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canadian tax journal / revue fiscale canadienne (2008) vol. 56, n o 4, 870 - 92 870 Tax Implications of Expropriation Adam Scherer and Shane Rayman* Précis 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. AbstrAct 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 * Adam Scherer is of Soberman LLP, Toronto. Shane Rayman is of Rueter Scargall Bennett LLP, Toronto. The authors wish to thank Stacie Scherer, of Pass It On Communications, Toronto, for editorial assistance, and Dorete Astroff and Adam Rubinoff of Soberman LLP, for their insightful comments during the development of this article. contents Introduction 871 Policy 872 Application of Policy 872 Entitlement to Proceeds of Disposition 873 Requirements for Expropriations or Involuntary Dispositions 874 Disposition of the Former Property 875

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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.

872 n canadian tax journal / revue fiscale canadienne (2008) vol. 56, no 4

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).

874 n canadian tax journal / revue fiscale canadienne (2008) vol. 56, no 4

(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.

876 n canadian tax journal / revue fiscale canadienne (2008) vol. 56, no 4

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).

878 n canadian tax journal / revue fiscale canadienne (2008) vol. 56, no 4

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).

880 n canadian tax journal / revue fiscale canadienne (2008) vol. 56, no 4

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.).

890 n canadian tax journal / revue fiscale canadienne (2008) vol. 56, no 4

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.