Elias Rogers Co Ltd. v. MNR, 73 DTC 5030, [1972] CTC 601 (FCTD)

The Chief Justice (orally):—This is an appeal from a judgment of the Trial Division dismissing an appeal by the appellant from its assessments under Part I of the Income Tax Act for the 1966 and 1967 taxation years.

The appellant carried on a business that included the selling of fuel oil. As part of its fuel oil business and, in particular to facilitate the marketing of fuel oil, the appellant acquired and leased water heaters to fuel oil customers or prospective customers.

The sole question involved in this appeal is the question whether one element of the expenses incurred by the appellant in connection with the leasing of water heaters was an expense of earning income that was deductible in computing its annual profit from the business notwithstanding paragraph 12(1 )(b) of the Income Tax Act, which reads as follows:

12. (1) In computing income, no deduction shall be made in respect of

(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part,

Each of the water heaters cost the appellant $197.

When a water heater was leased, it was leased under an agreement of which a sample copy reads, in part, as follows:

Lease Agreement dated August 5, 1966 between THE ELIAS ROGERS COMPANY LIMITED, 2200 Yonge Street, Toronto 1, Ontario, hereinafter called the “Company”, and:

NAME	MR. SAMUEL S. SUGAR
BILLING ADDRESS	609 COLDSTREAM AVE.	TORONTO 19 ONT.
hereinafter called the “Customer”.

The Customer hereby applies to and requests the Company to lease to the Customer a Rogers oil fired water unit (hereinafter called the “appliance”) Model No. 1000-30 for use in the Customer’s residence at 609 COLDSTREAM AVE.

The Customer agrees to lease from the Company and the Company to lease to the Customer said appliance, subject to the terms and conditions hereinafter contained:

1. Installation and all maintenance of the appliance shall be provided solely by the Company and none other. The Company reserves the right to refuse to rent the appliance to the customer if in the opinion of the Company and at its sole discretion, the cost of installation of the appliance is excessive or abnormally high, unless the Customer agrees to pay the additional cost of such installation.

2. The Company shall subject to the provisions of clause 7(b) hereof, at its expense maintain the appliance in efficient operating condition, provided, however, that the Customer shall, at all times, report promptly to the Company any and every indication of defective operation of the appliance. The Customer agrees not to remove, transfer, tamper with, adjust, repair or otherwise in any way interfere with the appliance without written permission from the Company.

3. In consideration of this lease of the appliance, the Customer will pay to the Company a monthly rental of $2.50, payment whereof shall begin on the first day of the month following installation of the appliance and thereafter, such monthly rental shall be due and paid on the first day of each and every month of the term hereafter stipulated. The Customer shall also pay to the Company together with the aforesaid monthly rental and on the dates of payment thereof during the term of this lease Provincial Sales Tax of .70¢.

NO RENTAL CHARGE DURING THE FIRST SIX MONTHS OF THIS AGREEMENT

4. As a condition precedent of this lease, the Customer agrees to purchase from the Company exclusively during the term of this lease all furnace fuel oil required to heat the said residence and for the operation of the said appliance. The sale to you of the furnace fuel oil and conditions of payment thereof are covered by a separate oil contract.

7. This lease is hereby made for a minimum term of two (2) years from the date hereof and shall thereafter continue in full force and effect from year to year, subject however, to right of termination thereof by either party hereto at the expiry of the said two (2) year term or of any subsequent year thereafter, as the case may be, by prior written notice of two (2) months from one party to the other.

8. Upon termination of this lease, the Customer shall surrender the appliance to the Company in the same general appearance and condition as it was at the time of installation thereof, ordinary wear and tear excepted.

9. The Company shall always remain the indisputable owner of the appliance leased by virtue of these presents and upon termination of this lease shall be entitled to disconnect and remove the appliance from the aforesaid residence. The Company will not be responsible for the re-installation or installation or connecting of either the former or any replacement water heater upon the termination of this lease.

It is to be noted that, having purchased the heater for $197, the appellant used it as a source of profit by parting with possession of it to a customer for a net rental of $2.50 or $2.99 per month and that, in addition to parting with possession of the heater during that period, to earn that rental, the appellant had to incur certain expenses, namely,

(a) it had to install the heater at the beginning of each lease, which involved, in 1966,

(b) it had to service the heaters during the term of the lease;

(c) it had to remove the heater at the end of the lease; and

(d) it had, in certain cases, to pay the manufacturer either $28 or $36 for reconditioning the heater between leases.

The plumbing and wiring fixtures and other material that were placed in a customer’s residence as part of the installation of a heater were of no value to the appellant when the heater was removed and were simply left there.

The learned trial judge found that, while the lease provided for a minimum term of two years, the heaters were installed in the expectation that they would be retained for a period of years and the appellant’s experience was that a majority continued for several years.

The appellant treated the purchase price of the heaters as the cost of capital assets. The other disbursements connected with this branch of the appellant’s business, with the possible exception of costs of reconditioning, were deducted by it as operating costs. The respondent allowed all such costs as operating costs except the costs of installation, which were disallowed by him as being expenses the deduction of which was prohibited by paragraph 12(1 )(b) (supra).

The learned trial judge approached the problem by saying, at page 240:

The heaters, when installed, are fixed capital assets. Thereafter, but not before, they are revenue earning assets. The expenses of installing them are preliminary and necessary to the revenue earning use of the heaters and the expenses are incurred in order to bring them into such use. I think that if the appellant had purchased from some supplier heaters which at the time of purchase were installed and ready to be used, the capital cost of the heaters to the appellant as so installed would be the price paid to the supplier, including installation charges. If that be so, why should the installa- tion expenses be classified differently when the appellant installs the heaters? . . .

The lease agreement for the heaters provides for a minimum term of two years and thereafter from year to year, terminable at the expiry of the two-year term or of any subsequent year by prior written notice of two months. There is always the possibility that a customer may terminate the lease at any time, and some have done so within the two years, but heaters are installed in the expectation on the company’s part that by and large the heaters will be retained for a period of years, and the company’s experience is that the majority of the leases continue for at least several years and that the heaters have an average useful revenue earning life of upwards of eight years. The installation expenditures are made once and for all with a view to bringing into use a capital asset for the enduring benefit of the company’s business, at least in the sense that the objective of the company when it enters into a lease of a heater is that the benefit will endure for some years and that the heater will earn revenue throughout that period. The company would hardly be in the business of leasing heaters without having that objective, having regard to the cost of the heater plus the cost of installation vis-a-vis the resulting net revenue. The outlay for installation is an initial expenditure, substantial relative to the cost of the heater itself, and while the expense recurs when a heater reaches the end of its useful life and has to be replaced, or when a lease is cancelled and the heater is removed and installed elsewhere, I do not think that the expenditure involved can be classed as made to meet a continuous demand or as a recurrent expenditure that may be deducted as a current expense from the income of the year in which the outlay is made. The heaters meet, it is true, a continuous demand for fuel oil and they serve the general purposes and general interests of the company’s business, but so do storage tanks and other fixed assets of the company that unquestionably are capital assets.

The learned trial judge then referred to the practice of the major oil companies in the treatment of such expenditures and to the accounting evidence and concluded, at page 241:

On my appreciation of the facts and the guiding features, which I hope is a commonsense appreciation made with proper regard for the business and commercial realities of the matter, I find that the expenses of $14,450 and $27,200 incurred by the appellant during its 1966 and 1967 taxation years on account of various costs relating to the installation of water heaters constituted an outlay or payment on account of capital within the meaning of paragraph 12(1)(b) of the Income Tax Act and, accordingly, were not deductible from income.

In my view, the result in this case does not depend in any way on the fact that the water heater rental branch of the appellant’s business was started with a view to improving its sales of fuel oil. I am of the opinion that the character of the expenses is just the same as it would be if the water heater rental business was carried on quite independently. I see no parallel between cases such as Strick v Regent Oil Co Ltd, [1965] 3 WLR 636, dealing with transactions whose sole purpose is the acquisition of long term “ties” and a case such as this where there are transactions that are a part of the ordinary current operations of the business with an incidental provision for “ties” in respect of other business.

It is common ground that the expenses in question were expenses of the appellant’s business and were therefore deductible unless their deduction is prohibited by paragraph 12(1 )(b) of the Income Tax Act. Compare BC Electric Railway Co Ltd v MNR, [1958] SCR 133, per Abbott, J at 137-38; [1958] CTC 21; 58 DTC 1022.

The significant prohibition in paragraph 12(1)(b) is the prohibition of the deduction, in computing income, of a “payment on account of capital”. These words clearly apply, in the ordinary case, to the cost of installing heavy plant and equipment acquired and installed by a businessman in his factory or other work place so as to become a part of the realty. In such a case the cost of the plant and the cost of installation is a part of the cost of the factory or other work place as improved by the plant or equipment. Clearly this is cost of creation of the plant to be used for the earning of profit and not an expenditure in the process of operating the profit making structure. Such an expenditure is a classic example of a payment on account of capital.

What we are faced with here is, however, quite different. The appellant has not used the water heaters to improve or create a profit-making structure. Quite the contrary, the appellant has parted with possession of the heaters in consideration of a monthly rental and it has no capital asset that has been improved or created by the expenditure of the installation costs. I think it must be kept clearly in mind that, while the installation costs are exactly the same as a businessman would have incurred if he had bought a water heater and installed it in his own factory, from the point of view of the question as to whether there is a payment on account of capital, there is no similarity between such an expenditure and an expenditure made by a lessor of a water heater to carry out an obligation that he has undertaken as part of the consideration for the rent that he charges for the lease of the water heater.

With great respect to the learned trial judge, as it seems to me, once the matter is regarded as an expenditure by a renter of equipment to carry out one of the covenants in his leasing arrangement, it becomes quite clear that it is not an expenditure to bring into existence a capital asset for the enduring benefit of the appellant’s business. It does not bring into existence any asset belonging to the appellant. On the contrary, as I view it, there is no difference between the installation costs and any other expenditure, such as those for repairs or removal of the heaters, that the appellant has to make in the course of its rental business.

I should have thought that, in any equipment rental business, while the cost of the equipment and money spent to improve the equipment is payment on account of capital, because the thing rented is the capital asset of such a business, money spent in order to carry out the lessor’s obligations under the rental agreements is cost of earning the income just as rents received under such agreements is the revenue of such a business.

If, for example, such a person rented a crane on terms that he would move it to the site where it is required and install it there, I should have thought that the money spent on such movement and installation would be costs of earning the rental whether the period of the lease was a day, a month, a year or five years.

Testing the matter another way, if in this case the water heaters were rented at the appellant’s premises at a somewhat lower rental under an agreement whereby, if the renter so desired, the appellant would transport and install them at the renter’s expense, the transaction, from a business point of view, would come to the same thing but I do not think that there could be any question of applying paragraph 12(1)(b) to prohibit the appellant from setting off the expenses of movement and installation against the reimbursement received from the renter.

Once it is established that the expenses in question are otherwise expenses of operating the business, the mere fact of extracting from the customer an incidental promise to use the appellant as his exclusive supplier of oil cannot, in my view, change the character of the expenses.

In my opinion the appeal should be allowed with costs in this Court and in the Trial Division, the judgment of the Trial Division should be reversed and the assessments under appeal should be referred back to the respondent for reassessment on the basis that the installation costs in question were deductible in computing the appellant’s income for each of the years in question.

Sheppard, DJ (orally):—This appeal arises out of the outlays by the appellant, The Elias Rogers Company Limited, in installing water heaters free of charge and as a result had an expenditure of $14,450 in the taxation year 1966, and $27,200 in the taxation year 1967, which outlays the appellant contends were made or incurred for the purpose of gaining or producing income from its business and were, therefore, deductible from its income under paragraph 12(1 )(a) of the Income Tax Act. On the other hand the respondent contends that the outlays were not deductible from the income as they were part of the capital costs within paragraph 11(1)(a) or 12(1)(b).

The appellant company of Toronto, Ontario sells fuel oil, sells and installs furnaces and services heating equipment and also leases fuel oil water heaters to customers. The fuel oil business had been opposed by the use of gas for purposes of heating and to meet thai competition and retain a market for fuel oil the appellant decided to install at its own expense fuel oil water heaters.

In 1966 the appellant entered into several agreements for the lease of water heaters to customers for fuel oil (Exhibit A3) providing for monthly rental of $2.50 to begin six months following installation and 10 cents a month for sales tax and for the appellant installing and maintaining the water heaters. In 1967 the monthly rental and the sum for sales tax were to commence on the first day of the month following installation, the other terms remained the same.

The benefits which the appellant received under such agreements were as follows:

(a) The rental of $2.50 per month or $30 per year.

(b) The sale of 300 gallons of fuel oil at 20 cents a gallon or $60 per year. This is the gross sum. The net is not given. The average householder used 900 gallons of fuel oil per year to heat his house.

(c) “As a condition precedent of this lease” the customer agreed to purchase exclusively from the appellant during the term of the lease all furnace fuel oil to heat the customer’s house and to operate the water heater.

(d) There were fewer cancellations amongst customers who had rented the water heaters than among other customers of the appellant. In 1969, 1.7% of the customers having water heaters cancelled and 6.49% of those customers who did not have water heaters. In 1970, 2.2% of those having water heaters cancelled while 6.28% customers without water heaters cancelled. (Exhibit A1.)

Under the agreements the appellant incurred the following liabilities:

(a) The purchase price of each water heater in the amount of $197. The cost of installing the water heaters was in 1966, $85 each and in 1967, $100 each. Also, the appellant, under clause 2, undertook the cost of maintaining the water heater in an efficient operating condition and in pursuance of this clause, had contracted with a third party for the cost of reconditioning the water heaters as required. The tanks were expected to last eight years and the oil burner 20 years. The agreement provided for the duration of the lease for a minimum of two years and thereafter from year to year with the right to termination on two months’ notice at the end of the year. However, as a matter of public relations, the appellant had to permit termination within the two years, but the average duration of the lease agreement was 6.8 years.

(b) The outlays here in question were made by the appellant for installing those water heaters under the agreements and the appellant, therefore, contends that the cost of installing was for the purpose of gaining or producing income from its business and there arises the issue on this appeal.

In MNR v Algoma Central Railway, [1968] SCR 448; [1968] CTC 161; 68 DTC 5096, the railway company employed another company to make a geological survey of the district in which the railway operated with a view to increasing the population and thereby its traffic. Fauteux, J in delivering the judgment of the Court stated at page 449 [162, 5097]:

Parliament did not define the expressions “outlay . . . of capital” or “payment on account of capital”. There being no statutory criterion, the application or non-application of these expressions ot any particular expenditures must depend upon the facts of the particular case. We do not think that any single test applies in making that determination and agree with the view expressed, in a recent decision of the Privy Council, B.P. Australia Ltd. v. Commissioner of Taxation of the Commonwealth of Australia, [1966] A.C. 224, by Lord Pearce. In referring to the matter of determining whether an expenditure was of a capital or an income nature, he said, at p. 264:

“The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer,” The learned President, after considering all the facts in the present case, decided that the expenditures in issue were not of a capital nature within the provisions of Section 12(1)(b) of the Income Tax Act. We agree with his conclusion. Hence, the appeal should be dismissed with costs.

The absence of a rigid test and the necessary regard to the “whole set of circumstances” has led to some difficulties in such cases.

In Usher's Wiltshire Brewery Ltd v Bruce, [1915] AC 433, the brewery reduced the rental of a public house in order to obtain covenants making it a tied house and the brewery company was held entitled to deduct the reduction in rental from its revenue.

In BP Australia Ltd v Commissioner of Taxation, [1966] AC 224, the company agreed to pay to garage owners a sum for the promise to buy gas exclusively from BP and the Privy Council held that the amount paid was an expenditure of income. On the other hand, in Regent Oil Co Ltd v Strick (Inspector of Taxes), [1966] AC 295, under similar facts, the House of Lords held the amount paid to be a capital payment. These cases differed in the circumstances. The Usher's Wiltshire Brewery Ltd case (supra) was a reduction of that sum otherwise received as income. The BP Australia Ltd case (supra) and the Regent Oil Co Ltd case (supra) may be regarded as outlays for advertising.

The costs of installation in the case at bar should be regarded as services of the appellant made for the purpose of gaining or producing income with paragraph 12(1)(a). The agreement contains two provisions:

(1) The lease proper is contained in the opening clause whereby the customer “applies to and requests the Company to lease to the Customer . . . for use in the Customer’s residence at 609 Coldstream Ave. The Customer agrees to lease from the Company and the Company to lease to the Customer said appliance, subject to the terms and conditions hereinafter contained:” together with clause 3 and the following clauses. This lease is completed for the appellant by delivery by the appellant to the customer and that delivery may be anywhere or at the residence of the customer, but certainly without installation and the customer is thereby restricted to use the water heater “in the Customer’s residence at 609 Coldstream Ave”.

(2) Collateral provisions for the services of the appellant in installing and maintaining the water heater were contained in clauses 1 and 2. The distinction between a clause forming part of the lease and a collateral provision was in the minds of the parties as indicated in clause 4 which begins “as a condition precedent of the lease”; clauses 1 and 2 do not contain any such words as those prefacing clause 4. Clause 3 makes the rental to begin to run following the installation, but the appellant could allow anyone, even the customer, to install the water heater. There is nothing in the lease proper to prevent clause 1 from being a collateral clause.

As stated by Lord Morris of Borth-y-Gest in Regent Oil Co Ltd v Strick (Inspector of Taxes) (supra) at page 329:

. . . There is a difference between the profit yielding subject and the process of operating it. . . .

Here, the water heater is the “profit yielding subject” and the installation in clause 1, and the maintenance in clause 2, are “the process of operating it”, hence are services rendered pursuant to these collateral clauses and result in the outlays in question. The expenses of maintenance cannot be a capital outlay as these are made from time to time as the need arises and not made “once and for all” within British Insuluated and Helsby Cables Ltd v Atherton, [1926] AC 205 (Viscount Cave, LC at 213). As the maintenance of the water heater must be “for the purpose of gaining or producing income” within paragraph 12(1 )(a), the installation must be for the same purpose a service to be rendered to the appellant and likewise within paragraph 12(1)(a).

The appeal will, therefore, be allowed with costs and I agree with the disposition of the learned Chief Justice.