Zygocki v. The Queen, 84 DTC 6283, [1984] CTC 280 (FCTD)

Strayer, J:—This judgment proceeded to trial on the basis of a statement of agreed facts. I shall summarize them briefly.

The plaintiff together with a limited company and another individual, referred to compendiously as the “Group”, purchased a piece of property in Whitby, Ontario in December, 1972 for $205,260. In May, 1973 the Group agreed to sell the property to Hillwood Investments Limited for $559,740, the sale to be closed on October 12, 1973. The sale was not completed and in January, 1974 the Group commenced an action against Hillwood for specific performance. On June 4, 1975 it obtained judgment against Hillwood in the Ontario High Court for specific performance. Hillwood commenced an appeal which was never heard. Instead by minutes of settlement dated November 25, 1976 it was agreed that the appeal would be dismissed by consent, that Hillwood would pay to the Group $435,000, that the Group would retain the Whitby property together with a $5,000 deposit already paid on it, and that the Group would waive all rights under the judgment; provided that, if the sum of $435,000 was not paid, the settlement would be void and the Group could proceed to enforce the judgment. The amount of $435,000 was, however, paid as required by the settlement with the result that the Group received in total the sum of $440,000 from Hillwood. Subsequently in November, 1977 the Group sold the property in question for $165,000.

The plaintiff, who had a 50 per cent interest in the property, reported in her 1977 tax return a net loss of $57,110 as a capital loss arising out of the sale of the property in November of that year, the property having been sold for less than the original purchase price and presumably some expenses having been incurred in connection therewith. The Department of National Revenue by a notice of reassessment dated October 5, 1979 reassessed her income by adding her share from the settlement of the action against Hillwood, in the amount of $190,712.47, treating this as income and also treating as an income loss her reported loss of $57,100.17 from the actual sale of the property in November, 1977.

Two other important facts were also agreed to. First, it was agreed that the Group including the plaintiff purchased the Whitby property speculatively for the purpose of making a profit, and that the possibility of reselling it was a motivating factor which induced the Group to purchase the property. Secondly, and flowing from the first, it was agreed that if the original transaction with Hillwood had been completed, her share of the proceeds of sale would have been taxable as income in the hands of the plaintiff’

As a result, at the time of trial there was no serious dispute as to the status of the loss suffered by the plaintiff from the sale which actually was completed. It was accepted that, consistently with the foregoing, the loss of $57,110.17 was an income loss fully deductible from income.

The main issue then is as to the status of the plaintiffs share of the proceeds from the settlement of the action against Hillwood, her share being apparently $190,712.47. The plaintiff takes the position that this amount should be treated as a capital gain. Briefly put, her position is that she received the money under the settlement in return for the disposition by her of her rights under the judgment for specific performance obtained on June 4, 1975. Therefore the money was not received as business income because she was not in the business of disposing of judgments. Nor was it received with respect to the Whitby property, because the Group still owned that property after the settlement was made. Therefore the plaintiff contends that this amount represents the proceeds of the disposition of her property in the judgment. Reliance is placed on the definition of property in subsection 248(1) of the Income Tax Act which includes “a right of any kind whatever, . . . or a chose in action”. The judgment gave the plaintiff an enforceable right and when she surrendered that right in return for money she was disposing of property. The result was a capital gain, in her view. The defendant, on the other hand, takes the position that the money received by the plaintiff under the settlement was business income because it was received in lieu of business income which would otherwise have flowed to her had the Hillwood transaction been completed.

I was urged by counsel for both parties to decide this matter on the basis of the substance of the transactions rather than their form. I intend to do so.

There are numerous authorities on the question of when moneys received as damages, or in settlement, for breach or termination of contract should be treated for taxation purposes as income and when they should be treated as capital. It is unnecessary to recite all of these. One of the leading statements is that of Diplock, L.J. in London and Thames Haven Oil Wharves, Ltd v Attwooll, [1967] 2 All E.R. 124 (C.A.) at 134, 136. He said in effect that if a trader receives from another person compensation because of his failure to receive another sum of money which, had it been received, would have been credited to profits, then the compensation should be regarded as income. If on the other hand a compensation is paid because of the destruction or permanent deprivation of a capital asset, then it should be treated as capital for taxation purposes. In Commissioners of Inland Revenue v Fleming & Co (Machinery), Ltd (1951), 33 TC 57 at 63 (CS), Lord Russell had said essentially the same thing in stating that if such payments were “no more than a surrogatum for the future profits surrendered” then they should be treated as income. If however “the rights and advantages surrendered on cancellation are such as to destroy or materially to cripple the whole structure of the recipient’s profit-making apparatus . . . the compensation represents the price paid for the loss or sterilization of a capital asset” and therefore compensation paid for such rights should be treated as capital. Distinc

tions of this nature have been applied in this Court: see, eg, MNR v Import Motors Limited, [1973] CTC 719; 73 DTC 5530; Packer Floor Coverings Ltd v The Queen, [1981] CTC 506; 82 DTC 6027.

I have come to the conclusion that the amount received by the plaintiff pursuant to the settlement of the action against Hillwood must be treated as income. In my view in substance it was revenue earned by her from her business. Using the conventional test as exemplified by the words of Diplock, L.J. in the London and Thames Haven Oil Wharves, Ltd case, supra, the money she received from the settlement was, in substance, compensation for the fact that Hillwood had not performed under the contract for the purchase of the Whitby property and had not paid the full purchase price of $559,740 as originally agreed upon. If there had not been a contract of sale and a prospect of a profit thereunder the Group would never have sued Hillwood for specific performance of the contract and never would have been in the position of receiving the benefits under this settlement. The contract of sale, which the plaintiff agrees was a venture in the nature of trade, was the effective cause of the settlement. The settlement was directly linked to the original contract because it relieved Hillwood from the obligation of performing the contract as required by its terms and as required by the judgment for specific performance. It is not sufficient in my view to argue, as the plaintiff does, that what the plaintiff disposed of by settlement was her rights in a judgment and not her rights in the Whitby property. In the first place, this is a technical argument at best which obscures the substance of the transaction. Further, by the terms of the settlement the plaintiff was being compensated for certain interests in the Whitby property, the principal one being the right of disposition of that property for a profit: a right which she and her partners had foregone from the time of entering into the agreement with Hillwood in May, 1973 until the date of the settlement in November, 1976.

It is irrelevant that the net result of the settlement, combined with the fact that the Group was subsequently able to sell the property, was that the Group including the plaintiff made a greater profit than they would have made if Hillwood had completed the purchase in accordance with the contract. What the plaintiff and her partners received from the settlement was a profit incidental to the purchase and resale of this property which was admittedly a venture in the nature of trade. It was as much incidental to the buying and selling of property for a speculative profit as would be for example a fee paid by a prospective purchaser for an option on the property which was never exercised, or a down payment under an agreement for sale of the property which down payment was forfeited for failure to pay the balance in accordance with the terms of the agreement.

Counsel for the plaintiff relied heavily on three decisions of this Court: Albert Manley v The Queen, [1984] CTC 8; 83 DTC 5440; and The Queen v B Atkins, [1975] CTC 377; 75 DTC 5263 (TD); [1976] CTC 497; 76 DTC 6258 (FCA). I have considered these cases carefully but I do not think they are applicable to the present situation. In the Manley case Collier, J held that where a taxpayer had successfully sued another party for breach of warranty of authority because that party had led him to believe that he could promise a finder’s fee to the taxpayer with respect to the sale of his family’s business, the damages thus obtained could not be treated as the equivalent of the finder’s fee and hence were not income. The case is distinguishable because, as Collier, J emphasizes, there was no contract amounting to an adventure or concern in the nature of trade. There was no contract at all between the plaintiff and the members of the family with respect to any finder’s fee. At 14 [5444] he says:

If there had been, and depending on the particular facts, that hypothetical transaction might, or might not, have been classed as an adventure in the nature of trade.

In the present case there was a contract for the sale of the property to Hillwood. The plaintiff agrees that this was a contract in the nature of trade, and that the proceeds of sale would have been taxable as income in her hands.

In the Atkins case Collier, J at trial held that an amount of $18,000 “severance allowance” paid to a senior employee of a corporation who was dismissed without notice was not taxable as a salary or other benefit received from an office or employment. Nor could it be regarded as a “retiring allowance” since he did not retire from his employment but was dismissed. The Court of Appeal confirmed this decision although the Chief Justice did say the following:

The situation might well be different if an employee was dismissed by a proper notice and paid “salary” for the period of the notice even if the dismissed employee was not required to perform the normal duties of his position during that period.

It is important to note, however, that the Supreme Court in the case of Jack Cewe Ltd v G W Jorgenson, [1980] CTC 314; 80 DTC 6233 at 315 [6234-35] has cast serious doubt on the correctness of the Atkins decisions. Pigeon, J, on behalf of the Court, after quoting from the Court of Appeal judgment, said:

I have grave doubt as to the validity of this reasoning. Damages payable in respect of the breach of a contract of employment are certainly due only by virtue of this contract, I fail to see how they can be said not to be paid as a benefit under the contract. They clearly have no other source.

In any event, the Atkins decisions are distinguishable from the present case in my view because they turn on the interpretation of the meaning of salary or benefit received from an office or employment or retiring allowance as referred to in sections 5 and 25 of the pre-1972 Act.

It is sufficient however for the purposes of the present case that I conclude that the payment received by the plaintiff pursuant to the settlement was in substance income received from a business. In my view that is the practical reality of the situation and I so hold.