By Alexandre C. Archambault
|How are transactions involving patents treated from an income tax perspective? A recent Tax Court of Canada decision examined whether certain patents were depreciable property for which a terminal loss could be claimed.|
“The hardest thing to understand in the world is the income tax”
No one will disagree with Einstein’s statement. Nevertheless, the mechanisms provided for in the tax regulations allow taxpayers to deduct certain losses from their income accounts. The 568864 B.C. Ltd. v. The Queen case deals precisely with this matter. Those who acquire patents as part of their business will be interested in the solution provided by the Tax Court of Canada.
Woodtone Group (hereinafter “W.G.”) is namely a manufacturer of wood boards.
Interact Wood Products Ltd. (hereinafter “Interact”) developed and patented a new technology that can make wide and long boards of almost any length or width.
W.G. was interested in Interact’s technology. Considering the benefits that W.G. was anticipating from supplying Interact’s lumber to its group of corporations, it advanced $3,500,000 to Interact. To secure the loan, the patent owner, Interact’s principal shareholder, granted W.G. a security interest in the coveted patents.
As Interact started to financially struggle, W.G. acquired its patents in the midst of Interact’s bankruptcy proceedings. Since the patents were originally secured for the loan of $3,500,000, the trustee in bankruptcy assigned the beneficial ownership of the patents to W.G. W.G. was deemed to have acquired them at a cost of approximately $3.9 million, which included various expenses it had incurred related to exploiting and protecting the patents, although the patents’ fair market value could have been much less.
Two years later, W.G. sold the patents to one of its related corporations for $1.00. As such, it claimed that it incurred a terminal loss of $3.9 million.
The Crown disagreed and from this disagreement arose the appeal presented to the Tax Court of Canada. In this regard, the Court first had to determine whether or not W.G. had beneficial ownership of the patents at the time it sold the patents and, secondly, if the latter acquired the patents for the purpose of earning income from the business or property.
Did W.G. have beneficial ownership?
In order to conclude that W.G. was indeed the beneficial owner of the patents, the Court took into account that at the time of Interact’s bankruptcy in 2005, it possessed the physical patent documents, had the right to exploit the processes protected by the patents and assumed all risk associated with these assets.
Beyond the beneficial ownership of the patents, the Court also had to look into the depreciable quality of the patents. In this regard, the Court noted that W.G. acquired sufficient interest in the patents and indicia of title: it acquired equipment to manufacture the wood to exploit the patents, moved the equipment for safe keeping at its costs and paid to protect its ownership of the patents. The patents thus became depreciable property in its hands.
Finally, for W.G. to benefit from the deduction it was seeking, the Court had to make sure that the patents had been acquired for the purpose of gaining or procuring income.
Did W.G. acquire the patents for the purpose of earning income?
By virtue of the Income Tax Regulations, a taxpayer needs to have acquired the asset for which he claims the deduction for the purpose of generating income.
As such, the Court considered that W.G.’s “prime motivating reason to lend $3,500,000 to Interact was to give Interact the means to exploit the Patents in such a manner that [W.G.] would get the wood sizes it wanted when it wanted and earn income as a result”.
The Court also noticed that, upon Interact’s bankruptcy, W.G. tried, albeit unsuccessfully, to make use of the patents through a joint venture or partnership with others.
These facts were sufficient to corroborate the acquisition of the patents in 2005 for an income-producing purpose.
Thereby, the Tax Court of Canada confirmed that certain patents were depreciable property for which a taxpayer could claim a terminal loss.