The Queen v. Nomad Sand & Gravel Ltd., 87 DTC 5343, [1987] 2 CTC 112 (FCTD)

Rouleau, J.: —This is an appeal commenced by way of statement of claim from a decision of the Tax Review Board dated January 4, 1982, allowing the defendant's appeal of a notice of reassessment issued by the plaintiff on March 16,1979 with respect to the defendant's 1976 taxation year.

During the period in question the defendant company carried on the business of operating a sand and gravel pit at Brighton, Ontario. The company's operation consisted of removing raw material from a gravel pit, transporting it to crushers and washers and from there to loading trenches. Three “966 Carruthers" front-end loaders were used to transport the material.

In order for the defendant to obtain the necessary licence to operate a gravel pit, it was required, pursuant to the Pits and Quarries Control Act, S.O. 1971, c. 96, to produce a site plan for the rehabilitation of the area. The rehabilitation required by the Act comprised levelling off the banks of the pit, the gradual sloping of the floor of the pit, covering the area with top soil and planting grass and trees on the site. The defendant estimated the cost of such rehabilitation to be approximately between $125,000 and $130,000.

Pursuant to section 5 of the Pits and Quarries Regulations, O. Reg. 545/71, a levy of $0.02 per ton was imposed on the material extracted from the pit as security towards the cost of the rehabilitation. The amount paid by the defendant as a levy bore interest at the rate of six per cent and was refundable when and if the rehabilitation of the pit was completed.

In its 1976 taxation year, the defendant claimed as an expense in carrying on business the amount of $7,994.02 paid by it to the Ontario government pursuant to the Pits and Quarries Control Act. The Minister reassessed the defendant's 1976 taxation year on the basis that the defendant's 1976 taxation year on the basis that the defendant was not entitled to claim the amount as an expense and that certain assets owned by the defendant and used in its operations, namely front-end loaders, should be classified as Class 10 assets for capital cost allowance purposes, rather than as Class 22 assets as claimed by the defendant, with the result that the capital cost allowance claimed was reduced by the amount of $3,972.85.

The defendant objected to the reassessment of March 1979 and the Minister of National Revenue confirmed the reassessment by a notification of confirmation dated June 13, 1980. The defendant then appealed to the Tax Review Board which, by judgment dated January 4, 1982, allowed the appeal. It is that judgment which is now under appeal.

There are two issues before the Court. The first is whether the payments made by the defendant to the Ontario government pursuant to the Pits and Quarries Act were an outlay or expense incurred by the defendant to earn income from its operation within the meaning of paragraph 18(1)(a) of the Income Tax Act and therefore deductible from its income for the taxation year in question or whether they are deposits or reserves which are not deductible under paragraph 18(1)(a) or (e) of the Act.

The second issue is whether the front-end loaders used by the defendant in its sand and gravel operations are, for the purpose of calculating capital cost allowance, items falling within Class 22, Schedule B of the Income Tax Act, as contended by the defendant or whether the equipment falls within Class 10, as alleged by the plaintiff.

The Crown's position is that the amounts paid by the defendant to the Ontario government pursuant to the Pits and Quarries Act are not an expense under the Income Tax Act because the moneys were paid into what the Crown calls a contingency account and are therefore not deductible. The Crown argues that the amount is paid on deposit with the Treasurer of Ontario and that the deposit may be forfeited if the rehabilitation program is not properly carried out by the company making the deposit. Further, the money cannot be considered an expense or an outlay because the loss of the deposit under subsection 11(2) of the Pits and Quarries Control Act, 1971 is contingent upon the discretionary power of the Provincial Minister. The Crown maintains that the province had no ownership in the moneys paid as a levy until such time as the rehabilitation work was not performed by the defendant. If, however, the work was performed then the moneys would be returned to the company but would not be considered to be income.

As to the second issue, the classification of the front-end loaders used in the defendant's operation, the plaintiff maintains that the loaders were acquired and used by the defendant for the purpose of gaining and produc- ing income from a mine and therefore fall within the definition of Class 10 property. It was agreed by both parties that the determination of this issue would depend on whether or not a gravel pit is a mine. It is the plaintiff's submission that the defendant's gravel pit operation did constitute a mining operation.

The defendant, on the other hand, argues that even though the payments made by it to the Government of Ontario are referred to in the Pits and Quarries Control Act, 1971 as a deposit as security for the rehabilitation of the sand and gravel pit, the defendant was under no obligation to carry out such rehabilitation and, in fact, never intended to do so since the cost of such rehabilitation would have been significantly higher than the total amount of the payments. The defendant further argues that it was required by law to make these payments in order to earn income from its sand and gravel operation. The defendant's operation was subject to the provisions of the Pits and Quarries Control Act and the Regulations which imposed a legal obligation on the defendant to make the payments in question to the provincial government. Accordingly, the plaintiff submits these payments were directly related to the defendant's revenues and in turn its profit or income, from the sand and gravel opertion for the year in respect of which the payment was made.

The defendant's position is that it would never in fact actually obtain a refund of the amount of moneys it paid as a levy. In order to get the payments back the defendant would have been required to spend a substantially higher amount towards the cost of rehabilitation; that is the cost of rehabilitation would greatly exceed the aggregate amount of the payments made pursuant to the legislation so that the defendant would never obtain an actual refund or get any money back as alleged by the plaintiff. Therefore, the defendant argues, once these moneys were paid by it to the province, they were gone forever.

The defendant's next submission in support of its argument that the payments are deductible is that they were made in accordance with the generally accepted accounting principles. The basic accounting principle supporting the deductibility of these expenses is that of matching revenues and expenses so that the financial statement of a particular period will present fairly the results of operations for that period; it is a matter of matching the expenses to the revenue for that period.

In this case the defendant argues, where the cost of rehabilitating the pit far exceeds the payments made by way of the levy charged, the payment made in each year would be reported as an expense for accounting purposes. Further, the payment was required in order to earn income from the business and was directly related to the amount of material removed from the pit in that year. In that way, there was an appropriate matching of revenues and expenses in calculating profit and loss for that year.

It is the defendant's position that generally accepted accounting principles should normally be applied for taxation purposes unless, by exception, some provision of the Income Tax Act requires a departure from those principles. The defendant's submission is that the payments made by it to the province were clearly outlays or expenses made or incurred for the purpose of producing income from the defendant's operation and are therefore proper deductions in the calculation of its income for income tax purposes pursuant to sections 9 and 18 of the Income Tax Act.

As to the classification of the front-end loaders, the defendant maintains that this equipment falls squarely within the definition of class 22 assets which during the year in question provided as follows:

Property acquired after March 16, 1964, that is power-operated movable equipment designed for the purpose of excavating, moving, placing or compacting earth, rock, concrete or asphalt, but not including a property that is included in class 7.

The front-end loaders, argues the defendant, were power operated, movable equipment designed for and used by the defendant for moving and placing earth or rock, in the form of sand and gravel. Contrary to the opinion held by the plaintiff, the defendant is of the view that its operation did not constitute a “mining” operation which would result in the front-end loaders being classified as Class 10 items for the purpose of calculating the defendant's capital cost allowance.

Counsel for the plaintiff relied on the Supreme Court of Canada decision in M.N.R. v. Atlantic Engine Rebuilders Limited, [1967] C.T.C. 230; 67 D.T.C. 5155 to support its argument that the defendant's payments to the province were deposits and not expenditures. I am not persuaded by the plaintiff's argument nor do I think that the Atlantic case is of any assistance to its proposition. The facts of that case are clearly different from those in the case at bar. There the respondent company rebuilt Ford engines. When a rebuilt engine was shipped to a Ford dealer, the dealer was charged the invoice price of the rebuilt engine plus a deposit to be held pending receipt of a used rebuildable engine of the same model. The unredeemed deposits held by the respondent company at the end of its taxation year were added by the Minister to the company's declared income for the year. The Minister argued that the company was not entitled to any deduction in respect of its liability to repay the deposits since the liability was contingent upon the delivery by the dealers of the used engines. The Court held that the deposits could not be regarded as forming part of the respondent company's profits and that there was nothing in the Income Tax Act to require them to be treated as profits.

That finding, according to the plaintiff, should lead this Court to the conclusion that a deposit made by a taxpayer is not an expenditure in the same way that the receipt of a deposit cannot be considered to be income.

I disagree with the plaintiff. The Atlantic case, supra, does not, in my opinion, lead to that conclusion. The dicta of the Supreme Court of Canada in Atlantic which is of particular importance to this case is that a taxpayer is to be taxed on its true profit in each year. I can see nothing in the case which is of assistance to the plaintiff based on the facts of this case.

I fail to see the relevance of the other authorities relied upon by the plaintiff in support of its position. For example, the plaintiff referred to the Federal Court of Appeal decision in The Queen v. Burnco Industries Ltd. et al., [1984] C.T.C. 337; 84 D.T.C. 6348. In that case the taxpayers upon excavating gravel from a gravel pit, became obligated to back-fill the area pursuant to an agreement with the local municipality. Although the costs of backfilling were not incurred until a subsequent taxation year, the taxpayers deducted the expenses in the year of excavation. The Federal Court of Appeal found that the deductions were properly disallowed, holding that an expense could not be said to have been incurred by a taxpayer who was under no obligation to pay out any money. Clearly, that is not the case here, where the defendant was obligated, pursuant to the Pits and Quarries Control Act and its regulations, to pay the levy to the Province of Ontario in order to carry out its sand and gravel pit operation. I agree with the Federal Court of Appeal's finding that expenses cannot be deducted until they are incurred; I disagree with the plaintiff that the decision in Burnco is of any relevance to this case.

In my opinion, the annual levy payments made by the defendant to the province constitute a part of the defendant's current operating expenses and are deductible under paragraph 18(1)(a) of the Income Tax Act. Subsection 9(1) of th Act states that income for a taxation year from a business or property is the "profit" therefrom for the year. It has long been recognized that tax must be imposed not on the gross amount received but on that amount /ess the expenses incurred to produce it. Paragraph 18(1)(a) of the Income Tax Act is recognition of that very fundamental principle:

18. (1) In computing the income of a taxpayer from a business or property 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 the business or property;

Paragraph 18(1)(b) of the Act prohibits the deduction of 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 Part I of the Act.

There are therefore two tests for an allowable deduction. First, the expenditure must pass the test of having been made for the purpose of gaining or producing income. Second, it must then be shown not to be capital in nature. Provided the expenditure meets these two criteria, it is then deductible as a current expense.

The Income Tax Act does not define the term "profit" as that word is used in subsection 9(1) of the Act. However, a judicial statement as to the proper approach for determining net profit is set out in Daley v. M.N.R., [1950] C.T.C. 254, 50 D.T.C. 877 where Thorson, P. stated at 260 (D.T.C.880)

. . . The correct view, in my opinion, is that the deductibility of the disbursements and expenses that may properly be deducted “in computing the amount of the profits or gains to be assessed" is inherent in the concept of “annual net profit or gain" in the definition of taxable income contained in Section 3. The deductibility from the receipts of a taxation year of the appropriate disbursements or expenses stems, therefore, from Section 3 of the Act, if it stems from any section, and not at all, even inferentially, from paragraph (a) of Section 6.

That being so, it follows that in some cases the first enquiry whether a particular disbursement or expense is deductible should not be whether it is excluded from deduction by Section 6(a) or Section 6(b) but rather whether its deduction is permissible by the ordinary principles of commercial trading or accepted business and accounting practice. . .

Section 3 was the forerunner to the present subsection 9(1) and paragraph 6(a) was the forerunner to the present paragraph 18(1)(a).

Therefore, in accordance with this principle, an expenditure properly deducted according to accounting standards would be deductible for tax purposes unless prohibited by some provision of the Act.

There is, in my opinion, no question that the amount paid in this case by the defendant to the Province of Ontario in the form of an annual levy constitutes an allowable deduction. The expenditure was made, indeed had to be made by the defendant, for the purpose of gaining income from its sand and gravel pit operation and is clearly not capital in nature.

With regards to the second issue, whether the front-end loaders used by the defendant fall within Class 10 or Class 22 for the purpose of determining the defendant's permissible captial cost allowance, there is no doubt in my mind that the defendant must succeed in its argument that the equipment falls squarely within the Class 22 definition of Schedule B of the Income Tax Act. In order for this Court to find that the front-end loaders fall within the Class 10 definition of assets the plaintiff would have to satisfy me that the equipment was used for the purpose of gaining or producing income from a "mine".

The plaintiff was unable to refer me to one case which stands as authority for the proposition that a gravel pit or stone quarry is a “mine”. The case of Paju et al. v. M.N.R., [1974] C.T.C. 2121; 74 D.T.C. 1087 deals most directly with this issue and the facts of that case are virtually identical to those in the case at bar. In Paju the taxpayers owned and operated a gravel pit. In 1970 the taxpayers purchased a new loader and classified this machine as well as two other loaders under Class 22 of Schedule B of the Income Tax Act in order to claim 50 per cent depreciation. The Minister refused to allow this. The Tax Review Board held that the taxpayers were allowed to claim 50 per cent depreciation on their equipment, finding that a gravel pit does not necessarily fall under the definition of a “mine” and therefore the loader qualified as a Class 22 asset. At page 2123 (D.T.C. 1088) the Board stated:

Learned counsel for the respondent argued that Class 10 (30%) applied to the loaders since this was mining machinery and equipment acquired for the purpose of gaining or producing income from a mine. On the basis of the judgment in Canadian Gypsum Co. Ltd. v. M.N.R., [1965] 2 Ex. C.R. 566; [1965] C.T.C. 210; 65 D.T.C. 5125, learned counsel argued that the gravel pit was a mine and the loaders accordingly were properly classified in this group by the respondent.

In my humble opinion I do not think this resolves the point. The term “mine” is as vague and indefinite as the term “mineral”. Whether in the circumstances this particular gravel pit would be called a “mine” is questionable to say the least. The appellants described the 1970 loader as a huge self-propelled diesel tractor on rubber tire wheels with a front end hydraulically-operated bucket having a capacity of 3 cubic yards, and cost $44,583.38. The two old loaders were much smaller and on January 1st, 1970, had a book value of approximately $200.00.

While it is conceivable that these loaders could be used in a mine, it does not follow that Class 22 is not open for depreciation purposes when they are used for excavating, moving or loading.

I have come to the conclusion that the respondent erred in reducing the amount of captial cost allowance claimed on the ground that a loader does not qualify as a Class 22 asset.

I do not think a clearer statement on the issue could be made. Counsel for the plaintiff attempted to circumvent the finding of the Tax Review Board in Paju, supra, by suggesting that the wording of subsection (k) of Class 10 of the 1970 Income Tax Act referred to mining machinery and equipment whereas the wording of the 1976 Act refers generally to property acquired for the purpose of gaining or producing income from a mine. Accordingly, the plaintiff maintains that the issue in Paju was whether the loader was mining equipment and not whether a gravel and sand pit operation was a mine. I disagree with the plaintiff and I am bound to conclude, as did the Tax Review Board in this case, that the decision in Paju goes further than what the respondent suggests.

Accordingly, in my opinion, the defendant's front-end loaders properly fall within the Class 22 definition of assets in Schedule B.

For the above reasons, the plaintiff's appeal is dismissed. Costs to the defendant.

Appeal dismissed.