http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/100175/index.do 
568864 B.C. Ltd. v. The Queen (December 29, 2014 – 2014 TCC 373, Rip J.).
Précis: The taxpayer sought to deduct a terminal loss of roughly $3.9 million on the disposition of patents in 2007. The taxpayer was part of a corporate group that derived the bulk of its income from the sale of exterior trim boards for new residential construction; sometimes called fascia boards or gutter boards. In the course of its business it ran across an unrelated corporation, Interact Wood Products Ltd. (“Interact”), which had developed and patented a technology that permitted the production of boards that were very valuable in the taxpayer’s business. It developed a relationship with Interact and, in 2003 it extended a loan of $3,500,000 to Interact. Included in the security for the loan were patents and patent applications owned by Interact’s principal shareholder, Mr. Cable (the “Patents”). In 2005 both Interact and Mr. Cable declared bankruptcy. Late in 2005 the intellectual property of Mr. Cable was transferred to the appellant by his trustee in bankruptcy subject to some pending litigation. A downturn in the construction industry resulted in the taxpayer disposing of the Patents in 2007 for $1.00. The Crown took the position that the taxpayer did not acquire beneficial ownership of the Patents until 2010 when the Trustee transferred legal title to it. The Crown also argued that the Patents were not available for use in 2007. Finally the Crown argued that the taxpayer did not acquire the Patents for the purpose of gaining or producing income since no business was being carried on at that time with the intellectual property. The Court rejected all three arguments and allowed the appeal with costs.
Decision: This is a decision involving the taxpayer’s claim to a terminal loss of $3,871,057 on the disposition of patents in 2007 for $1.00.
[1] 568864 B.C. Ltd. (“568″), the appellant, claims that in 2005 it acquired patents, a Class 14 asset, in a bankruptcy proceeding for $3,500,000 and when it sold the patents in 2007, the year in appeal, for $1.00, it incurred a terminal loss in accordance with subsection 20(16) of the
Income Tax Act (“Act”). The Crown disagrees. According to the Crown the appellant did not acquire the patents in 2005 and if it did, it did not acquire the patents for the purpose of earning income and therefore the patents were not depreciable property [paragraph 1102(1)(c) of the
Income Tax Regulations (“Regulations”)] and the appellant is not entitled to a terminal loss. The respondent assessed the appellant for 2007 on the basis the appellant disposed of a non‑depreciable capital asset which gave rise to a capital loss. An Order of the Court dated, May 16, 2014, permitted the respondent to file an Amended Amended Reply to the Notice of Appeal — three weeks before trial — to withdraw the Minister of National Revenue’s assumption that the sale of the patents occurred in 2007; the respondent’s new position was that beneficial title and interest in the patents were acquired by the appellant in 2010.
[2] For a taxpayer to deduct an amount as a terminal loss, the taxpayer must have incurred a capital cost in acquiring beneficial ownership of depreciable property of a prescribed class. In the matter at bar the appellant’s position is that the patents originally were security for a loan of $3,500,000 and on the loan becoming bad, it was assigned beneficial ownership of the patents: subsections 79.1(2) and 79.1(6) of the Act.
[3] There are two primary questions I have to answer in this appeal:
1) Did the appellant acquire beneficial ownership of the patents before September 2007, when it claims it sold the patents? If the answer is “no”, then the appeal must be dismissed;
2) If the answer to question 1 is “yes”, then I must decide if the appellant acquired the patents for the purpose of earning income from a business or property.
[Footnotes omitted]
The taxpayer was part of a corporate group that derived the bulk of its income from the sale of exterior trim boards for new residential construction; sometimes called fascia boards or gutter boards. In the course of its business it ran across an unrelated corporation, Interact, which had developed and patented a technology that permitted the production of boards that were very valuable in the taxpayer’s business. It developed a relationship with Interact and, in 2003 it extended a loan of $3,500,000 to Interact. Included in the security for the loan were patents and patent applications owned by Interact’s principal shareholder, Mr. Cable. In 2005 both Interact and Mr. Cable declared bankruptcy. Late in 2005 the intellectual property of Mr. Cable was transferred to the appellant by his trustee in bankruptcy subject to some pending litigation (the “Melchior” appeal which was subsequently resolved successfully for the Trustee):
[56] On November 23, 2005 the Inspectors in Mr. Cable’s bankrupcty resolved to and did release the intellectual property, the Family 1 Patents, to the appellant (and CVM Holdings Ltd.) “subject to ultimate accounting for the proceeds of disposition”. The Inspectors also discussed the Melchior appeal. Mr. Young [the principal shareholder of the corporate group controlling the taxpayer] testified that the purpose of the meeting of Inspectors was to have the appellant “get a hold of the IP, it was the rightful owner”. It is on the release of the Patents to the appellant that this appeal turns.
[57] The phrase “subject to an ultimate accounting for the proceeds of disposition” was subject to heated discussion between counsel, the respondent’s counsel arguing that these words nullified any claim by the appellant that it became beneficial owner of the Patents on November 23. Mr. Pallen testified he incorporated the phrase as part of the resolution because he was “trying to be pretty conservative”, that if Mr. Young could find “somebody in Dubai” willing to cover all Mr. Young’s costs, interest “and amounts up the road, I would like to get something to come back to the unsecured creditors” but he doubted this would happen. He had concluded that the “solid wood sector was in a long downturn, with very little capital investment going on in any market”, including Europe and Asia. Mr. Pallen explained that the appellant was a secured creditor for $3,500,000. PWC “could not see a situation developing where that [the] intellectual property could result in a greater realization than … [$3,500,000] …”. Mr. Pallen also believed that “there was a big well to keep throwing money into on this”. In his view the “[Melchior] trial was out of control”, taking 16 days. “Jobs [in the mills] were gone at that point.” The appellant had been funding the estate to deal with the Patents, he added. PWC (as Trustee) no longer had an economic interest in the intellectual property and there was no return to the unsecured creditors. The Trustee, he said, was devoting a lot of time and expense.
A downturn in the construction industry resulted in the taxpayer disposing of the Patents in 2007 for $1.00:
[73] Mr. Young’s view was that, notwithstanding the money 568 spent to obtain the Patents, purchase the Interact equipment and defend its interests in the Patents against Ms. Melchior and the time and sundry expenses Woodtone devoted to the project, conditions in 2007 did not warrant further time or money in the project. It was apparent 568 could not build a new plant itself or in a joint venture to manufacture engineered wood applying the Patent acquired from Mr. Cable that would be profitable. Things were not going to improve, Mr. Young concluded.
[74] Therefore, by Agreement “made with effect from September 30, 2007″ the appellant 568 sold to Young Financial Ltd., a corporation owned by Christopher Young, Mr. Young’s son, the beneficial interest in the intellectual property described in Schedule “A” of the Security Agreement by Mr. Cable securing the appellant’s loan to Interact, that is the Patents in Family 1, for one dollar, “the best estimate of the market value of the Property presently available” according to the Agreement.
…
[75] Three years later, by agreement dated August 24, 2010 (“Legal Transfer Agreement”), PWC, as Trustee of the Estate of Mr. Cable, sold, assigned, and transferred to 568 Mr. Cable’s entire “right and title to and the interest in” the Family 1 Patents for a “wood‑gluing and clamping system” and applications, the right to apply for patents on the invention in all countries in the name of the assignee or its successors or assignees. The appellant reduced its secured claim by $1,000,000 in consideration of the assignment of legal title.
[Footnote omitted]
The Crown took the position that the taxpayer did not acquire beneficial ownership of the Patents until 2010 when the Trustee transferred legal title. The Court did not accept this interpretation:
[93] The respondent submits that the appellant did not obtain beneficial ownership of the Patents in 2005, that beneficial ownership was assigned to the appellant when legal ownership was transferred to it in 2010. The phrase “subject to an ultimate accounting for the proceeds of disposition” in the resolution of Inspectors transferring the Patents to the appellant restricted the appellant’s right to real or beneficial ownership of the Patents. The appellant only obtained a security interest in the Patents in 2005. The appellant had to account to the Trustee for any proceeds of sale in the Patents in excess of $3,500,000. An equity of redemption, argued respondent’s counsel, belonged to the Trustee notwithstanding the purported release of the Patents to the appellant.
[94] Respondent’s counsel referred to the assignment of legal title in the Patents to the appellant in 2010, that what was being assigned was the “entire right and title to and interest in” the Patents and that this included both legal and beneficial ownership.
[95] Mr. Pallen, who testified as the Trustee in Bankruptcy representative, said that in November 2005, PWC intended to transfer beneficial title to the Patents to the appellant and the appellant intended to acquire such title. This is absolutely clear from the evidence of Messrs. Pallen and Young and was how they conducted themselves once PWC assigned the rights to the Patents to the appellant. The appellant had absolute use enjoyment and possession of the Patents. The appellant possessed physical patent documents and it had the right to exploit the processes protected by the Patents. Mr. Pallen confirmed to the patent agent that the appellant, through Mr. Young, was the person who henceforth would be instructing him. The appellant assumed all risk associated with the Patents. The appellant assumed the owner’s risk, for example, being the costs of ownership and was responsible for defending its Patent ownership rights against the claims of Mr. Cable’s wife. The Trustee did not interfere with the appellant’s use and enjoyment of the Patents. In short, November 23, 2005 the appellant gained all the incidents of beneficial title: possession, use and risk. It had the rightful claim to the Patents and was the only person who could deal effectively with the Patents as owner. By 2007 the appellant also had purchased the equipment capable of utilizing the Patents and in 2007 had defeated Ms. Melchior’s claim to the Patents. The appellant was the beneficial owner of the Patents and, like any other beneficial owner, had the right to sell the Patents to Young Financial in 2007.
[Footnotes omitted]
The Crown also took the position that the Patents were not available for use by the taxpayer in 2007. The Court also rejected this argument:
[98] The appellant exercised the attributes of a true owner, acquired equipment to manufacture the wood using the Patents, moved the equipment for safe keeping at its cost and, among other things, paid to protect its ownership of the Patents. The appellant acquired sufficient interest in the Patents and indicia of title, beneficial title thereto that it became depreciable property in its hands. That it did not own the equipment to exploit the Patents in 2005 is not significant, since the appellant could have licensed the Patents to others who could have acquired the equipment. It, therefore, had use of the Patents as early in 2005 in acquisition or as late as 2007 when it had acquired the equipment and defeated Ms. Melchior’s claims.
The Court next rejected the Crown’s position that the taxpayer had not acquired the Patents for the purpose of gaining or producing income since no business was being carried on at that time with the intellectual property:
[103] Once Interact and Mr. Cable became bankrupt the appellant’s goal had not changed: it still wanted to exploit the use of the Patents for profit. The lengthy evidence describes efforts made by Mr. Young to try to cause Interact to improve its business so that it could sell product to W.I. When this failed and Interact became a bankrupt, his efforts − and those of the appellant − were in trying to make use of the Patents by the appellant or a Woodtone company through a joint venture or partnership with others, charging a royalty for use of the Patents and a managerial fee to manage the joint partnership. The appellant was searching to use the Patents one way or another, originally on its own and later in a partnership or joint venture, to give Woodtone access to the wood it wanted. The appellant was treating the Patents no different than other property it had acquired and leased or licensed to Woodtone in the past. Even before the appellant became the beneficial owner of the Patents Mr. Young sought others in the industry to join the appellant in exploiting the Patents for profit. That the appellant was looking for potential joint ventures to join it in exploiting the Patents as early as September 2005 was assumed by the Minister in assessing and, for the period after acquiring the Patents in November 2005, corroborated by Mr. Douglas. One way or the other, by licensing the Patents to W.I. alone, in a partnership or joint venture, and, in addition earning management fees, would the appellant gain income from the Patents.
Finally the Court dealt with 4 documents that the Crown sought to introduce in evidence but were not included in its List of Documents. The Appellant successfully sought to exclude these documents because of the Crown’s failure to comply with Rule 89:
[104] On May 6, 2014 by motion of the respondent, the Court granted an Order to amend its Amended Reply to the Notice of Appeal to (a) correct the assumption of the Minister (and thus deny) that the appellant sold the Patents to Young Financial Ltd. on September 30, 2007; and (b) to allege that PWC, as Trustee of Mr. Cable’s estate, sold Mr. Cable’s entire right, title to and interest in the Patents to the appellant on April 24, 2010. The respondent was also permitted to plead that due to the claim of prior secured creditors the only property the appellant could seize in respect of the defaulted loans were the Patents received under the security agreement with Mr. Cable; that if the Patents were disposed of, the Patents were not depreciable property; and if they were depreciable property, they were not available for use by the appellant and therefore no amount is includable in calculating the adjusted capital cost of a depreciable property.
[105] Subsequently, at the opening of trial the appellant applied for an order that four documents ought not be admitted in evidence by the respondent since the respondent did not include them in her List of Documents in accordance with Rule 89 of the Tax Court of Canada Rules (General Procedure) (“Rules”). The respondent wished to produce these documents without including them on a required List of Documents as a result of their production on a discovery of the appellant on September 5, 2013. There is no evidence as how the respondent obtained these documents whether through the appellant’s witness on discovery or otherwise. The respondent argued that to disallow these documents would render null the Court Order of May 6, 2014. I reserved my decision until after trial of the appeal although the documents in question were submitted.
…
[107] There is no question that the respondent did not adhere to Rule 89. An Order allowing a party to modify a pleading to allege new facts and argument does not and cannot liberate that party from the requirements of Rule 89. The appellant’s application is therefore allowed. The documents complained of are struck from the record.
As a result the appeal was allowed with costs.