Where a business carries on several different types of work, it is important to ensure that those activities are segregated and that detailed records are kept in the event of a dispute with the Canada Revenue Agency (the "CRA"). One particularly difficult area of potential disagreement with the CRA is where a business uses equipment or property in its own business operations (capital assets) but also sells equipment or property (inventory). Since the sale of inventory is taxed on account of income as business income and the sale of capital assets is taxed as a capital gain, there can be additional tax owing if the CRA treats a sale of equipment or property as a sale of inventory rather than a sale of capital assets.
It can sometimes be difficult to distinguish whether a sale is on account of income or capital, which issue was central in the recent case of Klemen v The Queen, 2014 TCC 244. In that case, the taxpayer owned several companies which conducted various functions. Some of those functions included buying and selling oilfield equipment, cleaning up oil spills and tearing down plants. The taxpayer sold some of that oilfield equipment. The taxpayer declared the gain on the sale as a capital gain, claiming he used the equipment in his cleanup/demolition operations. The Minister took the opposite position, claiming that the transfer was on account of inventory and therefore constituted business income.
The Court examined the following criteria to determine whether the transfer was on account of capital or income:
- the nature of the property sold;
- the length of period of ownership;
- the frequency or number of other similar transactions by the taxpayer;
- work expended on or in connection with the property realized;
- the circumstances that were responsible for the sale of the property;
- motive;
- the intention of the parties;
- whether the conduct of the vendor was similar to that of an ordinary trader;
- the nature and quantity of the property in question;
- whether the transactions were isolated ones; and
- the uniqueness of the transactions when compared to the taxpayer’s normal activities.
After looking at all the contextual facts, the Court held in favour of the taxpayer based on evidence that included the following:
- the equipment was used in his various operations over a very long period of time;
- the type of equipment in question was never sold in previous taxation years;
- the appellant had not modified or altered the equipment for the purpose of realizing higher value;
- the appellant sold the equipment in response to a strong and unexpected upswing in the oil industry.
Accordingly, the Court determined that the taxpayer held the equipment as capital property and therefore that the amounts received were not business income.
The moral of this story is that tax litigation can result where a business and the CRA disagree on whether a sale constitutes income or capital gain. If you don’t have detailed records, you might not be able to prove your case. This is especially so where a business uses equipment or property in its own operations and also sells equipment or property.
If you buy equipment or property as a capital asset, it may be very valuable to keep a record and good notes as to the purpose of your purchase, the details and plans for the use of that property or equipment (for example preparing a written business plan or profit projections for the equipment or property purchased) and written notes and communications that set out the circumstances that led up to the decision to sell. We can help you to prepare records which retain critical evidence. This will help minimize the risk of a dispute with the CRA and minimize the cost of dealing with the CRA and maximizing your chances of a successful outcome.
Wesley can be contacted at 250-869-1226 or forgione@pushormitchell.com
