Alfred Dallaire Inc. v. MNR, 96 DTC 1094, [1996] 1 CTC 2218 (TCC)

Garon J.T.C.C.: — This is an appeal from a reassessment by the Minister of National Revenue (the “Minister”) dated February 10, 1987 for the appellant’s 1982 taxation year. This appeal concerns the fiscal treatment of $115,626 credited to the “reserve” account of the Fiducie du Québec, now Fiducie Desjardins (the “trustee”) according to the terms of a contract between the latter and the appellant.

Certain basic facts, including the substance of the model contract the appellant used with each of its clients, are well summarized in subparagraphs (a), (b), (c), (d), (e), (f) and (g) of paragraph 8 of the reply to the notice of appeal:

(a) the appellant runs a funeral home business and in this connection offers a pre-arrangement service, i.e., a funeral service package paid for in advance by the customer;

(b) the customer concerned signs a contract with the appellant (hereinafter the “contract”) whereby he chooses the type of funeral service he wants;

(c) he then pays the current price for that service in cash or by instalments;

(d) the contract provides that when death occurs the appellant shall provide the service for the price agreed upon at the time the contract was signed, whatever the actual price at the time of death;

(e) the contract further provides that the appellant shall deposit with the Fiducie du Québec or any other trustee that might replace it an amount equal to the sums received under the contract, and shall keep that amount with the trustee at all times;

(f) the contract also provides that the customer can demand a refund at any time before death and that in the event of such a demand, the customer’s deposit shall be refunded in its entirety, without interest;

(g) on July 12, 1979, the appellant signed an agreement with the Fiducie du Québec (hereinafter the “agreement”) for the management of customers’ deposits.

[Translation.]

The substance of certain clauses of the model contract binding the appellant to each of its customers has been stated in some of the above- mentioned subparagraphs of paragraph 8 of the reply to the notice of appeal. Nevertheless, I think it is necessary to reproduce the following excerpts from this contract:

Failure to pay under the stated terms and conditions shall render the balance immediately due and payable or shall permit Alfred Dallaire Inc. at its option to cancel this contract upon 30 days’ written notice or by following such formalities as may be prescribed by law. In the event the contract is rescinded, Alfred Dallaire Inc. shall remit to the customer the amounts paid under this contract, without interest.

The customer has the right to cancel this contract at his own discretion within ten days of each party being in possession of a duplicate of the contract. Moreover, the signatory shall have the right at any time before death to cancel this contract and in such event Alfred Dallaire Inc. shall remit to the signatory the entire amount received without deducting or charging any amount whatsoever.

The customer may at any time peruse at the head office of Alfred Dallaire Inc. the trust agreement reached with Fiducie du Quebec or its successors.

Alfred Dallaire Inc. undertakes to carry out the funeral service and to provide the coffin of the quality indicated at the agreed price, regardless of any future increase in price, in all cases in which the price stipulated under this contract has been fully paid within the 12 month period following the signature of this contract under the terms and conditions set out above. Alfred Dallaire Inc. shall have no other obligation beyond returning the amounts received at the time of death if the total price stated under this contract has not been fully paid within the prescribed period.

[Translation.]

I also think it would be useful to reprint the complete text of the preamble and the body of the contract reached between the appellant and the trustee on July 12, 1979. Due to the length of this text, these parts of the contract are appended to these reasons [not reproduced].

There was no dispute as to the facts. Three witnesses called by the appellant to give evidence offered explanations regarding certain relevant issues.

The first of these witnesses, Mr. Michel Juneau, was a self-employed consultant in financial services and products at the time of the hearing and until 1990 had worked for the trustee for more than 16 years. He took part in negotiating the agreement of July 12, 1979 as manager of the trustee’s taxation service. This witness explained that before the contract was signed, the trustee was already managing a few deposits for the appellant’s customers relating to “pre-arranged funeral service contracts”. From the trustee’s point of view, the primary purpose of the contract it had reached with the appellant was to protect the appellant’s customers. He explained particularly that the trustee wanted to make sure the appellant had the funds needed to provide the goods and services promised in the contracts it had executed with its customers. Protection of the public, he added at one point, is important to the trustee. A trust company’s public “image” is of the utmost importance.

Mr. Juneau stated that he was the one who suggested adding an indexation clause according to the annual rise in the consumer price index of the amounts held by the trustee. He had been led to make this suggestion by the high inflation rate at that time. The contracting parties (1.e., the trustee and the appellant) eventually agreed that the total amount to be deposited every year by the appellant into the “reserve” account opened by the trustee would be equal to the percentage increase of the consumer price index on an annual basis multiplied by 40 per cent of the total amount held by the trustee in the “capital” and “reserve” accounts as of June 30 of the preceding year.

Mr. Juneau also explained that in practice, the amounts making up the “reserve” account were appropriated from the income produced by the sums held in trust. He made the following statement regarding the process followed by the trustee with regard to the “reserve” account (transcript, page 14, lines 13 to 23):

A. Well, by contract we, for the role of trustee we assumed for Alfred Dallaire’s customers, really wanted to protect the customer, so we made sure that the sums were immediately taken out of the income generated by the sums that were deposited with us. We didn’t want to give the money to Alfred Dallaire and then ask them afterwards for the amount needed to set up the reserve. So it was...for us it was necessary for Dallaire to work.

[Translation.]

Mr. Juneau explained in the following terms the methods of administering the three accounts provided for under the contract of July 12, 1979 (transcript, page 36, lines 7 to 24):

Q. O.K. The reserve account, the income account, were the sums in those two accounts capitalized somewhere else? Was there some sort of mechanism for taking sums out of the reserve account and crediting them to the income account?

A. No, you see, the income generated by the capital account, the income generated by the reserve account made up the third account called the income account.

Q. Mm-hmm.

A. And we took out of the income account the sums that were needed to set up a new reserve which was added to the preceding reserve.

Q. O.K.

A. O.K., and that was done internally, there was never, nothing was ever taken out of funds from outside.

The same witness later explained how the trustee calculated the appellant’s investment income (transcript, page 44, line 5 to page 45, line 4):

Q. ...the investment income from that which was paid, which was supposed to be paid to Dallaire Inc. each year, is that right? You calculated the investment income like that?

A. We calculated the income.

Q. Mm-hmm.

A. We deducted our fees.

Q. O.K.

A. We deducted what Dallaire was supposed to put into the reserve.

Q. Right.

A. And whatever was left over we gave to Dallaire.

Q. O.K. Now, the clause allowing Dallaire to...allowing the Fiducie du Québec to appropriate sums for the reserve from the investment income of the three accounts. . .

A. Yes.

Q. ...in a pinch, if Dallaire, if the investment income was not sufficient to cover inflation, the clause, you would ask...

A. Well, in that case, we would ask Dallaire for a cheque.

Q. ...Dallaire to pay the reserve?

A. Yes, yes.

The second witness, Mr. Jean Boulanger, is a former first vice-president and chief executive officer of the Bank of Canada and was a member of the appellant’s board of directors during the relevant period. From his tes- timony it is important to note his explanations regarding the indexation clause. He represented the appellant in negotiation of the contract of July 12, 1979. The following is part of what Mr. Boulanger said (transcript, page 50, line 5 to page 51, line 19):

Q. Good. Now, if you look at this clause, Mr. Boulanger, at the bottom of page 4 and on page 5, and specifically on page 5 it says that the indexation rate shall apply to 40 per cent of the capital and reserve accounts; can you explain how this 40 per cent was arrived at?

A. Yes. When the trust company forced us, or at least strongly suggested, that we index the sums deposited by our customers in order to protect them against inflation, they suggested one per cent to us.

The board of directors agreed that indexation was necessary but that a rate of one per cent...the rate of 100 per cent indexation seemed excessive to us. So some studies were done and we thought, we should exclude from indexation, first of all the physical facilities that are there, which will not take, which will not follow the rate of inflation, they are there. For example, the...

Q. You are speaking of the physical facilities that belonged to Dallaire?

A. That belonged to Dallaire, yes, yes, those will stay the same. Then, for example, certain expenses, we thought they shouldn’t be indexed, some things shouldn’t be indexed. So we thought what should be indexed are the goods provided at the time of death, the services provided at the time of death, including the salaries of the people who provide the services.

Then we thought it’s 40 per cent maximum because we didn’t want to freeze sums in a reserve account for no reason when we wouldn’t benefit from them, we wanted to benefit from the money that...that belonged to us, as far as we were concerned. So we thought that 40 per cent is the logical or normal rate that should be indexed.

[Translation.]

The third witness, Jocelyne Légaré, has worked for the appellant since 1983 and is currently its vice-president. Her testimony includes some interesting perspectives on the following issues:

(a) there is no increase or decrease in the price paid by a customer whether the goods and services are provided under a “pre-arrangement contract” or an ordinary contract at the time of death; the price of goods and services covered by a “pre-arrangement contract” is, as it were, frozen;

(b) she confirmed that all sums received from customers are paid to the trustee and that no amount is deducted, not even for the commissions paid to the salesperson; she added that ever since a provincial law respecting pre-arranged funeral services was passed in 1988, the amount paid in trust represents 90 per cent of the amount received from the client;

(c) she added that in accordance with the contract of July 12, 1979, upon the death of a given customer for whom goods and services have been provided, the appellant receives from the trustee the entire amount in the “capital” and “reserve” accounts in respect of that customer; she explained that in such a situation, the entire amount in these two accounts is included in the appellant’s income;

(d) she stated that indexing the amounts in the “capital” and “reserve” accounts assures customers that funds will be available at the time of death and that the price of goods and services will not be increased.

Appellant's claims

The appellant’s principal claims appear in paragraphs 1 and 2 of its notice of appeal under the heading “Reasons for Appeal”. They are formulated as follows:

1. Contrary to what was indicated in support of the reassessment, the sum of $115,626 for 1982 represents a contribution actually owed by the company under the agreement of July 12, 1979 and not simply a reserve claimed by the taxpayer;

2. Furthermore, under the terms of this trust agreement and its stipulations for the benefit of a third party, and more specifically according to clause 111.3 which sets out the sums the trustee is to repay to the company, the only amounts the company had a right to for the 1982 taxation year were the net sum of $292,185 indicated in the table above, i.e., the net amount that was returned by the trustee after having deducted its fees and the amounts to be credited to the reserve fund and that was in fact declared as income for the fiscal year.

[Translation.]

In his submission at the hearing, counsel for the appellant followed the arguments (included in his book of precedents) hereinafter reproduced in their entirety:

1. The sum of $115,626 does not qualify as income because the appellant did not have an absolute and unrestricted right to it

— Robertson, Kenneth B.S., Ltd. v. M.N.R., [1944] C.T.C. 75, 2 D.T.C. 655 (at C.T.C. pages 90,91 and 93)

— St. Catharines Flying Training School Ltd. v. M.N.R., [1955] S.C.R. 738, C.T.C. 185, 55 D.T.C. 1145, at pages 742-43 (C.T.C. 189-90; D.T.C. 1147)

— In accordance with the presentation of the appellant’s financial statements

— In accordance with the matching principle of income and expenses

— West Kootenay Power and Light Co. Ltd. v. The Queen, [1992] 1 C.T.C. 15, 92 D.T.C. 6023, at pages 22-23 (D.T.C. 6028)

— In accordance with the agreement with the Fiducie du Québec and the parties’interpretation of it

2. If this sum constitutes income, it is business income in respect of which the appellant has the right to a reserve

— The sum of $115,626 constitutes business income

— IT-246, paragraph 6 states that it is even “active business income”

— Canadian Marconi Co. v. The Queen, [1986] 2 S.C.R. 522, [1986] 2 C.T.C. 465, 86 D.T.C. 6526 at pages 529-30 (C.T.C. 469-70; D.T.C. 6528-29)

— In fact, it is compensation for the business risk assumed by the appellant

- This is what the Minister himself decided in reassessing the appellant for 1982

- For the purposes of paragraph 20(1 )(m), this sum is “described” (“visée”) at 12(l)(a)

- The amount is reasonable

— See trust agreement, paragraph 11.5

3. In any event, the sum of $115,626 is deductible as a current expenditure in 1982 since it is a substantive contractual liability of determinate length and not a contingent debt

— trust agreement, para. 11.5

— interpretation of paragraph 18( 1 )(e) of the Act

— Day & Ross Ltd. v. The Queen, [1976] C.T.C. 707, 76 D.T.C. 6433, at pages 714-15 (D.T.C. 6437-38)

4. Consistency of appellant’s claims with principles of interpretation, actions undertaken, documents submitted and especially the object and spirit of the relevant legislation and the economic reality

— Minister of National Revenue’s interpretation

— IT-246

— Mattabi Mines Ltd. v. Minister of Revenue (Ont.), [1988] 2 S.C.R. 175, 2 C.T.C. 294 (at C.T.C. 305-06)

— General Motors Acceptance Corporation of Canada Ltd. v. Sous-ministre du Revenu du Québec, C.A. 500-09-415-893, judgment of February 2, 1994 (1994), 60 Q.A.C. 289 (at pages 14 et seq.)

— In light of these principles of interpretation, taxing the sum of $115,626 would amount to taxing today what in all likelihood will be an expense for the business in the future. For example, if the appellant today asks for $1,100, which represents the actual cost of the funeral service chosen by the customer plus an allowance for profit of, say, 10 per cent, but the customer is 50 years old, it is likely that the services will be provided for in 20 years. Given the annual rate of inflation, there is a strong possibility that costs of $1,000 today will be $3,000 by that time; the sole purpose of the interest accumulating on the sums in trust is to permit the appellant to meet its contractual obligations in the year in which the services will be provided and the costs incurred.

Taxing this interest today would inevitably create distortion, since not only would sums which are not at the appellant’s disposal be taxed today, but also the appellant would not have in trust for the customer sufficient sums to meet its future obligations unless the interest were to exceed the inflation rate on the appellant’s costs. This would be very surprising given the highly conservative way in which the inflation clause is drafted. It would also be absurd to have taxed this difference in the past. This cannot be the object or the spirit of the law.

Furthermore, taxing this sum in 1982 would essentially constitute double taxation, since the appellant taxed itself on all the amounts received from the Fiducie du Québec upon the death of its customers. Consequently, the said sum of $115,626 was included in the appellant’s income during subsequent years as customers died and services were provided.

[Translation.]

Respondent’s claims

In his reply to the notice of appeal, the respondent’s important propositions are found in Part A containing the “Statement of Facts” as well as in Part B entitled “Statutory Provisions and Supporting Reasons”.

Part A of the reply to the notice of appeal reads as follows at subparagraphs 8(n), (o), (p) and (q):

(n) the amount of $115,626 represents the appellant’s interest income for its 1982 taxation year in accordance with paragraph 12(l)(c) of the Income Tax Act;

(o) the amount of $115,626 constitutes an amount credited to a reserve account and is therefore not deductible under paragraph 18(1 )(e) of the Income Tax Act;

(p) the interest derived from the sums deposited with the Fiducie du Québec belonged entirely to the appellant for the 1982 taxation year;

(q) the pre-arrangement agreements with customers imply that the latter have no right to the interest. The pre-arrangement agreements only give the appellant the obligation to deposit the funds received from customers with the Fiducie du Québec.

[Translation.]

The only reason put forward by the respondent in Part B of the reply to the notice of appeal appears at paragraph 10, which reads as follows:

10. The respondent claims that he assessed the appellant properly by including a sum of $115,626 in computing its income for the 1982 taxation year in accordance with paragraphs 12(l)(c), 18(1 )(a) and 18(l)(e) of the Income Tax Act.

[Translation.]

At the hearing, counsel for the respondent followed the central idea of the reply to the notice of appeal and emphasized that the amount of $115,626 represents interest income within the meaning of paragraph 12(l)(c) or income under sections 9 and 3 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the “Act”). Secondly, he claimed that this amount credited to the “reserve” account is not an expense incurred during the year within the meaning of paragraph 18(l)(a) and section 9 of the Act; and even if it were such an expense, it would constitute a capital outlay according to paragraph 18(1 )(b) of the Act. The respondent also argued that paragraph 12(l)(a) does not apply in this case as the sums levied by the appellant were not included in its income. In support of the non-deduction of the $115,626, counsel for the respondent also cited the provisions of paragraph 18( l)(e), which forbids the deduction of an amount as, or on account of, a reserve or a contingent liability or amount.

Counsel for the respondent also emphasized that sections 254 to 260 of the Consumer Protection Act, in force since 1978, apply to the appellant. In particular, the Court’s attention was drawn to sections 256 and 259 of this Act, which respectively provide that a merchant who receives a sum of money from a consumer pursuant to a contract whose principal obligation is to be performed more than two months after the contract was made must place that sum in a trust account until the performance of his obligation, and that interest on sums deposited in such an account belongs to the merchant. According to the respondent, the sum of $115,626 was therefore the property of the appellant.

Analysis

First, it is important to precisely determine what is at issue in this appeal.

As was previously stated, counsel for the appellant’s main proposition at the hearing was that the sum of $115,626 does not qualify as income. He added as a first alternative proposition that if this sum does constitute income, it is business income in respect of which the appellant has a right to the reserve provided in paragraph 20(1 )(m). Only as a second alternative proposition did the appellant claim that this sum of $115,626 is deductible as a current expenditure for its 1982 taxation year.

For the respondent, much emphasis was placed at the hearing on the proposition that the amount in question is interest income under paragraph 12(1)(c). It was also added that if the amount in question is not interest income, then it is income from a business or property within the meaning of sections 9 and 3 of the Act. Counsel for the respondent made an alternative claim that the amount is not a deductible expense under paragraph 18(l)(a), and that if it were, it would not be deductible in light of paragraph 18(1 )(b), which prohibits the deduction of capital outlays.

It is clear from this summary of the appellant’s and respondent’s propositions at the hearing that the parties have had some difficulty in clearly defining the nature of the problem that must be solved in this case. Is it a question of including this amount of $115,626 in the appellant’s

income, or is it instead a problem of deduction: in other words, does the appellant have the right to deduct this amount of $115,626 when computing its income? As we have seen, apart from certain provisions of very general application such as sections 3 and 9 of the Income Tax Act, certain specific subsections of three different sections of the Income Tax Act have been referred to by the parties, among others, subsections 12(1), 18(1) and 20(1). However, each of these three subsections affects the calculation of income in a very different way. Subsection 12(1) sets out more than 20 situations in which amounts “shall be included in computing the income of a taxpay er...from a business or property”; subsection 18(1) states general principles of non-deductibility of expenses and outlays in computing a taxpayer’s income from a business or property; and finally subsection 20(1), as an exception to paragraphs 18(l)(a), (b) and (h), outlines more than 40 cases in which deductions are allowed in computing income from a business or property.

To summarize all this in a few words, is this a problem of including the sum of $115,626 in the appellant’s income or of deducting the same from the appellant’s income? It hardly needs mentioning that there is a fundamental difference between a case of including a sum in income and of deducting such a sum from income. The introductory words of subsections 12(1), 18(1) and 20(1) of the Act clearly illustrate the fundamentally different impact of each of these provisions when computing income from a business or property.

The nature of the issue in dispute can only be determined by examining the way in which the appellant treated this sum of $115,626 in its tax return and the attached financial statements, the way in which the Minister of National Revenue viewed this sum in issuing his reassessment, and finally, the appellant’s own observations on this matter in its notice of appeal. Studying these documents will allow us to determine the nature of the Minister of National Revenue’s decision — noted in the notice of reassessment - which the appellant objected to and appealed.

First of all, in its tax return for the disputed year the appellant estimated its income at $255,749.80. In the non-consolidated financial statements for the 1982 taxation year that accompanied the appellant’s tax return, the statement of results for this period shows the items and operations indicated below in arriving at “earnings before taxes”: [1]

1982

$4,284,824

VARIOUS FEES AND INCOME

1,955,215

COST OF SERVICES (note 4)

2,293,609 [sic]

GROSS EARNINGS

ADMINISTRATIVE AND SALES OUTLAYS (note 4)

BRANCHES AND PROPERTIES	1,191,257
ADMINISTRATION	895,897
	2,087,154
	206,455
DIVIDENDS RECEIVED FROM SUBSIDIARIES	37,800
EARNINGS BEFORE TAXES	244,255

[Translation.]

The financial statements entitled “Results, non-consolidated retained earnings”, “Evolution of non-consolidated financial situation” and “Nonconsolidated statement of accounts” (from which the assets part is missing) have attached to them 18 “Supplementary notes” at pages 6 to 12 and “Supplementary information” at pages 13 to 16. Detailed figures on “Various fees and income”, “Cost of services”, “Branch and property expenses” and “Administrative outlays” appear under the heading “Supplementary information”. The part of the “Supplementary information” dealing with “Administrative outlays” contains a large number of items for the disputed year totalling $1,073,819. After this total, the following items appear under the heading “Other income” for the same fiscal year:

Three items whose amounts were put in parentheses warrant our attention: “Contribution to pre-arrangement fund”, “Trustee’s fee” and “Commissions, pre-arrangement”. It will be noted that the amounts for these three items are subtracted from the entry “Interest” to give a total of $177,877. This total, to which is added $45 in “Dividends”, is subtracted to give a total of $895,897 in administrative outlays. This last amount appears in the statement of results as one entry deducted with other amounts from the total “Various fees and income”.

From these different figures appearing in the financial statements, and in particular from the “Supplementary information”, it can therefore be seen that the appellant considered its “Contribution to pre-arrangement fund” to be a subtraction entry or a deduction when computing its income in order to establish its income tax for the disputed taxation year.

For his part, in document T7W-C which accompanied the notice of reassessment of February 10, 1987, the Minister of National Revenue in the subject assessment states the following with regard to the readjustment made to the appellant’s income:

Amount contributed to reserve fund in pre-arrangement trust reserve not permitted under Act: $115,626.

[Translation.]

In this document attached to the notice of reassessment, the respondent refuses a deduction claimed by the appellant since the comment “Reserve not permitted under Act” is used.

In his “notification of confirmation”, the respondent gives the following reasons in support of his reassessment:

The amount of $115,626 credited to the “reserve” account of the Fiducie de Frais Funéraires Alfred Dallaire was not an outlay that you made or incurred within the meaning of paragraph 18(1 )(a) of the Act, but was instead a contingent liability for which no reserve is permitted according to paragraph 18(l)(e) of the Act; consequently, the interest of $115,626 was included in computing your income for the taxation year in accordance with the provisions of paragraph 12(1 )(c) of the Act.

[Translation.]

In reading the text of this notice of confirmation, it is apparent that the respondent is stating, first, that the amount of $115,626 is not an outlay within the meaning of paragraph 18(l)(a) but a contingent liability whose deduction is prohibited under paragraph 18(1 )(e) of the Act. The respondent then indicates in this notice of confirmation that as far as he is concerned, the amount of $115,626 must therefore be counted as income according to paragraph 12(l)(c) of the Act.

In the notice of appeal, as has already been indicated, the appellant gives as its main argument that the sum of $115,626 “represents a contribution actually owed by the company under the agreement of July 12, 1979”.

Based on all the facts and in particular on the examination of the appellant’s financial statements, document T7W-C attached to the notice of reassessment, the notice of confirmation and the notice of appeal, I have no hesitation in concluding that the real issue in this appeal is whether or not the appellant has the right to deduct this sum of $115,626 that it claimed in computing its income.

The Court must therefore enquire into the nature of this deduction in light of the relevant provisions of the Income Tax Act.

To answer this question adequately, it is necessary to examine the main provisions of the contract of July 12, 1979 between the appellant and the trustee, as it is this contract that the appellant claims gives it the right to a deduction.

Clause 1.1 of this contract requires the appellant to “deliver to the trustee all sums it has received or which it may in the future receive from all customers who have signed or will sign with it a pre-arrangement contract, known as an advance funeral service contract”.

Clause 1.2 of the contract reads as follows:

Dallaire shall in each case provide the trustee with a signed copy of the contract made with each customer, as well as the amount paid by each customer, upon delivery of the sums of money mentioned in the preceding article. The sums of money collected by Dallaire shall be paid to the trustee in monthly instalments which must be made no later that five working days before the end of the month.

[Translation.]

As prescribed under clause 11.1 of the contract, the trustee acting in its capacity as the appellant’s trustee must open three accounts:

1. Opening of accounts:

Three accounts described as Fiducie du Quebec in the capacity of trustee of Alfred Dallaire Inc. shall be opened by the trustee. Into the “capital” account shall be credited all sums of money delivered to the trustee by Dallaire and resulting from contracts; into the “reserve” account shall be credited all sums of money that Dallaire is required to pay into the said reserve; into the “income” account shall be credited all accrued interest resulting from the two above- mentioned accounts.

[Translation.]

Clause 11.4 of the contract stipulates that:

All moneys in the “capital” and “reserve” accounts must be put by the trustee in its name and under its control into guaranteed deposits issued by the trustee at the current rates then in force for a term of five years or for any other term if there are written instructions and agreement with Dallaire to that effect. The interest on these certificates shall be paid and credited to the “income” account half-yearly.

Moneys in the “income” account shall be deposited on request.

[Translation.]

Clause 11.5 of the contract imposes on the appellant an obligation, “in order to protect the sums of money deposited from certain effects of inflation”, to “pay to the trustee on June 30 of each year from June 30, 1980 onwards a sum of money computed” in the manner indicated in that clause; this sum of money is to be “credited to the ‘reserve’ account”. The formula prescribed under this last clause must take into account particularly the annual percentage increase in the consumer price index.

Clause 111.1 of the contract states that if a customer of the appellant rescinds the contract, the trustee undertakes to give back to the appellant no later than the 15th day of the month following the appellant’s written instructions, “upon proof of payment of the capital sum payable to the customer, the capital sum as well as that portion of the accumulated reserve attributable to the sum that it has in trust” in respect of the customer.

Should the contracting customer die, the trustee undertakes to give back to the appellant under clause 111.2 of the contract “...the sums of money in capital that it may hold in trust for the benefit of that contracting customer, as well as any sum accumulated in the ‘reserve’ account for the customer, upon presentation of a certificate signed by one of the authorized officers of Dallaire attesting that the goods and services mentioned in the contracting customer’s contract have been provided for the deceased”.

Clause 111.3 of this same contract states that “interest on the sums of money accumulated in the ‘capital’ and ‘reserve’ accounts shall be paid into the ‘income’ account so that it may be used” in the manner prescribed in that clause. This clause also stipulates that the trustee’s fees and outlays shall come out of the “income” account, and that the payments the appellant must make to the trustee and that are credited to the “reserve” account may be “withdrawn from the ‘income’ account, but only after the trustee’s fees and outlays have been withdrawn”. Finally, this clause provides that the trustee shall pay to the appellant on June 30 and December 31 of each year the balance of the sums of money accumulated in the “income” account after the trustee’s fees and outlays and the appellant’s payments into the “reserve” account have been withdrawn. To complete this discussion of withdrawals, it should be noted that the fees of the auditor who audits the accounts created under the contract of July 12, 1979 “shall be payable by” the appellant and “settled by the trustee out of the ‘income’ account” in accordance with clause V of the contract between the appellant and the trustee.

Finally, at paragraph 4 of clause 111 of the contract, the parties agreed that in case of the appellant’s notorious insolvency, bankruptcy, liquidation or cessation of business, the trustee must “repay to each contracting customer or their beneficiaries the sums of money credited to the ‘capital’ and ‘reserve’ accounts for the eventual benefit of the contracting customers”. It even states that the trustee shall withdraw from the “income” account the readjustment fees in case of “retraction of shares held in portfolio...as well as any unpaid amount of fees”.

This analysis of the main clauses of the contract of July 12, 1979 shows that the appellant is required under clause 11.5 of the contract to pay to the trustee on June 30 of each year from June 30, 1980 onwards a sum of money calculated under the terms of that clause. For the year which concerns us, the sum in question was $115,626. The purpose of this annual payment to the trustee is indicated in the same clause: “to protect the sums of money deposited from certain effects of inflation”. It will be recalled that the appellant’s deposit in trust of these sums into the hands of the trustee, which was stated in the contract of July 12, 1979, was required under clause 1.1 of this contract. The appellant’s deposit into the hands of the trustee of the sums paid by the customers was done “in order to ensure to all customers who have signed a contract like those mentioned above maximum protection for the sums of money they will have paid”. The contracts in question in this passage from the preamble to the contract of July 12, 1979 are “pre-arrangement or advance funeral service contracts”.

It will be noted that the appellant’s contract with the trustee anticipates four different situations or eventualities.

If a customer rescinds a contract, the trustee is required under clause 111.1 of this contract to repay to the appellant “...no later than the 15th of the month following these instructions, upon proof of payment of the capital sum payable to the customer, the capital sum as well as that portion of the accumulated reserve attributable to the sum that it has in trust for Dallaire in respect of that customer”. In the same situation, the appellant is only required under the second paragraph of clause 111.1 to refund to the customer the capital amount disbursed by the customer.

In the second eventuality, 1.e., the death of a contracting customer, upon presentation of proof that the goods and services mentioned in the contracting customer’s contract “have been provided for the deceased”, the trustee must pay back to the appellant “the sums of money in capital...as well as any sum accumulated in the ‘reserve’ account for that customer”.

A third possibility is covered by the second paragraph of clause 111.2: upon the death of the contracting customer, the appellant has not provided the goods and services mentioned in the contract executed with the customer. In such a case, the trustee pays back to the appellant the sums credited to the “capital” and “reserve” accounts and accumulated with respect to the customer in question. The appellant is only required to refund to the client the amount credited to the “capital” account, as in the first possibility mentioned above in which a customer of the appellant rescinds a contract.

Finally, the fourth eventuality covers the appellant’s notorious insolvency, bankruptcy, liquidation or cessation of business. Under clause 111.4 of the contract, the trustee must “repay to each contracting customer or their beneficiaries the sums of money credited to the ‘capital’ and ‘reserve’ accounts for the eventual benefit of the contracting customers”.

It seems to me indisputable that the appellant’s obligation to pay an amount that is credited to the “reserve” account to the trustee [2] each year is part of the appellant’s current operations within the context of operating its business. It is an outlay made by the appellant in order to gain or produce income within the meaning of the exception to the prohibition established by paragraph 18(1 )(a) of the Act. In fact, it was business reasons dictated by the desire to satisfy its customers’ needs and to ensure their protection that induced the appellant to execute the sort of contract it made with the trustee. An important element of the contracts that were entered into includes this obligation to pay a certain sum of money in order to protect the amounts deposited by the customers from certain effects of inflation, to paraphrase clause 11.5 of the above-mentioned contract. It seems plausible from the testimony of the appellant’s vice-president that the sort of contract executed between the appellant and the trustee, containing in particular clause 11.5, was also inspired by concern over competition with other participants in the funeral services market. The appellant’s contribution under clause 11.5 of the aforementioned contract is part of the normal course of this business’ activities.

It is equally important to note that the appellant divested itself of the amounts it paid to the trustee under clause 1.1 of the contract, and that these amounts are in the possession and under the control of the trustee. For example, in one of the four situations contemplated by the contract - Le., the one dealing with the appellant’s notorious insolvency, bankruptcy, liquidation or cessation of business — the trustee does not have to pay to the appellant the amounts in the “reserve” account. In the three other situations the trustee has the right, before it makes any payments to the appellant, to require from the appellant satisfactory evidence that the conditions set out in the clause applicable in the circumstances have been met. The witness Boulanger clearly understood the situation when he said the following in dealing with the amounts credited to the “reserve” account: [3]

Then we thought it’s 40 per cent maximum because we didn’t want to freeze sums in a reserve account for no reason when we wouldn’t benefit from it, we wanted to benefit from the money that...that belonged to us, as far as we were concerned.

[Translation.]

I therefore conclude that this “contribution” made by the appellant to the trustee and credited to the “reserve” account is in the nature of an outlay made by the appellant for the purpose of gaining or producing income from a business. This deduction is provided for by the exception to the rule set out in paragraph 18(1 )(a) of the Act. Furthermore, this deduction is not prohibited by paragraph 18(1 )(b) as it is a contribution that the appellant must make on an annual basis. The periodic nature of this outlay is expressly provided for by clause 11.5 of the aforementioned contract. Nor is this deduction prohibited under paragraph 18(l)(e) as it is not a deduction of an amount as, or on account of, a reserve or a contingent liability or amount, but rather an amount deducted as or on account of a contractual liability established by the agreement of July 12, 1979 between the appellant and the trustee.

Before concluding, I would like to briefly comment on certain issues raised by the respondent both in his relevant documents and in the course of his oral argument.

My first observation concerns the reserve. The respondent appears to misunderstand the nature of a reserve as opposed to a legal liability to make payments at specific times. I am referring in particular to document T7W-C accompanying the notice of reassessment, in which the respondent states that the amount of $115,626 is a reserve. However, the difference between a reserve and a legal liability is well expressed in paragraph 8 of the respondent’s Interpretation Bulletin IT-215R of January 12, 1981, updated by a special communiqué dated November 30, 1989. That paragraph reads as follows:

8. A distinction must be made between a reserve for a liability which is future or contingent that would be prohibited by paragraph 18(l)(c) and an amount that represents an existing liability which would be deductible under paragraph 18(1 )(a) if the expense is made or incurred by the taxpayer for the purpose of gaining or producing income from a business or property.

[Translation.]

In the instant case, as I have already stated, the appellant was contractually bound by clause 11.5 of its contract with the trustee to pay to the trustee the sum of $115,626 for its 1982 taxation year.

In referring as I have already mentioned to the Consumer Protection Act, counsel for the respondent alluded to the provisions dealing with trust accounts and argued from these provisions that the interest derived from the sums in the accounts established by the contract between the appellant and the trustee belong to the appellant. I do not share this point of view. Rather, I believe that the amounts credited to the “reserve” and “income” accounts are subject to a special system established by the contract of July 12, 1979. The sums in question were not deposited in a trust account in the appellant’s name in compliance with the Consumer Protection Act, but rather in the hands of a third party, the trustee, and the appellant’s and trustee’s rights with regard to the sums credited to the “reserve” and “income” accounts are established by the contract of July 12, 1979.1 do not have to decide whether the appellant, in acting as it did, complied with the Consumer Protection Act by taking into account the applicable law in the year in question. Rather, I must determine the fiscal consequences resulting particularly from the contract of July 12, 1979.

For these reasons, I am of the opinion that the appellant has the right to deduct the sum of $115,626 in computing its income for the 1982 taxation year. The appeal is allowed, with costs, on the basis that I have just indicated.

Appeal allowed.