MNR v. Enjay Chemical Co. Ltd., 71 DTC 5293, [1971] CTC 535 (FCTD)

WALSH, J :—This is an appeal from a decision of the Tax Appeal Board dated June 22, 1970 (reported [1970] Tax A.B.C. 742) allowing the appeal of En jay Chemical Co. Limited from an income tax assessment for its 1962 taxation year in which appellant had included, in computing respondent’s income, the sum of $112,350 credited to it as a rebate by Esso International Inc. which respondent had included in its statement of earnings for the year in question describing same as "‘Forgiveness of debt’’ and which it had deducted in computing its taxable income for the said year in the reconciliation statement filed together with its financial statements with its income tax return. Respondent is a corporation incorporated in the Province of Newfoundland and was at all material times a resident of Canada carrying on the business of buying, selling and otherwise dealing in chemicals of various kinds and other substances and was a wholly owned subsidiary of Standard Oil Company of Canada Limited which was, in turn, a wholly owned subsidiary of Standard Oil Company (New Jersey), and Esso International Inc. was also a wholly owned. subsidiary of Standard Oil Company (New Jersey), so that respondent and Ksso International Inc. were related persons within the meaning of Section 139(5a) (c) of the Income Tax Act and were therefore not dealing with each other at arm’s length within the meaning of Section 139(5) of the Income Tax Act. The respondent’s 1961, 1962 and 1963 fiscal periods ended on December 31, 1961, December 31, 1962 and December 31, 1963. respectively and it computed its profits annually on the accrual method of accounting. In November 1961 it purchased from Esso International Inc. 5,031,179 pounds of oxo-alcohol for U.S. $710,876.09 or Canadian $732,202.37, the conversion price having been established at the rate of exchange prevailing on the date of shipment of the oxo-alcohol. The purchase price was not paid at the time of purchase so respondent increased its accounts payable by the amount of $732,202.37 resulting from this purchase.

In conformity with the accrual method of accounting and the periodic inventory method of determining cost of goods sold, respondent computed its cost of goods sold for the 1961 fiscal period by adding the purchase price of Canadian $732,202.37 to the value of its inventory on hand at the commencement of its 1961 fiscal period and subtracted from the amount so arrived at the cost of its inventory on hand at the end of the 1961 fiscal period. In computing its cost of goods sold for its 1962 and 1963 fiscal periods respondent valued its 1962 and 1963 opening inventories at the amounts at which they were valued at the end of its 1961 and 1962 fiscal periods, respectively. No further oxoalcohol was purchased by respondent during the said three year period and the 5,031,179 pounds were sold as follows:

444,968 pounds in the 1961 fiscal period;

3,930,198 pounds in the 1962 fiscal period ; and

656,013 pounds in the 1963 fiscal period.

The purchase price of the oxo-aleohol was worked out at 15.44 cents per pound which was arrived at by deducting from the market price at which respondent could re-sell the oxo-aleohol, its handling and marketing costs and an expected profit margin, the market price in the United States and Canada at the time of the purchase being about U.S. 16 cents per pound. However, on or about February 2, 1962 the market price of oxo-alcohol at which respondent could re-sell declined by about 13% and, in addition, between November 1, 1961 and February 2, 1962, the Canadian dollar declined in value in relation to the U.S. dollar so that it became apparent that respondent would suffer a loss on the resale of the remaining inventory of oxo-alcohol. Respondent thereupon approached Esso International Inc. advising of the loss which it expected would be sustained if it were required to pay for the. oxo-alcohol at the purchase price agreed 111- in November 1961 and indicated that, in this event, insolvency was a possibility. Esso International Inc. reviewed these representations and, as a result, unconditionally abated and reduced by U.S. $107,000 the amount owing to it at April 30, 1962 by respondent. This abatement was in respect of losses occasioned or expected to be occasioned by the reduction of the selling price of the oxoalcohol and also loss on foreign exchange. The Canadian equivalent of U.S. $107,000 on April 30, 1962 was approximately $112,350 and the amount was arrived at as follows :

Respondent. was notified of the abatement by letter dated May 3, 1962 and immediately increased one of its income accounts in the amount of Canadian $112,350. Respondent in due course paid Esso International Inc. the following amounts on account of its obligation :

The sum Of these payments and the amount of Canadian $112,350 abated by Esso International Inc. is Canadian $759,041.92 which is Canadian $26,839.55 higher than the Canadian dollar equivalent of the purchase price of Canadian $732,202.37 incurred at the time of purchase and represents the increased cost to respondent of making the payments. of Canadian $646,691.92 occasioned by the decline in value of the Canadian dollar in relation to the United States dollar between the time:of purchase of the oxo-alcohol and the time of the payments made therefor.

Appellant claims that the sum of $112,350 was properly included in computing respondent’s income for the. 1962 taxation year in that :

(a) it was a liability in revenue account and arose out of a transaction in the course of respondent’s current business operations so that the adjustment to the liability in 1962 should be taken into account. and reflected in the computation of respondent’s profits or gains for that year ;

(b.) the reduction in 1962 in the cost of the inventory sold in 1962 must be reflected in the computation of respondent’s cost of goods sold for that year, as to treat the cost of goods sold as an amount which was greater than the true cost resulting from the ‘reduction artificially distorts respondent’s profits which is not in accordance with the Income Tax Act or with proper accounting principles ;

(c) in any event, since respondent has not paid the said amount of Canadian $112,350 to Esso International Inc., a person with whom it was not dealing at arm’s length before a day one year after the end of the 1962 taxation year, the amount is not deductible in computing respondent’s income for the 1962 taxation year pursuant to the provisions of Section 12(3) of the Income Tax Act even if it would otherwise have been a deductible outlay or expense, which appellant does not admit;

(d) in any event, the sum was a subsidy in trading account and properly formed part of respondent’s income for 1962;.

(e) in any event, if Esso International Inc. conferred a benefit upon respondent in the amount of $112,350 it should be included in computing respondent’s income by virtue of. Section 137 (2) of the Income Tax Act. , ;

Respondent’s amended reply to the notice of appeal which + was: filed at the opening of the hearing and was accepted by consent, sets out that its obligation to Esso International Inc. on account of the oxo-alcohol purchase was absolute and that it had no legal right to have the said obligation reduced for any reason whatsoever and that at no time were the terms of the purchase price renegotiated. An invoice was issued by Esso International Inc. in November 1961 when the oxo-alcohol was purchased by respondent and no amended or further invoice was ever issued in respect: to it. It further: sets out: that the amount of $112,350 was unconditionally forgiven to prevent respondent from becoming insolvent, that it was not computed by reference to the volume of purchases and was not otherwise a subsidy or rebate granted to respondent by Esse International Inc. It sets out that its obligation in respect ‘of the purchase was a trade debt incurred in its. 1961 year and that the forgiveness in 1962 did not constitute or cive rise to income in the hands of respondent in its 1962 taxation year. It claims that the amount of $112,350 was not a deduction in computing its income'for its 1962 taxation year and that the provisions of Section 12(3) of the Act are not applicable since the cost of purchasing the oxo-aleohol was the cost of purchasing an. asset and was not as such an otherwise deductible outlay or expense’’ within the meaning of that section and that, in any event, if the part of the cost of the oxo-alcohol that was reflected in its profit and loss statement in 1962 as part of its computation of. cost of goods sold was to be regarded as ‘‘an otherwise deductible outlay or expense’’ in that year, there was no part of such amount unpaid at the end of the respondent’s 1963 year. It further contends that the sum was forgiven for bona fide business reasons and was not a benefit conferred on respondent within the meaning of Section 137(2) of the Act. Alternatively, since the Minister has included the amount of $112,850 in income under the provisions of Part I of the Act, Section 137(2) even if it were found that the forgiveness constitutes a benefit which is not admitted, does not permit the Minister to include the amount thereof in income unless such amount would otherwise be regarded as income under the provisions of Part I of the Act. Finally, it pleads in the alternative that even if appellant is correct in stating that the amount of Canadian $112,350 should be reflected in respondent’s cost of goods sold, which it does not admit, it is nevertheless incorrect to state that the entire amount should be reflected in income in 1962 since not all of the inventory on hand at the end of 1961 was sold in 1962, 3,930,198 pounds being sold in 1962 and the balance of 656,013 pounds sold in 1963 and that accordingly the reduction in the cost of the inventory should be reflected in respondent’s cost of goods sold in 1962 and 1963 by reference to the amounts of oxo-alcohol sold in each of those years respectively. Finally, it contends that its 1962 profits were computed in accordance with generally accepted accounting principles and the provisions of the Income Tax Act and that it is entitled to be assessed accordingly.

The leading ease on the subject and that on which respondent relies most heavily is that of The British Mexican Petroleum Company, Limited v. Jackson (H.M. Inspector of Taxes), 16 T.C. 570, a case which was first decided by Rowlatt, J. in the King’s Bench Division whose judgment was confirmed on appeal by the Crown to the Court of Appeal and again confirmed on appeal to the House of Lords. Without going into too much detail with respect to the somewhat complicated facts of the case, it can be stated that the British Mexican Petroleum Company was incorporated for the purpose, inter alia, of entering into an agreement with the Huasteca Petroleum Company, which owned large oil resources, to buy oil from it. Huasteca had a substantial shares interest in the company. For a time the business prospered until there was a slump in the petroleum business as a result of which by June 30, 1921 it owed Huasteca £1,073,281 and on September 30, 1921 it owed the sum of £1,270,232, which liability was never disputed. In order to assist it in its difficulties which resulted from the fact that the rates under which the purchase contract had been based were in excess of the rates now current as a result of the slump, a new agreement was drawn up which, inter alia, provided that upon payment by British Mexican of the sum of £325,000 before a certain date, the existing contract would be cancelled and it would be relieved from further performance thereunder. As a result of this agreement it was relieved of indebtedness in the amount of £945,232, which was carried direct to the balance sheet and shown in a separate item as reserves. It. was agreed that this would be applied by reducing the amount shown in its books in respect of vessels to a figure more nearly representing the market value thereof. It was contended on behalf of the company that the sum relieved was not a profit or gain or of the character of a receipt arising in the course of its trade but, on the contrary, was in the nature of a gift explicable by reference to the interest of the Huasteca Company in its capital and, furthermore, that in arriving at its profits for any accounting period it was entitled to set against the receipts from its sales its indebtedness for the cost of goods purchased and that the sum of £945,232 should not be brought into account for the purpose of computing the profits of the company either for the year ending June 30, 1921 or the eighteen month period to December 31, 1922. The Crown on its part contended that the remission was a trading transaction and must be brought into account in computing the profits of the company either in the eighteen month period to December 31, 1922 during which the release was made or, alternatively, for the year ending June 30, 1921, the account for that year being reopened for the purpose. In his judgment in favour of the taxpayer, Rowlatt, J. stated at pages 584-85:

. . . What is chargeable to Income Tax . . . is the profit which is made by comparing the amount which you receive from selling goods or rendering services, or whatever it is, with the amount which you pay out in putting yourself in a position to do that by buying goods and equipping yourself, finding the expenses for rendering the services or whatever it is—with the necessary adjustments in the account to allow for the stock which is carried over from year to year . . . that is what it is, the difference which you enjoy between what you receive and what you have to pay out in the year’s trading. How on earth the forgiveness in that year of a past indebtedness can add to those profits I cannot understand. It is not a matter depending upon the form in which the accounts are kept. It is a matter of substance, looking at the thing as it happened, as a man who knows nothing of scientific accountancy might look at it—it is the receipts against payments in trading.

And again at page 585 :

. . In this case the debt was absolutely fixed at the time and has not been diminished by any sort of consideration owing to the validity or the disputability of the debt or anything of that kind. It has been diminished purely, for this purpose I must regard it, as an act of grace although business motives were behind it. But it has simply been forgiven and nothing else—for no reason and for no point connected with the transaction or the debt itself. It is purely for collateral business reasons that they do not want this Company to founder under the debts of past years. That is what that is.

In the House of Lords judgment; Lord Thankerton sets out appellant’s argument at page 591 as follows:

The main argument for the Appellant was that the amount of £1,073,281 owing to the Huasteca Company had been treated as an expense of the trade deductible from gross receipts in the trading account to 30th June, 1921, but that, to the extent to which it was subsequently released, it was in fact never expended; that the original price for the goods having been reduced by agreement, the price actually paid and not the original price was the amount of the deduction allowable for Income Tax purposes; and that the account to 80th June, 1921, should be opened up and the deduction should be brought into conformity with the amount actually paid. Alternatively, he maintained that the amount of the sum released ought to be brought into the profit and loss account as a credit item in the period in which the release was granted.

At page 592 he states:

My Lords, I am of opinion in the present case, that the account to 30th June, 1921, cannot be reopened, as the amount of the liability there stated was correctly stated as the finally agreed amount of the liability and the subsequent release of the Respondents proceeds on the footing of the correctness of that statement.

The Appellant’s alternative contention, which was not seriously pressed by the Attorney-General, is equally unsound, in my opinion. I am unable to see how the release from a liability, which liability has been finally dealt with in the preceding account, can form a trading receipt in the account for the year in which it is granted.

Lord Macmillan, in rejecting the argument that the sum of £945,232 should be entered as a credit item in these accounts for the eighteen months ending December 31, 1922, stated at page 593:

. . I say so for the short and simple reason that the Appellant Company did not, in those eighteen months, either receive payment of that sum or acquire any right to receive payment of it. I cannot see how the extent to which a debt is forgiven can become a credit item in the trading account for the period within which the concession is made.

In the case of Geo, T. Davie and Sons Limited v. M.N.K.,

[1954] Ex. C.R. 280; [1954] C.T.C. 124, Cameron, J. held that the abatement of a capital liability was not something received in the course of a taxpayer’s normal trading operations. It did not receive payment of the sum in question or acquire any right to receive it but its liability was diminished purely as an act of erace and this was not a profit from appellant’s business. He closely examined the judgment in the British Mexican case (supra) and stated at. page 295 [139] : o

In my view, that case is authority for the proposition that the mere cancellation or abatement of an undisputed trade debt does not give rise to taxable income in the hands of a taxpayer whose trade debt has been cancelled or abated, subject perhaps to the question reserved by Lord Macmillan and which I have referred to above.* [1] That being so, it cannot be found that the abatement of a capital indebtedness—as in the instant case—can give rise to taxable income.

In the Davie ease, however, the sum abated was part of the amount due to Canadian Commercial Corporation on loans made, and the indebtedness did not arise out of a purchase. The sum released was an abatement, not a subsidy.

In the case of Oxford Motors Limited v. M.N.R., [1959] S.C.R. 548; [1959] C.T.C. 195, the appellant was a distributor and retailer for foreign made automobiles and had become heavily indebted to the supplier, having a large inventory of cars on hand due to market conditions. The supplier then granted it a rebate of $250 on each automobile in stock and subsequently sold to be applied against the outstanding indebtedness. The Supreme Court held, Cartwright, J. dissenting, that the rebate was taxable as income earned in the course of appellant’s trading operations, each rebate being in the nature of a discount granted or subsidy paid to supplement the appellant’s trading receipts, referring to the ease of Lincolnshire Sugar Company, Limited v. Smart, [1937] A.C. 697. It further held that the fact that the rebate took the form of credits against appellant’s indebtedness did not alter the true character or make them merely the foregiveness of a debt previously incurred. It distinguished the British Mexican case, Abbott, J., in rendering the judgment of the Court, stating at page 553 [202] :

The British Mexican case did not decide, that under no circumstances can the forgiveness of a trade debt be taken into account, in determining the taxable profit arising from the carrying on of a business, and I have found no subsequent case in which it has been so held. No one has ever been able to define income in terms sufficiently ‘concrete to be of value for taxation purposes. In deciding upon the meaning of income, the Courts are faced with practical considerations which do not concern the pure theorist seeking to arrive at some definition of that term, and where it has to be ascertained for taxation purposes, whether a gain is to be classified as an income gain or a capital gain, the determination of that question must depend in large measure upon the particular facts of the particular case.

He emphasizes that in the British Mexican case the amount remitted was properly considered as a capital item quoting the judgment of Lord Hanworth at page 588 to the effect that the release was given

. . . not by way of return of something which had been taken out from the Company in a previous accounting period, but which was, by a new bargain made, to afford new capital and was under the terms of that bargain to be placed to the relief of the depreciation account and not otherwise. It cannot be brought into the profit and loss account of either 1921 or 1922.

The question was again considered by Dumoulin, J. in the case of Galipeau v. M.N.R., [1962] C.T.C. 289; [1962] DTC 1178, in which appellant borrowed $49,000 from Imperial Oil for the expansion of his garage and service station and Imperial Oil agreed to credit $275 each month against his indebtedness provided he continued to sell Imperial Oil’s products exclusively, such products to be supplied to him at regular prices. Appellant contended that the credits were a forgiveness of debt and therefore a capital receipt not subject to tax. The appeal was allowed, the DTC headnote reading:

The $275 monthly credits were not taxable as income in the appellant’s hands. Whether the agreement between the appellant and Imperial Oil was viewed as a conditional forgiveness of debt or a contract limiting the appellant’s freedom of action, the monthly credits could not be regarded as trading profits. In business practice, agreements for the forgiveness of a debt are usually conditional. The monthly credits received by the appellant as the consideration for accepting a restriction on his future trading rights, were in the nature of capital receipts.

The present case could be distinguished from Oxford Motors Ltd. v. M.N.R. as decided by the Supreme Court of Canada (59 DTC 1119). In the Oxford Motors case, the rebate of $250 per car was dependent upon the number of cars sold; in the present case, there was no relationship between the appellant’s sales and the monthly reduction of the amount of the loan.

Of considerable interest on the question of looking at the matter on ordinary commercial principles and determining it on practical considerations rather than on the evidence of accounting experts is the judgment of Jackett, P., as he then was, in the case of Associated Investors of Canada Limited v. M.N.R., [1967] 2 Ex. C.R. 96; [1967] C.T.C. 138, which dealt with the converse situation where the appellant wrote off as a business expense certain sums which had been advanced against commissions to salesmen in pervious years which were deemed irrecoverable and written off in the year in which this decision was made. It was held that the advances to salesmen were not capital transactions but an integral part of appellant’s business operations and a loss in their value must, on ordinary commercial principles, be taken into account in computing the profit of its business for the year in which appellant as a businessman recognized that the loss had occurred. At pages 101-102 [148-144] he sets out the general principle:

Profit from a business, subject to any special directions in the statute, must be determined in accordance with ordinary commercial principles (Canadian General Electric Co. Ltd. v. M.N.R., [1962] S.C.R. 3, per Martland, J. at p. 12; [1961] C.T.C. 512 at 520). The question is ultimately ‘‘one of law for the court”. It must be answered having regard to the facts of the particular case and the weight which must be given to a particular circumstance must depend upon practical considerations. As it is a question of law, the evidence of experts is not conclusive. (See Oxford Motors Ltd. v. M.N.R., [1959] S.C.R. 548, per Abbott, J. at p. 553; [1959] C.T.C. 195 at 202; and Strick v. Regent Oil Co. Ltd., [1965] 3 W.L.R. 636 per Reid, J., at pp. 645-6. See also M.N.R. v. Anaconda American Brass Ltd., [1956] A.C. 85 at p. 102; [1955] C.T.C. 311 at 319.

My first task is therefore to determine the proper treatment of the amounts in question in accordance with ordinary commercial principles. Having ascertained that, I must consider whether any different treatment is dictated by any special provision of the statute.

Ordinary commercial principles dictate, according to the decisions, that the annual profit from a business must be ascertained by setting against the revenues from the business for the year, the expenses incurred in earning such revenues.

In considering whether the results of any transaction can be considered in computing the profit of a business for a particular year, the first question is whether it was entered into for the purpose of gaining or producing income from the business (compare Section 12(1) (a)). If it was not, such results cannot be taken into account in computing such profits. Even if the transaction was entered into for the purpose of the business, if it was a capital transaction, its results must also be omitted from the calculation of the profits from the business for any particular year (compare Section 12(1) (b). See B.C. Electric Railway Co. Ltd. v. M.N.R., [1958] S.C.R. 133, per Abbott, J. at p. 187; [1958] C.T.C. 21 at 25). There is no doubt that the appellant made advances to its sales employees as part of its effort to make a profit from its business. What is said, however, is, in effect, that they were capital transactions.

This judgment refers to the case of Canadian General Electric Company v. M.N.R., [1962] S.C.R. 3; [1961] C.T.C. 512, a foreign exchange question in which the appellant had borrowed funds from its parent United States company, the loan being evidenced by promissory notes payable in U.S. funds, and during the currency of these notes the Canadian dollar rose from a discount to a premium over the U.S. dollar so that the appellant was able to pay off all the notes at a substantial saving which the Minister added to appellant’s declared income for 1952, the year in which the majority of the notes were paid off, under the heading "‘foreign exchange profit on notes payable”. The appellant contended that the profit should be computed on an accrual basis and that in order to give a true picture of the company’s position it was necessary, from an accounting point of view, to revalue the amount of Canadian dollars necessary on each balance sheet date to pay off the outstanding notes so that the total amount of the profits would be apportioned over the years 1950, 1951 and 1952. The appeal was allowed, and in rendering the majority judgment Martland, J. stated at page 14 [521] :

In 1951, at the commencement of the year, the appellant’s estimate of the liability as of the end of 1950 was carried forward. At the end of each subsequent month it was revised in accordance with the then existing exchange rate and again an estimate was made at the year end. During that year there had been a decline in the premium payable on the U.S. dollar, so that by the year end the cost to the company of paying off the U.S. obligation had declined. The liability which had been taken into account in computing profit for the year 1950 was now less than it had been in that year. In order properly to show the appellant’s position in the year 1951 it was necessary for it to make this revision of estimate and thereby it disclosed a "profit", which was really a reduction of the liability, as previously taken into account in 1950. The appellant’s position, under the "accrual" method of accounting, had improved. It was only because of the application of that method, in the first place, that the liability had been taken into account in terms of Canadian dollars in 1950.

And, again, on the same page [p. 522] :

In 1952 the notes were paid off and our problem is as to the “profit” which accrued in that year. In my view, the “profit” from its business, in 1952, in relation to the notes, should be the amount by which, in terms of Canadian dollars, the cost of payment was reduced in that year. This represented the difference between the estimate of the cost of payment as of the beginning of the year 1952 and the actual cost of payment in that year.

This judgment discusses the earlier Supreme Court judgments in foreign exchange cases of Eli Lilly c Company (Canada) Limited v. M.N.R., [1955] S.C.R. 745; [1955] C.T.C. 198, and Tip Top Tailors Limited v. M.N.R., [1957] S.C.R. 703; [1957] C.T.C. 309, pointing out that in both of those cases, the question before the Court was as to whether certain profits resulting to the taxpayer from fluctuations in the foreign exchange rate constituted capital gains or taxable income. Both cases held that the profit from exchange was taxable as it was a necessary part of appellant’s trading operations and not a capital gain, although in the Lilly case, dissenting judgments of Locke and Cartwright, JJ. would have applied the British Mexican case (supra) which was distinguished by the majority judgment, pointing out that in the case at bar there was no gift nor had the item in question ever been settled and that the parent company had continued to claim the invoice price of the goods in terms of United States dollars. In the Lilly case, Estey, J., rendering the majority judgment, stated very clearly at page 751 [204] :

. . . the principle that should be applied and, in my view, the established practice must. here be followed that whether there be a loss or a gain in respect to the item of foreign exchange it should be taken into account as a trading loss or profit in the computation of income tax.

In his dissenting judgment in the Tip Top Tailors Limited case, Cartwright, J., as he then was, makes an interesting distinction between that case and the Lilly case pointing out that in the Lilly case the relationship between the appellant and its parent company was throughout that of a vendor and purchaser and the account on payment of which the saving held to be taxable was made was the merchandise account for goods sold and delivered, whereas in the Tip Top Tailors Limited case the relationship was one of lender and borrower and he states at page 716 [321] :

. . . I can find nothing sufficient to displace this prima facie presumption that a saving made in discharging an obligation to a lender is properly treated as an item of capital and not of revenue.

In the present case we are, of course, dealing with the relationship of vendor and purchaser and not of lender and borrower and it should be pointed out that at least part of the rebate made was to compensate the purchaser for loss as a result of foreign exchange fluctuation, and in view of the above-cited Supreme Court jurisprudence it can now be taken as settled law that profit or loss arising from such fluctuations must be taken into account as part of a taxpayer’s taxable income. The Canadian General Electric Company case (supra) was not a decision on the question of whether such amounts should be included but the issue was rather the question of when this profit should be taxed.

A similar distinction to that made by Cartwright, J., as he then was, in the Tip Top Tailors Limited case (supra) was made by Gibson, J. in the case of Golden Horseshoe Turkey Farms Limited v. M.N.R., [1969] 2 Ex. C.R. 369; [1968] C.T.C. 294, in which Maple Leaf Mills Limited not only forgave a debt owing to it by the appellant incurred by the purchase of seed from it, which sum was not in issue, but also a further debt of $24,222.11 incurred by way of financial accommodation provided by Maple Leaf Mills Limited to the appellant when it paid that sum to a company known as Cuddy Turkey Farms Limited, a creditor of the appellant, in respect of four invoices for the purchase of turkey poults. Justice Gibson pointed out that the relationship between appellant and Cuddy Turkey Farms Limited was that of debtor and creditor in respect of turkey inventory but the relationship between the appellant and Maple Leaf Mills Limited was that of lender and borrower in respect of a similar sum of $24,222.11 and that it is the latter relationship which is in issue and that therefore the abatement of this debt, although resulting in a profit to the appellant arising out of its dealings with Maple Leaf Mills Limited, was in the course of their relationship of lender and borrower and the profit therefore was not income within the meaning of that term in the Income Tax Act and not taxable.

In the ease of J. D. Stirling Ltd. v. M.N.R., [1969] 2 Ex. C.R. 303; [1969] C.T.C. 418, while he found against the taxpayer on other grounds, Jackett, P., as he then was, stated at page 309 [424] :

. . . I have no doubt that, if a man carrying on a business asserts claims in a particular year for goods sold or services rendered in a previous year over and above anything that he may have charged for those goods or services in the year in which they were delivered or sold, and manages to collect such additional amounts even though he has no legal right to do so, the amounts so collected are revenues of his business for the year in which they are realized even though the profits of his business are otherwise computed on a so-called accrual basis.

He referred to the British Mexican and Oxford Motors cases (supra) at page 308 [423] stating:

Clearly, the release of a debt (such as the sum of $250,789.43 that was the balance of accounts as between the two companies in this case as it appeared from their respective books) does not of itself give rise to revenue from the debtor’s business even though the amount released is a debt that has been taken into account as an expense of that business. See British Mexican Petroleum Co. v. Jackson, 16 T.C. 570. A release of a trade debt may, however, be a means of effecting a payment that is part of the current revenues of a business. Compare Oxford Motors Ltd. v. M.N.R., [1959] S.C.R. 548; [1959] C.T.C. 195.

The case of the Lincolnshire Sugar Company, Limited v. Smart (supra) a leading case referred to in a number of the judgments cited and which was itself referred to by counsel for respondent, dealt with facts substantially different from the present case in that it concerned a subsidy paid rather than a release of indebtedness. In it advances had been made by virtue of the British Sugar Industry (Assistance) Act, 1931, to a company carrying on businesses as manufacturers of sugar from beet grown in Great Britain and they were held to be trading receipts of the company and liable to income tax. These advances were repayable under certain contingencies which did not arise during the relevant period and hence became irrecoverable. The judgment held, however, that the decisive question was that the payments were made to the company in order that the money might be used in its business and hence they were in the nature of subsidies or grants. The company, however, did not carry them into profit and loss but entered them as liabilities in the balance sheet. In rendering judgment, Lord Macmillan stated at page 704:

. . . It was with the very object of enabling them to meet their trading obligations that the "advances" were made; they were intended artificially to supplement their trading receipts so as to enable them to maintain their trading solvency.

In the present case, while no actual sums were paid by Esso International Inc. to appellant by way of subsidy but instead a voluntary forgiveness of part of the indebtedness was made, it could certainly be said that this forgiveness was made with the object of enabling appellant to meet its trading obligation and to artificially supplement its trading receipts so as to enable it to maintain its trading solvency.

I now turn to the accounting treatment adopted by appellant. I can find no fault with the inclusion in the 1961 accounts, prepared on an accrual basis, of the purchase price of the entire quantity of oxo-aleohol at the invoice price agreed to at the time. The market price did not fall until February 1962 and when the auditor came to examine the company accounts he very properly called attention to this in his report dated April 5, 1962, pointing out that no provision had been made in the accounts for the foreseeable loss on the disposal of inventory. While the auditor, Mr. Dunlop, in his evidence did suggest that the statement might have been re-written so as to provide for the loss of inventory by writing the inventory down to market value, this was not done, and I believe very properly so, aS the value did not decline in 1961 but only in February 1962. After the agreement with Esso International Inc. the payment of $112,350 Canadian was shown in 1962 as a forgiveness of debt which is also quite accurate. The accounts payable were reduced by this amount and the miscellaneous income increased as it was a non-recurring item. There was no credit note nor amended invoice or anything to indicate that it was a renegotiated price. The payment clearly relates to 1962 in which the reduction in debt was made. The cost of the product in the company’s records remained unchanged, however, and Mr. Dunlop testified that no change could be made since this was not considered as a reduction in price. The 1962 opening inventory had to be the same as the closing inventory in 1961 and the cost of goods sold in 1962 was based on this opening inventory which included the remaining oxo-alcohol valued at cost and the closing inventory for that year included the remaining oxo-alcohol valued at that time at its market value which was lower than cost. The statement of earnings for the year ending December 31, 1962, as reported to the shareholders, included the forgiveness of debt of $112,350 which wiped out the operating loss of $41,548, leaving income of $70,807 and provision was made for income tax in the amount of $35,592, leaving earnings for the year in the amount of $35,215 (page 26, Book of Documents). The reconciliation of net income as per the financial statements with taxable income, which document was filed with the income tax return (page 20, Book of Documents) added back to the earnings the provision for income taxes, and legal fees in the amount of $661, and deducted $112,350 for the forgiveness of debt to arrive at a deductible loss for the year 1962 of $40,882.

If it is found that the forgiveness of a debt in this case was of a capital nature then the British Mexican case clearly applies and it is not taxable, but if, on the other hand, it is considered that it was in the nature of a discount or subsidy paid to supplement respondent’s trading receipts, then the Lincolnshire Sugar and Oxford Motors cases (supra) apply. It is true that in the present case there was no renegotiation of the contract and it is common ground that Esso International Inc. was not obliged to make the forgiveness of debt which it did. On the other hand, it was in its business interest to do so. Respondent’s two principal customers for oxo-alcohol accounting for 90% of its sales, the Canadian Colours and Chemical Co. Limited and Monsanto Canada Limited, had been in the habit of importing it from the United States in tank-car lots and respondent felt that it would be a sound business move to establish a bulk inventory of oxo-alcohol in Canada which would be readily available for quick delivery when required. After taking into account various handling charges and a small commission which would be payable to respondent for its services, a purchase price was agreed upon with Esso International Inc., and it was on this basis that the shipment was made in November 1961 to Montreal where it was stored in rented storage tanks. It was estimated that the amount would be sufficient to meet all requirements for these two primary customers for a year and one-half or two years and, in fact, the shipment in question was completely disposed of by the autumn of 1963 at which time, due to ensuing serious changes in the market for oxo-alcohol, no additional stocks were ordered by respondent after the original bulk shipment had been finally disposed of. The initial purchase price was calculated, as already set out, by starting from the market price and working back so as to allow a small profit margin to respondent who was really rendering a service to Esso International Inc.’s Canadian customers. It was clearly in the interests of Esso International Inc. and, indirectly, Standard Oil Company of New Jersey, who wholly owned Esso International Inc. as well as respondent through its subsidiary, Standard Oil Company of Canada Limited, that respondent should not become insolvent as a result of the anticipated losses in this purchase, arising through no fault attributable to it, as a result of the fall in the market price and the increase in the cost of U.S. exchange. In calculating the amount of the forgiveness it was based on the anticipated operating loss of respondent on the resale and on the foreign exchange so as to retain approximately the same profit margin for respondent as was anticipated at the time of the purchase.* [2] It is true that there was no condition attached to this forgiveness of indebtedness so as to make it dependent on the sales made by respondent as in the Oxford Motors case (supra) where the rebate of $250 was allowed on each automobile as it was sold, but since it was relatively certain that respondent would dispose of the entire stock to the two large customers for whose convenience it had been acquired within a relatively short period, there was no need for any such condition and, certainly, Esso International Ine. made this forgiveness of indebtedness in anticipation that, as a result of this, it would at a relatively early date be paid in full for the oxo-alcohol sold to respondent less the amount of this rebate as, in fact, it was. Unlike the British Mexican case (supra) in which it was an express term of the agreement that the sum remitted should be applied by the debtor to reduce the amount shown in its books in respect of its assets to a figure more nearly representing the present value thereof, the remission in the present case seems to have been made to allow respondent to make the profit which it had anticipated making on the sale of the oxoalcohol at the original price, and that Esso International Inc., although not obliged in any way to make the remission, did have an indirect interest in assisting the respondent company in this way. I would apply, therefore, the dictum of Abbott, J. in the Oxford Motors case (supra) at page 503 [202] :

. . . In deciding upon the meaning of income, the Courts are faced with practical considerations which do not concern the pure theorist seeking to arrive at some definition of that term, and where it has to be ascertained for taxation purposes, whether a gain is to be classified as an income gain or a capital gain, the determination of that question must depend in large measure upon the particular facts of the particular case.

(See also the judgments of Jackett, P., as he then was, in Asso- dated Investors of Canada Limited v. M.N.R. and J. D. Stirling v. M.N.R. (supra).)

Taking a common sense commercial view of the matter, therefore, and not allowing the real issue to be obscured by the accounting practice adopted by respondent in this case, it is evident that respondent, as a result of this forgiveness of debt, was enabled to make a profit in the 1962 taxation year which is before me rather than suffering a loss which was otherwise inevitable and that it should, accordingly, pay the appropriate taxation on this profit.

One further question remains to be decided. Although the abatement was made as of April 30, 1962, it is clear that, save for the portion attributable to the loss on foreign exchange, it was made to cover the losses occasioned by the reduction in the selling price of oxo-alcohol which took place on or about February 2, 1962. In fact the letter of May 3, 1962 from Esso International Inc. to respondent confirming it reads, in part, as follows :

This will confirm that the amounts owing to Esso International Inc. are hereby abated and reduced by the amount of $107,000.00 U.S. in respect of losses occasioned by the reduction of about 13% in the selling price of oxo-alcohols, which reduction was effective on or about February 2, 1962.

It would therefore appear reasonable to spread the benefit of this reduction over the 1962 and 1963 fiscal periods. As pre viously stated, 3,930,178 pounds were sold in the 1962 fiscal period (we have no figures indicating what portion of this, if any, was sold prior to February 2, 1962) and 656,013 pounds were sold in the 1963 fiscal period. It is only the 1962 fiscal period which is before me, however, on this appeal and I agree, therefore, with respondent’s alternative plea in paragraph 12 of its amended reply to the notice of appeal to the effect that respondent should have reduced its cost of inventory on hand in 1962 by $112,350 Canadian, and since all the inventory on hand was not sold in 1962, the reduction in the cost of inventory should be reflected in respondent’s cost of goods sold in 1962 and 1963 by reference to the amounts of oxo-alcohol sold in each of those years respectively. This is in line with what was done in the foreign exchange cases cited and, in particular, in the case of Canadian General Electric Company Limited v. M.N.R. (supra).

In view of the finding which I have made it is unnecessary to go in detail into the other arguments raised by appellant. I might comment, however, that I doubt whether Section 12(3) applies. This section read in 1962 as follows:

12. (8) In computing a taxpayer’s income for a taxation year, no deduction shall be made in respect of an otherwise deductible outlay or expense payable by the taxpayer to a person with whom he was not dealing at arm’s length if the amount thereof has not been paid before the day one year after the end of the taxation year; but, if an amount that was not deductible in computing the income of one taxation year by virtue of this subsection was subsequently paid, it may be deducted in computing the taxpayer’s income for the taxation year in which it was paid.

The Minister’s case is not based on the fact that the taxpayer made a "‘deduction'' of the sum of $112,350 in 1962, but rather that it failed to consider as a taxable receipt the amount of the forgiveness of debt. Furthermore, as counsel for respondent pointed out in a calculation filed during his argument the purchase price of 5,031,179 pounds of oxo-alcohol for $732,202.37 Canadian works out at .1455 a pound. The 444,968 pounds sold in 1961 would have required a payment to Esso International Inc. at this price of $64,742.84, the 3,930,198 pounds sold in 1962 of $571,848.81, and the 656,013 pounds sold in 1963 of $92,449.89 to make up the total sum payable. These figures add to $729,036.54 which differs from the sum of $732,202.37 and the slight discrepancy is not explained, but this does not affect the reasoning of this argument. Actually, the payments due on the 1961 and 1962 sales totalled $636,586.65, and it is admitted that $646,691.92 had been paid by the end of 1963. Since there was no specific date set out for the payment of the total amount which was invoiced and set up in respondent’s books as “cost of goods’’ in 1961, and it seems to have been understood that respondent would pay, when it could, as the oxo-alcohol was sold, it would be proper to attribute the payments made in 1962 and 1963 to the 1961 and 1962 sales, with a balance of $10,106.27 to apply to the 1963 sales of $92,449.89 the balance of which respondent never had to pay as a result of the release of indebtedness. The amount resulting from the 1962 sales was therefore paid in full before the end of 1963, without recourse to the forgiveness of debt.

With respect to the argument based on the application of Section 137(2), however, which reads as follows:

157. (2) Where the result of one or more sales, exchanges, declarations of trust, or other transactions of any kind whatsoever is that a person confers a benefit on a taxpayer, that person shall be deemed to have made a payment to the taxpayer equal to the amount of the benefit conferred notwithstanding the form or legal effect of the transactions or that one or more other persons were also parties thereto; and, whether or not there was an intention to avoid or evade taxes under this Act, the payment shall, depending upon the circumstances, be

(a) included in computing the taxpayer’s income for the purpose of Part I,

(b) deemed to be a payment to a non-resident person to which Part III applies, or

(c) deemed to be a disposition by way of gift to which Part IV applies.

I believe that the words ‘‘transactions of any kind whatsoever’’ are broad enough to cover the forgiveness of debt which took place in this case and that Esso International Inc. therefore conferred a benefit on respondent and this despite the fact that the rebate was made for a legitimate purpose and not with an intention to avoid or evade taxes since Section 137(2) makes the benefit taxable ‘‘whether or not there was an intention to avoid or evade taxes under this Act’’. While the fact that it was made voluntarily makes it partake of the nature of a gift, it was not a ‘‘disposition by way of gift to which Part IV applies” within the meaning of Section 137(2) (c) of the Act since Part IV does not apply to a non-resident donor (see Section 115). I would therefore have included it in the taxpayer’s income under the provisions of Section 137(2) (a). I am strengthened in this conclusion by the wording of Section 137(3) which reads as follows:

. 137. (3) Where it is established that a sale, exchange or other transaction was entered into by persons dealing at arm’s length, bona fide and not pursuant to, or as part of, any other transaction and not to effect payment, in whole or in part, of an existing or future obligation, no party thereto shall be regarded, for the purpose of this section, as having conferred a benefit on a party with whom he was so dealing.

(Italics mine.) Not only were the parties not dealing at arm’s length but in this case the forgiveness of debt had the effect of paying in part an existing obligation.

In opposing the application of Section 137(2), respondent’s counsel referred to the cases of M.N.R. v. Granite Bay Timber Company Limited, [1958] C.T.C. 117, James N. Sissons v.

MN.R., [1968] C.T.C. 363, and M.N.R. v. Pillsbury Holdings Limited, [1964] C.T.C. 294. The Granite Bay case did not deal with Section 137(2) at all but rather with what was then Section 8(3) of the Act (S.C. 1949 (2nd Sess.), e. 25) concerning the capital cost of property transferred by one or more transactions between persons not dealing at arm’s length, and it was in this context that the meaning of the word "‘transac- tion’’ was examined. In this case, Thurlow, J., in rendering judgment, stated at page 128:

. . . In my opinion, the expression "one or more transactions" in Section 8(3) is wide enough to embrace all types of voluntary processes or acts by which property of one. person may become vested in another without regard for the reason or occasion for such processes or acts and regardless also of whether the process is undertaken or the act is done for consideration in whole or in part or for no consideration at all.

The, Sissons case dealt with appropriation of property to shareholders under the provisions of Section 8(1)(c) of the Act but did also briefly consider Section 137(2). In reaching the conclusion on the facts of that case that the profit which the appellant company would have earned if the first transaction had not been entered into was not a conferral of a benefit within the meaning of Section 137(2), Gibson, J. stated at page 368 :

. . . In my view, such cannot and does not constitute the conferral of a benefit within the meaning of that subsection. Money or other assets must be paid out to a shareholder who was a shareholder at least immediately prior to such payment out and such payment out must arise out of a contemporaneous transaction or a series of practically contemporaneous transactions to constitute a conferral of a benefit within the meaning of Section 137(2) of the Income Tax Act.

I do not consider that this case is authority for the proposition which respondent puts forth that there must be an actual paying over of something to the taxpayer in order to confer a benefit on it, and that a release of indebtedness cannot therefore be brought within this section, the wording of which is very comprehensive.

The Pillsbury Holdings case also arose out of the conferring of benefits on a shareholder within the meaning of Section 8(1) of the Act and is authority for the proposition that a bona fide transaction with a shareholder is not taxable if the benefit or advantage resulting to him therefrom accrues in his capacity as a customer of the corporation and not as a shareholder. It does not even discuss Section 137(2) which makes the benefit taxable "‘whether or not there was an intention to avoid or evade taxes under this Act’’.

Neither can I find any force in respondent’s argument to the effect that unless the transaction is one which would be otherwise taxable under Part I of the Act, Section 137(2) cannot be applied. Even if I had not found in favour of appellant on the question of the manner in which the forgiveness of debt in the amount of $112,350 should have been dealt with by respondent in his accounting and tax returns, therefore, I would have found in favour of appellant by the application of Section 137(2) of the Act, which question was not raised before the Tax Appeal Board.

I therefore maintain the appeal of appellant in part, finding that respondent should have reduced its cost of inventory on hand in 1962 by the sum of $112,350 Canadian following the forgiveness of debt in this amount by Esso International Inc. and that this reduction should be reflected in its cost of goods sold in 1962 and 1963 by reference to the amounts of oxoalcohol sold in each of those years respectively so that only that portion of the said sum of $112,350 attributable to respondent’s 1962 sales should be included in its income for that year, which is the only year in issue before me, and I refer the assessment back to the Minister for re-assessment of respondent’s 1962 taxation year on a basis not inconsistent with the terms of this judgment. Costs shall be in favour of appellant.