwasanon-taxablewindfall.79
Eligible Capital Property80
Eligible capital property of a business is broadly described as intangible capitalproperty,suchasgoodwillandother“nothings.”81Goodwillisthevalueofabusinessasagoingconcernthatexceedsthestand-alonevalueoftheassetsofthebusiness.Goodwillmayincludeanyofthefollowing:
(i) reputation,(ii) servicesofemployees,(iii) favourablecommercialcontracts,(iv) trademarksortradenames,(v) favourablefinancialrelationships,(vi) managementperformancerecord,and(vii) non-competitionprovisions.82
Acommoninstanceofthedispositionofgoodwilloccurswhenabusinessissold.Normally,thesaleofthegoodwillisadispositionofeligiblecapitalpropertyandtaxedsimilarlytoacapitalgain.83InThe Queen v. Toronto Refiners and Smelters Lim-ited,84thisissuewasexaminedwithdifferentresults.
TorontoRefinersandSmelters (“TRS”)carriedonabusinessof leadrefining.WhenitspropertywasexpropriatedbythecityofToronto(“thecity”),thecom-panywasunabletorelocate.TRSceasedcarryingonbusinessanddisposedofallitsbusinessassetstotheexpropriatingauthority.Thecitypaidatotalof$12millionin
78 Ibid.,at6082.
79 Ibid.
80 Replacementpropertyrulesapplicabletoeligiblecapitalpropertyarefoundinsection14oftheAct.
81 Interpretation BulletinIT-386R,“EligibleCapitalAmounts,”October30,1992,paragraph1.
82 Ibid.,atparagraph2(b).
83 Subsection14(1).
84 2003DTC5001(FCA).
tax implications of expropriation n 887
compensationtoTRS,brokendownasfollows:$2.9millionfortheland,$100,000forthebuilding,and$9millionbecausethebusinesscouldnotrelocate.85
TRStreatedthe$9millionasdamages,anon-taxablereceipt.However,onre-assessment,theministerdeterminedthatthe$9millionrepresentedproceedsfromthe saleofgoodwill—not compensation fordamages—and therefore constitutedproceedsfromthedispositionofeligiblecapitalproperty.Asaresult,TRSwasliablefortaxonthoseproceedssimilartothetaxonacapitalgain.
TheFederalCourtofAppealrejectedtheminister’sassessmentanddecidedinfavourofTRS.Thecourtfoundthatthe$9millionawardwasbasedonsection19(2)oftheExpropriationsAct(Ontario),whichoutlinescompensationforthedestruc-tionofthegoodwillofabusinessthatisterminatedasaresultofanexpropriationandcannotrelocate.86Thecourttooktheviewthatbecausethecityacquiredthelandforcivic,andnotbusiness,purposes,itdidnotpaythe$9milliontopurchasethegoodwillofthebusiness.87Rather,thatpaymentamountedtodamagestocom-pensateTRSforthecessationofitsoperations.Therefore,the$9millionwasnotadeductibleexpenditurebythepurchaser.Thecourtthenapplieda“mirrorimage”testbasedonsubsection14(1):ifthe$9millionwasnotaneligiblecapitalexpendi-tureforthepurchaser,itcouldnotbeaneligiblecapitalreceiptfortheseller.88
Inlightoftheseinterpretations,the$9millionwastreatedasdamages—anon-taxablewindfallforTRS.
Inwhatmaywellbearesponsetothisdecision,theActwasamendedbythesec-ond2006budgetimplementationbill.89Thisamendmentvariedthedescriptionof“E”inthedefinitionof“cumulativeeligiblecapital”insubsection14(5)tooverridethepreviousmirrorimagetest.Thisineffectchangedtheimplicationsofreceivingcompensationforlossofgoodwillasanon-taxablereceipt.
other issue s
Non-Residents
ThisarticlefocusesonissuesofconcerntoCanadianresidentswhodisposeofprop-ertyinvoluntarily.Incaseswheretheownerisanon-resident,othercomplicationsarise.IftaxableCanadianpropertyisdisposedof,thenon-residentwilllikelyhavetopayCanadiantaxandfileaCanadianincometaxreturn.90Thenon-residentmustapplyforacertificatefromtheministerinrespectofthedispositionofthepropertywithin10daysofthedateofdisposal,whetherornotsheincursataxliabilityonthedisposition.91Inaddition,25percentofthegrossproceedsfromthedispositionof
85 Ibid.,atparagraph3. 86 Ibid.,atparagraph13. 87 Ibid.,atparagraph23. 88 Ibid.,atparagraph20. 89 BudgetImplementationAct,2006,No.2,SC2007,c.2,section3(6). 90 Paragraphs2(3)(c),150(1)(a),and150(1.1)(b)oftheAct. 91 Subsection116(3).
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acapitalpropertywillbewithheld(50percentfordepreciableproperty),92unlessthenon-residentappliestotheministerforareductioninatimelymanner.93
PartxIIIwithholdingtaxmayalsoapplyoninterestpaymentsreceivedbyanon-residenttaxpayer.Therateforthiswithholdingis25percentunlessitisreducedthroughanincometaxtreatywiththeparticularcountry.94
Principal Residence
Iftheexpropriatedproperty,oraportionofit, isconsideredtobethetaxpayer’sprincipalresidence,hemaybeabletoelecttotreattheproceeds,ortheportionoftheproceedsrelatingtotheprincipalresidence,astax-free,ifcertainconditionsaremet.95
Easements
Generally,whenapropertyownergrantsaneasementorapublicrightofway,sheisdisposingofaportionofherproperty.Shemustallocateareasonableportionoftheadjustedcostbaseofthewholepropertytothedisposition.96
IntheCRA’sview,ifnomorethan20percentofthetotalareaisexpropriated,oraneasementisgranted,andtheamountofthecompensationreceivedisnotmorethan20percentoftheamountoftheadjustedcostbaseoftheproperty,thentheadjustedcostbasecanbecalculatedasbeingequaltothecompensationreceived.97Consequently,notaxwillbepayable.
Professional Fees
Inthecourseofnegotiatingasettlement,ataxpayercanincursubstantiallegal,accounting,appraisal,andotherexpertfees.Therulesforthetaxtreatmentanddeductibilityofthesefeesparallelthosethatapplytotheunderlyingcompensation.Reimbursementofalloraportionofthesefeesbytheexpropriatingauthorityalsoaffectstheirtaxtreatmentanddeductibility;undernormalcircumstances,feesre-coveredfromanauthorityoffsettheexpenditure.
Feesrelatingtoitemsthatareincomereceiptsareordinarilydeductible.Profes-sionalfeesrelatingtocapitalelementsaregenerallynotdeductible;instead,theyaretreatedasanoutlayorexpenseforthepurposeofdisposingofaproperty.Assuch,theyaretakenintoaccount,sothatanycapitalgain,loss,recapture,terminalloss,orbusinessinvestmentlossmustbeadjustedaswell.98
92 Subsection116(5).
93 Subsection116(5.2).
94 Paragraph212(1)(b).
95 Paragraph40(2)(b).Foradetaileddiscussionoftheprincipalresidenceexemption,seeInterpretation BulletinIT-120R6,“PrincipalResidence,”July17,2003.
96 Interpretation BulletinIT-264R,“PartDispositions,”December29,1980,paragraph2.
97 Ibid.
98 Interpretation BulletinIT-99R5(Consolidated),“LegalandAccountingFees,”paragraph14.
tax implications of expropriation n 889
Professionalfeesrelatingtoatax-freeitemofcompensationaregenerallynotdeductibleeitheronaccountofincomeoronaccountofcapital.
Voluntary Dispositions
TheActalsocontainsprovisionsforrollingoverproceedsintoareplacementprop-ertywhenavoluntarydispositionoccursinthecontextofexpropriation.Forexample,ataxpayermaysellhispropertytoathirdpartywhilethepropertyissubjecttoaformalexpropriation,orthethreatofone.Inthesecircumstances,thedispositionwillnotfallwithinparagraph44(1)(a),butitmayqualifyforarolloverunderotherprovisionsofsection44.
Therearetwosignificantdifferencesintherulesthatapplytoavoluntarydis-positionascomparedwiththoseforaninvoluntarydisposition:
1. Thepropertydisposedofmustbea“formerbusinessproperty”ofthetax-payer.99Aformerbusinessproperty isacapitalpropertythatthetaxpayerusedprimarilyforthepurposeofgainingbusinessincome.Itmustbearealproperty,andthedefinitiongenerallydoesnotincludearentalproperty.
2. Inordertobeeligibleforthedeferral,thetaxpayermustacquirethereplace-mentpropertybeforetheendofthefirst(ratherthanthesecond)taxationyearthatfollowstheyearofdisposition.100
tre Atment o f tA x Atio n in de ter mining comPensAtio n
Awards of compensation for business losses are normally based on the incomestreamofabusinessthatisterminatedoradverselyaffectedbyanexpropriation.Under the income capitalization approach to valuation, the income stream of apropertyisoftenacomponentofthedeterminationofmarketvalueaswell.Forthesepurposes,thedeterminationofcompensationunderOntario’sExpropriationsActmustbebasedonanincomestream(orprojectedincomestream)that is,orwouldnormallybe,subjecttotaxation.Theeffectoftaxationmayalsobeconsid-eredwhenadecisionmakermustdeterminethesumofcompensationthatisre-quiredtomakeanexpropriatedownertrulywhole.
TheOntarioDivisionalCourtdealtwiththetreatmentoftaxationofanincomestreamformingthefoundationofabusinesslossclaiminthedecisionofCity Park-ing Ltd. v. City of Toronto.101Inthatdecision,theclaimanthadaleaseholdinterestinaparkinglotandadvancedaclaimforabusinesslossbasedonthelossofincomeintheremainingyearsofthelease.TheLandCompensationBoard,indeterminingthebusinessloss,setcompensationonthebasisoftheafter-taxincomestreamoftheparkinglot.
99 Paragraph44(1)(b),andthedefinitionof“formerbusinessproperty”insubsection248(1).SeealsoInterpretation BulletinIT-491,“FormerBusinessProperty,”September3,1982.
100 Paragraph44(1)(d).101 (1980),20LCR159(Ont.Div.Ct.).
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Theclaimantappealedthedecision,submittingthattheboard’sconsiderationoftaxationamountedtodoubletaxation.Thisoccurredbecausetaxationreducedthein-comestreamuponwhichthedeterminationofcompensationwasbased,andtheawardofcompensationwouldalsobetaxedasincome.102
CoryJ(laterajusticeoftheSupremeCourtofCanada),writingfortheDivi-sionalCourt,distinguishedthismatterfromearlierdecisionsconcerningtaxationinexpropriationawards,whichwerebasedonthe“valuetoownerapproach”asop-posedtothemodernapproachundertheExpropriationsAct.103HethenfoundthattheLandCompensationBoard’sconsiderationoftheafter-taxincomestreamwasinerrorandamountedtoadoublepenalty,andpossiblydoubletaxation.Inprovidinghisreasonsforthisdecision,CoryJstated:
Thecompensationdoesnomorethanreplacethoseprofitsandisthereforeincomeinthehandsof thecompany. If theestimatedtax isdeducted fromthecompensationawardandsuchnetamountpaidtothecompany,itstillmustpaytaxonthesumre-ceivedandisthussubjecttoadoublepenalty,ifnotdoubletaxation.Nomatterwheretheonusmaylietoestablishthatincometaxwouldbepayableinthiscase,itwouldappearthat theevidence isveryclear that thecompanywouldbetaxableuponthecompensationreceivedandwillindeedpaytaxontheamountreceived.104
TheDivisionalCourtheldthattheeffectoftaxationonanincomestreamoughtnottobeconsideredwhentheultimateproceedsofcompensationaretaxableinalikemanner.Asnotedinthepassageabove,adecisionmakerrequiresevidenceoftheul-timatetaxationofcompensationinordertosupportaconclusionofdoublepenalty.
Thedecisionof theBritishColumbiaCourtofAppeal in British Columbia v. MacMillan Bloedel Ltd.105distinguishedtheCity Parkingdecision.MacMillan Bloedelinvolvedasimilarissue,butinthiscase,theExpropriationCompensationBoarddidnothavebeforeitevidencethatthedeductionofincometaxwouldsubjecttheexpro-priatedownertoanincometaxpenalty.Accordingly,theCourtofAppealpermittedthedeductionoftaxfromtheincomestreamofthepropertyinthedeterminationofcompensation.106Thus,insituationswhereportionsofawardsforcompensationarenotsubjecttoincometax,107thebasisforthecourt’sholdinginCity Parkingmaybebroughtintoquestion.
102 Ibid.,at160.
103 See,forexample,Florence Realty Company Limited et al. v. The Queen,[1968]SCR42.Inthisdecision,theSupremeCourtofCanadadeterminedthatitisappropriatetodeductincometaxfromtheincomestreamformingthevaluetoanownerofanasset.Insupportofthisholding,SpenceJstated(ibid.,at52)thataprudentownerwouldcalculatethebenefitfromtheexpropriatedassetonthebasisofitsafter-taxcontributiontoprofit.
104 Supranote103,at163.
105 (1995),56LCR81(BCCA).
106 Ibid.,atparagraphs52-53.
107 See,forexample,Toronto Refiners and Smelters Limited,supranote84.
tax implications of expropriation n 891
Despitesuchdistinctions,theOntarioMunicipalBoardhasrecentlyacceptedthat“itwassettledinlawformorethan20yearsthatincometaxisnottobede-ductedfromawardsmadeundertheExpropriations Act.”108Itthereforeappearsthat,undertheOntarioExpropriationsActandinotherjurisdictionsthathavesimilarlegislation,nodeductioninrespectofincometaxesistobemadeinthedetermina-tionofanawardofcompensationwhentheawarditselfissubjecttotaxation.
Compensationawardedfollowinganexpropriationisnottobeincreasedinordertoreimbursetheownerfortaxesthattheownermustpayontheawardofcompensa-tion.109ItappearsthatthepolicybasisforthistreatmentisthattheActispresumedtotreatexpropriatedownersfairlyininstanceswheretheyreceivecompensationforcapitalproperty.
reimbur sement fo r tA x A dv ice
OneofthefundamentalpoliciesofcompensationunderOntario’sExpropriationsActistoensurethatanexpropriatedownerisleftwholeandisnotprejudicedasaresultofthepublicneedtoacquiretheowner’sproperty.110TheExpropriationsActendeavourstoachievethisgoalbyprovidingcompensationforallelementsofthelossarisingfromanexpropriation.111
Certainclaimshavebeenadvancedwhereownersseektherecoveryoftheircostsfortaxadvicepursuanttosection32oftheExpropriationsAct.Section32addressestherecoveryofreasonablelegal,appraisal,andothercostsfromtheexpropriatingauthorityincurredbytheowner“forthedeterminationofcompensation.”Accord-ingly,ininstanceswhererecoverywassoughtpursuanttosection32andthecostsincurred were not for the determination of compensation, expropriated ownershavebeenunsuccessfulinrecoveringthecostofanaccountant’sadviceontaxmat-ters,orcostsforthepreparationoftaxfilingsnecessitatedbytheexpropriation.112Intheeventthattaxadviceisrequiredprincipallyforthepurposeofadvancingaclaimforcompensation,thecostoftheadvicemayberecoverablepursuanttosec-tion32oftheExpropriationsAct.
Anowner’scostsfortaxadviceorthepreparationoftaxdocumentsappeartoberecoverableincaseswheretheownerisforcedtoincurout-of-pocketexpensesfortaxadviceasaresultofanexpropriation.Thisrecoverywouldbemadepursuanttosection13(2)(b)oftheExpropriationsAct(disturbancedamages)andsection18(1)
108 Gadzala v. Toronto (City)(2004),84LCR176,at238(OMB);aff ’d.inpart(2006),89LCR81(Ont.Div.Ct.),andspecificallyaffirmedontaxtreatment,ibid.,at115.
109 SeeHebron Investments Ltd. v. Scarborough Bd. of Ed.(1972),3LCR356(Ont.LCB);andLoukras et al. v. The Queen(1974),7LCR240,at273(FCTD).
110 Ontario,Royal Commission Inquiry into Civil Rights—Report,vol.3(Toronto:Queen’sPrinter,1968),11;andToronto Area Transit Operating Authority v. Dell Holdings Ltd.,[1997]1SCR32,at43.
111 ExpropriationsAct,supranote12,sections13,32,and33.
112 JeffreyJ.Wilker,“ReimbursementoftheClaimant’sCosts:Section32oftheExpropriationsAct,”paperpresentedatthe1997fallconferenceoftheOntarioExpropriationAssociation.
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(reasonablecoststhatarethenaturalandreasonableconsequenceoftheexpropria-tion).UndertheflexibleapproachtodamagesadvocatedinDell Holdings,section13(2)(b)andsection18arebroadenoughtoencompassanyreasonablelosstotheowneroccurringasaresultoftheexpropriation,providedthatcompensationforsuchlossisnototherwiseawardedundertheExpropriationsAct.113
Awardsfordisturbancedamageshaveincludedawardsforthepaymentofprofes-sionalfeesthatwereincurredasaconsequenceofanexpropriation.114Moreover,awardshavebeengivenforotherfeesthattheownerwasforcedtoincurasaresultof theexpropriation, suchas land transfer taxon thepurchaseof a replacementproperty.115Ifanownerisforcedtoincurout-of-pocketcostsrelatingtotaxadviceasaresultoftheexpropriation,thosecostswillconstitutedisturbancedamagesforwhichcompensationispayable.
Itisincumbentontheownertodemonstratethatthecostisreasonable,andthatitwasanaturalandreasonableconsequenceof theexpropriation.116 In instanceswherethecostoftaxadvicewouldhavebeenincurredatalaterdateandtheexpro-priationhasacceleratedtherequirementforthisexpense,theprovisionoffullcom-pensationforthetaxadviceremainsinquestion.Inthemajorityofcases,however,specifictaxadviceisrequiredfortheexpropriation,andthisexpensewouldconstitutecompensabledisturbancedamages.
co nclusio n
Asevidencedbythediscussionabove,theIncomeTaxAct,muchliketheExpropri-ationsAct,endeavourstoavoidpunishinganowner/taxpayersimplybecauseherpropertywasexpropriated.Anexpropriationshouldnotaccelerateanowner’staxburden,becauseitisaninvoluntaryevent.Animmediatetaxliabilitywouldonlyservetopunishanexpropriatedownerfortheacquisitionofherpropertyforthepublicgood.
Inordertoensurethatexpropriatedownersreceivefairtaxtreatment,theIncomeTaxActhasputinplaceprovisionstoallowthedeferraloftaxonawardsofcom-pensation, where certain condition are met. In addition, current expropriationslegislationandjurisprudencewilldeterminetheappropriatetaxationofanyproceedsreceived from an expropriating authority, whether as “income,” “capital,” or a“windfall.”Giventhecomplexityofthismatter,itisimportantforanownertodis-cussthetaximplicationsofanexpropriationwithaprofessionalwhoisfamiliarwiththeprovisionsoftheIncomeTaxActthatmayapplytoawardsofcompensation.
113 Dell Holdings,supranote110;andLafleche v. Ministry of Transportation and Communications(1975),8LCR77,at85(Ont.Div.Ct.).
114 See,forexample,Ridgeport Developments v. Metro-Toronto Conserv. Authority(1976),11LCR143,at156(Ont.LCB);andLiebovitch v. City of Vanier(1975),8LCR109,at111(Ont.LCB).
115 Gorczyca v. Ontario (MTC)(1988),41LCR39,at49(OMB).
116 Gerencer v. The Queen(1977),12LCR97,at111(FCTD);andEricC.E.Todd,The Law of Expropriation and Compensation in Canada,2ded.(Toronto:Carswell,1992),560.