CAE Inc. v. The Queen

CAE Inc. v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2011-08-12
Neutral citation
2011 TCC 354
File numbers
2008-1944(IT)G
Judges and Taxing Officers
Gaston Jorré
Subjects
Income Tax Act
Decision Content
Docket: 2008-1944(IT)G
BETWEEN:
CAE INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
Appeal heard on November 4, 5 and 6, 2009, at Montreal, Quebec,
and submissions as to costs heard by telephone conference
on July 14, 2011, at Ottawa, Ontario.
Before: The Honourable Justice Gaston Jorré
Appearances:
Counsel for the appellant:
Wilfrid Lefebvre, Q.C.
Dominic C. Belley
Counsel for the respondent
Martin Gentile
JUDGMENT
In accordance with the attached Reasons for Judgment, the appeal from the reassessments made under the Income Tax Act for the 2000, 2001 and 2002 taxation years is allowed and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the following basis:
(a) The profit realized on the sale of the A320 and A330/A340 simulators (used at the Toronto training centre) and the CL-65 and A330/A340 simulators (used by Air Canada) created income.
(b) The appellant was entitled to claim capital cost allowance in relation to the CL-65 and A330/A340 simulators (used by Air Canada), the A320 (Airbus) simulator, the Boeing 747‑400 simulator and the A320 simulator (initially built for US Airways).
Each party shall bear its costs.
Signed at Toronto, Ontario, this 12th day of August 2011.
"Gaston Jorré"
Jorré J.
Translation certified true
on this 28th day of October 2011.
Erich Klein, Revisor
PUBLIC VERSION
Citation: 2011 TCC 354
Date: 20110812
Docket: 2008-1944(IT)G
BETWEEN:
CAE INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
REASONS FOR JUDGMENT
Jorré J.
Introduction
[1] The appellant, CAE Inc., is the leading manufacturer of civil aviation flight simulators. It also provides flight training services.
[2] The appellant is also involved in other activities, such as manufacturing military simulators and providing military training services, but this case involves civil aviation simulators and training only.
[3] The appellant is appealing reassessments for the taxation years ended March 31, 2000, 2001 and 2002.
[4] The dispute pertains to seven simulators and five different situations.
[5] In some cases, the respondent disallowed capital cost allowance claimed by the appellant. In other cases, the appellant sold simulators and the respondent considered those sales as giving rise to business income, while the appellant considers the sales as giving rise to capital gains.
[6] The facts are not really in dispute.
[7] For the reasons set out below, I find that the appellant's position concerning the capital cost allowance is correct, but that the respondent's position concerning the nature of the sales is correct.
[8] The witnesses in these proceedings were as follows: Derek Burney, the appellant's former president; Alain Raquepas, CA, the appellant's chief financial officer; Sylvie Brossard, CA, a tax specialist and the appellant's tax director; and Ginette Phisel, CA, large business auditor with the Canada Revenue Agency. All the exhibits, including the transcripts of the examinations for discovery, were filed in evidence on mutual consent.[1]
The nature of the appellant's business and the evolution of its business model
[9] Flight simulators are large. They include a full flight deck, a visual system that generates very realistic images simulating what pilots would see from the flight deck, a motion system, the electronic equipment necessary for the simulation, and software. Flight simulators cost roughly $10 million to $20 million each.
[10] The realism of simulators enables airlines to reduce their costs because they can do a significant amount of their pilot training on a simulator. They can thus reduce the number of flight training hours aboard an aircraft. Moreover, simulators make it possible to simulate difficult flight conditions and equipment failures for training purposes.
[11] Simulators generally operate 20-22 hours a day, 365 days a year.
[12] In the past, the appellant sold flight simulators that were built to order.
[13] The civil aviation industry experiences significant cyclical highs and lows, so the simulator market is also very cyclical. The appellant built anywhere from a dozen or so to roughly 30 simulators per year.
[14] The appellant set out to do two things. One was to increase sales, which was very difficult because it was already the largest supplier of flight simulators for the civil aviation sector. The other was to achieve a more stable income stream.
[15] In order to achieve its objectives, the appellant[2] expanded its offering.
[16] The appellant broadened its use of its simulator design and construction expertise by offering a more complete range of services to its customers. In addition to simply selling simulators, it began to offer
(a) simulator leasing (full-time or hourly) with or without maintenance services, and
(b) complete flight training services with an instructor, in which case the appellant took care of maintenance.
[17] The appellant also created flight training centres.
[18] Since the costs of building simulators are very high, and simulators are specific to aircraft type, the appellant does not build simulators without having
(a) a purchaser, or
(b) a lease or training customer, an "anchor tenant",[3] who will lease the simulator for a sufficient number of hours or purchase a sufficient amount of training hours to justify building that particular simulator.
Transactions
Simulators for Canadair Regional Jet CL-65 and Airbus A330/A340[4] aircraft (Air Canada)
[19] Although there are differences between the facts concerning the CL-65 simulator and the facts concerning the A330/A340 simulator,[5] the differences are not important for the purposes of this case. Therefore, I will only discuss the situation involving the CL-65 simulator, noting, however certain differences pertaining to the A330/A340 simulator.
[20] In April 1997, the appellant and Air Canada signed a contract concerning a CL-65 simulator.[6] The essential elements of the contract were as follows:
(a) The appellant would build a CL-65 simulator that Air Canada could use.
(b) The simulator would be built, installed, tested and ready to use for training in July 1998.[7]
(c) The simulator would be located on the appellant's premises in Montreal.
(d) The appellant would maintain the simulator while it was located on its premises. If the simulator was moved elsewhere, Air Canada would have to maintain it. In either case, Air Canada was responsible for maintaining the avionics.
(e) The appellant would not provide the services of an instructor while the simulator was being used.
(f) Air Canada agreed to use the simulator for [CONFIDENTIAL] years ([CONFIDENTIAL] years in the case of the A330/A340 simulator) in consideration of (i) certain fixed monthly payments[8] and (ii) other payments that varied depending on the number of hours of simulator use.
(g) [CONFIDENTIAL][9]
(h) The [CONFIDENTIAL] –year term could be shortened by the appellant if its annual revenue was below a certain target; in such a case, the appellant could terminate the contract on 15 months' notice. The appellant also had the option to terminate the contract if Air Canada sold all or substantially all of its CL-65 aircraft.
(i) Third parties could use the simulator; if they did, the income from the third parties [CONFIDENTIAL]. [CONFIDENTIAL] would be split between the appellant and Air Canada, with certain adjustments.
(j) Air Canada would schedule the simulator use and undertook to make reasonable efforts to sell other airlines the simulator time that it was not using. The appellant could also sell simulator time not used by Air Canada, provided it made sure the hours of use were established jointly with Air Canada.
(k) [CONFIDENTIAL]
(l) There was a purchase option clause entitling Air Canada to purchase the simulator on three months' notice, subject to agreement between the parties on the terms, particularly with respect to price.[10]
[21] [CONFIDENTIAL]
[22] Air Canada began to use the simulator during the 1999 taxation year, and the appellant claimed capital cost allowance in computing its income for tax purposes.
Sale and leaseback contracts
[23] On December 22, 1999, the appellant signed five contracts concerning the CL‑65 simulator:[11] The first contract sold the simulator to the Bank of America Canada Leasing VIII Company ("Bank of America"). In the second, Bank of America leased the simulator to the appellant. The third was a contract between the appellant and Air Canada for the supply of services involving use of the simulator; this contract replaced the April 1997 contract with Air Canada. The fourth was between the appellant, Air Canada and Bank of America. The fifth, entitled "Participation Agreement 1999‑1", was between the appellant and Bank of America.
[24] These contracts clearly form a whole. The lease of the simulator to the appellant depended on it having been sold to the bank.
[25] The new contract with Air Canada contains the main elements of the first contract, though there are a few differences (such as the fact that the new contract states that the simulator is to be moved to the Air Canada training centre in Toronto). There is no change that is relevant to this matter.
[26] The lease contract with Bank of America provides for a lease term of [CONFIDENTIAL] years. According to the lease contract, the appellant must, at its expense,[12] make all necessary repairs and any changes or updates required by the country's laws.[13] The appellant must insure the simulator at its expense and is responsible for any risks[14] related to the simulator.
[27] At the end of the lease, the appellant must return a simulator [CONFIDENTIAL] to the bank.[15]
[28] The lease contract also states that the appellant guarantees the bank that the simulator will have a minimum residual value.[16]
[29] Further provisions of the lease contract enable the appellant to purchase the simulator before the expiry of the lease, notably if Air Canada wishes to exercise the purchase option granted in the contract for the supply of services, or on a fixed date that is approximately six months prior to the end of the contract for the supply of services entered into with Air Canada.[17]
[30] The contract contains financial terms and conditions governing each of the cases in which the appellant can terminate the lease before its expiry. Although those terms and conditions vary depending on the different termination clauses, the appellant must always [CONFIDENTIAL].
[31] From the appellant's standpoint, these sale and leaseback transactions are a financing method, a way to "monetize" the value of the simulators.[18]According to Mr. Raquepas, the result of the sale and leaseback is similar to the result that would have been achieved if there had been a loan and the appellant had given the simulator as security. In the course of the lease, the bank receives payments in excess of the purchase price and therefore receives a return on its investment, that is, imputed interest; the rent, including imputed interest, was similar to a repayment of loan principal plus interest.[19]
[32] Mr. Raquepas testified that the bank was not a customer; in his view, the profit from the simulators is derived from the lease to Air Canada, not the sale to Bank of America.[20]
The accounting treatment of these transactions
[33] Mr. Raquepas testified that, from an accounting standpoint, the transactions of December 22, 1999, were not recorded as a sale to a customer, but, rather, as a disposition of assets, because the company's auditors would not have permitted the company to "crystallize" the profit from the transactions during the year in which the transactions occurred.[21]
[34] The accounting treatment of these transactions was as follows: the gain on the disposition of each simulator to the bank — that is to say, the selling price to the bank minus the cost of the simulator — was treated as a "deferred gain." This gain [CONFIDENTIAL] is realized gradually as a reduction of rent paid during each year of the lease.[22] As for the balance of the gain [CONFIDENTIAL], this balance, minus any payment made under the [CONFIDENTIAL], will be realized at the end of the lease.[23]
[35] This is illustrated by the following example:
Selling price
$100
Less cost
($80)
Deferred gain
$20
[CONFIDENTIAL]
___
Gain over term of lease
$12
Gain realized at end of lease
$8 (less any payments pursuant to [CONFIDENTIAL])
In this example, part of the gain, $12, is realized over time as a reduction of the rent during the lease. The $8 balance [CONFIDENTIAL] will be included in the appellant's income at the end of the lease. [CONFIDENTIAL]
[36] With respect to the two simulators, there are two points in issue:
(a) Prior to the sale and leaseback arrangement with Bank of America, could the appellant claim capital cost allowance?
(b) Did the sale to Bank of America give rise to income or to a capital gain?
Airbus A320 and A330/A340 simulators (Toronto training centre)
[37] The appellant decided to open a flight training centre in Toronto and to build an A320 simulator and an A330/340 simulator for that centre. These two simulators were the first ones installed at the Toronto training centre. Their construction began on December 1, 2000, and September 4, 2000, respectively.
[38] The appellant had major customers (anchor tenants) for the A320 simulator (Skyservice Airlines and Canada 3000) and the A330/A340 simulator (Skyservice Airlines) (contract dated September 29, 2000, with Skyservice, and contract dated December 6, 2000, with Canada 3000).[24]Each of these airlines undertook to lease the simulator for at least a certain number of hours per year. In both cases, the appellant performed the maintenance but did not provide an instructor.
[39] The guaranteed minimum number of rental hours per simulator in the case of Skyservice Airlines was less than half the rental hours contemplated [CONFIDENTIAL] in the aforementioned two contracts with Air Canada. However, upon reading the contract, one can see that there is an expectation that the use will exceed these guaranteed hours because, for one thing, the customer, Skyservice, agrees to do all of its training for A320 and A330/A340 aircraft on the appellant's simulators, subject to certain conditions, and for another, the appellant reserves the right to cancel the contract if, during each of the first three years of the contract, the customer does not increase the number of crews undergoing Airbus training by [CONFIDENTIAL] crews per year.[25] In the case of the contract with Canada 3000, the evidence does not reveal the details.[26]
[40] The term of the contract with Skyservice is three years.[27] The term of the contract with Canada 3000 is six years.[28]
[41] Both contracts provide that the lease will begin before the two simulators in question for the Toronto training centre are built, installed and certified. Consequently, the lease began with the appellant’s simulators in Montreal,[29] and continued in Toronto once the Toronto training centre and its simulators were operational.
[42] As it did with the two aforementioned simulators for Air Canada, the appellant decided to “monetize” the two simulators built for the Toronto training centre. Consequently, sale and leaseback contracts for these two simulators were entered into between the BAL Simulator Leasing 2001 Company (another Bank of America subsidiary) and the appellant.
[43] These sales and leasebacks took place when the simulators became operational (late September 2001) but before the appellant used them. The simulators always remained in the appellant's possession. The essential terms and conditions of these contracts are very similar to the essential terms and conditions of the sale and leaseback agreements involving the aforementioned simulators used by Air Canada.[30] The duration of the leaseback by the appellant from the bank is [CONFIDENTIAL] years.
[44] For accounting purposes, these two sale and leaseback arrangements were treated the same way as those involving the two simulators subleased to Air Canada discussed above.
[45] The issue concerning the simulators being presently considered is whether the sale to BAL gave rise to income or to a capital gain.
Airbus A320 simulator [CONFIDENTIAL]
[46] In June 1997, the appellant and Airbus Industrie signed an agreement. Under the agreement, the appellant was to build and install, on Airbus's premises in Toulouse, an A320 simulator that would be operational on June 30, 1998. [CONFIDENTIAL].[31]
[47] The agreement provided that, after the [CONFIDENTIAL] -year period, Airbus could either lease the simulator and pay on that basis, or purchase it. Fixed prices were provided for should Airbus exercise either of these options. In addition, the agreement provided for the possibility of leasing or purchasing after the third year, at fixed prices.
[48] [CONFIDENTIAL].[32]
[49] [CONFIDENTIAL].[33]
[50] Airbus exercised the option to lease, and rented the simulator for one year following the loan period. At the end of the lease, the simulator was not used for a while. It was sold to Khalifa Airways in 2003, which is beyond the period relevant to this litigation.
[51] The issue with respect to this simulator is whether the appellant was entitled to claim capital cost allowance.
Airbus A320 simulator (built for US Airways)
[52] US Airways ordered an A320 simulator and cancelled its order in June 2000.[34] The appellant had completed nearly 60% of the simulator's construction, and decided to finish it. The simulator became operational around November 2000.[35]
[53] [CONFIDENTIAL].[36]
[54] The simulator was then used for training purposes on the appellant's premises in Montreal. Apparently, under the contracts discussed above, Skyservice and Canada 3000 were the first users of this simulator, or among the first. It is not certain how the simulator was used from December 2001 to June 2002.[37]
[55] In August 2001, the appellant signed a five-year lease of the simulator with Frontier Airlines, commencing on the simulator's anticipated commissioning date in Denver, Colorado.[38] That date was June 30, 2002.[39]
[56] Under the agreement, the appellant would not provide any instructors and, subject to certain exceptions, Frontier agreed to do all its A320 training on this simulator located in Denver, though it did not guarantee a minimum number of hours. The agreement offered Frontier two choices: it could (i) lease by the hour; or (ii) have "exclusive" use of the simulator for a fixed annual price.[40]
[57] The agreement could be terminated under certain circumstances, notably if Frontier used less than a specified number of hours annually.
[58] If Frontier made choice (ii), but was not using all the simulator hours, the appellant retained the right to sell the unused hours to other airlines, in which case the revenues would be shared.
[59] Civil Aviation Training Services (CATS) is a Denver-based subsidiary of the appellant that operated a flight training centre.
[60] In September 2002, the appellant sold the simulator to CATS. The simulator became operational in Denver on October 5, 2002.[41]
[61] The issue is whether the simulator was depreciable.
Boeing 747-400 simulator
[62] In April 1997, the appellant purchased a Boeing 747-400 simulator from Singapore Airways. The simulator was to be delivered to the appellant in Singapore within 90 days.[42] The appellant spent more than $1,000,000 to renovate and update this simulator, which it had originally built, and to get it recertified.
[63] At the time of the purchase, the appellant had United Airlines in mind as a customer for the simulator, but the appellant and United only signed an agreement in March 1999.[43] At the time of signing, the simulator had already been delivered to the premises of United in Denver.[44]
[64] The agreement provided
(a) that United
- would use the equipment to train pilots,
- would maintain the simulator,
- would be the simulator's operator,
- would make reasonable efforts to sell and market training services using the simulator,
- would have the option to purchase the simulator in accordance with a predetermined price calculation method, and
- [CONFIDENTIAL];
(b) that unless United exercised the purchase option,
- either party could terminate the agreement after 15 months, on six months' notice,
- either party could terminate the agreement after 15 months, on 30 days' notice, if the use of the simulator was below a certain minimum;
(c) that the revenues would be shared between United and the appellant (the percentage of revenues attributed to each party would be calculated using a scale in which the percentage attributed to United increased as certain thresholds were exceeded);
(d) that United had to insure the simulator and the parts, while the appellant had to obtain liability insurance; and
(e) that unless United purchased the simulator, the appellant would remain its owner.
[65] After just over two years, United terminated the agreement, after which the simulator was transferred to the appellant's training centre in Toronto.[45]
[66] The issue is whether the Boeing 747-400 simulator was depreciable.
Analysis[46]
General considerations[47]
Nature of the business
[67] It is important to bear in mind the nature of the appellant's business in the field of civil aviation.
[68] The appellant creates simulators. It also provides flight training services. Drawing on its employees' knowledge and exploiting intellectual property rights, it designs, builds, verifies and installs civil aviation flight simulators using its employees' labour and purchased parts and materials. After building the simulators, it turns them to account by selling them, leasing them out, or using them to sell flight training services.
[69] The appellant built roughly 12 to 30 simulators per year.
[70] The evidence shows a great deal of flexibility with regard to clients; this is reflected in the many options available to satisfy their needs for simulators, simulator time, or training. In addition, the appellant's contracts and its actions show flexibility in terms of the possibilities in relation to a given simulator.[48]
[71] There is a single civil aviation simulator business. The evidence does not establish the existence of a distinct simulator leasing or training business.
The word "capital" can have various meanings
[72] It is helpful to point out that the word "capital" can have different meanings. For example, a capital expenditure might be made to acquire property that will procure benefits over several fiscal years; in this sense, it is the opposite of a current expenditure. In some cases, a capital expenditure in this sense results in the acquisition of "depreciable property" within the meaning of the Income Tax Act (the Act).[49]
[73] The term "capital expenditure" can also be mean an expenditure for the purpose of acquiring property the disposition of which would give rise to a capital gain or loss for the taxpayer.[50]
[74] Would a capital expenditure in the first sense of the term automatically be a capital expenditure in the second sense? In other words, does a capital expenditure in the first sense necessarily result in the acquisition of property which, if sold, will give rise to a capital gain or capital loss? We will come back to this question.
Difficulties in distinguishing between a capital gain and income in certain cases
[75] It is also worth noting that it is often difficult to determine whether the sale of certain property produces income or a capital gain.
[76] In some cases, the distinction is easy to make. The classic example is the distinction between a fruit tree and the fruit it produces. A farmer who buys an orchard and sells the fruit from its trees receives income from the fruit. Upon selling the orchard when he retires 40 years later, he is clearly realizing a capital gain.
[77] However, things can get complicated very quickly. If a person purchases the orchard with the intention of reselling it at a profit because the person believes that a builder will purchase it for a new suburban residential development, but the person is happy to receive in the meantime the income from the sale of the fruit, the proceeds of the sale are not a capital gain, but income, because there was at least a secondary intention to resell. One might also call this a dual intention.
[78] In the instant case, the situation is even more complicated because the appellant "created" the simulators.
[79] At the moment that a simulator is ready to be used, the difference between the fair market value of the simulator and its cost (all costs, namely salaries, materials, parts, depreciation, etc.) — that is to say, the value created — is a product of the efforts made by the appellant and by its business. This created value is not merely a change in the value of an investment.
[80] Consequently, getting back to the fruit tree analogy, what is the nature of a tree that has been created by its owner, whose calling is to plant and grow trees (i.e. to be a "tree creator") and to sell the trees (or the orchard) when they have grown sufficiently to bear fruit? The tree is the fruit of the owner's work. Obviously, if the tree is simply sold, it is part of inventory,[51] and the sale is income.
[81] Similarly, the building and then selling of a simulator produces income.
[82] But what if this "tree creator" (or, here, creator of simulators) leases out or uses one of the trees (or simulators) and sells it later? We will come back to this.
[83] The question whether depreciable machines or equipment used by a business give rise to a capital gain or to income upon their disposition is of limited importance if they are sold at a price lower than their cost.[52] In such a case, the Act's provisions concerning recapture and terminal loss[53] will render any loss or recapture completely deductible or taxable, even if the sale, in the absence of those provisions, gives rise to a capital gain or loss.
[84] However, if the machine or equipment is sold for more than its cost, the distinction is of major importance.
[85] It is surprising that the question whether the sale of depreciable property gives rise to income or a capital gain has not come up more often in the case law. Perhaps the scarcity of case law reflects the fact that the owner of depreciable property is rarely able to sell it for an amount that exceeds its cost.
[86] I will come back, further on, to the issue of whether the sale of depreciable property can give rise to income.
The sales
[87] I will analyze the nature of the gain from the disposition of the simulators in two stages:
(a) If the simulators had been sold to an airline or a flying school unconnected with the appellant, what would the nature of the gain have been?
(b) Does a sale to a financial institution alter that nature?
If the sales had been made to an airline
[88] One approach is to examine the appellant's use of the property and the nature of the revenues generated by that use. One must also consider the four criteria from Friesen v. Canada:[54]
17 IT-218R, which replaced IT-218 in 1986, lists a number of factors which have been used by the courts to determine whether a transaction involving real estate is an adventure in the nature of trade creating business income or a capital transaction involving the sale of an investment. Particular attention is paid to:
(i) The taxpayer's intention with respect to the real estate at the time of purchase and the feasibility of that intention and the extent to which it was carried out. An intention to sell the property for a profit will make it more likely to be characterized as an adventure in the nature of trade.
(ii) The nature of the business, profession, calling or trade of the taxpayer and associates. The more closely a taxpayer's business or occupation is related to real estate transactions, the more likely it is that the income will be considered business income rather than capital gain.
(iii) The nature of the property and the use made of it by the taxpayer.
(iv) The extent to which borrowed money was used to finance the transaction and the length of time that the real estate was held by the taxpayer. Transactions involving borrowed money and rapid resale are more likely to be adventures in the nature of trade.
[89] If, after using this approach, one concludes that the primary object of the transaction does not constitute an adventure in the nature of a trade, then the following question must be asked: Was there also a secondary intention to sell, or a dual intention? In this approach, one must bear in mind that in order for there to be a secondary intention, it is not sufficient that the business be prepared, if offered a high enough price, to sell what it intended to keep for its own use.[55]
[90] Although the criteria in Friesen are articulated in the context of real estate transactions, they are, subject to the necessary adjustments, generally accepted. However, it must be borne in mind that they do not constitute a complete list of potentially relevant factors.
[91] It is important to note that these criteria are for determining whether there is an "adventure or concern in the nature of a trade", this being an addition to the concept of business.[56]
[92] The other approach, as I understand it, places more emphasis on the nature of the business and the question whether the transaction is integral to the operation of the business. The decision of the House of Lords in Gloucester Railway Carriage and Wagon Co., Ltd. v. Commissioners of Inland Revenue [57] is at the heart of this approach.
[93] Another way to describe this second approach is that it is one which determines that a "business" exist without resorting to the concept of "adventure or concern in the nature of a trade."
[94] Before examining Gloucester, it would be helpful to recall the decision in California Copper Syndicate v. Harris,[58] which the House of Lords followed in Commissioner of Taxes v. The Melbourne Trust Ltd.,[59] a decision which was, in turn, followed by the Supreme Court of Canada in Anderson Logging Co. v. The King,[60] where that court stated:
The principle of these decisions can best be stated for our present purpose in the language of Lord Dunedin in his judgment delivered on behalf of the Judicial Committee, in Commissioner of Taxes v. The Melbourne Trust, Ltd.,
It is common ground that a company, if a trading company and making profit, is assessable to income tax for that profit. *** The principle is correctly stated in the Scottish case quoted, California Copper Syndicate v. Harris. It is quite a well settled principle in dealing with questions of income tax that where the owner of an ordinary investment chooses to realize it, and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit in the sense of schedule D of the Income Tax Act of 1842 assessable to income tax. But it is equally well established that enhanced values obtained from realization or conversion of securities may be so assessable where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business;
or, in the language of the judgment from which this quotation is made, which follows in sequence after the passage cited:
What is the line which separates the two classes of cases may be difficult to define and each case must be considered according to its facts; the question to be determined being — Is the sum of gain that has been made a mere enhancement of value by realizing a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?
or, in the form adopted by Sankey J. — in Beynon v. Ogg — from the argument of the Attorney General — was the profit in question
a profit made in the operation of the appellant company’s business?[61]
[Emphasis added.]
[95] The decision in Gloucester was cited in Anderson.[62] Gloucester Railway Carriage and Wagon Co. built, sold and leased railway wagons, and purchased wagons built by others. Gloucester was followed by Thorson P. of the Exchequer Court in Canadian Kodak Sales Ltd. v. M.N.R.,[63] where he summarized Gloucester as follows:
Moreover, I am unable to distinguish this case in principle from the case of Gloucester Railway Carriage and Wagon Co. v. Inland Revenue Commissioners, (1925) A.C. 467 and 12 T.C. 720. In that case the Company was formed to manufacture, buy, sell, hire and let on hire wagons and other rolling stock, and for many years it manufactured railway wagons, either selling them outright or on the hire-purchase system or letting them on simple hire. In the books of the Company the wagons built to be let on hire were capitalized at a sum which included an amount added as profit on manufacture, and year by year an amount was written off the value of the wagons for depreciation. In 1920 the Company decided to cease letting wagons on hire and to sell them. It then sold the entire stock of wagons used in that branch of its business for a sum in excess of the value of the wagons in the Company's books. The surplus was included in an assessment to corporation profits tax on the Company in respect of the profits of its business, and the Company appealed contending that the surplus arose from the realization of capital assets used in its hiring business. The Special Commissioners disagreed with the contention of the Company that the profit on the sales was an accretion of capital. They found as follows, at page 734 of 12 T.C.:
We are unable to take this view. In our opinion we must have regard to the main object of the Company which is to make a profit in one way or another out of making wagons and rolling stock. We are unable to draw the very sharp line which we are asked to draw between wagons sold, wagons let on hire purchase and wagons let on simple hire, nor do we consider that this very sharp division in fact exists. We do not regard ourselves as precluded by the fact that as long as the wagons were let they were treated as "plant and machinery" subject to wear and tear, from deciding that they are stock in trade when they are sold, even though let under tenancy agreements, for they seem to us to have in fact the one or the other aspect according as they are regarded from the point of view of the users or the Company. In our view, shortly, it makes no difference that one way of making profit out of the wagons was given up, for the very giving up itself involved the making of a profit in another way out of the same wagons, and the purpose of the Company's trade is to make a profit out of wagons.
The decision of the Commissioners was affirmed by Rowlatt J. of the King's Bench Division. An appeal from his decision to the Court of Appeal was dismissed, Pollock M.R. dissenting. The judgment of the majority of the Court was clearly to the effect that the profit made by the Company was profit arising from the business. On an appeal being taken to the House of Lords it was unanimously dismissed. I need quote only the last paragraph of Lord Dunedin's speech, reported at page 474 of (1925) A.C.:
The appellants argue that this is really a capital increment; and to say so they call these wagons plant of the hiring business. I am of the opinion that in calling them plant they really beg the whole question. The Commissioners have found -- and I think it is the fact -- that there was here one business. A wagon is none the less sold as an incident of the business of buying and selling because in the meantime before sold it has been utilized by being hired out. There is no similarity whatever between these wagons and plant in the proper sense, e.g. machinery, or between them and investments the sale of which plant or investments at a price greater than that at which they had been acquired would be a capital increment and not an item of income. I think that the appeal fails.
The principles applied in the Gloucester Railway Carriage and Wagon Company case (supra) are applicable in this one. Counsel for the appellant sought to distinguish it from the present case on several grounds one of which was that in the case cited there was only one business whereas in the appellant's case there had always been a sharp separation between its Recordak Division and its other business so that the former was really a separate business, but the fact is that in each case there was only one business. The appellant's Recordak Division was not a separate business. The manner in which the appellant kept its accounts proves this beyond dispute. Moreover, just as in the case cited the Commissioners did not regard themselves as precluded by the fact that as long as the wagons were let they were treated as plant and machinery from deciding that they were stock in trade when they were sold, and Lord Dunedin considered that "a wagon is none the less sold as an incident of the business of buying and selling because in the meantime before sold it has been utilized by being hired out", so the fact that the appellant's recordaks were formerly leased and treated as capital assets subject to depreciation does not prevent the profit from their sale being profit from the appellant's business once it had made the business decision to sell them and sold them in the course of its ordinary business of selling photographic equipment and supplies. It was in exactly the same position in which it would have been in if it had acquired the recordaks for resale. There was nothing of a capital nature in the sale of its recordaks and it is fanciful to say that they were realizations of investments. There was no difference in principle between its sales of recordaks and its sales of other photographic equipment. They were all sales in the course of the appellant's business.[64]
[96] Gloucester Railway Carriage and Wagon Co. was a firm that manufactured railway wagons that it sold or leased. Sometimes it purchased wagons made by others and then leased them or, less frequently, resold them right away.[65]
[97] The decision in Gloucester[66] applies to the case at bar. There, as here, a manufacturer sold and leased its products. There, as here, there is only one business. The appellant does not have a separate leasing business. Having a separate leasing business would in fact be contrary to its strategy of offering a full range of options to airlines, with a great deal of flexibility as to options for each customer. The activities involved are at the very heart of the appellant's business.[67]
[98] The fundamental principle on which Gloucester is based is this: A profit constitutes income if it is derived from systematic efforts rather than from a mere investment. This principle is clearly expressed by Justice Noël in Dansereau v. Canada:[68]
12 A line must be drawn under the Act between a mere investment in property and an activity or activities that constitute a business. The expansive definition of the term "business" in section 248 is not exhaustive. It extends to any endeavour that occupies time, labour and attention with a view to profit. To the extent that income is derived from human activity rather than from the passive ownership of property, its source can be properly described as business. The distinction must be made in light of the facts and circumstances surrounding each particular case (compare The Queen v. Rockmore Investments Ltd., 76 D.T.C. 6156, per Jackett C.J. at 6157).[69]
[99] Consequently, if there were sales to airlines, the profit from those sales of the A320 and A330/A340 simulators (used at the Toront