T-255-75
The Queen (Plaintiff)
v.
Alfred C. Huxtable (Defendant)
Trial Division, Thurlow A.C.J.—Halifax, May 31;
Ottawa, July 8, 1977.
Income tax — Income calculation — Deductions —
Associated companies — Unused reserve for ship's quadrenni
al survey in 1968 accounts to be included in vendor company's
1969 income — Vendor allowing purchasing company equal
amount against consideration payable in non-arm's length
transaction in 1969 = Whether or not vendor company
allowed to deduct amount for 1969 tax year — Income Tax
Act, R.S.C. 1952, c. 148, ss. 6(1)(eb), 11(1)(ea), 12(1)(a),(e).
This is an appeal from a judgment of the Tax Review Board
that allowed an appeal by the defendant from a re-assessment
of income for 1969. Bedford Investments Limited became a
personal corporation in 1969, and the defendant, as owner, was
liable for tax in respect of a dividend deemed to have been
distributed to him equal to the income of the company for the
year. The issue is whether the company was entitled to deduct
$48,750 which it allowed "New Newfoundland", a company
that had bought Bedford's ship, goodwill and entitlement to a
tax refund in a non-arm's length transaction in 1969. That
amount had been entered in Bedford's 1968 accounts as
"reserves" for a quadrennial survey of its ship. As that reserve
had not been used in that year, it was to be included in
Bedford's 1969 tax year. Bedford credited New Newfoundland
$48,750 against what would have been the balance of consider
ation to have been paid, and in that sense, Bedford paid New
Newfoundland the amount in respect of the cost of the ship's
quadrennial survey. As other assets of Bedford were transferred
in the same transaction, the $48,750 could not be regarded as a
reduction in purchase price of the ship.
Held, the appeal is allowed. Bedford's allowance of $48,750
is not in any relevant sense a reserve within the meaning of
paragraph 12(1)(e). Although the amount set up in Bedford's
1968 accounts was a reserve and deductible in 1968, what was
allowed New Newfoundland was not a reserve but an item of
disbursement. Paragraph 12(1)(e) has no application to prohib
it its deduction. Although this disbursement must be taken to
have been incurred within the meaning of paragraph 12(1)(a),
it was not made for the purpose of gaining or producing income
from Bedford's business within the meaning of that paragraph.
The incurring of the need for a survey is not equivalent to the
making of an outlay or the incurring of expense for a survey,
and cannot be treated as an expense. There was in fact and in
law no expense incurred by Bedford to which Bedford's allow
ance to New Newfoundland could relate and from which it
could take the character of an expense for a quadrennial
survey.
INCOME tax appeal.
COUNSEL:
G. W. Ainslie, Q.C., and Mrs. Alison Scott-
Butler for plaintiff.
E. C. Harris, Q.C., and G. S. Black, Q.C., for
defendant.
SOLICITORS:
Deputy Attorney General of Canada for
plaintiff.
Daley, Black & Moreira, Halifax, for
defendant.
The following are the reasons for judgment
rendered in English by
THURLOW A.C.J.: This is an appeal from a
judgment of the Tax Review Board which allowed
an appeal by the defendant from a re-assessment
of income tax for the year 1969. In that year
Bedford Investments Limited (formerly New-
foundland Canada Steamships Limited) became a
personal corporation, as defined in section 68 of
the Income Tax Act, and under section 67 of the
Act the defendant, as owner of the company, was
liable for tax in respect of a dividend deemed to
have been distributed to him equal to the income
of the company for the year. The issue in the
appeal is whether the company in computing its
income was entitled to deduct an amount of
$48,750 which it allowed or credited to a newly
incorporated company, named Newfoundland
Canada Steamships Limited, in the transaction
which is described in what follows.
The Tax Review Board, after hearing evidence,
concluded that Bedford was entitled to the deduc
tion and accordingly allowed the appeal. In this
Court, however, the case was presented on an
agreed statement of facts which, with the docu
ments therein mentioned, including the pleadings,
constitutes the material on which the matter must
be determined. In summary, what they disclose is
that Bedford, after operating a ship known as the
Bedford II for some years, on January 1, 1969,. in
a transaction not at arm's length, sold the ship, the
company's goodwill and its entitlement to a tax
refund to the new company (hereinafter New
Newfoundland), and that that company assumed
certain items shown on its opening balance sheet
as liabilities. Included under the latter was an item
referred to as "reserves", Quadrennial Survey,
$48,750. Such an amount was included by Bedford
in computing its income for the year ending
December 31, 1968, as a reserve for quadrennial
survey under paragraph 11(1)(ea) of the Income
Tax Act' and, in consequence and since the quad
rennial survey was not done in 1968, it became
necessary for Bedford, under paragraph 6(1)(eb) 2 ,
to include that amount in computing its income for
1969. Of that, there is no longer any dispute. It is
claimed, however, that Bedford is entitled to
deduct a like amount of $48,750 as a revenue
expense incurred in the course of the transaction of
January 1, 1969. In this connection, the plaintiff's
statement of claim contains, among others, the
following three paragraphs which were admitted
by the defendant:
8. As the vessel, Bedford II, was subject to the provisions of the
Canada Shipping Act for quadrennial surveys, Old Newfound-
land, Bedford, had set up a reserve in its accounts of $48,750 as
of December 31, 1968, in respect of the survey which was to be
required to be performed during 1969;
9. Bedford transferred the vessel on January 1, 1969, to New
Newfoundland at its undepreciated capital cost in the hands of
Bedford;
' R.S.C. 1952, c. 148, paragraph 11(1)(ea) added 1966-67, c.
91, subsection 3(2).
11. (1) Notwithstanding paragraphs (a), (b) and (h) of
subsection (1) of section 12, the following amounts may be
deducted in computing the income of a taxpayer for a
taxation year:
(ea) such amount as may be prescribed as a reserve for
expenses to be incurred by the taxpayer by reason of
quadrennial or other special surveys required under the
Canada Shipping Act, or the regulations thereunder, or
under the rules of any society or association for the
classification and registry of shipping approved by the
Minister of Transport for the purposes of the Canada
Shipping Act;
2 R.S.C. 1952, c. 148, paragraph 6(1)(eb) added 1966-67, c.
91, subsection 1(2).
6. (1) Without restricting the generality of section 3,
there shall be included in computing the income of a taxpay
er for a taxation year
(eb) the amount deducted as a reserve under paragraph
(ea) of subsection (1) of section 11 in computing the
taxpayer's income for the immediately preceding year;
10. Bedford also agreed to give New Newfoundland an amount
of $48,750, the amount appearing on the books of Bedford as a
reserve for quadrennial surveys, in respect of the estimated cost
of the quadrennial survey;
In view of this and the other facts appearing
from the agreed statement, it appears to me that:
(1) in the transaction, the amount of $48,750
was in fact allowed or credited by Bedford to New
Newfoundland, against what otherwise would have
been the balance of the consideration to be paid or
given by New Newfoundland;
(2) in that sense, the amount was paid by Bed-
ford to New Newfoundland on January 1, 1969, in
respect of the estimated cost of the quadrennial
survey; and,
(3) as other assets of Bedford were transferred
in the same transaction, the $48,750 should not be
regarded simply as a reduction of the price to be
paid for the ship.
It should be noted, however, that while the
owner is required by the Canada Shipping Acta to
have the quadrennial survey done, and cannot get
a certificate to permit further operation of the ship
until the survey has been done, it is no more than a
condition for further operation since the owner has
at all times the alternatives of disposing of the ship
to a buyer or of having her broken up for scrap in
either of which instance there would be no further
obligation on him to have a survey made. Or he
might let her lie idle. It is only if he proposes to
continue operating the ship that he must have the
survey made.
The question then is whether Bedford is entitled
to a deduction in respect of the $48,750 which it
allowed or paid to New Newfoundland. The prin
cipal points of Mr. Ainslie's argument, as I under
stand it, were that there was never any actual
liability on Bedford to have the quadrennial survey
carried out, that at most there was a potential
liability which would mature only if Bedford con
tinued to operate the ship, that this potential liabil
ity and the state of the ship were no doubt taken
into account in arriving at the value of the assets
to be transferred to New Newfoundland but that
this does not give rise to a deductible expense, that
even if Bedford had agreed to have the survey and
3 R.S.C. 1970, c. S-9.
repairs carried out, on the authority of Montship
Lines Limited v. M.N.R. 4 , the amount would not
be deductible, and that if the $48,750 is an amount
allowed in respect of dilapidations, since no repairs
were carried out, the amount is a mere estimate
and its deduction is prohibited by paragraph
12(1)(e). On the latter point, counsel relied on
Edward Collins & Sons, Ltd. v. The Commission
ers of Inland Revenues, The Naval Colliery Co.,
Ltd. v. The Commissioners of Inland Revenue 6
and Peter Merchant, Ltd. v. Stedeford (H.M.
Inspector of Taxes)'. He also read from Southern
Railway of Peru Ltd. v. Owens, James Spencer &
Co. v. Commissioners of Inland Revenue 9 , and
Federal Commissioner of Taxation v. James
Flood Proprietary Limited 10
While these cases illustrate principles applied in
other jurisdictions, I do not find them of much
assistance in resolving the present problem. It
must, I think, be remembered that they are deci
sions on provisions of the statutes applicable to the
situations with which they deal and that such
provisions are not necessarily the same as those of
the Income Tax Act. The difference between the
English statute and the Australian statute is
brought out in the following passage from the
judgment in the Flood case at pages 505-506. It is
also apparent from the passage that both statutes
are different from the Income Tax Act.
In considering such questions the difference should never be
overlooked between the English income tax law and the Com
monwealth statute. The Report of 1936 of the Income Tax
Codification Committee, par. 76, contains the following
description of the English system:—"It has often been the
subject of judicial comment that the existing Acts contain no
general direction as to the ascertainment of business profits.
Such guidance as they give is confined to a statement that the
amount to be assessed is 'the balance of the profits or gains' of
the business, subject to a series of provisions prohibiting certain
specific deductions—some of which, being in the form of
limitations, are taken as authorisations of deductions within the
limits. It has been left to the Courts to lay down that 'the
balance of the profits or gains' must, in the absence of express
provision to the contrary, be arrived at in accordance with
ordinary commercial principles, and to formulate the principle
that a proper debit item in a trading or in a profit and loss
4 [1954] Ex.C.R. 376.
5 (1924) 12 T.C. 773.
6 (1928) 12 T.C. 1017.
7 (1948) 30 T.C. 496.
8 [1957] A.C. 334.
9 (1950) 32 T.C. 111.
10 [1953] 88 C.L.R. 492.
account is, in general, a proper debit item in an income tax
computation."
The principle of the Commonwealth Act, on the other hand,
is to calculate the taxable income as the amount remaining
after deducting from the assessable income all allowable deduc
tions and to restrict allowable deductions to deductions allow
able under the Act. What losses and outgoings arising in the
course of business are to be deducted is a matter which must be
governed by s. 51(1) of the Income Tax Assessment Act. Under
its provisions all losses and outgoings may be deducted to the
extent to which they are incurred in gaining or producing the
assessable income, or are necessarily incurred in carrying on a
business for the purpose of gaining or producing such income,
provided, of course, they are not of a capital nature or other
wise excluded. The word "outgoing" might suggest that there
must be an actual disbursement. But partly because such an
interpretation would produce very strange and anomalous
results, and partly because of the use of the word "incurred",
the provision has been interpreted to cover outgoings to which
the taxpayer is definitively committed in the year of income
although there has been no actual disbursement.
The scheme of the Income Tax Act, so far as it
is applicable to the present situation, is found in
sections 3, 4, and 12. By section 3, the income of a
taxpayer (which, under paragraph 139(1)(av),
includes any person) for a taxation year includes
inter alia income from all businesses. By section 4
subject to the other provisions of Part I of the Act,
income for a taxation year from a business or
property is the profit therefrom for the year. It is
well established that the profit from a business is
the profit as ascertained by the application of
ordinary commercial principles, but for income tax
purposes the profit so established is subject to such
limitations or alterations as are required to give
effect to the other provisions of Part I of the Act.
Among these is section 12 which provides inter
alia that:
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,
(e) an amount transferred or credited to a reserve, contin
gent account or sinking fund except as expressly permitted
by this Part,
Under these provisions, in order to qualify for
deduction an outlay or expense that is deductible
in computing profit on ordinary commercial prin
ciples must also fall within the exception to para-
graph 12(1)(a). If, on the other hand, the item to
be claimed is not an actual outlay or expense but
an amount set aside or taken into account to
provide for some anticipated outlay or expense for
which liability has not yet arisen, it will be, in
substance and in fact, a reserve and will fall under
the prohibition of paragraph 12(1)(e).
On the facts of the case, it appears to me to be
impossible to regard the allowance or payment of
$48,750 made by Bedford to New Newfoundland
in the transaction of January 1, 1969, as in any
relevant sense a reserve within the meaning of
paragraph 12(1)(e). The amount of $48,750 set up
by Bedford in its accounts for the period ending
December 31, 1968, was a reserve, and was
deductible as such, in computing income for 1968,
under paragraph 11(1)(ea) and the regulations,
notwithstanding paragraph 12(1)(e). But what
was allowed or paid to New Newfoundland on
January 1, 1969, was not a reserve. It was, if it
was anything at all, an item of disbursement and
the fact that its amount was calculated or arrived
at as an estimate of the cost of the survey does not
make it in any sense a reserve. Paragraph 12(1)(e)
accordingly has no application to prohibit its
deduction.
On the other hand, adverting to paragraph
12(1)(a), while I think the disbursement must be
taken to have been "made" or "incurred" within
the meaning of those terms in the paragraph, I am
not satisfied that it was made or incurred "for the
purpose of gaining or producing income from" the
business of Bedford, within the meaning of that
paragraph. The business had been that of operat
ing the Bedford II. But the amount was not
allowed or paid to enable Bedford to continue to
operate the ship, and the transaction in which the
amount was allowed or paid was not a transaction
in the course of the business. It was a transaction
that disposed of the assets employed in the busi
ness and put an end to it. Such a transaction is not
one for the purpose of gaining or producing income
from the business. Nor is the amount which Bed-
ford, in the transaction, agreed to pay or allow an
outlay or expense incurred "for the purpose of
gaining or producing income from" the business.
The exception to paragraph 12(1)(a) is not a
narrow one. Speaking generally, it includes any
expense that is an incident or part of the profit-
earning operation. But, even if it is broad enough
to include, in some instances, an expenditure
incurred in a transaction by which the business is
terminated, of which there may be some question
and which it is not necessary now to decide, it does
not appear to me to embrace an expenditure of the
kind here in question, that is to say, an expenditure
not for a survey of the ship but simply to give the
purchaser of the capital assets of the business,
including the ship, an allowance in respect of the
anticipated cost of a survey which he might there
after use or not use for that purpose, as he might
see fit. Plainly it was not an outlay for a survey
because no survey was made.
The defendant's position was that the expense of
a quadrennial survey is really incurred while the
ship is being operated but, as there is no annual
outlay made or expenses incurred for it, nothing
could be deducted in respect of it in any of the first
three years because of paragraph 12(1)(e), that
Parliament recognized this as being unfair and has
provided for it by paragraph 11 (1) (ea), that if and
when a taxpayer pays anyone else to do with
respect to a quadrennial survey what otherwise the
taxpayer would ultimately have to do and then
becomes entitled to deduct the cost, what the
taxpayer pays equally relates to the operation of
the vessel in the preceding years and the payment
takes its character from that of the expense for
which it was substituted. He cited as an instance of
this the common practice of apportioning current
taxes between vendor and purchaser in closing real
estate transactions. It is a tempting argument, but
I do not think it can prevail.
With respect to the submission that the expense
of a quadrennial survey is incurred while the ship
is being operated, it is to be observed that the
material before me provides no guide as to how the
matter is regarded or dealt with in ordinary com
mercial practice. It was said, however, that for
income tax purposes the amount of the reserve
deducted under paragraph 11(1)(ea) in 1968 was
equal to three-quarters of an estimate of what the
survey would cost, based on the experience of the
actual cost of the previous quadrennial survey.
Throughout that stage, however, there was no
outlay made or expense incurred for the survey.
There was only a reserve which, so far as income
tax purposes are concerned, fell under the prohibi
tion of paragraph 12(1)(e) except to the extent
permitted by paragraph 11(1)(ea). It appears to
me to follow that in the statutory scheme the
incurring of the need for a survey is not equivalent
to the making of an outlay or the incurring of
expense for a survey and cannot be considered or
treated as, in itself, an expense. There was, thus, in
fact and in law no expense incurred by Bedford to
which, in computing income for income tax pur
poses, the allowance or payment made by Bedford
to New Newfoundland could relate or from which
it could acquire or take the character of an
expense for a quadrennial survey.
With respect to the practice in real estate trans
actions, the analogy appears to me to break down
because in such situations there is, in fact, a
liability for taxes which is an expense incurred by
one party or the other in respect of the year in
which the sale occurs. Here there was no quadren
nial survey and no cost was incurred by vendor or
purchaser for one.
In the course of argument, counsel for the
defendant suggested that, if I should conclude that
the $48,750 was simply a reduction in the price of
the ship, the matter should be referred back to the
Minister with a direction to deduct a terminal
capital cost allowance. The point, however, was
not raised in the defence and, in any case, I have
not concluded that the $48,750 was a reduction in
the price of the ship.
The appeal accordingly succeeds and will be
allowed with costs and the re-assessment will be
restored.
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.