Harlequin Enterprises Ltd. v. The Queen, 74 DTC 6634, [1974] CTC 838 (FCTD), aff'd 77 DTC 5164, [1977] CTC 208 (FCA)

Mahoney, J:—Two amounts in respect of the calculation of the plaintiff’s 1969 taxable income are in issue. One is the deduction from income of $128,040 claimed by the plaintiff, being “gross profits on books on hand at wholesalers”, disallowed by the Minister of National Revenue. The other amount is a deduction from income, calculated at approximately $220,000 to which the plaintiff claims it is entitled in respect of goods sold which could reasonably be expected to be returned in accordance with the terms of the agreements under which the goods were sold.

The plaintiff is a book publisher. In 1969 it published only paperback novels of a light romantic nature at the rate of eight new titles per month. These were marketed in both Canada and the United States of America through distinct distribution chains to what are known as the wholesale and direct markets.

The plaintiff's marketing strategy is based on the desire for a wide exposure of its books to the buying public, the fact of a very low actual unit cost of the books themselves and the assumption, confirmed by experience, that if a particular title is not accepted by the public within a relatively short time of its appearance on the retailers’ display racks, it is not going to be accepted and should be removed to make room for another title. Thus, each title is distributed in sufficiently large quantities to ensure, in the plaintiff’s judgment, adequate coverage of the retail outlets but on the basis that unsold titles are fully returnable.

In the wholesale market the publisher deals with a distributor who handles the product of a number of publishers and, in turn, deals with a number of wholesalers. The wholesalers deal with a number of distributors on the one hand and with numerous retail outlets in their territory. The retailers put the product on display where the consumer is invited to buy. In the direct market, the wholesaler does not appear; the distributor deals direct with large retailers such as chain stores. There is provision at all stages along both chains of distribution for the return of unsold books. In this case, the relevant arrangements are those between the plaintiff publisher and its distributors.

The first item in issue, the $128,040 deduction claimed and disallowed, relates only to the wholesale market in Canada. It represents the plaintiff’s gross profit on books in the hands of Canadian wholesalers on December 31, 1969, the plaintiff’s fiscal year end. Its deduction is claimed on the basis that deliveries of books by the plaintiff to its distributor did not constitute outright sales but rather deliveries made on sale or return and that the profit referable to such deliveries is not properly to be included in computing the plaintiff’s income until the right of the distributor to return the books has expired. In the alternative, it is said that even if the deliveries to the distributor were not on a sale or return basis, they were sales subject to a condition subsequent and the profit element thereof is properly deductible in computing income.

The Supreme Court of Canada, in Sinnott News Company, Limited v MNR, [1956] SCR 433; [1956] CTC 81; 56 DTC 1047, considered a similar situation that arose at a different level of the distribution chain. There the appellant taxpayer was a wholesaler and the transactions in issue were deliveries of magazines, not books, to retailers and returns by them to the wholesaler. The appellant sought the right to deduct from its income for the year a “reserve for loss on returns” being the estimated loss of profit on magazines not sold by retailers and liable to be returned in the following year.

The judgment of the Court was delivered by Locke, J and concurred in by Cartwright and Fauteux, JJ, as they then were. Kellock, J concurred in the result but on the basis of a different finding of the facts than the majority. Locke, J said, at page 439 [86, 1049] that:

The arrangements made between the appellant and the retailers to whom it delivers the publications for sale have been found by the learned trial judge to constitute deliveries on sale or return and, accordingly, Rule 4 of Section 19 of The Sale of Goods Act (RSO 1950, c. 345) applies.

and, at page 442 [89-90, 1051] that:

While the learned trial judge found as a fact that the deliveries made to the retailers were on sale or return, he concluded that they were thereafter treated by the parties as outright sales and that, accordingly, the amounts which would become payable by the dealers if the goods in their hands were all sold or retained should be treated as accounts payable.

I am unable, with respect, to agree with the finding that in the present matter these transactions became outright sales.

The judgment of the Court was that, being deliveries on sale or return, Rule 4 of section 19 of The Sale of Goods Act of Ontario applied and that property in the goods did not pass to the retailers nor were they liable to pay for the goods delivered other than for goods sold by them or not returned within the agreed period.

The Court disallowed the reserve for loss on returns which the appellant had originally claimed but achieved the result desired by the appellant by directing that its taxable income be restated by deleting from revenue and expense the accounts receivable and payable that had been set up in respect to the goods subject to sale or return remaining in the hands of the retailers at the appellant’s fiscal year end. The plaintiff in this case, being at the inaugural, rather than an intermediate, position in the distribution chain, has only accounts receivable and no comparable accounts payable and so seeks to achieve the desired result by deducting its profit on the books delivered by it and in the hands of wholesalers. It may be conjectured that the plaintiff did not seek the same deduction in respect of books in the hands of retailers because of the practical difficulty inherent in ascertaining the quantities thereof at a given time. The principle would appear to be no different so long as the books were subject to being sent back up the distribution chain to the plaintiff.

The parties herein made no issue of whether the deliveries were governed by the law of Ontario, where the plaintiff was located at the end of 1969, or of Manitoba where its printer, who actually shipped the books on its behalf, was located. The comparable provisions of the Manitoba* [1] and Ontario! [2] Sale of Goods Acts in 1969 were, in their effect, identical to those of the Ontario Act considered in the Sinnott News case. The Ontario Act provided:

18. (1) Where there is a contract for the sale of specific or ascertained goods, the property in them is transferred to the buyer at such time as the parties to the contract intend it to be transferred.

(2) For the purpose of ascertaining the intention of the parties regard shall be had to the terms of the contract, the conduct of the parties and the circumstances of the case.

19. Unless a different intention appears, the following are rules for ascertaining the intention of the parties as to the time at which the property in the goods is to pass to the buyer:

Rule 4. When goods are delivered to the buyer on approval or “on sale or return” or other similar terms, the property therein passes to the buyer:

(i) when he signifies his approval or acceptance to the seller or does any other act adopting the transaction;

(ii) if he does not signify his approval or acceptance to the seller but retains the goods without giving notice of rejection, then if a time has been fixed for the return of the goods, on the expiration of such time, and, if no time has been fixed, on the expiration of a reasonable time, and what is a reasonable time is a question of fact.

Whether the books were delivered by the plaintiff to its wholesaler “on sale or return” is a question of fact to be determined from the agreement between them, their conduct and the circumstances surrounding the transaction.

Distribution in Canada to both the wholesale and direct markets was done by Curtis Distributing Company Limited (herein called “Curtis Canada”) under a written agreement dated March 22, 1949 in which the plaintiff was designated “publisher” and Curtis Canada was designated “Curtis”. It provided:

2. . . . The number of titles and amount of copies of books to be shipped in any one month hereunder will be determined by mutual agreement. Shipment of titles in the quantities so agreed upon shall be made by publisher f.o.b. such wholesaler destination points as shall be specified by Curtis. Title to books and risk of loss thereof shall remain in publisher until delivery to wholesalers.

3. Books which are considered unsaleable shall be fully returnable. Curtis and publisher shall, from time to time, determine what books are unsaleable, but in any event, books which have been on sale for twelve months shall be conclusively presumed to be unsaleable, and shall be fully returnable at the option, of Curtis. . . . All returns shall be shipped, return transportation collect, to such points as publisher shall designate. Curtis shall be entitled to credit on its monthly statements for all returns, at the price charged Curtis for books hereunder.

4. . . . Settlement shall be made hereunder by Curtis by the 10th of the month for books shipped during the second preceding month.

In practice, the plaintiff, in Toronto, did not itself ship the books. Its printer, in Winnipeg, did so on its behalf. Also, in practice, books returned were not physically returned to the plaintiff or even to Curtis Canada or the wholesalers. The retailer stripped the front covers, or perhaps just the portion of the front covers showing the title, from returnable books. The books were destroyed by the retailer and the covers passed back up the distribution chain as evidence of destruction. When they reached Curtis Canada, it issued a credit note to the wholesaler and transmitted a copy of the credit note to the plaintiff. This served as an invoice from Curtis Canada to the plaintiff and was taken into account on the monthly statement as required by clause 3 of the agreement.

It appears that, in theory, the return process could be initiated by retailers at any time but, in practice, books distributed through the wholesale market in Canada usually remained on retailers’ shelves three or four months. Further, the claims for return credit were delayed between six and eight weeks at the wholesale level because a wholesaler had to process claims from numerous retailers in respect of products delivered by many distributors and to break down and allocate the claims to the proper distributors. Once a claim was made on the distributor, it was immediately allocated and passed on to the publishers who were ultimately liable to satisfy it.

The plaintiff acknowledges that the settlement pattern called for in the agreement was generally adhered to by Curtis Canada throughout 1969 and into 1970 until Curtis Canada was advised of the plaintiff’s intention to terminate the agreement. Termination was effective in September, 1970. Thus, in practice the plaintiff would be paid for a book shipped in a given month by Curtis Canada about 40 days after the end of that month. If that book were returned, the credit for its return would not normally be given by the plaintiff to Curtis Canada until between four and a half and six months after shipment.

The agreement provided that books be shipped “f o b” by the plaintiff and that “title to books and risk of loss thereof” would remain in the plaintiff “until delivery to wholesalers”. Prima facie, where goods are sold “f o b”, the moment property passes to the purchaser is the moment of shipment, however it is open to the parties to postpone that moment. The plain significance of the provision that -title and risk would remain in the plaintiff until delivery is that, in this case, the parties did agree to postpone the moment that property in the books was to pass but only until delivery.

The Rules under section 19 of The Sale of Goods Act govern “unless a different intention appears”. Having regard to the provision in the agreement that property in the books was to pass to Curtis Canada on their delivery to the wholesalers designated by it and to the fact that, in the ordinary course of events, a given book would actually be paid for long before credit for its return would be given, I find that Rule 4 has no application.

The books were not delivered “on sale or return”; they were sold subject to a condition subsequent which, if invoked by the publisher, Curtis Canada, would re-vest property in the goods in the plaintiff. This, then, is the plaintiff’s alternative position and is also essentially the factual situation found to exist in the Sinnott News case by Kellock, J. Having found that property in the magazines passed from the appellant wholesaler to the retailer dealers on delivery, he went on to say, at page 437 [85-6, 1048-9]:

This, however, does not end the matter, as the parties were at one that there was a right on the part of the dealers to return the magazines at any time. . . . This being so, while the transactions between the appellant and its dealers were sales and not deliveries on consignment, they were nevertheless sales subject to a condition subsequent, the result being that, in the case of magazines actually returned, the property re-vested in the appellant; Head v Tattersall, 7 Ex D 7 per Cleasby, B, at 14; May v Conn 23 OLR 102; Benjamin, 8th ed. 415. The situation would be otherwise where there is a sale but the vendor has bound himself to repurchase in certain events, such as was considered to be the situation in The Vesta, [1921] IAC 774 at 782-3.

Accordingly, the appellant is not entitled to set up, as it has done, any reserve of profits.* [3] The reserve sought to be set up is made up of the profit element in the sale value of goods delivered to dealers during each of the years in question which the appellant estimated would be returned to it during the three months following. This estimate, to quote the appellant’s factum, ‘‘was practical, reasonably accurate, and arrived at on the basis of the actual experience of the company with each magazine for a reasonable time prior to the end of the year”.

As deposed to by the witness Sinnott, at the end of the three month period, the appellant would “know exactly” the value of goods actually returned.

Accordingly, instead of deducting the above mentioned reserve from the sales figure in respect of each of the years in question, the appellant should be entitled, in its income tax returns, to deduct the estimated sales value itself,* subject, however, when the actual figure is ascertained at the end of the three months’ period, to adjustment in the year in which such returns are actually made.

Kellock, J did not link his conclusion as to the deductibility of the estimated sales value to any provision of the Act. While the judgment does not state expressly what is meant by the term “sales value” the following remark, at page 438 [86, 1049], is helpful:

Although the appellant fails with respect to the basis upon which it contested this litigation, the practical result is the same.

“Sales value” is not “profit” but it is an amount equal to “profit” and is the same as “profit element” that the plaintiff, in this case, seeks to deduct not from its profit after that has been calculated but rather from its earnings prior to the calculation of profit. The law to be applied in determining whether that deduction should be allowed is the Same as the law to be applied in determining whether the $220,000 deduction should be allowed. It is therefore convenient here to set out the facts relevant to that deduction.

Distribution in both the wholesale and direct markets in Canada was pursuant to the agreement with Curtis Canada. Its material provisions have already been recited. Distribution in the United States of America to the wholesale market only was done by Curtis Circulation Company (herein called “Curtis US”) under a written agreement dated December 19, 1968, in which the plaintiff was designated “Harlequin” and Curtis US was designated “Curtis”. It provided:

(3) Harlequin agrees to sell and Curtis agrees to purchase the books for resale in accordance with this Agreement... The purchase price shall become due and payable by Curtis sixty days after shipment by Harlequin and Harlequin shall invoice Curtis monthly. Books shall be shipped and delivered by Harlequin or its agent to the wholesaler or other outlets as directed by Curtis . . . Curtis shall become the owner of the books purchased on delivery of the same to such delivery points specified by Curtis.

(4) Curtis shall sell Books to Customers subject to full return privileges as hereinafter described. Books shall always be fully returnable by Curtis to Harlequin for full credit. Curtis will initiate computation of the Customers’ Credit for returns for unsold Books via return authorizations issued by Curtis. . . . Curtis shall give return credit to Customers upon receipt of authorizations from Customers and shall receive credit from Harlequin upon the giving of such credit to Customers . . .

(6) Curtis shall pay Harlequin for shipments of books to Curtis or to Customers within sixty days after shipment is made by Harlequin. This payment shall be adjusted for return credits (issued in accordance with paragraph 4 hereof) for previously uncredited returns.

In practice, as under the agreement with Curtis Canada, the books were actually shipped by the printer and covers were stripped and books destroyed rather than physically returned. The terms of payment called for in the agreement were generally observed until it, too, was about to be terminated in September 1970.

Distribution in the direct market in the United States was on an entirely different basis. It was governed by an agreement in writing dated December 31, 1968 between the plaintiff, therein designated “Harlequin” and Simon & Schuster, Inc, therein designated “Publisher”. Under that arrangement Harlequin provided Publisher with plates and negatives permitting Publisher to print in the US titles Harlequin had or proposed to distribute in Canada. Publisher undertook to cause a minimum number of copies of each title to be printed within a specified time of the provision of the plates and negatives and to pay Harlequin royalties on net sales. “Net sales” was defined as “copies shipped by Publisher to retail chain store outlets less returns” and it was provided that “Publisher shall have unlimited and uncontrolled discretion in the matter of accepting returns”.

The material provisions relative to the accounting for and payment of the royalties follow:

10. (a) On the last day of each month, publisher will render a written statement to Harlequin of the aggregate sales and returns of Titles during the preceding calendar month and will pay to Harlequin an amount on account of royalties hereunder based upon 75% of the net sales during such preceding

(b) Publisher shall render royalty statements to Harlequin on May 30 for the period from October 1 to March 31 and on November 30 for the period from April 1 to September 30... Within 10 days thereafter, Publisher shall pay to Harlequin the royalty applicable to the reported period . . . less amounts paid on account thereof pursuant to subparagraph (a) of this paragraph, and less a reserve of 25% of net sales during the last two months of the period accounted; and plus the reserve so withheld in respect to the prior period. If such statement shows an overpayment of royalties, promptly on receipt of the statement, Harlequin shall make refund to publisher...

The return experience on books distributed in each of the four distribution chains was different. As at December 31, 1969, the plaintiff provided in its accounts a current liability of $232,889 for returns of books then outstanding in the distribution system. Omissions in the calculation at the time resulted in this amount being more than the amount now claimed.

The calculation follows:

Canadian Sales

Wholesalers

Last 9 months sales of

The omissions which render the $232,889 figure inaccurate are the failure to convert the Simon & Shuster rebate from US to Canadian dollars and the failure to take into account that any rebate to which Simon & Shuster became entitled would, ipso facto, reduce the plaintiff’s liability to pay royalties to a third party. I am not satisfied that the revised figure given at the trial is necessarily correct and I see no need to determine it. For convenience, I have assumed it to be in the neighbourhood of $220,000. If this deduction were allowed to the plaintiff then the similar provision made at the end of its previous year and carried forward would have to be added to income. The net result would be a reduction in the provision of about $35,000 since the provision established, but not claimed for tax purposes, was higher at December 31, 1968. Again I see no need to determine and, indeed, on the evidence am not able to determine accurately the amount of the reduction.

The expert evidence of Ronald Walker Scott is to the effect that the provision for returns, in the circumstances of the plaintiff's business, conforms with generally accepted accounting principles and is, in fact, fair and reasonable. Mr Scott is a chartered accountant, a partner in the accounting firm Clarkson, Gordon & Co, working in that firm’s National Accounting Standards Department. That is a service department within the firm responsible, inter alia, for research into developments in accounting principles and standards. Clarkson, Gordon & Co are the plaintiff’s auditors. I accept Mr Scott’s evidence that, having regard to the manner it conducted its business, the plaintiff's practice of making provision for book returns was a necessary conformity to generally accepted accounting principles. On the evidence as to the plaintiff’s actual return experience before, during and since 1969 the provision appears to have been reasonably calculated in so far as returns under the Curtis agreements were concerned.

While decisions dealing with deposits and credit notes can readily be distinguished on their facts from the present case, the law applicable is the same law and is not to be distinguished. The decisions of the Supreme Court of Canada in MNR v Atlantic Engine Rebuilders Ltd, [1967] SCR 477; [1967] CTC 230; 67 DTC 5155, and Time Motors Ltd v MNR, [1969] SCR 505; [1969] CTC 190; 69 DTC 5149, are authority for the proposition that generally accepted accounting principles are most relevant in arriving at a determination of the facts to which the provisions of the Income Tax Act are to be applied.

The first question is whether the deduction claimed was required by generally accepted accounting principles to be made in order to ascertain the plaintiff’s true profit for the year ended December 31, 1969. If that is answered in the negative, it is not necessary to inquire further, but if the answer is affirmative, it remains to be answered whether the deduction is prohibited by a provision of the Act. The expert evidence did not deal with the deduction of the entire profit element attributable to books in the hands of Canadian wholesalers as at December 31, 1969. The expert evidence dealt only with the provision, by way of a current liability, for the rebates that might reasonably bé expected to be made in respect of returns of books in the distribution system at the plaintiff’s year end.

It is not suggested that all of the books in any particular part of the system, in this instance, those in the Canadian wholesale chain still in the hands of wholesalers, could reasonably be expected to be returned. That basis of deduction may have been selected with a view to tailoring the deduction as closely as might be to the judgment of Kellock, J in the Sinnott News case. With the greatest respect, I cannot accept that judgment as the judgment of the Court, having regard to the very different finding of facts by the majority, and must assess what the plaintiff has done in the light of generally accepted account- ing principles. It is significant that in the case of Sinnott News, the deduction sought was part only of the profit reasonably estimated on the basis of experience to be attributable to publications likely to be returned for credit. In this case, the plaintiff seeks to deduct the entire profit element attributable to all the publications at a certain point in one of its distribution chains.

I accept that returns of some of those books was a certainty and that the application of generally accepted accounting principles requires some provision for those returns. The provision which the expert evidence supports was based on 10.5% of books delivered to Canadian wholesalers over a nine month period being returned. It seems to me that the elimination of the entire profit element, including that attributable to the approximately nine of ten books that would not be expected to be returned, has no rational foundation. The evidence in this case does not support the proposition that generally accepted accounting principles required that the entire profit element attributable to all of the books in the hands of Canadian wholesalers at a given time be deducted from income in order to present a true, or at least truer, financial measurement of its operations to that point in time.

With respect to books outstanding under the Simon & Shuster agreement as at December 31, 1969, I am by no means satisfied on the evidence that the plaintiff had actually received royalty payments liable to be refunded. The agreement appears to have been designed to protect Simon & Shuster from overpaying the plaintiff. The evidence is that the terms of the agreement as to the accounting and payment were observed. Thus, as at December 31, the plaintiff would not have been paid or be entitled to be paid 25% of the royalty on net sales during August and September, being the last two months of last accounting period, nor October, November and December, being in the then current accounting period.

1969 was the first year of the Simon & Shuster agreement. Previously, the plaintiff had acted as its own wholesaler in parts of the United States and Simon & Shuster, handling books printed in Canada, had been the wholesaler in other parts of the United States. The provision for rebate of royalties was based on that experience but does not appear to have taken into account the holdback. The 25% holdback of the royalties in respect of the last five months’ net sales is well in excess of the 16% and 14% respectively, of the royalty on the last five months’ net sales, which the plaintiff did set up, on the basis of actual experience, under the new arrangement at the end of 1970 and 1971. I therefore find that this provision in 1969 did not conform with the requirements of generally accepted accounting principles.

The balance of the provision for returns in the total of approximately $203,800 did, on the evidence, conform with the requirements of generally accepted accounting principles. The application of those principles in the determination of the plaintiff’s profit is to be allowed unless the Act contains an express prohibition.

The relevant provisions of the Act are:

4. Subject to other provisions of this Part, income for a taxation year from a business or property is the profit therefrom for the year.

12. (1) In computing income, no deduction shall be made in respect of

(e) an amount transferred or credited to a reserve, contingent account or sinking fund except as expressly permitted by this Part,

The decision of the Supreme Court of Canada in Dominion Telegraph Securities Limited v MNR, [1947] SCR 45; [1946] CTC 236; 2 DTC 875, held that three distinct accounts: (1) a reserve, (2) a contingent account, and (3) a sinking fund, are described in paragraph 12(1)(e). In order for it to be an account within the contemplation of the section, the allocation of an amount to it from another account must have the effect of reducing income. This case is not concerned with a sinking fund as I understand that term.

The adjective “contingent” means “liable to happen or not: of uncertain occurrence or incidence”.* [4] The term “contingent account” taken literally would appear to be nonsense. An account, once set up is itself not contingent: it has, so to speak, happened and is not uncertain. It exists. The term must be taken to mean “account for a contingency”. In other words, it is not the account that must be found to be contingent but rather the thing in respect of which it was set up: in this case the liability to pay or give credit for the refunds and rebates. I have been unable to find Canadian authority defining the term “contingent liability’; however, in Winter et al v IRC, [1963] AC 235, the House of Lords did so in the context of the Finance Act, 1940, 3 &4 Geo VI, c 29.

The facts of that case were complicated by the intervention of a company controlled by the deceased. Accordingly, the law lords were looking through the corporate veil to arrive at the value of shares for estate duty purposes by ascertaining the true worth of the company. Certain company assets, in respect of which capital cost allowance had been claimed, had a fair market value on the death of the deceased well in excess of their written-down value on the company’s books. If sold for anything more than the written-down value, a recapture of the capital cost allowance would necessarily have given rise to an adverse change in the company’s income tax situation. The legislation imposing the estate duty expressly required that “contingent liabilities” be taken into account in determining the dutiable value of the estate. The executors contended successfully that the notional tax on the recapture of depreciation was a contingent liability at the moment of death. Their lordships held that the term “conditional obligation’” which is well defined in Scots law has the same meannig as the term “contingent liability”. A number of their lordships discussed the definition in their speeches, Lord Reid most extensively. At pages 248 et seq he said, in part:

lt would seem that the phrase “contingent liability’ may have no settled meaning in English law... But the Finance Acts are United Kingdom Acts, and there is at least a strong presumption that they mean the same in Scotland as in England. A case precisely similar to this case could have come from Scotland and your Lordships would then have considered the meaning of this phrase in Scots law. So I need make no apology for reminding your Lordships of its meaning there. Perhaps the clearest statement of the Law of Scotland is in Erskine’s Institute, 3rd ed., vol 2, Book Ill, Title 1, section 6, p 586, when he says: “Obligations are either pure, or to a certain day, or conditional... A conditional obligation, or an obligation granted under a condition, the existence of which is uncertain, has no obligatory force till the condition be purified; because it is in that event only that the party declares his intention to be bound, and consequently no proper debt arises against him till it actually exists; so that the condition of an uncertain event suspends not only the execution of the obligation but the obligation itself . .. Such obligation is therefore said in the Roman law to create only the hope of a debt. Yet the granter is so far obliged, that he hath no right to revoke or withdraw that hope from the creditor which he had once given him”.

So far as I am aware that statement has never been questioned during the two centuries since it was written, and later authorities make it clear that conditional obligation and contingent liability have no different significance. I would, therefore, find it impossible to hold that in Scots law a contingent liability is merely a species of existing liability. It is a liability which, by reason of something done by the person bound, will necessarily arise or come into being if one or more of certain events occur or do not occur. If English law is different — as to which I express no opinion — the difference is probably more in terminology than in substance.

Then, after dealing with the other classes of liability the statute required the Inland Revenue Commissioners to take into account, he said:

. . . The third class is “contingent liabilities” which must mean sums, payment of which depends on a contingency, that is, sums which will only become payable if certain things happen, and which otherwise will never become payable. There calculation is impossible, so the commissioners are to make such estimation as appears to be reasonable.

The last class appears to me to cover exactly the conditional obligation dealt with by Erskine in the passage I have quoted. I agree with the respondents’ argument to this extent, that this class can only include liabilities which in law must arise if one or more things happen, and cannot be extended to include everything that a prudent business man would think it proper to provide against.

I see no reason not to accept the same meaning in Canadian law.

Certain as it was that the plaintiff would, in due course, be obligated to give rebates on royalties or on returns of books, the fact is the plaintiff’s liability to do so, under the terms of the agreements which were, in practice, observed, did not arise until the plaintiff was presented with a demand for the credit. The plaintiff’s obligation to the distributors in respect of credits for returns was a contingent liability. So was its obligation to rebate royalties to Simon & Shuster. An account set up to provide for those contingent liabilities whether by way of a provision for returns and allowances on its balance sheet or a deduction from earnings in the calculation of its taxable income was a contingent account within the meaning of paragraph 12(1)(e). No deduction in respect of that account, even to the extent that generally accepted accounting principles required it to be made, is permitted in the calculation of the plaintiff’s taxable income.

This case is to be distinguished from Sun Insurance Office v Clark, [1912] AC 451, where it was expressly found that no statutory pro- hibitions against deductions applied* [5] and the only issue was that the deduction had, of necessity, to be estimated. It is also to be distinguished from the Atlantic Engine Rebuilders and the Time Motors cases where, in each case, the uncertainty did not pertain to the coming into existence of the liability (it came into existence when the deposit was accepted or the credit note issued, as the case may be) but rather pertained to whether the creditors would do what was necessary to enforce the existing liability.

In this instance, it is neither the fact than an estimate had necessarily to be made nor that it might or might not have been called upon to meet the liability that defeats the plaintiff. Rather, it is the fact that the liability, as at the pertinent date, was contingent and the account set up to provide for it, whatever the mechanics, was a contingent account.

The two Curtis agreements were terminated in September, 1970. When they were advised of the plaintiff’s intention to terminate, sometime in 1970, the Curtis companies both suspended payment as required by the agreements until all returns had been processed and credits ascertained. The Curtis companies then paid the plaintiff the balances owing.This evidence was adduced in support of the plaintiff’s contention that a portion at least of the provision for returns and allowances was properly deductible as a reserve permitted by subparagraph 11 (1)(e)(i) of the Act.

11. (1) . . . the following amounts may be deducted in computing the income of a taxpayer for a taxation year:

(e) a reasonable amount as a reserve for

(i) doubtful debts that have been included in computing the income of the taxpayer for that year. . . .

The plaintiff had not experienced any problems in collecting from either Curtis company prior to intimating its intention to cancel. That occurred subsequent to the year in question. The plaintiff had not, in its financial statements for that year, set up a reserve for that purpose.

This deduction was sought in an appeal to the Tax Appeal Board in respect of its 1949 income tax assessment by a taxpayer with which the present plaintiff may have had some connection. In that case,t [6] the learned member of the Board, RSW Fordham, QC said, with reference to the term “doubtful debts”, that:

Those two words imply a definite financial indebtedness that, for some identifiable reason, probably — but not, It should be noted, certainly — will not be satisfied by the debtor.

I agree with that interpretation. For a debt to be doubtful within the contemplation of subparagraph 11(1)(e)(i), its collectability must be attended by a doubt based on a real consideration, not on mere speculation, that leads to the conclusion that it will not likely be collected. A doubtful debt and a slow debt are not the same thing. There is nothing in evidence to support the proposition that the debt due from either Curtis company was doubtful as at December 31, 1969.

Finally, the defendant took objection, on the basis of the pleadings, to the Court dealing with any deduction except the $128,040 claimed by the plaintiff in its return and the reserve for doubtful debts. It was noted that the deduction of the provision for returns and allowances had not been claimed in the return and it was argued that it was not pleaded in the statement of claim.

The statement of claim is by no means crystalline in its definition of the issues; however, the time for rectification of that deficiency is past when the trial begins. It is reasonably open to construction, by virtue of various cross-references, as raising the deductibility of the provision for returns and allowances other than as a reserve for doubtful debts.

Understandably, in the circumstances, the statement of defence did not raise the question of whether the deduction could be sought at all in this action in view of its not having been claimed in the return and, hence, not having been the subject of the assessment from which this appeal is taken. Neither, however, did the statement of defence raise the same objection concerning the reserve for doubtful debts which was sought for the first time in the statement of claim. The provision for returns and allowances, unlike the reserve for doubtful debts, at least appeared in the financial statements that accompanied the tax return even though it was washed out in the accompanying reconciliation of earnings per financial statements with taxable income.

While, in the result, a disposition of this objection is not necessary, it does seem to me that, the appeal being an appeal from an assessment, it is a moot question whether the Court is entitled to consider, on appeal, a deduction that was not even the subject matter of the assessment. I should not, however, be prepared to express a view on such a question without the benefit of comprehensive argument directed to the point. I was not the beneficiary of such argument in this instance.

The appeal is dismissed with costs.