Date: 20010507
Docket: 90-159-IT
BETWEEN:
REDHEAD EQUIPMENT LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Beaubier, J.T.C.C.
[1]
These appeals were heard at Regina, Saskatchewan, on April 20,
2001. Gary Redhead, owner and president of the Appellant
("Redhead"), was the only witness. At all material
times Redhead was the Saskatchewan distributor for Champion Road
Machinery Limited.
[2]
In 1986 Champion Road Machinery Limited ("Champion")
introduced the Uptime warranty 5/5 (5 years or 5,000 hours)
extended powertrain warranty. It is summarized in Champion's
"Recommendations and Suggestions..." which it sent to
the Appellant (Exhibit A-2). Paragraphs 5 and 6 of Exhibit A-2
read:
5.
The Warranty is spelled out in detail on Form CW002. Champion
warrants a new Grader, delivered to a Governmental/Municipal
Power, for 5 Years or 5000 Hours, whichever comes first, for all
the powertrain as listed in para. 3. Cummins warrants the Engine,
and this is detailed on the forms in the Kit. The Customer has
paid $5,000.00 for this protection. One Dollar per operating
hour.
6.
You will be making UPTIME 5/5 Inspections every six months. It is
recommended that you spend time in advance studying this form
before going to do your first Inspection. You will probably find
it helpful to do a dry run Inspection on a used Grader in your
yard.
The issue is whether the Appellant could claim a reserve on
account of the inspection program.
[3]
Mr. Redhead testified that upon this being introduced the
Appellant reviewed its Champion Grader pricing and created five
pricing components for sales purposes:
1.
The cost of the grader;
2.
$5,000 payable to Champion for its 5/5 program;
3.
$5,000 inspection cost to Redhead;
4.
Salesman's commission; and,
5.
Redhead's profit.
The sales in question were to municipalities, and usually
involve a trade-in. All of the sales were by negotiation, not
tender. None of these components were identified to the customers
because Redhead expected that the end result of negotiations
would occur when the customer finally said "Well, I will buy
your grader if you throw in the inspection program". The
Court finds this to be a logical and sensible expectation by
Redhead respecting negotiated sales deals.
[4]
The result was that Redhead fixed an anticipated inspection cost
to it of $5,000, which was the same figure as the one Champion
identified as its fixed costs of the 5/5 program. It then
calculated a reserve at the end of 1986 consisting of 4/5 of
$5,000 x 56, the number of Champion graders which it sold with
the 5/5 program. That reserve was not allowed and this appeal
ensued.
[5]
The portions of Section 20 of the Income Tax Act
("Act") upon which the appeal is centred are the
following:
20(l) Deductions
permitted in computing income from business or property –
Notwithstanding paragraphs 18(1)(a), (b) and
(h), in computing a taxpayer's income for a taxation
year from a business or property, there may be deducted such of
the following amounts as are wholly applicable to that source or
such part of the following amounts as may reasonably be regarded
as applicable thereto;
...
(m)
reserve in respect of certain goods and services – subject
to subsection (6), where amounts described in paragraph
12(1)(a) have been included in computing the
taxpayer's income from a business for the year or a previous
year, a reasonable amount as a reserve in respect of
(i)
goods that it is reasonably anticipated will have to be delivered
after the end of the year,
(ii)
services that it is reasonably anticipated will have to be
rendered after the end of the year,
(iii)
periods for which rent or other amounts for the possession or use
of land or chattels have been paid in advance, or
(iv)
repayments under arrangements or understandings of the class
described in subparagraph 12(l)(a)(ii) that it is
reasonably anticipated will have to be made after the end of the
year on the turn or resale to the taxpayer of articles other than
bottles;
...
20(7) Exception –
Paragraph (1)(m) does not apply to allow a deduction
(a)
as a reserve in respect of guarantees, indemnities or warranties;
...
[6]
Thus the particular question is whether or not Redhead's
reserve for inspections was a deduction forbidden by subsection
20(7) because it was on account of a guarantee, or indemnity or a
warranty. Or, within the terms of Redhead's and
Champion's agreement and the sale to the customer, was the
inspection program a warranty by Redhead? A second question,
which will be dealt with first, is whether 4/5's of $5,000
per grader was a "reasonable" reserve under paragraph
20(l)(m).
[7]
The Uptime 5/5 program only applied to municipalities, which
ranged from 25 to 300 miles away from Redhead's three
Saskatchewan outlets. Redhead had to send a qualified staff
member out to each grader every six months to perform the
inspection. Redhead was advised by Champion of the sum Champion
would contribute to each inspection, which ranged from $150 per
inspection in year one, to $200 per inspection in year five.
Redhead knew that this was not enough to pay the cost of sending
a "technician", vehicle and proper equipment anywhere
from 25 to 300 miles away and then do the inspection. The
inspection was detailed respecting each of the fluid systems; the
engine frame area; the air intake, exhaust and cooling system;
the fuel supply system; the final drive; the circle and
"moldboard" area; the operator station and hinge area;
an operational checkout; the electrical system; "maintenance
and adjustments" and the "blade" system. Both the
owner and Redhead signed each inspection report (Exhibit A-3).
This was no "drive-by" inspection. On the other hand,
it was merely an inspection. Redhead did not have to maintain,
replace or repair. A-3 is specific – maintenance and repair
is the responsibility of the owner. But Redhead had to provide
the skilled labour, equipment and time for such inspections,
miles away from its premises, every six months.
[8]
Redhead had been in the business for 18 years in 1986. But there
is no evidence that it had any experience with such an inspection
program. However, ten elaborate inspections would cost
considerably more than Champion would pay Redhead. To the Court,
an estimate of an extra $500 per inspection under such
circumstances is not unreasonable. The average mileage to and
from a rough and mostly rural inspection site would exceed 300
miles and the actual cost of that would easily amount to $2.00
per mile for the equipment and an appropriate vehicle, even in
1986. To this there must be added the cost of the technician, his
benefits and a possible overnight stay. A further factor is the
general overhead cost. It should be noted that two inspections
per year amounts to a possible average of 112 days for
inspections each year. This is one-half a working man-year plus a
vehicle and other equipment. $56,000 per year as a charge plus
Champion's annual payment per inspection to Redhead then
appears quite reasonable. In 1988, during the objection stage,
the Appellant's chartered accountant had Redhead calculate
its actual average costs of each inspection in 1986, presumably
after Champion's payment was received. These were $3,734.40
per machine. Thereupon Redhead reduced its reserve claim to
$3,734.40 x 56 x 4/5 = $167,301.12. Two things should be noted
about this:
1.
This was done after 1986, and based upon the 1986 experience.
2.
Champion had estimated an increased cost as the years passed and
each machine got older and required longer inspection time, and
as costs of everything increased. Undoubtedly Champion's view
is sensible. In the Court's view, Redhead's calculation
of $5,000 per machine was reasonable and its revised claim is
conservative respecting the remaining four years.
[9]
The reserve itself was not for a guarantee or an indemnity.
Nothing was guaranteed and no loss was protected. The contract
was merely that Redhead would inspect.
[10] Moreover
Redhead did not warrant. Champion itself warranted the 5/50
warranty in the letter of its agreement. Paragraphs 5 and 6 of
Champion's agreement with Redhead (Exhibit A-5) reads:
5.
The DISTRIBUTOR agrees to carry out, on a semi-annual basis and
in the manner set out in the UPTIME REPORT, inspections of all
GRADERS in respect of which the WARRANTY has been purchased (the
"UPTIME INSPECTIONS") employing only fully trained and
qualified technicians (the "TECHNICIANS"). The
TECHNICIANS will prepare and present to the OWNER, obtaining a
receipt, an UPTIME REPORT in respect of each such UPTIME
INSPECTION, specifying the required repairs or replacement of
parts. If unable to present the UPTIME REPORT to the Official as
indicated in para. 18 of the WARRANTY, the DISTRIBUTOR will mail,
using "Certified Mail" service, addressed to the
Official.
6.
The DISTRIBUTOR agrees, upon authorization by the OWNER, to carry
out all repairs or replacement of parts covered by the WARRANTY
("WARRANTED REPAIRS") and specified in the UPTIME
REPORT, as well as any other repairs or replacement of parts
("NON-WARRANTED REPAIRS") authorized by the OWNER
(together, the "REQUIRED WORK"), REQUIRED WORK must be
completed by the DISTRIBUTOR within fourteen (14) days of the
UPTIME INSPECTION. All other WARRANTED REPAIRS must be completed
by the DISTRIBUTOR within seven (7) days of the date on which the
WARRANTY claim is made by the OWNER. All WARRANTED and
NON-WARRANTED REPAIRS shall be carried out by TECHNICIANS
only.
[11] The
inspection and its consequent "Uptime Report" (the
inspection report) was a prerequisite to Champion carrying out
its warranty. Redhead, in turn, supplied the labour for the
warranty separate and apart from the inspection program. In fact,
Champion and the Owner were the signatories to the "Champion
Extended Powertrain Warranty" (Exhibit A-4). Redhead was not
a signatory. Paragraph 5 of Exhibit A-4, Champion's warranty
agreement with the owner, makes the inspections a condition of
the warranty, but not part of the warranty.
[12] The Court
finds that Redhead did charge $5,000 per grader in question which
it sold in 1986 for the inspection program and included that sum
in its income pursuant to paragraph 12(1)(a) of the
Act. 4/5's or more of this $5,000 was for inspection
services to be rendered by Redhead in inspections after 1986.
Redhead contracted to provide these inspections and the history
of graders owned by municipalities is that they are all owned for
more than five years and they are not destroyed by accident or
for other reasons. Thus, there was to be an inspection every six
months and there was no contingency involved. For this reason,
the 4/5 fraction calculated was correct.
[13] The
inspections did not constitute warranties, indemnities or
guarantees. Their purpose was to verify that the graders were
being maintained and operated properly. The inspection process
also instructed the municipality's staff in proper
maintenance. This served Champion to protect its warranty. It
also served the municipality because it acted as a check on its
staff and it was also a prerequisite to its contract with
Champion for the warranty.
[14] For these
reasons, the appeals are allowed and the matter is referred to
the Minister of National Revenue for reconsideration and
reassessment in accordance with these reasons.
Signed at Ottawa, Canada, this 7th day of May,
2001.
"D. W. Beaubier"
J.T.C.C.
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