Port Colbourne Poultry Ltd. v. R., 97 DTC 237, [1997] 2 CTC 2480 (TCC)

Rowe DJ.T.C.:

The appellant appeals from an assessment of income tax for its 1991 taxation year. During the 1991 taxation year the appellant operated a poultry processing plant in Port Colborne, Ontario and was convicted of an offence under the Ontario Water Resources Act which led to the imposition of fines in the amounts of $15,003.75 and $5,003.75 which the appellant paid and then sought to deduct from income together with an amount pertaining to legal costs. Initially, the Minister of National Revenue (the “Minister”) disallowed both the fines and the legal fees but then issued a reassessment allowing the deduction of the legal fees. The disallowance of the deduction of the total amount of the fines was confirmed.

Patricia Bowman appeared as agent for the appellant and testified that she is the comptroller for Port Colborne Poultry Limited (PCPL). She stated that on April 12, 1990, an employee of the company was filling up a tanker with sludge that is a by-product of the poultry processing business of the appellant and spilled some of the material onto the ground. The employee then proceeded to use a hose to apply water, under pressure, to the spilled sludge sufficient to cause that waste material to be deposited into a ditch. Approximately five kilometres from that site, a fishkill later occurred and the Ministry responsible for enforcing the Ontario Water Resources Act alleged that this event was caused by the spill from the appellant’s plant. The appellant was charged with four counts under that Act and sought legal advice to contest the allegations of the Crown. On August 21, 1991, an arrangement was entered into whereby the appellant pled guilty to two counts and was fined the sums of $15,003.75 and $5,003.75 for a total of $20,007.50 which it later deducted from income. Ms. Bowman stated that management of PCPL did not want any bad publicity that would probably result from a trial on the charges. The sludge is a natural by-product of the processing of poultry and is used for agricultural purposes by persons operating sod farms, corn farms and other similar enterprises. The birds are slaughtered and cleaned during a process which uses between 200,000 and 250,000 gallons of water per day. Through a particular method of treating the effluent, the suspended solids are separated while the rest of the water is placed into holding lagoons and discharged twice a year subsequent to obtaining approval from the Ministry of Environment. When the solids settle, about 3,000 gallons of sludge are produced per day. Information gathered by the appellant about the spill revealed that the tanker was on the appellant’s property and was being filled with the sludge, in the usual manner, when it overflowed onto the ground. The employee, operating on his own initiative, used the water supply to dilute the material and disperse it into a nearby ditch. Ms. Bowman stated she had been employed by the appellant since 1981 and it had never before been convicted of any environmental or other offence arising from business operations. She stated the appellant follows strict procedures and the particular incident giving rise to the charges occurred late at night when there was no supervisor on site. The appellant has 170 employees and processes between 45,000 and 50,000 birds per day. The circumstances of the spill were, in her opinion, highly unusual but the major factor leading to the pleas of guilty to two counts was to avoid negative publicity for the company. However, the plea of guilty - on August 21, 1991 to two counts - was based on an agreement between Counsel that no linkage between the sludge having been washed into the ditch and the killing of fish elsewhere in a creek be alleged by the Crown during submissions prior to sentencing.

In cross-examination, Ms. Bowman stated she was not familiar with the precise language of the particular charges to which the pleas of guilty were entered.

Ms. Bowman submitted that, although the appellant had entered pleas of guilty to the regulatory offences and paid the fines, the circumstances were such that the incident was on the verge of being an accident and should be deductible from income.

Counsel for the respondent submitted that the appellant, by exercising reasonable care, could have avoided the spill and the dispersal of the sludge into the natural watercourse. The act of pollution was not linked to the production of income by the appellant and the Minister allowed the deduction of legal fees because the reduction from four counts to two counts saved the appellant money. In addition, Counsel submitted that public policy should prohibit the deduction of fines in such circumstances and the offences were in the category of strict - as opposed to absolute - liability. Therefore, the penalties were not inevitable merely because the spill had occurred.

In the case of Amway of Canada Ltd. v. R., (1996), 96 D.T.C. 6135 (Fed. C.A.), the Federal Court of Appeal considered the deduction of a penalty by the appellant which, in the words of Strayer, J.A., had adopted a deliberate and complex scheme for defrauding the Canadian revenue by falsely stating the value of goods it imported into Canada. As a result Amway corporation avoided - temporarily - payment of customs duties and excise taxes amounting to $28.8 million. However, it paid this sum as part of an overall settlement with Her Majesty totalling $45 million. The payment of $45 million was regarded by Revenue Canada as a penalty and not as a receipt of taxes. Dealing first with the issue as to whether payment of that sum was an expense incurred for the purpose of gaining or producing income in order to be deductible pursuant to the Income Tax Act, Strayer, J.A. at page 6140 of his judgment stated:

Are Penalties Deductible as Business Expenses?

This is a question on which there appears to be no authority binding on this Court in respect of the particular circumstances of this case.

There emerges in the jurisprudence and the literature a recognition of two possible criteria for deciding whether amounts expended for the payment of fines or penalties should be deductible as a business expense. The first test is whether it was an expense incurred for the purpose of earning income. In essence this means the expense must be deductible within the meaning of paragraph 18(l)(a) of the Income Tax Act which provides as follows:

18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property...

The second criterion sometimes invoked is that of public policy: that is, even if the expense was incurred to produce income would it be contrary to public policy to allow a taxpayer to reduce his net income, and thus save taxes, by virtue of having been obliged to pay a fine or penalty for some wrongdoing?

With respect to the first criterion a seminal decision was that of the English Court of Appeal in The Commissioners of Inland Revenue v. Alexander von Glehn & Co., Ltd) [1] It involved penalties paid by an exporter under customs legislation for not having taken adequate care that its exports not reach enemy countries during war time. The Court held that the penalties paid were not deductible. The various reasons given by the judges, while perhaps not entirely clear, all conclude that the penalty imposed under the customs law was not an expenditure “connected with or arising out of such trade...”. An observation made by Lord Sterndale, M.R. is of interest given the later developments in Canadian jurisprudence. He stated:

Now what is the position here? This business could perfectly well be carried on without any infraction of the law at all. This penalty was imposed because of an infraction of the law and that does not seem to me to be, any more than the expense which had to be paid in the case of Strong v. Woodifield [2] appeared to Lord Davey to be, a disbursement or expense which was laid out or expended for the purpose of such trade, manufacture, adventure or concern; nor does it seem to me, though this is rather more questionable, to be a sum paid on account of a loss connected with or arising out of such trade, manufacture, adventure or concern. [3]

This concept of avoidability of a penalty, as a test of whether its payment amounts to a business expense, has been developed, I believe correctly, in decisions of the Federal Court Trial Division. The first of these is Day & Ross Limited v. Her Majesty the Queen [4] where Dubé, J. held that fines paid by a trucking business for its trucks being loaded above weight restrictions were deductible as a business expense. He noted that it was virtually impossible for the business to ensure that its trucks were not overloaded as it had to rely on weights declared by shippers when loads were picked up, there being no scales immediately available to verify the size of the loads. Violations being unintentional and fines being virtually inevitable from time to time, he found that they were incurred for the purpose of earning income. He did also make reference to the public policy test, observing that as it was possible to obtain special permits in advance to carry loads over the normal permitted weight the occasional unintended violations of those limits were “obviously not outrageous transgressions of public policy”.

This decision was followed by Cullen, J. in TNT Canada Inc. v. Her Majesty The Queen [5] The fines involved there had been paid under the Customs Act and the Excise Tax Act for various trucking violations committed by the plaintiff, a common carrier by road. These fines had been imposed upon the plaintiff for having repair work done on its trucks in the United States and the purchase of parts there without paying Canadian sales and excise tax; and for using a foreign carrier in Canada who made more than one stop in this country. Cullen, J. appears to have held that these expenses, as in the Day & Ross case, were unavoidable and therefore they met the test of having been incurred for the purpose of earning income. He then proceeded to consider the public policy criterion which he held to be an additional and necessary test beyond the requirement of meeting the test of paragraph 18(1)(a) of the Act in order to establish deductibility. He concluded that there was no violation of public policy in allowing deductibility, apparently on the basis that the taxpayer was not intentionally flouting the law. He emphasized that there had been only very few contraventions arising out of some 80,000 dispatches of trucks.

With respect to the first criterion I believe that one legitimate test of whether fines should be deductible as a business expense is that of avoidability of the offences. I believe there is support for this not only in the jurisprudence mentioned, but by analogy in a decision of the Exchequer Court involving deductibility of damages paid for a marine collision. In Imperial Oil Limited v. M.N.R. [6] the taxpayer as a major petroleum producer operated a fleet of oil tankers. One of these tankers collided with another vessel while bringing a cargo of petroleum from South America. It was sued for damages and eventually settled the claim out of court. In finding that the cost of the settlement was a deductible expense, Thorson, P. emphasized that marine transport of petroleum products was a normal part of the taxpayer’s business and “that the risk of collision between vessels is a normal and ordinary hazard of marine operations generally...”. [7] He went on to say that negligence on the part of the taxpayer’s servants in the operation of its vessels was a normal and ordinary risk and incidental to its business.

In adopting this test of avoidability of the offences leading to fines, and thus the avoidability of this particular type of expense, I do not purport to pronounce a more general rule concerning the deductibility of other types of expense. The question here is not: could the taxpayer have run his business more cheaply? It is: could the taxpayer have reasonably been expected to run his business in consistent conformity to this kind of law?

In a recent decision, Sunys Petroleum Inc. v. R., 96 D.T.C. 1759 (T.C.C.), the Honourable Judge Bell, T.C.C. dealt with the situation where the taxpayer was a corporation carrying on the business of operating gas stations. The appellant failed to pay federal and excise taxes for the period between August 1984 and September 1985. After reviewing the facts and analyzing them in the context of the decision in Amway, Judge Bell at page 1764 stated:

Respecting avoidability of a penalty, a concept endorsed by the Amway decision [8] , I find that the Appellant could not reasonably have avoided the failure to make the required remittances. It had grown in business and had grown in accounting and tax expertise with the engagement of Mulligan. The test of avoidability of a penalty cannot be properly applied in a theoretical and therefore atypical set of circumstances. It must be considered with an appreciation of the business world with particular consideration of the facts surrounding the failure to remit. The acts of a servant of the company cannot constantly be monitored nor should they be in situations like those of the Appellant where a man with expertise was engaged to attend, among other things, to the very matters giving rise to the imposition of the penalty. I find, therefore, that the penalty assessed in this case is deductible under paragraph 18(1)(«) of the Act.

I must now deal with whether it would be contrary to public policy to allow the deduction of that penalty. I do not regard the Amway decision as authority for the proposition that it is contrary to public policy to allow deduction of any penalty as a business expense. The comments on the test of public policy were made by the learned justice in a case where, in his own words, Amway adopted “a deliberate and elaborate scheme for defrauding the Canadian revenue”. Further, the stated reason for his conclusion is that the penalty was not deductible as an expense incurred for the purpose of gaining or producing income and, in so concluding, there was no expressed incorporation of the public policy criterion influencing that conclusion. In the Amway decision, the penalty was clearly avoidable and that formed sufficient grounds for the conclusion reached by the court. Therefore, it seems unnecessary for it to have incorporated any public policy considérant in that conclusion.

Accordingly, the appeal is allowed with costs.

Certainly, the incident giving rise to the penalty paid by the appellant in the within appeal is a far cry from the pervasive, deliberate and fraudulent avoidance practised by the taxpayer in Amway. It is also an isolated incident as opposed to the situation in Sunys Petroleum where the default giving rise to the penalty persisted over the course of more than a year and was attributable to the omissions of a particular employee charged with the responsibility to ensure taxes were remitted. However, it is not the act of spilling the sludge on the ground during the course of filling the tanker which is objectionable, it is the act of the employee thereafter - without supervision and by personal choice - deciding to flush the material into a ditch which was connected to a watercourse. That act was certainly avoidable. Had the spill been left in place pending instructions from a supervisor, it would have been a different matter. There should have been a policy in place to allow for proper handling of such an incident which is not so rare as to not be reasonably foreseeable when dealing with 3,000 gallons of sludge per day and ultimate transport of that substance in the course of supply to consumers. The offence was not one based on absolute liability and therefore the defence of due diligence, in accordance with the jurisprudence concerning matters of strict liability, could have been pursued. The offence in the within appeal does not fall into the category of repeated violations as in the case of Day & Ross Ltd. v. R., [1976] C.T.C. 707 (Fed. T.D.), where they were found by Dubé, J. of the Federal Court - Trial Division - to have been unintentional and nearly inevitable. Having regard to all of the circumstances, including evidence that the appellant routinely processed nearly 50,000 birds per day and used more than a quarter of a million gallons of water producing 3,000 gallons of sludge without prior incident, does not change the nature of the act of its servant leading to the conviction being entered following the pleas of guilty to two counts. As a result, I cannot conclude that the first criterion for deductibility has been met. I wish to make it clear that there is no difference in the result whether the appellant entered pleas of guilty or had been found guilty after trial.

In the event that I am wrong in so holding, I will address the matter of the second criterion - that of public policy - in deciding whether the fines should be deductible. In his decision in Amway, Strayer, J.A. at page 6141 stated:

With respect to the public policy criterion, it has been argued with some force by learned commentators [9] that undefined notions of public policy should not preclude the application of the simple principle that income tax is owing only on the net income of a taxpayer. These arguments are premised on the assumption that in a given case the fine or penalty was incurred for the purpose of producing income. As I have concluded above, a fine or penalty cannot be considered to have been incurred for the purpose of producing income unless in all the circumstances the incurring of the fine or penalty must be seen as an unavoidable incident of carrying on the business. Secondly, in my view it is contrary to public policy to allow the deduction of a fine or penalty as a business expense where that fine or penalty is imposed by law for the purpose of punishing and deterring those who through intention or a lack of reasonable care violate the laws. In a case such as the present the penalties are fixed by statute (albeit that the Minister first remitted about one third of the penalty and ultimately settled for less than one third of the total penalty owing under statute). It would frustrate the purposes of the penalties imposed by Parliament if after paying those penalties exigible by law a taxpayer were then able to share the cost of that penalty — and the higher his marginal rate of taxation the more he could share — with other taxpayers of Canada by treating it as a deductible expense and thus reducing his taxable income. Such a result would, I believe, clearly be contrary to public policy. Suggestions that instead a court imposing a penalty can augment it in anticipation of the accused being able to deduct the fine from his taxable income [10] are not applicable to a situation such as this where the penalties are specifically defined by statute. Nor do I believe that sentencing courts should be required to anticipate the value of an income tax deduction to a penalized party. For this reason I think that the deductibility of penalties set by courts exercising their discretion should be subject to the same rules as I have elaborated above in respect of a penalty set by statute.

In recent years the subject of pollution of the air we breathe and the water we use for drinking, recreation or other purposes has been foremost in the minds of most Canadians. Preservation of fish habitat is of utmost importance. Dumping of dangerous or merely unpleasant substances into the environment - in violation of the law - has come to be regarded as highly undesirable conduct. While I am aware the plea of guilty to the two counts was entered on the basis there was no nexus between the spill and the killing of fish at a point five kilometres from the plant, the pollution of water or air (even in circumstances some might regard as almost accidental or, at worst, merely careless) it is difficult to think of a penalty that should be less entitled to qualify for deductibility other than, for example, a fine for selling cigarettes to minors. The fines imposed by the Provincial Court of Ontario were substantial and obviously took into account the nature of the offence and the purpose of the legislation. I cannot see how public policy is served by permitting deduction of the penalty in this case. There will always be fact patterns that run the gamut from the outrageous conduct in Amway to actions consistent with near accident or inevitability in the usual sense of those words. Clearly, the appellant in the within appeal is not in the Amway category and has operated a large business for many years in a lawful manner but, on balance, I choose to reject deductibility on the second ground as well because the whole point of that kind of environmental regulation is to punish a breach of the law by making penalties large enough to have an impact on the offender and also to serve as a warning to the wider community. There is not much point in making it hurt if the salve of deductibility is available to soothe the pain. The appellant’s management did not want to proceed to trial on the charges, partly to avoid the inevitable publicity. The negative aspect of such publicity was a sensible recognition by corporate officers that the public would be offended by an unsupervised employee of a poultry processing plant washing that kind of sludge into a ditch which was connected, directly or indirectly, to a watercourse.

The appeal is hereby dismissed.

Appeal dismissed.