Date: 20010704
Docket: 1999-1758-IT-G
BETWEEN:
TERENCE D. COUGHLAN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowie J.
[1]
These appeals are brought from assessments under the Income
Tax Act (the Act) for the taxation years 1993 and
1994. They raise issues as to the incidence of tax on certain
amounts awarded to the Appellant by a Judgment of the Supreme
Court of Nova Scotia, Trial Division, as amended by the Nova
Scotia Court of Appeal.
[2]
The Appellant was president and chief executive officer of a
resource company called Seabright Resources Inc. (Seabright)
prior to 1988. In January of that year, he and the other
shareholders of Seabright sold their shares to an Australian
group which changed the name of the company to Westminer Canada
Limited (Westminer). Revenue Canada considered the Appellant to
be a trader in shares, and his gain from this sale was taxed as
income from a business. In July 1988, Westminer began an action
in the Supreme Court of Ontario against the Appellant and the
other former directors of Seabright. The allegations against the
Appellant in that action included fraud, deceit, conspiracy and
insider trading.
[3]
The Appellant and the other former directors then brought actions
in the Supreme Court of Nova Scotia against Westminer and its
directors, in which they alleged conspiracy to injure and breach
of fiduciary duty. These actions went to trial, and the Ontario
actions were stayed pending their outcome. In the result, the
Appellant and his fellow directors were successful in the Nova
Scotia actions, and the actions against them in the Supreme Court
of Ontario were then abandoned. Nunn J. of the Supreme Court of
Nova Scotia, found that there had been a civil conspiracy among
the defendants to injure the plaintiffs, and he awarded very
substantial damages. He also held that the plaintiffs were
entitled to be indemnified for the costs to them of defending the
proceedings brought in Ontario under an indemnification clause in
the by-laws of Seabright. By his judgment dated May 14, 1993,
Nunn J. awarded to the Appellant:
i)
general damages for the conspiracy in the amount of $1,000,000,
together with prejudgment interest from August 25, 1988 to
May 14, 1993;
ii)
solicitor-client costs of the proceeding before him, which he
later taxed at $2,992,668.39; and
iii)
certain other amounts which are not in issue in these
appeals.
He did not award prejudgment interest on the solicitor-client
costs, presumably because the Judicature Act of Nova
Scotia did not permit him to do so.[1]
[4]
Both sides appealed to the Nova Scotia Court of Appeal, largely
without success. However, that Court held that Nunn J. should not
have awarded solicitor-client costs, but rather damages for loss
of indemnity under the Westminer by-law, and that when so
characterized that amount qualified for the application of
prejudgment interest. Paragraphs 5 and 6 of the Court's
judgment read:
5.
The award of costs at trial is hereby affirmed as damages for the
loss of indemnity, and the Appellant Westminer Canada Limited is
liable to pay and shall pay to the Respondents the sum of
$401,891.59 representing prejudgment interest on the award of
damages for the loss of indemnity in respect of the expenses
incurred by the Respondents in the trial of this proceeding, plus
interest thereon in the amount of $12,497.18;
6.
The Appellants [Westminer et al.] are jointly and severally
liable to pay to the Respondents as damages for the loss of
insurance benefits, their reasonable expenses of this appeal,
less a set-off in respect of a portion of the Appellants'
costs of the cross-appeal on a party and party basis, in the net
amount of $493,456.93 together with prejudgment interest in the
amount of $7,117.06 provided that any payment under this
paragraph 6 shall reduce pro tanto the liability of the
Appellant Westminer Canada under paragraph 7 of this Order;
[5]
The Appellant therefore received the following amounts, among
others, under the judgment of Nunn J., as varied by the Court of
Appeal:
In
1993:
$2,992,668 (the first amount) as damages for loss of indemnity;
and
In
1994:
$493,457 (the second amount) as damages for the loss of insurance
benefits, and $401,892 (the third amount) as prejudgment interest
on the amount of $2,992,668.
It is with these three amounts that these appeals are
concerned. The Minister of National Revenue has included them in
the Appellant's income in the years in which he received
them.
[6]
The Appellant's position is that the first and second amounts
are awards of damages, and are of a capital and not an income
nature. Alternatively, if they are to be characterized as a
reimbursement of legal costs they are nevertheless not included
in income because they relate to a capital purpose, and the
expenses of the litigation were not deductible when incurred. As
to the third amount, the Appellant takes the position that it is
not interest at all, but an additional award of damages of a
capital nature. Finally, counsel for the Appellant submitted
that
Alternatively, if it were found that the prejudgment interest
was genuine interest on a debt and that the damages or indemnity
award represented income from business, the amount of this
business income should be considered to have been owing to the
Appellant from the time when he incurred the related expenses.
Under the accrual system of accounting for business income, the
income in question would need to be recognized when it arose
rather than when it was received.[2]
[7]
The Respondent's position is that the first two amounts are
properly included in the Appellant's income for 1993 and 1994
respectively, either as income from a business, or in the
alternative, under paragraph 12(1)(x) of the Act as
"amounts previously expensed and deducted by the Appellant
on account of income ...".[3] The third amount, the Respondent submits, is
interest received in the year 1994, and is therefore taxable in
that year pursuant to paragraph 12(1)(c) of the
Act.
[8] A
number of additional facts need to be taken into account in the
characterization of these payments. I accept the Appellant's
evidence that his primary concern in this litigation was to
protect his reputation as a businessman and a promoter in the
financial community. It was essential to his future ability to
raise capital and to earn a living that he should be vindicated
of the serious allegations made against him in the Ontario
actions. That this is so can also be seen from the Reasons for
Judgment given in the two Courts in Nova Scotia. The Nova Scotia
Court of Appeal was careful to point out, in varying the judgment
at trial, that the first amount was payable to the Appellant not
as costs, but as damages. Seabright had placed insurance to
protect the directors from liability for wrongful acts and
defaults alleged against them in connection with their duties as
directors. Following the takeover, the new management permitted
this insurance to lapse. In addition, the by-laws of Seabright,
and subsequently Westminer, provided the directors with similar
indemnification from the company. It was Westminer's breach
of its obligation to indemnify the Appellant pursuant to the
by-law, and its breach of the obligation to keep this insurance
in force, which gave rise to the awards of the first and second
amounts as damages. This is not altered by the fact that Nunn J.
fixed the first amount by reference to the costs that would be
awarded on a solicitor-client scale, and that the Court of Appeal
fixed the second amount on the same basis. I accept the
Appellant's evidence that these two amounts, although given
as damages for breach of the indemnity and for the loss of
insurance benefits, did not fully compensate him for the amounts
he spent in connection with the litigation in Ontario and Nova
Scotia.
[9]
Between the years 1989 and 1994, the Appellant spent some
$4,725,635 in defence of the Ontario actions and in prosecuting
the Nova Scotia actions, and he claimed to be entitled to deduct
these amounts in computing his income. These deductions were
initially disallowed by the Minister, but ultimately, after some
negotiation, were allowed. Three of his fellow directors, Hansen,
Amirault and Hemming, were not permitted these deductions, and
they appealed to this Court from the assessments by which they
were disallowed. Their appeals failed,[4] on the basis that their purpose in
the litigation was to protect their accumulated assets, including
their reputations. I have already found that protection of his
reputation and the ability to earn his livelihood were the
primary motivation for the Appellant's expenditures in this
litigation, and I conclude that he would have fared no better on
appeal than Hansen, Hemming and Amirault did. It may be
surprising that the Minister allowed the deductions to the
Appellant, but that fact cannot change the true legal character
of the payments.
[10] To
determine whether these amounts were received on revenue account
requires an examination of the true nature of the loss which they
are meant to compensate.[5] The damages, whether for loss of indemnity or for loss
of insurance benefits, must be considered in light of the purpose
and the effect of the action in which they were awarded.[6] In this case the
damages were awarded, as I have already found, in the context of
the failure of the Westminer group to indemnify the Appellant in
respect of the expense of litigation, and to maintain insurance
that should have been available to him for that purpose. The
evidence establishes that the purpose, and the effect, of that
litigation was to protect and preserve the Appellant's
reputation as a businessman and as a promoter of resource
companies. The outlays made to conduct the litigation are
therefor of a capital nature,[7] and so are the damages recovered for failure to
indemnify and to insure against those outlays. The
Respondent's main argument in support of this aspect of the
assessment seems to be that the Appellant was permitted the
deduction of amounts expended by him in the litigation in earlier
taxation years. As I have already said, this fact cannot change
the true character of the damage award that he received.[8]
[11] Nor are
the first and second amounts taxable under paragraph
12(1)(x) of the Act. In order to make it
comprehensible, I reproduce here only the applicable words of
that paragraph, omitting those which could not apply to the
present case.
12(1) There shall be
included in computing the income of a taxpayer for a taxation
year as income from a business or property such of the following
amounts as are applicable:
...
(x)
any particular amount ... received by the taxpayer in the
year, in the course of earning income from a business or
property, from
(i)
a person ... who pays the particular amount in the course of
earning income from a business or property ...
...
where the particular amount can reasonably be considered to have
been received
...
(iv) as a
..., reimbursement, ... allowance or as assistance,
whether as a grant, ... in respect of
...
(B) an outlay or expense,
to the extent that the particular amount
(v)
was not otherwise included in computing the taxpayer's
income, ..., for the year or a preceding taxation year,
As Teskey J. held in Hansen, supra, and as I
have concluded earlier in these Reasons, the action in the
Supreme Court of Nova Scotia was not brought by any of the
plaintiffs "in the course of earning income from a business
or property". For that reason alone, the first and second
amounts do not come within paragraph 12(1)(x).
Moreover, these amounts have been unequivocally characterized by
the Nova Scotia Court of Appeal as damage awards, and as such
they are not a reimbursement of the amounts laid out by the
Appellant to fund his litigation: see Westcoast Energy Inc. v.
Canada.[9]
[12] This
conclusion is also consistent with the judgment of the Supreme
Court of Canada in Ikea Limited v. Canada,[10] where
Iacobucci J., for the Court, said:
... Where a payment is made to a taxpayer as a
reimbursement for the cost of capital property, it is to be
treated as a capital receipt for tax purposes. On the other hand,
a payment that is made as a reimbursement for an expense on
revenue account is to be treated as income.
The second and third amounts are, as I have said, not
reimbursements of expenses. They are damages for failure to
maintain insurance and to indemnify. That is the characterization
given to them by the Nova Scotia Court of Appeal, which is the
Court having jurisdiction to make that determination.
[13] I turn
now to the third amount, which the Court of Appeal awarded as
prejudgment interest. The Minister has assessed tax on the third
amount, relying on paragraph 12(1)(c) of the
Act.
12(1) There shall be
included in computing the income of a taxpayer for a taxation
year as income from a business or property such of the following
amounts as are applicable:
...
(c)
subject to subsections (3) and (5), any amount received or
receivable by the taxpayer in the year (depending on the method
regularly followed by the taxpayer in computing the
taxpayer's income) as, on account of, in lieu of payment of
or in satisfaction of, interest to the extent that the interest
was not included in computing the taxpayer's income for a
preceding taxation year;
Counsel for the Minister simply took the position in argument
that the third amount is interest received in the year, and is
therefore within this paragraph. For the Appellant,
Mr. Harris drew a distinction between prejudgment interest
awarded in a judgment for a sum owing on a contract, on the one
hand, and a case, such as the present, where the prejudgment
interest is on an award of damages.
[14] The
definition of interest most frequently referred to is found in
the judgment of Rand J. in the Farm Security Act[11] case:
Interest is, in general terms, the return or consideration or
compensation for the use or retention by one person of a sum of
money, belonging to, in a colloquial sense, or owed to, another.
There may be other essential characteristics but they are not
material here. The relation of the obligation to pay interest to
that of the principal sum has been dealt with in a number of
cases including: Economic Life Assur. Society v. Usborne
(1) and of Duff J. in Union Investment Co. v. Wells (2);
from which it is clear that the former, depending on its terms,
may be independent of the latter, or that both may be integral
parts of a single obligation or that interest may be merely
accessory to principal.
But the definition, as well as the obligation, assumes that
interest is referrable to a principal in money or an obligation
to pay money. Without that relational structure in fact and
whatever the basis of calculating or determining the amount, no
obligation to pay money or property can be deemed an obligation
to pay interest.
Several cases were referred to in argument which demonstrate
that an amount is not truly interest, and therefore within
paragraph 12(1)(c), simply because it is called interest
by the legislature.
[15] In
Huston, Whitehead and Whitehead v. M.N.R.,[12] Thurlow J.
had to consider whether "interest" paid under the
War Claims Regulations fell within the provisions of
paragraph 6(1)(b), the predecessor to the present
paragraph 12(1)(c). Those Regulations made
provision for the payment of compensation to persons for loss of
property as a result of World War II. The Regulations
specifically provided that they conferred no right of payment;
they simply gave authority to make a discretionary payment from
the War Claims Fund. They also provided that "interest
... may be paid ...". After considering Riches
v. Westminster Bank,[13] Glenboig Union Fireclay Ltd. v.
C.I.R.,[14]C.I.R. v. Ballantyne[15] and Simpson v.
Executors of Bonner Maurice,[16] Thurlow J. concluded that
the real question to be decided is "... whether the
amounts in question are of an income or a capital nature".
He concluded that in the case before him, the amounts awarded as
interest, along with the compensation, were not of an income
nature and, therefore, were not interest within the meaning of
section 6 of the Income Tax Act. This was so because no
principal sum was owing to the Appellants at any time. They had
no right to compensation, and they sustained no loss of revenue
for which they could be entitled to either damages or
compensation. Bellingham v. The Queen[17] is another case which
demonstrates that not all statutory interest payments are
received on income account. Under subsection 66(4) of the Alberta
Expropriation Act,[18] the Land Compensation Board may award
"additional interest" along with the compensation and
interest otherwise payable, if the expropriating
authority's proposed payment to an expropriated owner is
less than 80% of the amount the Board awards for compensation.
The Federal Court of Appeal held that this "additional
interest", being in the nature of a penalty imposed on the
authority, does not assume the character of income in the hands
of the owner.
[16] The
Riches and Ballantyne cases illustrate that
prejudgment interest may fall into either of two categories,
depending on the circumstances of the case in which it is
awarded. In Riches, the plaintiff contracted with Ridsdel
to introduce him to a transaction whereby he could profit from a
purchase and sale of shares, on consideration that Ridsdel would
pay one-half of his profit to Riches. Ridsdel purchased the
shares and resold them at a profit, but paid Riches less than
one-quarter of his share of the profit. Riches sued for the
balance once he discovered the fraud, and recovered judgment for
the amount withheld by Ridsdel, together with a further
£ 10,028 awarded as prejudgment interest. The House of Lords
held that the interest was income subject to tax, essentially
because it was given for the wrongful withholding of a debt.
[17] In
Ballantyne, an award of damages by an arbitrator included
the words "with interest thereon at the rate of 5% per
annum from the 4th day of November 1918, until payment".
The award was made as damages arising out of the breach of a
construction contract. The Scottish Court of Sessions held that
the interest component, running from an arbitrary date some two
years prior to the award, was in reality an additional amount of
damages. It did not relate to any specific amount wrongly
withheld by the defendant in the action, or a specific period
during which a capital sum had been withheld.
[18] The third
amount is prejudgment interest on the first amount. It was
awarded for the first time by paragraph 5 of the Order of the
Court of Appeal, and it appears from paragraphs 211, 213 and 214
of the Reasons for Judgment of the Court of Appeal that the Court
computed the amount of $401,891.59 on the basis of 11% interest
on each of the component amounts making up the
solicitor-client costs assessment[19] which was transformed by the Court
of Appeal into damages for loss of indemnity, from the date each
component was paid by the Appellant to August 4, 1993, the date
of the final judgment of Nunn J. As to the amounts which together
make up the first amount, the Court of Appeal said:[20]
[211] In this case the
right to be indemnified pursuant to the bylaw arose on the date
the respondents were sued in Ontario. From that date on, the
respondents were entitled to be indemnified for each expense and
cost incurred as the payment was made. Although there was no way
of knowing on that date the quantification of the indemnity
award, it was an obligation to pay as of that date. The concept
of indemnity as debt is strengthened by the following passage
from Halsbury's (4th Ed.):
"In law an action on a contract of indemnity does not
normally lie until the promisee has paid the third person's
claim. Where he has paid, the amount so paid constitutes a debt
due to him from the promisor which save in certain circumstances,
he may recover with interest in an action." (vol. 20, p.
173)
[213] The indemnity award is a
debt that is subject to the provisions of s. 41 of the
Judicature Act. There is no valid reason for denying
prejudgment interest on the award. ...
[214] In this case it is
necessary to award prejudgment interest on the indemnity award in
order to fully compensate the respondents. Accordingly, the
decision and order of the trial judge is varied to provide that
interest shall be payable at the rate of 11% per annum from the
date of each payment of costs and expenses included in the
indemnity award to the date of the Order for Judgment, May 14,
1993. The matter of prejudgment interest on amounts assessed
after that date is dealt with below in section VIII C.
These passages make it clear to me that the third amount was
awarded as interest on liquidated amounts wrongfully withheld,
rather than as incremental damages. It therefore has the
character of income, and so falls to be taxed under
paragraph 12(1)(c).
[19] Counsel
for the Appellant relied in argument upon a document published by
Revenue Canada in 1998 which indicated that prejudgment interest
on awards of damages for wrongful dismissal will not be
considered taxable. That document refers to Interpretation
Bulletin IT-365R2, which indicates that the Minister does not
consider prejudgment interest on an award of damages for personal
injury or death (or an equivalent amount included in a settlement
agreement) to be taxable. This, however, is simply a reflection
of the difference between prejudgment interest on a debt or other
liquidated amount wrongly withheld, and on an award of damages
assessed, as established by such cases as Riches and
Ballantyne.
[20] Paragraph
12(1)(c) of the Act taxes interest "received
or receivable by the taxpayer in the year (depending on the
method regularly followed by the taxpayer in computing the
taxpayer's income) ...". The prejudgment
interest was taxed in 1994, the year of receipt. As I understood
Mr. Harris in argument, he suggested that it should be taxed, if
at all, in the year of accrual and not the year of receipt. As
the entitlement to interest arose only upon the variation by the
Court of Appeal of the judgment at trial, which occurred in April
1994, it is difficult to see how the interest could possibly have
accrued before that date. The interest is computed with reference
to prior years, but the right to receive it did not arise until
the Court of Appeal pronounced its judgment. This is not a case
such as The Queen v. Johnson & Johnson Inc.,[21] where an
amount received in the year should properly be included in
computing the income of prior years. Mr. Coughlan, in those prior
years, had no more than a hope that when the litigation ended he
would recover his expenditures, with prejudgment interest.
[21] In any
event, the Appellant has neither pleaded nor proved that he has
regularly computed his income on the accrual basis for the years
prior to 1994.
[22] In the
result, the appeals are allowed and the assessments are referred
back to the Minister for reconsideration and reassessment on the
basis that the amount of $2,992,668 received by the Appellant as
damages for loss of indemnity in 1993, and the amount of $493,457
received by him as damages for loss of insurance benefits in
1994, are not subject to tax. The Appellant is entitled to his
costs.
Signed at Ottawa, Canada, this 4th day of July, 2001.
J.T.C.C.
COURT FILE
NO.:
1999-1758(IT)G
STYLE OF
CAUSE:
Terence D. Coughlan and
Her Majesty the Queen
PLACE OF
HEARING:
Halifax, Nova Scotia
DATE OF
HEARING:
August 25, 2000
REASONS FOR JUDGMENT BY: The
Honourable Judge E.A. Bowie
DATE OF
JUDGMENT:
July 4, 2001
APPEARANCES:
Counsel for the Appellant: E. C. Harris, Q.C. and Charles W.
Demond
Counsel for the
Respondent:
John Bodurtha and Marcel Prevost
COUNSEL OF RECORD:
For the
Appellant:
Name:
E.C. Harris, Q.C. and Charles W. Demond
Firm:
Daley, Black & Moreira
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
1999-1758(IT)G
BETWEEN:
TERENCE D. COUGHLAN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on August 25, 2000, at Halifax,
Nova Scotia, by
the Honourable Judge E.A. Bowie
Appearances
Counsel for the
Appellant: E.C.
Harris, Q.C. and Charles W. Demond
Counsel for the Respondent: John
Bodurtha and Marcel Prevost
JUDGMENT
The
appeals from assessments of tax made under the Income Tax
Act for the 1993 and 1994 taxation years are allowed and the
assessments are referred back to the Minister of National Revenue
for reconsideration and reassessment on the basis that the amount
of $2,992,668 received by the Appellant as damages for loss of
indemnity in 1993, and the amount of $493,457 received by him as
damages for loss of insurance benefits in 1994, are not subject
to tax.
The Appellant is entitled to his costs.
Signed at Ottawa, Canada, this 4th day of July, 2001.
J.T.C.C.
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