T-4268-74
Lawrence H. Mandel (Plaintiff)
v.
The Queen (Defendant)
Trial Division, Walsh J.—Toronto, June 16, 17
and 18; Ottawa, August 9, 1976.
Income tax—Notice of objection to re-assessment—Wheth-
er interest acquired in taxation year for purposes of claim of
capital cost allowance—Whether income taxable as income
from a business so as to be governed by Regulations 1100(3)
and 1102 or 1104 Whether contingent liability or contingent
debt—Onus on taxpayer to invalidate assessment presumed
valid by statute Income Tax Act, R.S.C. 1952, c. 148, as
amended prior to S.C. 1970-71-72, c. 63, ss. 3, 4, 11(1)(a),
12(1)(a) and 137(1) Income Tax Regulations, 1100(1)(a) and
(3), 1102(1)(a) and (3), 1102(1)(c) and 1104(1)(a) and (b).
Defendant claims that plaintiff's deduction from income of
loss on partnership investment consisted solely of capital cost
allowance. A portion of the loss was disallowed because the
plaintiff's contribution to capital cost was less than the total
paid, the limited partnership formed by the plaintiff and others
to acquire the investment was not engaged directly or otherwise
in any business and the interest in the investment was not
acquired by the partnership in the 1971 taxation year. Defend
ant further claims that if any interest in the investment was
acquired, it was not acquired or used for the purpose of gaining
or producing income; that the plaintiff's share of the losses of
the partnership was limited to his capital contribution and that
the purported acquisition of the investment was a sham trans
action to avoid tax on other income of the plaintiff. Alternative
ly, defendant claims that if the investment was acquired for the
purpose of gaining or producing income, the 1971 taxation year
was less than 12 months and any such income would be income
from a business, with deductions limited by Regulations
1100(3) and 1104 to the Income Tax Act (ss. 3, 4, 11(1)(a),
12(1)(a) and 137(1)). If it was not acquired for the purposes of
gaining income then according to Regulation 1102(1)(c) no
deduction is available under section 11(1)(a) of the Income
Tax Act and the plaintiff is not entitled to deduct capital cost
allowance in excess of that allowed by the defendant. (In the
other eleven cases, involving the other partners, similar re
assessments were made followed by similar notices of objection.
Those cases were heard on common evidence and the final
judgment rendered in this case would, if necessary, allow
corrections of those assessments by applying the same
principles.)
Held, the appeal is dismissed. The plaintiff was not in the
film business and no income he might derive would be income
from a business rather than income from property. Regulations
1100(3) and 1104 are therefore not applicable, but neither is
Regulation 1102(1)(c), since there is no reason to conclude that
the property was not acquired for the purpose of gaining or
producing income. There is, in addition, no evidence that the
purchase of the film rights was a sham. The principal argument
concerns the propriety of the accounting method used by the
plaintiff. Expert witnesses called by the plaintiff and the
defendant disagreed on this point, i.e., whether the liability of
the partnership should be described as a contingent debt or a
contingent liability. Either method might be said to be accept
able under the governing income tax law. However, there is a
statutory presumption in favour of an income tax assessment
until it is shown to be erroneous and the onus is on the taxpayer
to do so.
INCOME tax appeal.
COUNSEL:
D. K. Laidlaw, Q.C., P. Harris and G. Dra-
binsky for plaintiff.
N. A. Chalmers, Q.C., and N. W. Nichols for
defendant.
SOLICITORS:
Macaulay, Perry, Toronto, for plaintiff.
Deputy Attorney General of Canada for
defendant.
The following are the reasons for judgment
rendered in English by
WALSH J.: This case was heard on common
evidence with 11 other cases bearing Court Nos.
T-4291-74, Vaile v. The Queen; T-4258-74, Howie
v. The Queen; T-4259-74, Rush v. The Queen;
T-4260-74, Farley v. The Queen; T-4261-74,
Rogers v. The Queen; T-4262-74, Macaulay v.
The Queen; T-4263-74, Howie v. The Queen;
T-4264-74, Gibson v. The Queen; T-4265-74, Lilly
v. The Queen; T-4266-74, Outerbridge v. The
Queen, and T-4267-74, Perry v. The Queen, pursu
ant to an order issued on October 10, 1975. The
issue arises out of notices of objection made by
plaintiffs in each case to re-assessments made of
their income tax for the 1971 taxation year. The
grounds for the objection are set out by plaintiff
Lawrence H. Mandel in his notice of objection
dated January 3, 1974, to the re-assessment of his
taxation made on October 19, 1973, which reads
as follows:
On or about December 23, 1971, I, Lawrence H. Mandel,
became a limited partner in a limited partnership known as and
registered as One Flag Under Ontario Investments Limited &
Film Associates ("the partnership") for the purpose of invest
ing in and acquiring the ownership of a film called "Mahoney's
Estate". The acquisition of the said film by the partnership
occurred on or about December 23, 1971.
I would submit therefore that pursuant to Section 11(1)(a) of
the Pre 1972 Income Tax Act (Canada) and Section
1 100(1)(a)(xv) of Income Tax Act Regulations of the Pre 1972
Income Tax Act (Canada) that I was entitled as a partner in
the partnership to capital cost allowance of 60% of the aggre
gate of the cash down payment and promissory note attribut
able to my partnership interest and with respect to the purchase
of the film by the partnership.
Pursuant to Paragraph 165(3)(b) of the post 1972 Income Tax
Act (Canada) I wish to appeal immediately to the Federal
Court and I hereby waive reconsideration of the re-assessment
and would request the consent of the Minister of National
Revenue to same.
In the other 11 cases similar re-assessments were
made followed by similar notices of objection, but
the amounts involved are not identical since the
contributions of each of the parties to the limited
partnership was different, and of course the per
sonal incomes of each of the parties from other
sources also differed. It is common ground how
ever that once the legal issue involved has been
determined by final judgment rendered in this
case, corrections of the assessments can be made,
if same becomes necessary, by applying the same
principle to the other 11 cases.'
In the amended statement of defence to the
notice of objection defendant contends that in
filing his return of income for the 1971 taxation
year plaintiff claimed as a deduction in computing
his income a loss on his partnership investment in
the film Mahoney's Estate in the amount of
$14,264.96, which loss consisted solely of capital
cost allowance claimed by him. In re-assessing
plaintiff the Minister of National Revenue disal
lowed a portion of the said loss in the amount of
$9,522.56. In so re-assessing plaintiff the Minister
concluded that the capital cost of the interest in
the film Mahoney's Estate to the limited partner
ship was $150,000 (being the total of the partners'
cash contributions to the limited partnership) of
which plaintiff's contribution was $7,904, that the
limited partnership during the 1971 taxation year
The exhibits have been filed in the record of T-4258-74,
Howie v. The Queen.
was not engaged directly or otherwise in the
motion picture business or in any other business,
that the film Mahoney's Estate was not acquired
by the partnership in the 1971 taxation year, nor
was any interest in it acquired that year, and if an
interest was acquired in the film the interest is
merely a licence to distribute same. The Minister
further contends that if the film Mahoney's Estate
or an interest in it was acquired by the partnership
it was not acquired for the purpose of gaining or
producing income nor was the film used at any
time during the 1971 taxation year by the partner
ship for this purpose, that the capital cost to the
partnership of the film was not in excess of $150,-
000 and it did not acquire the film or any interest
therein and that plaintiff's share of the losses of
the partnership was limited to his capital contribu
tion in the amount of $7,904. The Minister further
contends that the purported acquisition of the film
was a sham transaction undertaken solely to avoid
tax on the professional and other income of plain
tiff and for no legitimate business purpose.
Alternatively the Minister pleads that if the film
Mahoney's Estate was acquired by the partnership
for the purpose of gaining or producing income,
the 1971 taxation year of the limited partnership
was less than 12 months and any such income
would be income from a business so that the
deduction of capital cost allowance by the plaintiff
would be limited by the provisions of Regulations
1100(3) and 1104 of the Income Tax Regulations.
The Minister relies inter alia upon sections 3, 4,
11(1)(a), 12(1)(a) and 137(1) of the Income Tax
Act, R.S.C. 1952, c. 148, as amended prior to S.C.
1970-71-72, c. 63 and Regulations 1100, 1102 and
1104 thereto. If the film was not acquired for the
purpose of gaining or producing income, as the
Minister contends, then he states that by virtue of
Regulation 1102(1)(c) it does not come within one
of the classes of property for which a deduction
may be taken under section 11(1)(a) of the
Income Tax Act, and that plaintiff in any event is
not entitled to deduct capital cost allowance with
respect to the film in excess of that allowed by the
Minister of National Revenue as the deduction
thereof would unduly or artificially reduce plain
tiff's income.
A book of documents was produced by consent
of the parties as well as additional documents
arising out of the discovery which were produced
from time to time during the evidence of various
witnesses. It was agreed that the discoveries taken
in one case would apply to all the others.
It is not necessary for the purpose of these
proceedings to analyze in detail the very complex
series of agreements relating to the production of
the film Mahoney's Estate which were entered
into by various parties before plaintiff and his 11
associates all of whom, with one exception, were
members of the same law firm in Toronto, the sole
exception being a doctor, entered into the picture.
It is sufficient to say that as of September 14,
1971, an agreement was entered into between
Topaz Productions Limited, Niagara Television
Limited, Robert Lawrence Productions (Canada)
Limited, and John T. Ross, who was to be the
executive producer of the film Mahoney's Estate,
which was to be produced for a budget estimated
at $653,000, by virtue of which it was stated that
Alexis Kanner should play the role of Mahoney,
that he was also the co-writer of the screenplay
and the picture, that Topaz sold 25% of its rights,
title and interest in the screenplay and picture to
Niagara, retaining 75% ownership, that Topaz as
producer would commence photography on or
about September 27, 1971, so as to insure the
completion of the filming by December 31, 1971,
that of the compensation to be paid to Topaz for
the production of the picture $20,000 was to be
deferred and it was to receive 25% of the net
profits for the picture. Of the compensation to be
paid to Robert Lawrence Productions, $15,000
was deferred and it was to receive 8% of the net
profits. Niagara advanced Topaz $125,000 toward
the production repayable out of revenues. Robert
Lawrence Productions was responsible for arrang
ing the financing of any costs of production in
excess of $375,000 exclusive of deferred costs.
When the picture was completed an audit was to
be made by Deloitte, Haskins & Sells, Chartered
Accountants, to verify and determine the total
production costs on instructions from Topaz which
was required to also furnish a copy to Niagara and
Robert Lawrence Productions. The net profits in
excess of the expenses as established by the audi
tors were to be divided in the proportion of 20% to
the Canadian Film Development Corporation, 22%
to Niagara, 8% to Robert Lawrence Productions,
25% to Topaz, 7% to Harvey Hart, 1.5% to Maud
Adams and 1.5% to Sam Waterston with the
remaining 15% to such persons as might be jointly
designated by Topaz and Robert Lawrence Pro
ductions and in default of such designation, equal
ly between these two corporations.
By an earlier agreement on July 8, 1971,
Harvey Hart was engaged as director of the film.
By agreement dated August 20, 1971, Alexis
Kanner was engaged as an actor to play the part of
Mahoney. Kanner had assigned to Topaz Produc
tions Limited (of which he was President) all his
rights in the draft screenplay which he had co
authored into a shooting script. By agreement
dated September 14, 1971, the same date as the
main agreement between the various parties, the
Canadian Film Development Corporation agreed
with Topaz Productions Limited and Niagara
Television Limited as owners, Topaz Productions
Limited as the producer and John T. Ross as the
executive producer to advance $250,000 toward
the production of the film of which $5,000 had
already been advanced. In return for this it was to
receive 20% of the net profits of the film as stated
above. By agreement dated August 31, 1971, be
tween Topaz Productions Limited and Niagara
Television Limited referred to as the licensors and
International Film Distributors Limited referred
to as the distributors, the distributors agreed to the
distribution of the film on a percentage basis of
gross receipts and on December 9, 1971, the Bank
of Montreal loaned $100,000 in consideration of a
2 1 / 2 % participation in the net profits, the rate of
interest to be 2 1 / 2 % over the bank's prime rate,
repayment to commence approximately three
months after completion of production.
On December 22, 1971, the Toronto law firm of
Thomson, Rogers of which plaintiff and all the
other plaintiffs save one are members wrote to
Topaz Productions and Niagara Television Lim
ited confirming that $150,000 had been assembled
in order to purchase 100% ownership of the film
Mahoney's Estate to be advanced by December
31, 1971 on condition that Niagara would convert
the $125,000 that was already invested in the
production under the agreement of September 14,
1971 to an advance bearing no interest repayable
on the same terms as the advance of $250,000
made by the Canadian Film Development Corpo
ration. The balance of the purchase price was to be
paid by the assumption by the purchasers who
were to be formed into a limited partnership with a
company to be incorporated as the general partner
and all the investors to be limited partners, of all
the obligations of the producer for payment or
repayment including the monies advanced by the
Canadian Film Development Corporation and by
Niagara and the monies agreed to be paid by the
producer under all agreements, contracts and
arrangements in existence or made thereafter for
the purpose of completing the film. The producer
was to arrange financing to the extent of $100,000
with a Canadian chartered bank (this was appar
ently the loan which had been arranged with the
Bank of Montreal) and the total purchase price
was to be the cost of production as determined by
the producers' auditors, Messrs. Deloitte, Haskins
& Sells. The $150,000 paid as the cash portion of
the purchase price was to be eventually refunded
pari passu and pro rata with the Canadian Film
Development Corporation for its advance of $250,-
000 and Niagara for its advance of $125,000, the
limited partnership to receive 12 1 / 2 % of the net
profits of the film.
On December 30, 1971, these terms were incor
porated into an agreement between Topaz Produc
tions, Niagara Television Limited, Canadian Film
Development Corporation, Robert Lawrence Pro
ductions (Canada) Limited, John T. Ross, and
One Flag Under Ontario Investments Limited &
Film Associates, acting by its general partner One
Flag Under Ontario Investments Limited. As a
result of this agreement the 15% of the net profits
which, under the production agreement of Septem-
ber 14, 1971, was to be paid to such persons as
might be jointly designated by Topaz and Robert
Lawrence Productions was now distributed in the
proportion of 12.5% to the purchasers One Flag
Under Ontario Investments Limited & Film
Associates, and 2.5% to the bank, the percentages
of the other parties to the original agreement
remaining unchanged. Thomson, Rogers were paid
$15,000 forthwith by Topaz in consideration of
their services in procuring the purchase by the
owner of the film.
As of December 31, 1971, the cost of the film
had come to $577,892 as established by the audi
tors, although the payment of some portions of this
amount was deferred. On December 30, 1971, the
partnership One Flag Under Ontario Investments
Limited & Film Associates was duly registered as
a partnership commencing business on December
23, 1971. The audited statement showed in addi
tion to the investment in Mahoney's Estate
amounting to $577,892, an item referred to as
deferred costs of film production in the amount of
$179,050, and an advance to production company
of $93,539. The deferred costs of film production
is shown as both an asset and a liability and the
accompanying notes explain that the deferred costs
represent costs incurred on a contingent basis and
liabilities to be settled only out of the proceeds of
distribution. Another note states that under the
terms of the agreement the limited partnership
as§umed all liabilities associated with the produc
tion including obligations to repay amounts
advanced by Canadian Film Development Corpo
ration, Niagara Television Limited and other
creditors, shown as the bank in the amount. of
$100,000 of which $50,000 had been provided to
December 31, 1971, Niagara in the amount of
$125,000, Canadian Film Development Corpora
tion in the amount of $250,000 of which $246,580
had been advanced to December 31, 1971, and the
partnership in the amount of $150,000. Reference
was also made to the fact that Niagara had agreed
to advance any amount required to complete the
film in excess of the amount of $625,000 with the
repayment of any amount so advanced to be an
obligation of the partnership but that no such
amounts had been ,so advanced as of December 31,
1971. Reference is also made to amounts totalling
$54,850 to various persons participating in the
production as "preferred deferred" creditors. Their
names and the amounts due to them appear in the
purchase agreement of December 30, 1971. This
amount of $54,850 together with a reference to
other deferred production costs totalling $124,200,
seems to form the total of $179,050 shown as
deferred costs of film production in the balance
sheet.
Certain agreements although made after the
1971 taxation year may have some bearing on the
decision of the matter. An agreement dated Febru-
ary 1, 1973, between Canadian Film Development
Corporation, Amaho Lirpited referred to as the
assignee, Topaz Productions Limited, Niagara
Television Limited, Robert Lawrence Productions
Limited, John T. Ross, and One Flag Under
Ontario Investments Limited & Film Associates
and Alexis Kanner, sets out that Niagara provided
financing of the film in the amount of $125,000
and paid a further sum of approximately $10,000
in connection with the completion of it. It assigns
all its rights, save for the $10,000, to Amaho
Limited, the assignee, and in consideration of
$1.00 the Canadian Film Development Corpora
tion assigns any interest which it had to recoup-
ment of monies advanced by it out of a share of
the profits the film made, and the parties release
the Corporation from any demands or claims for
the balance of its $250,000 commitment which it
had not yet paid (which was only $3,420). On
February 11, 1974, an agreement was entered into
between Topaz Productions Limited and British
Lion Films Limited which sets forth that principal
photography in the film has been completed but
that additional finance is required to complete
production and deliver same ready for exhibition
which Lion has agreed to provide in return for the
acquisition of distribution rights in the film and
media throughout the world. The agreement is a
lengthy and complex one containing what are said
to be the standard distribution clauses.
Before dealing with the evidence of the account
ing experts it would be best to deal with the
evidence of the witnesses with respect to the pros
pects of the film eventually producing revenue and
with respect to reasons for the delay in its comple
tion and distribution. Mr. Victor Perry, one of the
plaintiffs, testified that at the time of the purchase
by them of Mahoney's Estate the filming of it had
been completed. Mr. Kanner wanted to cut it to
his own satisfaction, Mr. Hart having already done
so in a manner not approved by Mr. Kanner who
was the producer, part author and star, whereas
Mr. Hart was the director. There was friction
between them. When British Lion came into the
picture subsequently it was their intention to add
background music.
Mr. Nathan Taylor who is also a lawyer but not
one of the plaintiffs and is an expert in the film
industry, being a member of the Advisory Group
of the Canadian Film Development Corporation
testified as an expert witness his affidavit being
taken as read. He has been engaged in the film
industry since about 1924 when he became secre
tary of the Motion Picture Theatre Owners of
Ontario, has operated theatres and was the Presi
dent of International Film Distributors, as well as
having financed feature film productions, built
studios, and has also been involved in television.
He testified that as of 1971 a regular and accept
able method of financing a production was to have
money advanced to defray the costs on the basis
that such money would be repaid out of the earn
ings of the film. In his view Mahoney's Estate,
with Alexis Kanner as producer and star, and
co-stars Sam Waterston, Maud Adams and Diana
Leblanc, together with Robert Lawrence Produc
tions (Canada) Limited with John T. Ross as
executive producer and Harvey Hart as director
provided all the elements for a successful motion
picture. His company, International Film Distribu
tors had sufficient confidence in it to make a
deferment of studio rental which would approxi
mate $20,000, the film being produced in its stu
dios. He also believes that Mr. Ross would not
have gone into it as executive producer without
feeling confident of the success of the film and
that the distribution agreement eventually entered
into with British Lion Films Limited, one of the
major distributors in the United Kingdom, signifi
cantly improves the chances of its financial suc
cess. The fact that it invested £70,000 sterling in
1974 in the film indicates to him that they must
have considered it had great potential. On cross-
examination he conceded that the 5 years it took to
complete the film was exceptionally long. He
stated in general in deciding whether to invest in a
film one looks first at what he calls a "handle"
that is to say either a pre-sold property like a play
or a book, or a well known cast or some special
"gimmick" as well as a good script. Mahoney's
Estate had a good cast, director and script. He
conceded that the present plaintiffs are something
like "angels" for stage productions and that there
is a tax advantage in having a large cost to use as a
capital cost allowance base.
Michael Spencer, the executive director of the
Canadian Film Development Corporation, who
previously had been with the National Film Board
as a producer and director of planning and before
that with the Canadian Army Film Unit, testified
that by the agreement of February 1, 1973, the
Corporation withdrew from Mahoney's Estate. He
had seen the edited material in about November
1972 and concluded that the film might never be
finished in a manner to have any potential for
distribution. As a result he recommended to the
Corporation that they withdraw. He felt that the
editing of the film had taken an extraordinarily
long time and although the Corporation had
advanced all the money they had undertaken to
with the exception of some $3,400 he nevertheless
felt that even this small saving could be used to
better advantage elsewhere. He understood that
there had been unresolvable artistic differences
between the producer, director and principal actor
and in his view the film which in its original
concept was an amusing one had become a boring
lengthy one. He stated that the Canadian Film
Development Corporation has backed 188 films
from April 1, 1968 to March 31, 1976, and has got
some money back from 40 or 50 of them and all its
money back in only 10. In the case of the well-
known film Duddy Kravitz all their money was
recovered plus a 10% profit. In another film which
cost only $150,000 they got back their investment
plus an additional 125%. The only film which the
Corporation has abandoned after an initial invest
ment is the subject film Mahoney's Estate. He
said that the film was supposed to be fully com
pleted by January-February of 1972 and that the
delay from then until November had disturbed
him. He is aware that there had been a camera
problem which led to an insurance claim in 1972,
some film being damaged which might have
involved some reshooting. It is his understanding
that Mr. Hart, the director made the first cuts but
that the actual director Kanner and the producer
were not satisfied.
Don Owen who has worked in film business for
20 years being a writer, director and producer for
some 15 years, having turned out 4 feature films
and some 30 documentaries, testified as an expert,
his report being taken as read. It is his opinion that
Mahoney's Estate is without narrative, drive or
shape, that the behaviour of the central character
is inconsistent and unmotivated, the story confused
and boring and totally lacking in commercial or
artistic value. He stated that he sometimes reads
scripts and gives advice. He knows and respects
Kanner as an actor but doubts his maturity and
experience to act as a producer. He admitted
however in testifying that Kanner, Adams, Water-
ston, and Robert Lawrence Productions operated
by John T. Ross are all well known in Canada. He
agreed that the Canadian Film Development Cor
poration must have had confidence in the success
of the film in 1971 to undertake to put up $250,-
000 and he can see that he himself might have
agreed with this as of that date, his present opinion
being based on the present state of the film. He
does not consider that the script is bad but that the
story line got lost in the shooting and the film was
mutilated by bad editing.
Another witness, Lawrence Rittenberg, was
called on behalf of the plaintiffs. He is employed
with International Film Distributors Limited, his
responsibility being to place the film in as many
theatres as possible. At the time of the trial in
June 1976 arrangements had been made to place
the film in Edmonton on August 13, Calgary,
August 27, Halifax, October 22, Saint John, N.B.
December 3, Moncton, N.B. December 15 to 18,
and Fredericton, N.B. December 15 to 18, and
negotiations were going on for other theatres in the
rest of the country. He stated that it was not
offered for exhibiting before because all the ma
terial was not ready. International Film Distribu
tors would receive 35% to 50% of the gross on a
sliding scale.
The Court refused a motion by defendant to
view the film. I do not consider it appropriate to
attempt to form a personal opinion, without having
any special qualifications for doing so, either as to
the artistic merits or commercial prospects of the
film generating sufficient earnings to pay back the
substantial amounts invested in it. Any such find
ings should be based on the evidence of the
experienced witnesses who testified together with
whatever conclusions can be drawn from the exist
ing contracts.
For what it is worth a letter of Deloitte, Haskins
& Sells dated December 3, 1971 to Messrs. Thom-
son and Rogers was admitted in evidence over
plaintiff's objection. This letter had various tax
calculations and tables based on various hypo
theses attached. It is not necessary to go into the
details but the purport of the letter and tables was
that based on assumed taxable income of $100,000
per annum for each of 6 investors in a film costing
$500,000 of which $125,000 was invested by the 6
individuals, each investor would have a total after-
tax income of $284,205 for the years 1971 to 1976
inclusive if there had been no investment in the
film. As a result of the film investment, if no
income was derived from the film the total after-
tax income for the same six-year period would be
$313,555, an increase of nearly $30,000. If the
film were successful and all the $500,000 invested
were recovered and an additional $250,000 was
earned in each of the years 1973 and 1974, the
after-tax income of each individual investor would
have totalled $287,337 for the 1971 to 1976 period
an increase of only some $3,000 over his situation
if the film investment had never been made. In a
final illustration based on the hypothesis that only
$300,000 of the $500,000 invested in the film was
recovered, the total after-tax income would have
amounted to $295,519 for the six-year period, a
gain of some $11,000. The fundamental conclusion
is that the tax savings would be greatest if the film
earned no income and none of the investments
could be recovered, and that there would be little
tax advantage to the individual investors if the film
proved to be very successful. It was stressed that to
obtain the highest leverage it was essential that the
Canadian Film Development Corporation, the dis
tributors, and others who advanced substantial
amounts be induced to accept repayment only out
of the proceeds and that the individual investors
would be able to depreciate all of the film costs for
tax purposes regardless of the amount that they
had invested in order to obtain 100% ownership of
it. One conclusion to be drawn from this document
is that, save for the possible loss of the $150,000
cash invested, the plaintiffs were in a position
where they would secure tax advantages from an
unprofitable business venture, and that the more
unprofitable the film was up to a certain point the
greater the tax advantage. The other conclusion to
be drawn, which is not surprising in view of the
fact that the plaintiffs are knowledgeable attor
neys, is that they were well aware of the tax
advantages at the time they purchased the film
and that this was undoubtedly a major consider
ation in inducing them to purchase it.
This does not, however, justify a conclusion that
this was in any way improper nor that their moti
vation has the consequence of depriving them of
whatever tax advantages resulted from the pur
chase, since it is a fundamental principle in taxa
tion law that a business man may so arrange his
affairs in the frame of the relevant taxing statute
and regulations as to minimize his tax liability.
Neither do I find on the evidence before me that,
as defendant suggests, plaintiffs deliberately
sought to purchase a film which would not be
financially successful. While there is considerable
difference of opinion between the various witnesses
as to the potential of the film, I believe that the
better view, and I so find on the facts before me, is
that as of 1971, there was nothing to indicate that
the film Mahoney's Estate had little prospect of
succeeding, other than the generally accepted
statement that film producing is a business with a
high element of risk with only a minority of the
films produced being really successful. It is not
sufficient to say by hindsight, that if by late 1972
or early 1973 it became evident that the film was
unlikely to be a commercial success this was
anticipated when plaintiffs bought it in 1971. In
1971 it had a good script, cast, producers and
directors, to such an extent that not only the
Canadian Film Development Corporation but the
Bank of Montreal and Niagara Television Limited
were prepared to contribute substantial sums to its
production. Moreover even at a much later date, in
February 1974, an experienced distributor, British
Lion Films Limited, was prepared to invest very
substantial additional sums in the film, and it is
now finally about to be shown in commercial
theatres, although some 3 years later than
anticipated. It would be wrong therefore to con
clude that in 1971 it was purchased deliberately
for its loss potential. What the purchasers actually
did was to invest $150,000 in a highly risky busi
ness adventure with the knowledge that, even if it
were not successful, they would benefit from sub
stantial tax advantages while if, by some chance, it
should prove to be highly successful then of course
they would benefit by the profits from same.
I now turn to the accounting evidence respecting
the manner in which this investment should have
been treated for taxation purposes which is the
real issue. The sections of the Act and regulations
to which reference was made in argument are as
follows:
11. (1) Notwithstanding paragraphs (a),(b) and (h) of sub
section (1) of section 12, the following amounts may be deduct
ed in computing the income of a taxpayer for a taxation year:
(a) such part of the capital cost to the taxpayer of property,
or such amount in respect of the capital cost to the taxpayer
of property, if any, as is allowed by regulation;
12. (1) In computing income, no deduction shall be made in
respect of
(a) an outlay or expense except to the extent that it was
made or incurred by the taxpayer for the purpose of gaining
or producing income from property or a business of the
taxpayer,
137. (1) In computing income for the purposes of this Act,
no deduction may be made in respect of a disbursement or
expense made or incurred in respect of a transaction or opera
tion that, if allowed, would unduly or artificially reduce the
income.
1100. (1) Under paragraph (a) of subsection (1) of section
11 of the Act, there is hereby allowed to the taxpayer, in
computing his income from a business or property, as the case
may be, deductions for each taxation year equal to
(a) such amounts as he may claim in respect of property of
each of the following classes in Schedule B not exceeding in
respect of property
(i) of class 1, 4%,
(ii) of class 2, 6%,
(iii) of class 3, 5%,
(iv) of class 4, 6%,
(v) of class 5, 10%,
(vi) of class 6, 10%,
(vii) of class 7, 15%,
(viii) of class 8, 20%,
(ix) of class 9, 25%,
(x) of class 10, 30%,
(xi) of class 11, 35%,
(xii) of class 12, 100%,
(xiii) of class 16, 40%,
(xiv) of class 17, 8%,
(xv) of class 18, 60%,
(xvi) of class 22, 50%,
(xvii) of class 23, 100%,
(xviii) of class 25, 100%,
(xix) of class 26, 1%,
of the amount remaining, if any, after deducting the
amounts, determined under sections 1107 and 1110 in
respect of the class, from the undepreciated capital cost to
him as of the end of the taxation year (before making any
deduction under this subsection for the taxation year) of
property of the class;
1100. (3) Where a taxation year is less than 12 months in
duration, the amount allowed as a deduction under paragraphs
(a), (d) and (h) of subsection (1) shall not exceed that propor
tion of the maximum amount allowable that the number of
days in the taxation year is of 365.
1102. (1) The classes of property described in this Part and
in Schedule B shall be deemed not to include property
(c) that was not acquired by the taxpayer for the purpose of
gaining or producing income.
1104. (1) Where the taxpayer is an individual and his
income for the taxation year includes income from a business
the fiscal period of which does not coincide with the calendar
year, in respect of the depreciable properties acquired for the
purpose of gaining or producing income from the business, a
reference in this Part to
(a) "the taxation year" shall be deemed to be a reference to
the fiscal period of the business, and
(b) "the end of the taxation year" shall be deemed to be a
reference to the end of the fiscal period of the business.
SCHEDULE B
CLASS 18
(60%)
Property that is a motion picture film other than a television
commercial message.
I do not conclude from the evidence before me
that plaintiffs were in the film business or that any
income which they might derive would be income
from a business rather than income from property
Clause 7 of the purchase agreement reads a:
follows:
7. Except as herein specifically amended, the Owner agrees t<
be bound by all the terms of all the agreements, contracts, anc
arrangements at present in existence between Topaz and other:
for the production of the film and by the terms of all other
agreements made by Topaz hereafter for the completion, distri.
bution and exploitation of the film, it being the intent that the
Owner shall be an investor (and, as such, owner of) the film bur
that all decisions of whatsoever nature normally made by a filly
producer shall remain the responsibility of the Producer of the
film as set out in the Production Agreement.
Plaintiffs themselves had nothing whatsoever to dc
with the production of the film or with the distri
bution of same and appear to have merely made ar
investment in it. Therefore I do not find that
Regulations 1100(3) or 1104 are applicable. As I
have already indicated I do not conclude on the
evidence before me that the property was not
acquired by the taxpayer for the purpose of gain
ing or producing income, since there was always a
possibility that it might do so, and therefore I dc
not believe that section 1102(1)(c) is applicable
(See Walsh v. M.N.R. 2 )
Neither do I conclude that the purchase of the
film rights by plaintiff was a sham within the
meaning of the case of Snook v. London & Wen
Riding Investments Ltd. 3 The purchase by plain
tiff did not become a sham as defendant contends
merely because Topaz Productions Limited in the
subsequent distribution agreement of February 11.
1974, with British Lion Films Limited acted as it
they were still owners and did not make it clear
that they were merely acting as agents for the
owners One Flag Under Ontario Investments Lim
ited & Film Associates in entering into this Agree
ment. Paragraph 7 of plaintiff's purchase agree
ment makes the relation between Topaz
Productions Limited and the purchasers as owners
of the film clear. This disposes 'of most of the
subsidiary arguments raised by counsel for defend
ant, but the main argument dealing with the pro
priety of the accounting method adopted, which is
the principal argument, remains to be dealt with.
2 [1966] Ex.C.R. 518.
3 [1967] 1 All E.R. 518 at 528.
No witness testified on behalf of the auditors,
Deloitte, Haskins & Sells but it can safely be
presumed that if such a witness had been produced
he would have supported the manner in which they
treated the investment in Mahoney's Estate as
being correct and proper. An expert accounting
witness was called on behalf of plaintiff, namely
Mr. Robert Fraser, C.A. of the Thorne, Riddell
firm who also supported this treatment. On the
other hand defendant also called an expert witness,
Mr. David Bonham, F.C.A. who adopted an
opposing point of view. Both supported their opin
ions by frequent references to accounting authori
ties as to the appropriate practice and both are
highly qualified experts. It is necessary therefore
to examine their evidence in some detail since the
entire issue depends on this.
Mr. Fraser, whose affidavit was taken as read
and who testified at some length, states in his
affidavit that he examined the method of financing
employed in meeting the production expenses of
the film including the agreements with the
Canadian Film Development Corporation, the
Bank of Montreal and Alexis Kanner, as well as
the agreement by virtue of which the limited part
nership purchased the film and that he has
reviewed the agreements covering the financing of
the film by the limited partnership and the finan
cial statements of the limited partnership for the
period ending December 31, 1971 reported on by
Deloitte, Haskins & Sells. He states "In my opin
ion it is in accordance with generally accepted
accounting principles to treat the costs of the film
in the hands of the partnership on the basis which
includes the payments made to defray those costs
as reflected in the agreements referred to earlier".
He also states "In my opinion the cost to the
limited partnership of the film Mahoney's Estate
in the amount of $577,892 and disclosed in the
financial statement referred to above is appropri
ately the cost to that partnership in accordance
with the generally accepted accounting principles".
Mr. Bonham's opinion is given in the form of a
letter to Mr. N. W. Nichols, Barrister and Solici
tor of the Department of Justice and is annexed to
Mr. Nichols' affidavit, and was taken as read, and
he was then examined on it. In his letter he states
that he has been asked for his opinion as to the
proper accounting treatment for an asset acquired
for a total consideration part of which is contin
gent upon the happening of one or more possible
future events. In giving his opinion he states that
he was asked to assume that the obligations
incurred by the purchasers when they acquired the
film were unconditional to the extent of their
payment of $150,000 and conditional or contin
gent with respect to the payment of any further
amounts up to a maximum of $427,892 as estab
lished as of December 31, 1971, the total max
imum consideration at that date being $577,892,
the condition being that there must first be monies
available from the exploitation of the film accord
ing to the terms of the relative agreements. It is
based on a further assumption that "at the end of
the 1971 fiscal year there was no reasonable basis
to predict that the economic prospects for the
exploitation of the film were such that the condi
tional obligation referred to above would almost
certainly become payable. In other words the
acquisition of the film by One Flag was clearly a
speculative venture". He concludes that on the
basis of these a ssumptions the most appropriate
accounting treatment for this transaction in
Canada under generally accepted accounting prin
ciples at the relevant date would have been:
1. To record an asset as to the end of 1971 fiscal year being the
rights of the film acquired for an initial cost of $150,000.
2. To disclose in the same year by way of a note to the
financial statements a contingent liability (equal to the contin
gent consideration of $427,892) dependent upon the economic
results of exploiting the film.
3. As and if payments were required under the contingent
liability referred to in No. 2 above the acquisition cost of the
film rights would be increased accordingly.
Mr. Fraser testified that in accounting practice
it is perfectly proper to take into cost, liabilities
which do not require to be met until a future date
as liabilities once assumed form part of the cost.
The assumption of the liabilities by the partnership
in the agreement represent part of the cost of
acquisition. Reference was made to the publication
Terminology for Accountants of the Canadian
Institute of Chartered Accountants in which cost
is defined as "The amount measured in money of
the expenditure to obtain goods or services", and
liability as "In general, a debt owed. In accounting
the money cost of discharging an enforceable obli
gation and represented by a credit balance that
may properly be included in a balance sheet in
accordance with the accepted accounting princi
ples". He conceded that this involves a determina
tion of whether the liability is a contingent one or
not. He stated that a contingent liability is an
obligation which may arise from a future event,
the happening of which future event may be possi
ble or probable. If it is probable the liability is not
contingent and he believes that in the present case
the liabilities assumed were real and that it is only
the payment of them which was contingent. He
laid great stress on the distinction between the
occurrence of a liability and the payment of same.
He was referred in cross-examination to the
Canadian Institute of Chartered Accountants'
Handbook recommendations No. 1580 in which
Section .33 reads:
Where the amount of contingent consideration can be reason
ably estimated at the date of acquisition and the outcome of the
contingency can be determined beyond reasonable doubt, it
should be recorded at that date as part of the cost of the
purchase. Where the amount of contingent consideration or the
outcome of the contingency cannot be determined beyond
reasonable doubt, details of the contingency should be disclosed
in a note to the financial statements; when the contingency is
resolved, the consideration should be recorded as an additional
cost of the purchase.
He agrees with this and he conceded that unless
the outcome of the contingency can be determined
beyond a reasonable doubt the amount should be
shown as a note and recorded only when paid. In
the present case there was an obligation enforce
able against the assets of the partnership although
payable only out of the earnings, so in his view it
was not contingent. He referred also to Kohler's
Dictionary for Accountants which defines contin
gent liability as one "due only on failure to per
form a future act" stating that he did not consider
that this is such a case, and pointed out that the
Bank and Niagara Television Limited evidently
considered the advances to be an appropriate com
mercial loan, and that at the time the Canadian
Film Development Corporation evidently con
sidered their advances as an investment even
though somewhat risky. He compared it to a drill
hole for a mine which may yield nothing but is
nevertheless expensed in the accounting state
ments, or to the case of a bankrupt who may never
have to pay off a liability but nevertheless this
liability exists. He conceded that it is necessary to
look at the amount of the liabilities to see if the
price paid was realistic or not. He looks on the
total cost to the other parties as a test of the cost
to the partnership. He would value the obligations
to repay at 100% because there was a real liability.
The only liabilities that should not be recorded are
those that would only arise if a certain event
occurs. The figure of $179,050 shown as deferred
production costs was because the creditors of these
amounts had agreed that if the film did not earn
money they would not make a claim, but the other
items are not in this category so that while this
amount is a contingent account the other amounts
due to the Bank, Niagara, Canadian Film De
velopment Corporation and the partners them
selves for their investment in the partnership are
not.
Mr. Bonham for his part testified that the objec
tive of accounting is to achieve a fair presentation
and accountants should look at the real substances
of transactions. The fundamental concept of what
constitutes cost to a purchaser was already well
established by 1971. He also referred to the text of
Terminology for Accountants which defines ex
penditure as "A disbursement, a liability incurred,
or the transfer of property for the purpose of
obtaining goods or services". He referred to
Accounting Terminology Bulletin No. 4 of the
American Institute of Certified Public Account
ants which defines cost as "cash expended ... or a
liability incurred, in consideration of goods or
services received or to be received". He conceded
that the liabilities to be recorded in the balance
sheet would be a debt even though only payable in
future. He considers the Canadian Institute of
Chartered Accountants' Handbook as the most
authoritative publication in Canada and referred
to Item 3290.01 dealing with contingencies which
states:
Any contingent liabilities to the extent not reflected in the
balance sheet should be disclosed. Their nature, and where
practicable, the approximate amounts involved, and the nature
and amount of any guarantees or pledges of assets, etc., should
be stated.
The witness stated that there are two ways of
recording a contingent liability: first by a note on
the balance sheet advising of its existence, and
second by showing it as a surplus reserve and that
either method can be used but in no case should
they be shown as regular liabilities on the balance
sheet. He referred to Opinion No. 16 of the
American Institute of Certified Public Account
ants which he stated is authoritative in the United
States and persuasive here which states under No.
79:
Contingent consideration should usually be recorded when the
contingency is resolved and consideration is issued or becomes
issuable. In general, the issue of additional securities or distri
bution of other consideration at resolution of contingencies
based on earnings should result in an additional element of cost
of an acquired company.
and again under No. 80:
Contingency based on earnings. Additional consideration
may be contingent on maintaining or achieving specified earn
ings levels in future periods. When the contingency is resolved
and additional consideration is distributable, the acquiring
corporation should record the current fair value of the consider
ation issued or issuable as additional cost of the acquired
company.
This is similar to Paragraph .33 of Item 1580 of
the Canadian Institute of Chartered Accountants'
Handbook referred to (supra) and to the para
graph designated as .35 therein which reads:
In situations where additional consideration becomes payable
as the result of maintaining or achieving specified earnings
levels in periods subsequent to the acquisition, such consider
ation should be recorded, when determinable, as an additional
cost of the purchase. Details of such contingent consideration
should be disclosed.
While this Handbook was not adopted until March
1974, and hence was not in effect at the time the
balance sheet in this case was prepared it is in the
nature of a codification of accepted principles. He
also referred to what the witnesses admit to be the
leading textbook in Canada, Skinner's Accounting
Principles at page 412 in which the author states:
To the extent that liability under the contingent payment clause
was considered likely, provision for it should be made by the
purchaser. If the likelihood of the payment were small, a note
to the financial statements disclosing the contingency would be
adequate.
Mr. Bonham concluded that in the present case
the proper way to disclose the liability over the
$150,000 actually paid, was by way of notes to the
balance sheet, and the additional amounts would
only be recorded as they became payable out of
the proceeds of the distribution of the film. He
stated that if the liability is a contingent one then
the question of the valuation of it does not come
up, as this would only occur if it were a real and
determinable liability. In his view, and this is
where he differs totally from Mr. Fraser, if a
payment is contingent it results in a contingent
liability even if there is a definite liability to pay
subject to the contingency. He stated that he was
unable to find any justification for treating the
sum of $179,050 shown as deferred cost of film
production in any different manner from the liabil
ity of $577,892 shown on the balance sheet. He
stated that the fixed liability to pay a fixed amount
at an undetermined future date may be contingent
or not depending on the mechanism for determin
ing the date. If it is certain that payment will
mature at some time then it is not a contingent
liability but if it is not merely the time of payment
but the possibility of payment which is uncertain
then it is contingent. Thus a demand note is an
ordinary liability as, while it is not certain that a
demand for payment will ever be made, this
demand is in the control of the creditor. While in
Topaz books the cost actually expended would
properly be capitalized, the purchasers are not in
the same position since the purchasers in setting
up their financial statements must reflect their
cost to them. Even some of Topaz's liabilities
would only be payable if the film made a profit,
and he would be concerned if they should be
shown as liability on the balance sheet.
Counsel for defendant, in his argument, referred
to Stroud's Judicial Dictionary Volume 1, 4th
Edition, page 575 which defines contingent debt
as: "One the time for the payment of which may
or may not arrive" and contingent liability as: "a
liability which by reason of something done by the
person bound will necessarily arise if a certain
event occurs". This is precisely the present case.
Reference was also made to the definition of
contingent liability in the publication Terminology
for Accountants (supra) which reads as follows:
A legal obligation that may arise out of present circumstances
provided certain developments occur. The possibility of a future
liability does not of itself constitute a contingent liability; it
must be a possibility arising out of present circumstances or
pending affairs.
Both parties made extensive reference to the
leading British case of Winter and Others (Execu-
tors of Sir Arthur Munro Sutherland (deceased))
v. Inland Revenue Commissioners' although it
appears that on the facts it can be distinguished
from the present case. It dealt with estate duty
under section 50(1) of the Finance Act 1940 deal
ing with allowances to be made for debts and
incumbrances of a company which provided that
"the commissioners shall make an allowance from
the principal value of those assets for all liabilities
of .the company (computed, as regards liabilities
which have not matured at the date of the death,
by reference to the value thereof at that date, and,
as regards contingent liabilities, by reference to
such estimation as appears to the commissioners to
be reasonable)". Lord Reid stated at page 858:
No doubt the words "liability" and "contingent liability" are
more often used in connexion with obligations arising from
contract than with statutory obligations. But I cannot doubt
that if a statute says that a person who has done something
must pay tax, that tax is a "liability" of that person. If the
amount of tax has been ascertained and it is immediately
payable it is clearly a liability; if it is only payable on a certain
future date it must be a liability which has "not matured at the
date of the death" within the meaning of s. 50(1). If it is not
yet certain whether or when tax will be payable or how much
will be payable why should it not be a contingent liability under
the same section.
It is said that where there is a contract there is an existing
obligation even if you must await events to see if anything ever
becomes payable, but that there is no comparable obligation in
a case like the present. But there appears to me to be a close
similarity. To take the first stage, if I see a watch in a shop
window and think of buying it, I am not under a contingent
liability to pay the price: similarly if an Act says I must pay tax
if I trade and make a profit, I am not before I begin trading
under a contingent liability to pay tax in the event of my
starting trading. In neither case have I committed myself to
anything. But if I agree by contract to accept allowances on the
footing that I will pay a sum if I later sell something above a
certain price I have committed myself and I come under a
contingent liability to pay in that event.
[1961] 3 All E.R. 855.
At page 859 he quotes from Erskine's Institute of
the Law of Scotland, Vol. 2, Book III, title I, s. 6
as follows:
A conditional obligation, or an obligation granted under a
condition the existence of which is uncertain, has no obligatory
force till the condition be purified; because it is in that event
only that the party declares his intention to be bound, and
consequently no proper debt arises against him till it actually
exist: so that the condition of an uncertain event suspends not
only the execution of the obligation, but the obligation itself.
He then goes on to say:
So far as I am aware that statement has never been questioned
during the two centuries since it was written and later authori
ties make it clear that conditional obligation and contingent
liability have no different significance.
It must be remembered in the present case,
however, there is no statute requiring an estimate
at the date of the financial statement of the
present value of the obligation to pay the balance
of the purchase price and furthermore, as defend
ant contends, the uncertainty is not merely as to
when the obligation will be paid but whether it
ever will be. In the case of M.N.R. v. Time Motors
Limited' a car dealer when purchasing cars from
individuals paid for them partly with credit notes
which could be applied only by the holder thereof
and within a stipulated time against the purchase
price of another car of stated minimum value.
These notes were set out in the company's
accounts as a liability at their face value and when
the credit note was redeemed the total selling price
of the automobile was taken into income and the
credit note eliminated from the liability account.
The notes were non-transferable and could not be
redeemed for cash. The Minister contended that
they constituted a contingent liability to be exclud
ed from determining income under the provisions
of section 12(1)(e) and the company argued that
the notes created an immediate binding legal obli
gation that was in no way contingent. Gibson J. in
upholding the Minister's position held that there
existed uncertainty as to the obligations arising
from the credit notes at all material times in that
the company knew that a substantial number of
them would expire without being redeemed. At
page 5083 he states:
5 68 DTC 5081.
The words "contingent account" are not defined in the
Income Tax Act. They are not words of art. By dictionary
definition there must be an element of uncertainty before an
account qualifies as a contingent account, and the element of
the uncertainty must be as to the obligation.
and again:
... it is clear that there existed the uncertainty as to the
obligations arising from these credit notes at all material times,
in that the respondent knew that a substantial number of them
would expire and not be redeemed.....
Extensive reference was also made to three cases
which, while not directly in point, give an indica
tion of the trend of authoritative judicial thinking
on the matter. In the British case of City of
Birmingham v. Barnes (Inspector of Taxes) 6 the
question was whether the corporation which had
laid tramway tracks and received a grant for part
of the cost of the work done could claim capital
cost allowance on the actual cost of the work even
though as a result of the reimbursement its net
total cost was a lower figure. It was allowed to
claim the total cost on an interpretation of the
words in the statute "actual cost to the person". In
rendering judgment Lord Atkin said at page 298:
What a man pays for construction or for the purchase of a work
seems to me to be the cost to him: and that whether some one
has given him the money to construct or purchase for himself;
or, before the event, has promised to give him the money after
he has paid for the work; or, after the event, has promised or
given the money which recoups him what he has spent.
This judgment was referred to in the decision of
President Jackett as he then was in the case of
Ottawa Valley Power Company v. II .N.R.' In that
case Ontario Hydro expended $1.9 million to
change the generating and distribution system of
appellant from 25 cycles to 60 cycles current.
Appellant undertook to change its contract permit
ting it to supply 25 cycle power to a contract for
the supply of 60 cycle power. Appellant claimed
capital cost allowance on the additions and
improvements to its plant paid for by Hydro claim
ing that this was in consideration for giving up the
valuable capital right which it had of delivering 25
cycle power for the balance of the term of the
contract. The appeal was dismissed on the ground
6 [1935] A.C. 292.
7 [1969] 2 Ex.C.R. 64.
that appellant had failed to establish that there
was a capital cost to it of the assets in question on
the basis of the arguments raised by it. In render
ing judgment the learned Chief Justice stated at
pages 75-76:
The straightforward sort of bargain that might have been
expected when the appellant was approached by Hydro in 1955
was that Ontario Hydro would pay to the appellant, for the
desired amendment to the supply contract, whatever it might
cost the appellant to effect the necessary change in its plant.
Had that been the bargain that the appellant made with
Ontario Hydro, the appellant would have incurred the capital
cost of the additions and improvements and, even though it had
been reimbursed by Hydro, it would have been entitled to
capital cost allowance in respect of the capital cost it had so
incurred.
He supported this conclusion with reference to the
Corporation of Birmingham v. Barnes case
(supra) although at the same time pointing out
that the opposite result was reached in a similar
case in the United States of Detroit Edison Co. v.
Commissioner of Internal Revenue 8 which how
ever he distinguished.
However, in a later judgment in D'auteuil
Lumber Co. Ltd. v. M.N.R. 9 he explained his
reasoning in the Ottawa Valley Power Company
case in further detail. In the D'auteuil Lumber
case the Province of Quebec had expropriated 95%
of appellant's timber limit and subsequently the
company exchanged the remainder of its timber
limit together with its right to compensation for
thé expropriated portion for certain cutting rights
granted by the Province. Appellant took the view
that the capital cost to them was the value of the
cutting rights at the time of their acquisition while
the Minister contended that the capital cost was to
be determined by the value of the portion of the
timber limit expropriated together with damages,
interest and the value of the remainder of the
timber limit at the time it was conveyed to the
Province, which was a much lower figure. It was
held that the cost of the cutting rights to the
appellant was the value of what it gave up to get
them. Chief Justice Jackett stated at pages 424
and 426:
8 (1942) 319 U.S. 98.
9 [1970] Ex.C.R. 414.
In view of the reference by the appellant to my judgment in
Ottawa Valley Power Company v. Minister of National Reve
nue, [1969] 2 Ex.C.R. 64 at pages 75 et seq., I must make some
reference to that judgment. There, in a part of my reasons
which did not express any concluded view, I said that, in the
hypothetical case that I was discussing, a supplier was paying
for his plant "by entering into the low-priced supply contract"
and that "prima facie, what he pays for the plant is the value of
the plant". This comes very close to the contention of the
appellant in this case, and, in retrospect, I must admit that I
did not express myself as carefully as I should have done.
There, I was considering a case where the consideration given
for the "plant" was "entering into the low-priced supply con
tract" —a consideration very difficult to put a value on—and
what I am sure that I had in mind is that, "prima facie", the
value of the consideration is equal to the value of what is
received for it, so that where, as in my hypothetical case, what
was received can easily be valued and what was given is almost
impossible to value, it is a fair statement that "prima facie,
what he pays for the plant is the value of the plant". Thus, in
any particular case, there may arise a question as to what
evidence is admissible. Where the value of the thing given for
the capital asset in question can be determined with the same
kind of effort as is required to value the capital asset itself, I
should have thought that the Court would not look kindly on
attempts to lead evidence as to the value of the capital asset in
lieu of, or in addition to, evidence as to the value of what was
given for it. On the other hand, when the value of what was
given is almost impossible to determine and the value of the
capital asset is almost beyond the realm of controversy, it may
well be that the only practicable basis for determining the value
of what was given is to look at the value of the capital asset.
These cases have some bearing in the present
action in that plaintiff contends that, since sums
have been expended or committed in the produc
tion of the film in the amount of $577,892, which
is not disputed, this is the proper cost figure to use
in the calculation of capital cost allowance, where
as defendant contends that only the amount actu
ally expended by the purchasers prior to the end of
the 1971 taxation year can be claimed by them for
capital cost allowance purposes in that year. In
making the purchase they incurred an obligation
to pay the balance but only out of the proceeds of
the film so that both the time of payment and
whether the payment would ever be made were
contingent and these amounts should only be
claimed when and if they are so paid. Certainly, to
use the words of Chief Justice Jackett in the
D'auteuil Lumber case "what was received can
easily be valued and what was given is almost
impossible to value". He goes on to say however
"Where the value of the thing given for the capital
asset in question can be determined with the same
kind of effort as is required to value the capital
asset itself, I should have thought that the Court
would not look kindly on attempts to lead evidence
as to the value of the capital asset in lieu of, or in
addition to, evidence as to the value of what was
given for it". It appears to me in the present case
that the value of the consideration can eventually
be determined with complete accuracy when the
net proceeds of the distribution of the film are
finally received and there is no statutory or other
requirement that an estimate be made of this as of
the end of the 1971 taxation year, in which event
these proceeds would have been impossible to
value.
I cannot adopt plaintiff's argument therefore
that since the purchasers assumed all of Topaz's
obligations in addition to paying $150,000 cash
they are in the place and stead of the vendors and
that the capital cost of the film to them at the end
of 1971 was the same as it would have been to the
vendors.
The question of what weight should be given to
the expert evidence of accountants in tax cases was
dealt with at some length by Thorson J. then
President in the case of Publishers Guild of
Canada Limited v. M.N.R. 10 in which he stated at
pages 49-50:
At this stage it would, I think, be appropriate to make some
remarks of a general nature regarding the role of accountancy
experts in income tax cases. The accountancy profession is not
a static one and the system of accounting which accountants
should apply to the accounts of the businesses in which they are
called upon to act are not immutable. A system of accounting
that would be appropriate to one kind of business is not
necessarily appropriate to a different kind. Only an arbitrary
minded person would contend that there is only one system of
accounting of universal applicability. No reasonable person
would do so. But while accountants devise changes in systems
of accounting to meet the changing conditions in the business
world and new ways of conducting business their guiding
principle must always be the same. Accounting is really the
recording in figures, instead of words, of the financial implica
tions of the transactions of the business to which it is applied.
The accountant is thus the narrator of the transactions, his
narrative being in the form of figures instead of words. His
narrative should be such as to disclose to persons understanding
his language of figures the true position of his client's business
at any given time or for any given period. The accountant
cannot fulfil the duty thus required of him unless he has
carefully considered the manner in which his client carries on
his business and has applied to it the system of accounting that
10 [1956-60] Ex.C.R. 32.
is appropriate to it and most nearly accurately reflects its
financial position, including its income position, at the time or
for the period required.
But the Court must not abdicate to accountants the function
of determining the income tax liability of a taxpayer. That
must be decided by the Court in conformity with the governing
income tax law. It is an established principle of such law in this
Court that there is a statutory presumption of validity in favor
of an income tax assessment until it is shown to be erroneous
and that the onus of doing so lies on the taxpayer attacking it.
But while the Court must be mindful of this principle it must in
its effort to apply the law objectively keep a watchful eye on
arbitrary assumptions on the part of the tax authority such as,
for example, that it is within its competence to permit or refuse
any particular system of accounting and that its decision in the
matter is conclusive. I cannot express too strongly the opinion
of this Court that, in the absence of statutory provision to the
contrary, the validity of any particular system of accounting
does not depend on whether the Department of National Reve
nue permits or refuses its use. What the Court is concerned
with is the ascertainment of the taxpayer's income tax liability.
Thus the prime consideration, where there is a dispute about a
system of accounting, is, in the first place, whether it is
appropriate to the business to which it is applied and tells the
truth about the taxpayer's income position and, if that condi
tion is satisfied, whether there is any prohibition in the govern
ing income tax law against its use. If the law does not prohibit
the use of a particular system of accounting then the opinion of
accountancy experts that it is an accepted system and is
appropriate to the taxpayer's business and most nearly accu
rately reflects his income position should prevail with the Court
if the reasons for the opinion commend themselves to it.
In the present case the Court had the benefit of
two expert accountants' opinion; one from Mr.
Robert Fraser, C.A., a partner with the well-
known firm of Thorne, Riddell who supported the
accounting method adopted by the auditors of the
partnership, the equally well-known firm of
Deloitte, Haskins & Sells, and on the other hand
the opinion of Mr. David Bonham, F.C.A., an
accountancy professor and author of a textbook on
the subject who would merely have set up the
$150,000 down payment for capital cost allowance
purposes, treating the balance of price as a contin
gent liability to be shown by footnotes on the
balance sheet to set up for capital cost purposes
only when and if future payments were made.
There is certainly no prohibition in the governing
income tax law against either method and the
matter is sufficiently controversial that it may be
said that either method is an accepted system of
accounting. In view of the difference of opinion
between the experts however it devolves upon the
Court to determine which system was most appro
priate to the business in question and most accu
rately reflects plaintiff's income tax position,
always bearing in mind as President Thorson
stated that there is a statutory presumption of
validity in favour of an income tax assessment
until it is shown to be erroneous and that the onus
of doing so lies on the taxpayer attacking it.
While the obligation clearly existed in the sense
that the partnership could not unilaterally with
draw from it, and I have concluded that there was
no sham involved in that in 1971 there always
existed a reasonable possibility of the film eventu
ally producing income, I am nevertheless of the
view that the question of whether any further
payments above $150,000 would ever be made on
the obligation was sufficiently uncertain, both as
to time of payment and whether sufficient profits
would ever be generated to allow such further
payments to be made, that the preferable practice
would be to treat this as a contingent liability
directing attention to it by footnotes as Mr.
Bonham suggests. When and if the film generates
profits and additional payments are made on
account of the liability, as now appears possible in
view of the distribution of the film which is now
commencing, the partnership can at that time set
up these further payments as part of the capital
cost and plaintiff can benefit by claiming capital
cost allowance against same in the year or years in
which such additional capital cost is created. As I
indicated previously, however, I do not consider it
proper to equate the capital cost of $577,892
incurred or committed for by the vendors with the
capital cost of the film to the purchasers, who,
while they undertook to pay this sum, only actually
paid $150,000 with the balance being contingent
on the generation of profits by the film.
For the above reasons the appeal is dismissed
with costs and the same judgment applies to the
appeals of the other eleven plaintiffs. Since the
actions were heard at the same time on common
evidence however only one set of costs arising out
of the trial of the action should be allowed with
costs being allowed in the other eleven actions only
up to the time when the order was made for the
hearing of them on common evidence.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.