The Chief Justice (judgment delivered from the Bench) (all concur):— This is an appeal from a judgment of the Trial Division dismissing with costs an appeal from reassessments of the appellant, who is a building contractor, under Part I of the Income Tax Act for the 1967, 1968 and 1969 taxation years.
It is common ground that whether or not the appeal is to succeed depends upon the proper treatment for tax purposes of certain payments under transactions between the appellant and its customers which, it is agreed, are typified by the documents that evidence an arrangement between the appellant and the Quebec Autoroute Authority.
In the normal course of its business, amounts payable to the contractor are withheld by its customers (pursuant to the construction contracts) as “holdbacks” for a certain period of time after completion of the work and are then payable subject to specified conditions — eg certification of the work as satisfactory.
lt is common ground that, at least for tax purposes, holdbacks are not, in the case of the appellant, brought into the computation of its income for any year until they are received or receivable.
The reassessments in question were made on the assumption that, although not payable until a subsequent year, the holdbacks in question “were nevertheless paid by the customers and received by the contractor in the years 1968 and 1969” and on the further assumption that “for the release or payment of the holdbacks, securities were given to the customers by the appellant to guarantee the work done”.
The holdbacks in question apparently do not carry adequate interest. In order to obtain adequate interest income on holdbacks payable to it in the future, the appellant made the arrangements with its customers that give rise to the problem in this case.
That arrangement was, in each case, to the following effect:
(1) the appellant would purchase a term note of a third person made payable to the customer in an amount equal to the holdback and maturing on the date when it was expected that the holdback would become payable;
(2) the term note would be placed “in escrow” with a bank and would not be released except on the written authority of the customer;
(3) the customer would then “release” the holdback to the appellant;
(4) the interest on the term note would “accrue” for the appellant’s benefit and, when received by the customer from the maker of the note, would be paid by the customer to the appellant; and
(5) at the maturity date of the term note, the face value would be paid to the customer, who would in turn “release” the money to the appellant “under the same terms that would have applied” to the holdback.
The position taken by the appellant in the Trial Division was that the holdbacks were not in fact paid under the construction contracts in 1968 and 1969 and should not, therefore, be included in computing the appellant’s incomes from its business for those years.
The learned trial judge rejected this contention and, on my first reading of the matter, I agree with him. I cannot think of any interpretation to give to the provision in the arrangement that the customer “will then immediately release . . . the holdbacks” other than that it is a requirement that the customer will pay the holdbacks immediately notwithstanding that it is otherwise entitled to hold back payment for a period of years. However, it is not necessary to express any firm opinion on this question as, in my opinion, the appeal must be allowed even if the holdbacks were paid in 1968 and 1969.
In this Court the argument of the appellant, as set out in its Memorandum of Fact and Law, suggests a new approach to the problem. I refer to the following paragraphs of the Memorandum:
5. Upon entering into a special arrangement with a customer, the Appellant did not receive payment of the holdback but only received an amount equal to that of the holdback.
6. Upon entering into a special arrangement with a customer, the respective obligations and rights deriving from the initial construction contract of both involved parties remained intact except that, thereafter, the holdback instead of being held in the form of cash was held in the form of a suitable security.
7. The substance rather than the form of the special arrangements must be seeked in order to ascertain the tax consequences, if any, deriving from such special arrangements.
8. By concluding that the amount of a holdback was received by the Appellant upon entering into a special arrangement, one must also conclude that the Appellant became enriched after it entered into such a special arrangement.
9. According to the facts, the Appellant immediately after having entered into a special arrangement was neither richer nor poorer than it was immediately before. The Appellant remained after entering into such special arrangements a contingent creditor for amounts equal to that of the holdbacks.
10. According to the facts, if the amount of the holdbacks are held to have been paid to the Appellant at the time it entered into special arrangements, the Appellant’s cash flow should necessarily at the same time be increased by a similar amount whereby the Appellant would have been in a position to pay any taxes on account of such receipts of moneys. On the contrary, according to the facts of this case, the Appellant, in order to pay the income taxes as per the re-assessments, would have to borrow in order to meet this tax liability.
11. If one was to accept that the Appellant was in fact paid the amount of the holdbacks upon entering the special arrangements, one would also have to accept that the Appellant was not thereafter entitled to any further payments from its customers. Under such an assumption, the Appellant’s status would have changed from a contingent creditor to a fully paid creditor.
12. Under the assumption specified in the above paragraph, how can we explain the amounts to which the Appellant, after having entered into special arrangements, was still entitled to receive at the time the holdbacks become due and payable except by accepting that the suitable securities given constituted a deposit made by the Appellant in guarantee of its obligation under the initial construction contracts.
In my view the appellant has misdirected its attempts to obtain proper tax treatment. In order to obtain payment of a holdback in the year when the work was completed, it entered into an arrangement under which it had to disburse, in that year, an amount equal to the holdback and obtained a right to payment of an amount equal to the holdback at the time when, and subject to the conditions upon which, the holdback would have been payable if its payment were not advanced under the arrangement. Instead of claiming, in the year when the holdback was received as part of its income, deduction of an amount disbursed in the same year to obtain such income payment, the appellant has been wrongly contending that it did not receive the income payment at all.
In my view, the arrangement made by the appellant with its customer in respect of the holdbacks was one of the transactions of its construction business and, as it was carried out in the process of earning the profit of the business, it was a transaction on revenue account and not on capital account. It follows that, not only must the appellant take into its profit and loss account, for the year when it was received, the holdback immediate payment of which was received as a result of that transaction, but it is entitled to include, as a debit in its profit and loss account for that year, what it had to pay out in the year to obtain immediate payment of the holdback. It follows, also, that it must take into profit and loss account for some subsequent year an amount received under such revenue transaction (ie when the holdback would be payable under the construction contract).
The result, as I see it, is that, apart from the special transaction, the effect of the amount held back on the appellant’s profit and loss accounts would have been
(1) Year of completion
(2) Year of certification
— holdback payment on revenue side
whereas, as a result of the arrangement with the customer, the result is
(1) Year of completion
— holdback on revenue side
— amount equal to holdback on debit side
(2) Year of certification (if certified)
— amount equal to holdback on revenue side.
(Interest payments would also receive their appropriate treatment in the accounts.)
It follows that, in my view, the appeal should be allowed, the judgment of the Trial Division should be set aside, and the assessments referred to in the notice of appeal should be referred back to the respondent for reassessment on the basis that the amounts paid by the appellant for the “securities” referred to in paragraph 5 of the notice of appeal were disbursements on revenue account that should be taken into account in computing its profits or losses. I am of Opinion that we should hear counsel on the question of costs.