Date: 20020305
Docket: 1999-5040-IT-G
BETWEEN:
IPSCO INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasonsfor
Judgment
Rowe, D.J.T.C.C.
[1]
The appellant appealed from a reassessment of income tax for its
1994 taxation year. Counsel for the appellant filed - as
Exhibit A-1 - an Agreed Statement of Facts (Agreed Facts) and a
binder entitled Joint Book of Documents, tabbed 1-11, inclusive,
as Exhibit A-2 and reference to a tab number indicates the
relevant material or documents will be located within said
Exhibit A-2. The Agreed Statement of Facts reads as follows:
For the purposes of this appeal, the parties, by their respective
counsel, admit the following facts and agree that their admission
of facts shall have the same effect as if the facts had formally
been proved and accepted by the Court as true. The parties each
reserve the right to adduce additional evidence which is relevant
and probative of any issue before the Court and which is not
inconsistent with the facts admitted herein. All statutory
references are to the Income Tax Act (Canada)
("Act") as it read during the 1994 taxation
year, unless noted otherwise. All references to the
"Regulations" are to the Income Tax
Regulations.
1.
The Appellant is a public corporation and a taxable Canadian
corporation for purpose of Act, the fiscal period of which ends
on December 31.
2.
The Appellant carries on a steel production and fabricating
business including manufacturing of steel pipe.
3.
The Appellant owns a pipe manufacturing plant in Calgary, Alberta
("Calgary Plant"),
4.
The Appellant entered into a written agreement dated September 9,
1991 ("Contract") with ASEA Limited ("ASEA")
for the design, engineering and supply by ASEA of a "quench
and temper" pipe treatment system ("System") for a
total price of $3,887,000.
5.
The Appellant and ASEA at all times dealt at arm's length for
purposes of the Act.
6.
The System was built and installed by ASEA.
7.
ASEA warranted and guaranteed that the System would perform as
specified in the Contract.
8.
In its 1983, 1984 and 1985 taxation years, the Appellant incurred
total costs of $4,066,925 in respect of the construction of the
System which, for purposes of the Act, were capitalized to
classes 3 and 29 of depreciable property.
9.
After installation of the System by ASEA, the Appellant incurred
additional costs in an effort to make it perform as specified in
the Contract.
10.
The total additional costs incurred by the Appellant in the 1985
to 1988 taxation years amounted to $7,593,791, of which
$6,117,023 was added to the undepreciated capital cost
("UCC") of classes 29 and 39 and $1,476,768 was charged
to costs of sales.
11.
The Appellant was the sole plaintiff in a civil action
("Action") against ASEA relating to the design,
engineering and supply of the System.
12.
The Appellant and ASEA ultimately agreed to a settlement of the
Action. The terms of the settlement were set forth in Minutes of
Settlement dated January 13, 1994. In accordance with the Minutes
of Settlement, ASEA paid to the Appellant $4,800,000
("Settlement Amount") in respect of the Appellant's
claim for additional construction and installation costs relating
to the System.
13.
None of the System was transferred to ASEA under the terms of the
settlement; the System was retained in its entirety by the
Appellant.
14.
The System continues to be used in the Appellant's pipe
manufacturing operation.
15.
In computing its income for its 1994 taxation year for purposes
of the Act the Appellant treated the Settlement Amount as a
non-taxable receipt. The Appellant did not reduce the
capital cost of the System, or otherwise reduce the UCC of its
class 29 or class 39 depreciable property by the Settlement
Amount.
16.
For accounting and financial statement purposes the Appellant
reduced the historical cost of the System assets by the
Settlement Amount.
17.
The legal expenses incurred by the Appellant in connection with
the Action were fully deducted on a current basis on income in
the year incurred for both accounting and income tax
purposes.
18.
The Appellant's tax return for its 1994 taxation year was
assessed as filed, by the Minister of National Revenue
("Minister") on August 28, 1995.
19.
In a letter dated February 13, 1997 to the Department of National
Revenue, the Appellant elected to transfer its class 29
depreciable property to class 39, pursuant to
subsection 1103(2d) of the Regulations.
20.
By Notice of Reassessment dated July 28, 1997 ("First
Reassessment"), the Minister reassessed the Appellant's
1994 taxation year to, among other things, reduce the CCA claim
in respect of class 39 depreciable property by $1,200,000 on the
basis that the Settlement Amount reduced the capital cost of the
System or otherwise reduced the UCC of the Appellant's class
39 depreciable property by $4,800,000.
21.
The Appellant filed a Notice of Objection to the First
Reassessment on October 22, 1997.
22.
By Notice of Reassessment dated September 20, 1999, the Minister,
among other things, confirmed for the Appellant's 1994
taxation year the $1,200,000 reduction in the CCA claimed in
respect of class 39 depreciable property.
[2]
As disclosed in paragraph 15 of the above stated facts, the
appellant treated the Settlement Amount as a non-taxable receipt.
The Minister of National Revenue (the "Minister")
disagreed with this characterization and deducted the Settlement
Amount from the capital cost of the system on the basis it
constituted proceeds of disposition - generally - or in the
alternative - as set forth in paragraph 13 of the Amended Reply
to the Notice of Appeal - (Amended Reply) because it
resulted from a disposition of property, being compensation for
property injuriously affected. In either case, the Minister
decided the effect of receiving the Settlement Amount was to
reduce the undepreciated capital cost (UCC) of the assets in that
class. The position of the appellant is that there was no
requirement under the Income Tax Act (the
"Act") to make any such deduction or
otherwise to reduce the UCC of the appellant's class 29 or
class 39 depreciable property in respect of the Settlement
Amount.
[3]
Charles Backman testified he is employed by Ipsco - in
Regina, Saskatchewan - as a Senior Vice-President, and
began working for the appellant in 1982. He graduated from the
University of Manitoba with a Bachelor of Engineering
(mechanical) degree. Originally, Ipsco owned and operated only
pipe mills but it now owns three steel plants and pipe mills in
Canada and the United States. The plant located in Calgary,
Alberta was used to manufacture pipe. On September 9, 1981,
a Canadian corporation - ASEA - entered into a
contract (tab 1) with Ipsco to install a particular pipe
treatment system described as a "quench and temper"
system. Backman stated that, although he was a newcomer at Ipsco,
he was assigned responsibility for oversight of this new
construction project. The pipe produced in the plant - ranging in
size from 4 inches to 10 inches in diameter - was utilized in the
oil patch mainly for down-hole casings while other pipe was used
as line pipe. The pipe production process commenced with rolled
steel - known as skelp - in the width of the desired diameter of
the pipe to be manufactured. The coiled steel was fed into a
forming mechanism in order to make it round and it was then
subjected to a method of longitudinal seam welding in order to
create the finished pipe. Backman explained the "quench and
temper" system takes normal steel, heats it sufficiently to
change the grain structure from ferrite to ostenite, passes it
through 4 induction coils and then quenches it with water jets in
order to cool the material for the purpose of changing - again -
the grain structure. Then, to temper the steel, the pipe is
subjected to heat produced by another set of coils with a view to
attaining a desired temperature for a specified period of time in
order to reduce the stress created by the earlier quenching
process. Backman stated the system was subjected to performance
testing during which mechanical parts - including water jets and
belts - were observed to ensure they worked properly. At that
time, the system passed the test and seemed to be functioning
adequately but later - when different grades and sizes of pipe
were sent through the system - it did not create the required end
product. Backman explained the problem occurred when the raw pipe
entered the quench phase and the water application was
insufficient to change the grain structure, and the subsequent
tempering process did not provide sufficient, sustained heat for
the requisite period needed to produce high-grade pipe. As a
consequence, Ipsco conducted metallurgy tests which revealed the
pipe - as produced - was not consistent with the specifications
set forth in the contract. A supplier - Ajax - was contacted and
it installed a new quench head. In order to rectify the heating
problem, a gas-fired furnace was installed with the intent it
would produce sufficient heat to temper the pipe. Backman stated
that after these new installations were completed and the process
of pipe production was restored, the desired specifications for
the pipe were attained but the rate of production was less than
50% of the metric tons per hour specified in the contract with
ASEA. Ipsco decided to continue utilizing the system even though
it functioned properly only when operating at reduced capacity.
Backman stated Ipsco spent a total of $7,593,791 (see para. 10 of
Agreed Facts) in an attempt to make the system work, as intended.
The appellant commenced a civil action against ASEA and its
Swedish parent corporation - ASEA AB - relating to the
design, engineering and supply of the system. Backman was
referred to the Statement of Claim - tab 2 - filed in
the registry of The Queen's Bench on May 23, 1986 at
Regina, Saskatchewan. Details of special damages were set forth
therein on pages 18-20, inclusive, including - at
paragraph 28 (a)(iii) - the extra construction and
installation costs - associated with attempts to remedy
deficiencies in the system - in the amount of $4,257,117. In
addition, extra costs relating to construction and installation
incurred in planning and construction of normalizing the line in
reliance on completion of the system were claimed in the sum of
$1,721,000 - at paragraph 28(b) - on the basis the costs
were wasted when the system was not completed. As stated in
paragraph 10 of the Agreed Facts, the sum of $6,117,023 was
added to the UCC of classes 29 and 39 and $1,476,768 was
charged to costs of sales. Backman stated a settlement was
reached on January 13, 1994 and in accordance with the
Minutes of Settlement (Minutes), ASEA paid Ipsco the sum of
$4,800,000, referred to in paragraph 12 of the Agreed Facts
as the Settlement Amount. Backman explained that attempts to
settle with ASEA had been undertaken prior to the commencement of
litigation and recalled that he had been required to participate
in a 21-day Examination for Discovery because he was a
member of a group of officers of Ipsco involved in the
decision-making process concerning the litigation. Backman
identified a letter - tab 3 - dated January 5,
1994 from Larry LeBlanc at MacPherson Leslie & Tyerman -
the law firm retained by Ipsco - concerning the prospects for -
and categorization of - potential heads of damages in any
recovery from ASEA. In said letter, LeBlanc expressed the opinion
that the best head of damages was for extra construction and
installation costs rather than claims for lost profit and
interest which were considerably weaker and the least likely to
succeed. Backman stated the settlement of $4,800,000 set forth in
the Minutes - Tab 4 - resulted from hard negotiations
assisted somewhat by ASEA's interest in providing its
services to Ipsco in relation to new plants being constructed in
the United States.
[4]
In cross-examination, Charles Backman was referred to a letter -
at tab 5 - dated April 12, 1996 from Kevin Harle to an
official at Revenue Canada - in relation to an income tax audit -
in which the breakdown of certain capitalized amounts was
explained. He was also directed to a memorandum - at tab 10
- dated June 2, 1993, from John Comrie of the Ipsco legal
department - to Kevin Harle - in which Comrie stated that
the "combined case and contract in tort against the Canadian
company, ASEA Inc. and its Swedish parent, ASEA, AB, totals
approximately $33 million." Of that amount, Mr. Comrie
attributed the sum of $12,000,000 to a claim for lost profit. A
document - at tab 9 - set forth a precise and
detailed breakdown of heads of damages in which the sum of
$4,779,534 was categorized as the cost of construction and
installation. Backman stated the Swedish company - ASEA AB - was
well known to him during his previous employment and he regarded
it as a competent corporation capable of fulfilling the terms of
the contract with Ipsco. In expressing his level of confidence
with the ASEA organization, he remarked "it was the last
company I would check on."
[5]
Robert Eisner testified he is Assistant Treasurer of Ipsco and
Controller of Canadian Steel Works and Coil Processing. Until
October, 2000, Eisner was the Treasurer of Ipsco and in that
capacity was familiar with the manner in which the appellant
treated the $4.8 million dollars received from ASEA in settlement
of the litigation both for purposes of Ipsco financial statements
and for reporting income. Counsel referred Eisner to paragraph 15
of the Agreed Facts and Eisner agreed it was an accurate
description of the manner in which Ipsco treated the Settlement
Amount for income tax purposes. He stated Ipsco sought outside
tax advice and, based on that opinion, decided the proper
treatment of those funds was not to reduce the capital cost
allowance. Eisner also agreed with the statement contained in
paragraph 16 of the Agreed Facts that, for accounting and
financial statement purposes, Ipsco reduced the historical cost
of the system assets by the amount of the settlement. He stated
this procedure was undertaken in accordance with advice received
from Ernst & Young, the appellant's external
auditors.
[6]
In cross-examination, Eisner was referred to the appellant's
corporate tax return for the year ending December 31, 1994 - at
tab 6 - and to the Non-Consolidated Statement of
Financial Position (marked by a green tab) and to a yellow
highlighted entry indicating capital assets (expressed in
thousands of dollars) increased in 1993 from 229,310 to 232,195
in 1994. In the financial statement at note 4 - Capital Assets -
a table indicated one of the components was the cost of capital
assets which increased from 410,914 to 426,687. Eisner was
referred to another green tabbed statement entitled
"Non-consolidated Statement of Changes in Cash Position
Years Ended December 31", and to a yellow highlighted entry
including the figure 16,290 (again, expressed in thousands of
dollars) with a reference to Note 10 indicating an addition to
capital assets of 15,773 ($15,773,000). Eisner was referred to
the last page of tab 7, a sheet with a handwritten notation
at the top, "1994 Fixed Assets". Eisner explained the
accounting entries contained therein included a reduction in the
write down of assets regarding the ASEA construction project by
the amount of $4.8 million, the sum received as a result of the
litigation instituted by Ipsco against ASEA and an excerpt from
journal entries (third page of tab 7) recorded receipt of
that amount. Eisner agreed the legal expenses incurred by Ipsco
in respect of the litigation were fully deducted on a current
basis on income account in that taxation year both for accounting
and income tax purposes. Eisner stated Ipsco followed the advice
contained in an internal memorandum - tab 11 -
concerning the ASEA settlement and - at page 2 thereof - the
second last paragraph read:
Since the settlement relates to construction and installation
of the equipment, the settlement would therefore be considered
capital in nature and should be recorded as a reduction of fixed
assets...
[7]
Counsel for the appellant submitted there is no requirement under
the Act that the appellant deduct the Settlement Amount
from the UCC of any class of the appellant's depreciable
property having regard to the circumstances in which the
Settlement Amount was received and further contended said amount
did not constitute proceeds of disposition, as defined by the
relevant provisions of the Act. More specifically, counsel
submitted the amount received in settlement of the litigation was
not compensation for property injuriously affected within the
meaning of that expression contained in the definition of
"proceeds of disposition" in subsection 13(21) of the
Act nor did it constitute "compensation for property
damaged" within the meaning of that expression in the
definition of "proceeds of disposition" in said
subsection. The position of the appellant was that it was
appropriate for it to have complied with the comprehensive
legislative scheme of rules for entitlement of a taxpayer to
deduct Capital Cost Allowance (CCA) in respect of capital costs
incurred to acquire depreciable property. In that sense, any
requirement for the appellant to reduce the UCC of class 29 or 39
property - in respect of the Settlement Amount - must be found
within the wording of the Act and the appellant's
treatment of said amount is based on the reasoning that no such
provision exists, notwithstanding that Parliament has otherwise
expressly determined certain other amounts should reduce the
capital cost of depreciable property. In the face of this
specificity, counsel submitted that if Parliament had intended to
include damage awards or amounts received in settlement of
litigation, then it would have expressly provided for that event
in a manner like that contained in subsection 13(7.1) of the
Act relating to amounts required to be deducted in respect
of depreciable property if they were received as assistance from
a government, municipality or other public authority in respect
of certain grants, subsidies, loans and similar financial
aid.
[8]
Counsel for the respondent submitted the assessment issued by the
Minister was in accordance with Interpretation Bulletin IT-365R2
regarding the tax consequences of damages and settlements.
Further, counsel referred to the general scheme of reporting
income pursuant to sections 3 and 9 of the Act, including
the application of section 18 in limiting deductions from income,
and the interplay of provisions governing CCA with respect to
depreciable property - set forth in paragraph 20(1)(a) of
the Act - and the effect of Regulation 1100
- referred to therein - together with the use of the formula for
calculating UCC as set out in subsection 13(21). Under subsection
13(21), counsel submitted the statutory definitions of
"disposition of property" and "proceeds of
dispositions" do not require an actual transfer or giving up
of property for there to be a disposition under the Act
and, therefore, the Settlement Amount constituted proceeds of
disposition - either generally - or specifically under paragraphs
(e) or (f) of subsection 13(21) of the Act -
which had the effect of reducing the UCC of the assets within
that class. In counsel's view of the relevant jurisprudence,
there is a requirement for the appellant to have reported the
Settlement Amount in the manner assessed by the Minister because
that would have presented the true picture of Ipsco's profit
from business on the basis that the amount on which CCA is
calculated must be representative of the actual cost of the
system to the appellant. Counsel submitted that to ignore the
Settlement Amount - in the sum of $4.8 million - is to grant a
huge windfall to the appellant resulting in the cost of the asset
being falsely inflated with the further effect that income is
artificially deflated in that year and in the years that
follow.
[9]
The issue in the within appeal is essentially one of taxation of
damages which usually depends on the nature of the legal right
giving rise to the payment, whether following a victory in court
or through settlement to end the litigation. The Statement of
Claim - tab 2 - issued by Ipsco sought special damages - as
detailed in paragraph 28 thereof - as well as general damages
- in unspecified amounts - for incremental fixed and
variable costs it incurred by reasons of the delay - on the
part of ASEA - in performance under the contract as well as
lost profits - both current and future - together
with a claim for loss of market share and loss of reputation. The
Minutes - tab 4 - provided that ASEA - and its parent ASEA AB -
pay the sum of $4.8 million to the appellant "in respect of
the Plaintiff's claim for additional construction and
installation costs". Paragraph (b) of the said Minutes
stated, "there shall be no payment in respect of any of the
other claims and counterclaims in this action." The
agreement further provided that each party would bear its own
costs of, and incidental to, the action and the parties agreed to
file Notices of Discontinuance relating to both the Statement of
Claim and the Counterclaim. The parties also agreed as
follows:
It is agreed that the terms of subparagraphs (a), (b), (c),
and (d) above constitute a final and conclusive determination and
settlement of all claims, rights and causes of action asserted
in, or arising out of the matters referred to in, the pleadings
in this action. For greater certainty, it is confirmed that all
such claims, rights and causes of action are fully satisfied by,
and merged in, these Minutes of Settlement.
[10] In my
view, it is clear that none of the amount of $4.8 million is
attributable to lost income and/or profit and - instead - was
paid in respect of the appellant's claim for additional
construction and installation costs resulting from the lack of
performance in the system as designed and installed by ASEA
pursuant to the contract between the parties. As a capital
receipt, depending on its nature for purposes of analysis in the
within appeal, it is either a capital gain or a non-taxable
windfall.
[11] The
policy of Canada Customs and Revenue Agency (CCRA) with respect
to the characterization of capital amounts - relied on by the
Minister in issuing the assessment to the appellant - is
expressed in the relevant portion of paragraph 8 and
paragraph 9 of IT-365R2 as follows:
8. An amount received by a taxpayer in lieu of the performance
of the terms of a business contract by the other party to that
contract may, depending on the facts, be either an income or
capital receipt. If the receipt relates to the loss of an
income-producing asset, it will be considered to be a capital
receipt; on the other hand, if it is compensation for the loss of
income, it will constitute business income...
9. Where an amount received by a taxpayer as compensation for
a breach of a business contract is a capital amount according to
the comments in 8 above, that amount would relate either to a
particular asset of the taxpayer or to the whole structure of the
taxpayer's profit-making apparatus. If, on the basis of the
facts of the case, such as the terms of a contract, settlement or
Judgment, the amount received relates to a particular asset
(tangible or intangible) which is sold, destroyed or abandoned as
a consequence of the breach of contract, it will be considered
proceeds of disposition of that asset or a part thereof, as the
case may be. Where the amount of compensation relates to a
particular asset that was not disposed of, the amount will serve
to reduce the cost of that asset to the taxpayer. On the
other hand, where the amount of compensation is of a capital
nature but it does not relate to a particular asset as indicated
above, the amount will be considered as compensation for the
destruction of, or as damages to, the whole profit-making
apparatus of the taxpayer's business. Such compensation may
result in an "eligible capital amount" for the purpose
of subsection 14(1) and subparagraph 14(5)(a)(iv). [emphasis
added]
[12] The
appellant's position is that there is no express provision in
the Act requiring the Settlement Amount to be deducted
from UCC and that the Federal Court of Appeal has held -
consistently - that where a taxpayer receives a reimbursement or
compensation from a third party for capital costs of depreciable
property, there is no requirement under the Act that the
taxpayer reduce the original capital costs by the amount of the
reimbursement or compensation. In the case of The Queen v.
Canadian Pacific Limited [1977] C.T.C. 606, the Federal Court
of Appeal considered the situation where Canadian Pacific (CP) -
at the request of a third party - would make capital expenditures
after the third party had agreed to reimburse CP for an amount
not exceeding the costs incurred by it to improve or build
facilities to serve the third party. In that case, CP calculated
its CCA claim in respect of the assets it had acquired - as a
result of the arrangement - on the basis that the amounts
received by the third party were not to be deducted from the
capital cost of those assets in computing the UCC of the relevant
class. Pratte J.A. - writing for the Court - at page 611
stated:
The learned trial Judge, in my opinion, rightly rejected that
contention which appears to me to be inconsistent with the
decision of the House of Lords in Birmingham Corporation v.
Barnes, [1935] A.C. 292, where it was held that "the
actual cost to" a taxpayer of depreciable property is equal
to the amount paid by the taxpayer. As Lord Atkin said in that
case (at page 298):
What a man pays for construction or for the purchase of a work
seems to me to be the cost to him: and that whether someone has
given him the money to construct or purchase for himself; or,
before the event, has promised to give him the money after he has
paid for the work; or, after the event, has promised or given the
money which recoups him what he has spent.
[13] Later,
the Federal Court of Appeal heard the case of The Queen v. The
Consumers' Gas Company Ltd., [1984] C.T.C. 83, wherein
the issue concerned the reimbursement - by customers - to
Consumers' Gas company for all or part of relocating portions
of its gas lines at the request of those customers. In computing
the CCA claims under the Act, Consumers' Gas took the
position that it could add the gross cost of the line relocations
to the UCC of the relevant class and then calculate CCA
entitlements on that gross cost without taking into account the
reimbursements received from the customers. The trial judge held
the method followed by the taxpayer was correct. The Crown
appealed and, although there was an issue concerning the
sufficiency of pleadings by the Crown at trial, the Court did
rule on the contention by counsel for the Minister that the
decision in Canadian Pacific, supra, was not applicable.
The judgment - dismissing the appeal - was delivered for the
Court by Urie J. and at p. 86, he stated:
The learned trial judge, rightly, I think, found that he was
bound by the principle expressed in the Canadian Pacific
case in so far as the treatment of the reimbursements as an
addition to undepreciated capital cost is concerned. However, he
went further and, after reviewing considerable jurisprudence
concluded that in the Canadian Pacific case contributions
were not taken into revenue but were capitalized (page 18 of
reasons) and, therefore, found as follows (page 21 of
reasons):
I have concluded that Plaintiff in the present case was
justified in considering that contributions received towards the
relocation of its pipelines done, not for its benefit, but for
the benefit of the parties making the contributions, can be
carried to a contributed capital account without passing through
income.
[14] The
decision in Consumers' Gas, supra, was followed by the
Federal Court of Appeal in Pacific Northern Gas Ltd. v. Her
Majesty the Queen, [1991] 1 C.T.C. 469. In that case, Pacific
Northern sold gas and delivered it to its customers by means of
additional lines running off the main pipeline. The gas company
received certain payments from its customers to pay for the
connector lines to their premises and the trial judge held the
payments to defray the cost of the connector lines were not
income receipts but were to be applied to increase the UCC of the
lines and in so doing relied - inter alia - on the
decisions in Consumers' Gas and Canadian Pacific, both
supra. The Federal Court of Appeal found the trial judge
did not err in concluding there was no material difference
between the receipts in question before him and those previously
found to have constituted capital receipts in the cases referred
to above.
[15] Prior to
the case of Westcoast Energy Inc. v. Her Majesty The
Queen, [1992] 1 C.T.C. 471, arriving at the Federal
Court - Trial Division - in 1992, Parliament had enacted
paragraph 12(1)(x) of the Act in an attempt to bar
the door to what the Minister had considered to represent a
glaring omission in tax legislation. In Westcoast, supra,
the taxpayer - as plaintiff - had received a sum in excess of $20
million from Ipsco (demonstrating once more that what goes around
comes around) in settlement for an action brought by Westcoast
Energy against Ipsco and others in which it claimed damages for
breach of contract and negligence. Westcoast took the position
the settlement was a payment for damages for breach of contract
and negligence while the Minister argued that the failure of the
settlement to include an admission of liability could be
considered as further support of the assessment in addition to
the proposition that, in light of the new provision of the
Act and the relationship of the payment to the replacement
cost of the pipeline, the assessment was otherwise valid. Denault
J. concluded that paragraph 12(1)(x) did not include
damage awards even though he held that the legislative change had
been made with the intent to plug the hole as exemplified in the
case of Consumers' Gas, supra. Further, Denault J.
found there was no evidence Parliament had intended the new
paragraph to include damage awards under the word,
"reimbursement" and - at p. 481 - went on
to state:
I can appreciate the defendant's position that this
situation creates a taxation inequity. The plaintiff in this case
added the costs of rebuilding the failed pipeline to its
undepreciated capital cost, sought recovery from IPSCO for breach
of contract, recovered moneys for the reconstruction, and then
did not reduce its undepreciated capital cost by the amount
recovered, as well as not including its damage award in its
corporate income. Howerver, I am not prepared to expand the legal
meaning of the word reimbursement to capture this inequity. It is
not the function of this Court to expand the meaning of a word to
make the tax system fair. Parliament could have been more
specific if the intention was to include commercial damage awards
in paragraph 2(1)(x). If there is any ambiguity in
legislative intent to tax, the taxpayer is entitled to the
benefit of the doubt.
[16] The
Federal Court of Appeal upheld the trial judge with regard to his
interpretation (see Her Majesty The Queen v. Westcoast Energy
Inc., [1992] 1 C.T.C. 261). An interesting
feature of the trial before Denault J. was that the Crown -
perhaps inspired by the sage choice of Robert the Bruce for
respite rather than resumption of battle - decided to concentrate
solely on the application of paragraph 12(1)(x)(iv)
of the Act to the settlement amount and abandoned
arguments that the $20,250,000 sum was either compensation for
property injuriously affected or constituted compensation for
property damages, pursuant to various relevant paragraphs in
subsection 13(21) including (f).
[17] In the
within appeal, the Minister did not advance the
"reimbursement" argument probably because the law in
that respect appears to be settled and there has been no
amendment to the relevant paragraph - following the decision in
Westcoast - to expand the provision in order to include
damage awards and/or settlement amounts. To have done so, would
probably have discouraged most taxpayers from further litigation
over whether such payments were - after such amendment - still
capable of being considered non-taxable receipts. While the
failure of Parliament to do something does not assist in matters
of statutory interpretation, it is still interesting to note that
the analysis developed within the body of jurisprudence remains
paramount to the resolution of the issue as opposed to the
application of specific language embodied in statute.
[18] Counsel
for the respondent relied on the decision of the Federal Court of
Appeal in Her Majesty The Queen v. Mohawk Oil Co. Ltd., 92
DTC 6135 as support for the proposition that a settlement
received from a corporation was not a windfall. In that case, the
taxpayer had contracted with a U.S. corporation - Phillips - to
supply and install a waste oil reprocessing plant. As in the
within appeal, the plant failed to operate satisfactorily and,
following certain negotiations, Phillips paid Mohawk Oil the sum
of US $6 million in full settlement of its claims even though the
original compensation sought had been in the sum of
US $15 million. Initially, Mohawk Oil characterized the
settlement proceeds as a loss of profits and as a reduction of
the cost of assets. Later, it took the position that the entire
amount received in the settlement was in respect of damages and,
as such, constituted a non-taxable receipt. The Minister assessed
on the basis that part of the settlement proceeds was income
flowing from a claim for loss of profits and part was capital
because it met the definition of proceeds of disposition as
defined in subsection 13(21) of the Act with the
result that said part was credited to the UCC pool. Hugessen J.A.
- writing for the Court - after reviewing British and Canadian
cases including The Queen v. Cranswick, 82 DTC 6073
(F.C.A.) concluded the facts did not meet the criteria of a
"windfall" for various reasons including the fact there
had been an exchange of mutual releases and the parties had also
agreed to terminate a business relationship created by a specific
agreement. Overall, the payment to Mohawk Oil - by Phillips - was
seen by Hugessen J.A. as an amount paid in partial satisfaction
of a claim for compensation sought by Mohawk Oil pursuant to an
agreement within the context of a business transaction that had
turned sour. At p. 6141, Hugessen J.A. stated:
I must now pass to consider the correctness of the reassessment
itself. The first question here is whether the Minister was right
in assessing the sum of $3,443,708 as compensation for lost
profits and expenditures incurred. In my view, there was evidence
which supported this assessment. I have already referred to the
correspondence and documentation which indicate that the
respondent did seek to be made whole including compensation for
lost profits. Its treatment of the settlement amount in its
accounting records is to the same effect. Moreover, the evidence
reveals that in its fiscal years 1981 and 1982 the respondent
suffered a loss of profits by virtue of operating expenses
associated with the inoperable plant. The evidence further shows
that in computing its income for these fiscal years the
respondent deducted as "net expenses incurred" the
amounts of $1,184,235 and $1,164,296, respectively. What is
apparent in the present case is that Phillips agreed to take back
the plant and, obviously, to recognize in the settlement a
portion of the respondent's claim that was not represented by
the expenditures for land, storage tanks and other auxiliary
facilities which the respondent decided in the end to retain and,
indeed, apparently put to use again after it acquired a new plant
from another source.
We must also decide whether the reassessment was right in
allocating a portion of the settlement amount to "proceeds
of disposition of capital property" to the extent of
$3,718,430. It seems to me that this too depends on whether the
evidence supports that allocation as made by the Minister in the
reassessment. In my respectful view, it does. To begin with, it
is clear beyond doubt that the settlement amount did include
compensation for the plant itself which, apart from the
hydrotreater, was turned back to Phillips who then decided to
have it dismantalled [sic] on site. This item alone had
represented a capital outlay by the respondent of $3,942,000
Canadian ($2,850,000 U.S.) as the purchase consideration. Again,
the respondent, in endeavouring to be made whole, sought to be
compensated in respect of its capital investment. Moreover, its
own accounting records, as approved by its board of directors,
allocated a portion of the settlement amount as "proceeds of
disposal of lubricant plant" and allocated a portion of the
settlement amount to "deferred development costs".
[19] On the
face of it, it would appear as though this decision is
inconsistent with the one in Westcoast, supra. However,
there are two significant differences. First, in Mohawk,
supra, Phillips agreed to take back the plant and paid
compensation for loss of profits associated with it. Phillips,
after taking back the plant, dismantled it on site. That is an
important distinction because - in the within appeal -
payment by ASEA of the sum of $4.8 million - following the
conduct of actual litigation past the Discovery stage - was not
connected to any loss of profits nor did Ipsco abandon, transfer
or otherwise provide ASEA with any property in return for
accepting the payment. I also consider that Phillips decided to
make the payment to Mohawk Oil prior to any legal requirement to
do so and prior to the commencement of any civil action - by
Mohawk Oil - to enforce payment. In that sense, it was a free and
voluntary choice made by the board of directors. Further, it is
apparent that Mohawk Oil clearly disposed of property to
Phillips, thereby triggering a capital gain.
[20] Counsel
for the respondent submitted that in order to obtain a true
picture of the profit of the appellant in the taxation year under
appeal, it is necessary to ensure that the amount on which CCA is
calculated is representative of the actual cost of the system to
Ipsco. In support of that proposition, counsel referred to the
decision of the Supreme Court of Canada in Canderel Limited v.
Her Majesty The Queen, 98 DTC 6100. In that case, the
taxpayer - a corporate real estate developer - deducted all of
the tenant inducement payments made by it during that year. The
Minister disagreed with the method of computation utilized by the
taxpayer and assessed accordingly. At p. 6110, Iacobucci J, set
forth certain principles to be observed in relation to
computation of income, as follows:
(1)
The determination of profit is a question of law.
(2)
The profit of a business for a taxation year is to be determined
by setting against the revenues from the business for that year
the expenses incurred in earning said income: M.N.R. v.
Irwin, supra, Associated Investors,
supra.
(3)
In seeking to ascertain profit, the goal is to obtain an accurate
picture of the taxpayer's profit for the given year.
(4)
In ascertaining profit, the taxpayer is free to adopt any method
which is not inconsistent with
(a)
the provisions of the Income Tax Act;
(b)
established case law principles or rules of law; and
(c)
well-accepted business principles.
(5)
Well-accepted business principles, which include but are not
limited to the formal codification found in G.A.A.P., are not
rules of law but interpretive aids. To the extent that they may
influence the calculation of income, they will do so only on a
case-by-case basis, depending on the facts of the
taxpayer's financial situation.
(6)
On reassessment, once the taxpayer has shown that he has provided
an accurate picture of income for the year, which is consistent
with the Act, the case law, and well-accepted business
principles, the onus shifts to the Minister to show either that
the figure provided does not represent an accurate
picture, or that another method of computation would provide a
more accurate picture.
[21] The issue
in the within appeal does not, however, revolve around different
philosophies concerning appropriate accounting methods and the
rational choice of one over another, both of which are inherently
valid. Instead, the Act provides an extremely precise and
detailed method by which CCA is to be calculated and the
provisions are utilized in a manner to override - in my opinion -
any general concept of calculating what the Minister would like
to have regarded as "true profit" for the year. In an
admirable display of bootstrapping, the Minister assessed Ipsco
on the basis of the administrative pronouncement promulgated in
IT-365R2 on the basis that "where the amount of compensation
relates to a particular asset that was not disposed of, the
amount will serve to reduce the cost of that asset to the
taxpayer". My reading of the relevant jurisprudence leads me
to conclude that this ministerial proclamation is not otherwise
supported by the case law in this field. There was no
"disposition of property" - as defined in
subsection 13(21) of the Act - because the
transaction or event entitling the appellant to the sum of $4.8
million did not involve any disposition of property, even
considering the term, "property" in a broad sense, in a
manner consistent with the analysis performed by several courts
in various cases over many years dealing with diverse subject
matters. The particular definition referred to in
subsection 13(21) of the Act reads:
"disposition of property" - "disposition
of property" includes any transaction or event entitling a
taxpayer to proceeds of disposition of property.
[22] In the
within appeal, Ipsco incurred at least $10,183,948 of capital
costs (see paragraphs 8 and 10 of Agreed Facts) to install the
system and then to make it perform as contemplated in the
contract with ASEA. The Settlement Amount received from ASEA
represented compensation or reimbursement with respect to a part
of those costs and ASEA received nothing in return except a
Discontinuance of Action in respect to litigation rooted in
breach of contract and negligence relating to the design and
installation of the system. In my opinion, an exchange of
releases by way of mutual discontinuances and minutes of
settlement does not constitute property for the purposes of the
subsection. The Minister noted the accounting treatment by Ipsco
- with regard to the sum of $4.8 million obtained from ASEA - in
which the shareholders were notified that the whopping amount of
the additional expenditures in relation to the system were not as
gloomy as they seemed because the bottom-line cost thereof had
been reduced by the amount of the recovery from ASEA through the
litigation process. For internal purposes concerning the
financial state of the corporation, that just makes good sense.
That does not, however, mean the same method must be utilized
when reporting income pursuant to the Act. By reducing the
amount of the historical cost of the system by deducting the sum
of $4.8 million for its own accounting purposes, Ipsco obviously
wanted to present an accurate picture of the situation.
Ironically, that is exactly what counsel for the respondent
submitted the appellant should have done when filing a return of
income under the Act because the failure to do had the
effect of distorting Ipsco's true profit picture in that
taxation year and following years. However, the reporting of
income in accordance with the Act - particularly when
observing a rigid set of rules governing a particular aspect of
income inclusion or deduction of expense - does not preclude
different treatment of the same transaction for other legitimate
business purposes unconnected with making a return of income.
[23] In the
alternative, the position of the Minister is that the Settlement
Amount constituted proceeds of disposition of property, being
compensation for property injuriously affected. The definition of
"proceeds of disposition" in subsection 13(21) of the
Act is as follows:
"proceeds of disposition". - "proceeds of
disposition" of property includes
(a)
the sale price of property that has been sold,
(b)
compensation for property unlawfully taken,
(c)
compensation for property destroyed and any amount payable under
a policy of insurance in respect of loss or destruction of
property.
(d)
compensation for property taken under statutory authority or the
sale price of property sold to a person by whom notice of an
intention to take it under statutory authority was given,
(e)
compensation for property injuriously affected, whether lawfully
or unlawfully or under statutory authority or otherwise,
(f)
compensation for property damaged and any amount payable under a
policy of insurance in respect of damage to property, except to
the extent that the compensation or amount, as the case may be,
has within a reasonable time after the damage been expended on
repairing the damage,
(g)
an amount by which the liability of a taxpayer to a mortgagee is
reduced as a result of the sale of mortgaged property under a
provision of the mortgage, plus any amount received by the
taxpayer out of the proceeds of the sale, and
(h)
any amount included in computing a taxpayer's proceeds of
disposition of the property by virtue of paragraph 79(c);
[24] With
respect to paragraph 13(21)(e), the respondent asserted
the Settlement Amount constitutes "compensation for property
injuriously affected". However, that concept is commonly
associated with expropriation of property in the context of
recognizing that payment must be made not only for the land taken
but for consequential damage to other property. Counsel for the
appellant referred to the phrase "injurious affection"
as being present in the expropriation legislation of several
provinces and submitted the expression at issue is equally
entitled to have "an established and accepted legal
meaning", in the words of Major J. - at paragraph 33 -
of his decision in the case of Will-Kare Paving &
Contracting Ltd. v. Her Majesty The Queen, 2000 SCC 36, as
the word "sale" which was the subject of interpretation
before the Supreme Court of Canada. In the within appeal, the
action taken by the appellant against ASEA had nothing whatever
to do with any allegation of injurious affection to land owned by
it and it was clear the litigation was rooted in breach of
contract and negligence pertaining to the inadequate performance
of the system and the payment - by ASEA - was to compensate the
appellant for the additional construction and installation costs
as stated in the Minutes (tab 4).
[25] The next
matter to be addressed - within the purview of subsection 13(21)
of the Act - is the wording of paragraph (f). If -
as asserted by counsel for the respondent - the payment by ASEA
to the appellant can be characterized as "compensation for
property damaged", then the sum of $4.8 million would have
to be regarded as "proceeds of disposition" and the
applicable rules for calculating CCA would require that amount be
taken into account to reduce the UCC of assets in their class.
Again, the Statement of Claim filed by the appellant and the
resulting Minutes do not refer in any way to the damage -
by ASEA - of Ipsco property. The litigation was based on the
deficiencies in the construction of the "quench and
temper" system and it was alleged that, in creating and
installing this specialized process, ASEA did not live up to the
specifications contained in the construction contract. The
payment by ASEA was made because it had not been able to deliver
the goods as promised and it recognized that the appellant had
been forced to incur additional expenditures in the sum of
$7,593,791 - in the 1985 to 1988 taxation years - in order to
make the system work at substantially less capacity than
originally intended according to specifications set forth in the
contract between the parties. One can see from the wording of
paragraph (f) that it is also intended to be utilized in
instances where there has also been an amount payable under an
insurance policy and there is reference to repairing damage. Had
ASEA, in the process of building and installing the system,
damaged other portions of the appellant's plant or otherwise
interfered with separate and non-related income-producing
activities, then there might be some validity to the argument
that the payment - however categorized in any settlement
documents - was actually attributable to that head of damage.
That is not the case. The very thing that was created and
integrated into an overall system was deficient and there was no
damage in the usual and ordinary meaning of that term. Simply
put, there was a flaw in the design, installation or - perhaps -
the concept was over-ambitious at the outset but the work done by
ASEA in constructing the system within the plant owned by Ipsco
did not result in any property of Ipsco being damaged and no
compensation was paid in that respect. The Supreme Court of
Canada in St. Pierre v. Ontario (Minister of Transportation
and Communications), [1987] 1 S.C.R. 906 considered the
matter of the effect of highway construction on a certain strip
of land owned by the plaintiffs. It is apparent from said
decision that the entire thrust of the tort of injurious
affection relates to damage caused to the subject property and
not to any head of compensation such as personal injury or injury
to business or trade. One must assume that Parliament was well
aware of the specialized meaning of this term because there is
reference to property injuriously affected, whether lawfully or
unlawfully or "under statutory authority or otherwise".
There is no ambiguity present in that phraseology and to extend
it in the manner suggested by counsel for the respondent is to
re-write the provision in order to embrace a concept never
intended by the legislators.
[26] From time
to time, the Minister seeks to tax amounts that do not fit neatly
within the confines of any of the provisions of an Act now
more than 2,200 pages - including Regulations - and
attempts to assess on the basis that to ignore what appears to be
a windfall is to violate the object and spirit of the taxing
legislation. Legislation weighing more than a kilogram does not
have much room in it for liberal, general interpretation,
particularly when the road to the resolution of a specific issue
is well-marked and the voyage is undertaken in accordance with a
detailed map and a handy guidebook. The argument made on behalf
of the Minister is that paragraphs 13(21)(a) through
(h) are not necessarily exhaustive and the type of
settlement in the within appeal could still be categorized as
constituting proceeds of disposition. I do not agree. Parliament
intended it to be exhaustive in the same manner as other precise
legislation when it is crafted within the context of a specific
purpose. Had it wanted to tax this type of settlement award, it
would have amended the Act following the decisions in
Consumers' Gas, and Westcoast Energy,
supra.
[27] In the
within appeal - unlike the situation in Mohawk Oil, supra
- there was no transfer of property from the appellant to ASEA in
return for payment of the Settlement Amount and this was admitted
by the respondent at paragraph 9 (n) of the Amended Reply. In
addition, there was no termination of an intended long-term
business relationship and in the Mohawk Oil case the
settlement included compensation for the plant itself which was
turned back to the payor. In light of those previous decisions of
the Federal Court of Appeal on similar fact situations, I
conclude that the transfer of the plant - apart from one
component known as the hydrotreater - to the payor of the
settlement, was the governing factor in the decision of the Court
in Mohawk Oil. At paragraph 9 (m) of the Amended Reply,
the respondent asserted that, in computing its income for the
taxation year, the appellant deducted all legal costs relating to
the ASEA lawsuit. Generally, legal fees are deductible only when
incurred for the purpose of earning income and legal costs
expended in collecting damages on account of capital are not
deductible. Notwithstanding the deduction of legal costs claimed
by the appellant when filing its return of income, that does not
make it correct nor does it transform the Settlement Amount into
a receipt on account of income. In accepting the deduction for
legal fees, it seems the Minister bobbled the ball. It may be
that within the context of the facts in the within appeal, the
term "win-win" is shorthand for
"windfall-windfall" but strange things happen from time
to time in the mysterious domain of taxation. Since the inception
of a tax on income - as a temporary measure, in 1917 - the regime
of tax collection is the result of constant accretion leading to
a metamorphosis whereby the modern Income Tax Act became
an instrument of social and economic policy designed to influence
the behaviour of people together with the power to exert a
profound effect on economic development of certain geographical
regions within Canada. It also provides tax incentives for growth
of certain industries and investments including the development
of new technology within a rapidly-changing marketplace. The
Act also differentiates among citizens, often based on
age, occupation, residence, or type of investments held, without
crossing the line into discrimination forbidden by the Charter
of Rights and Freedoms. In the 1960's, there was a brief
foray into uncharted territory when it was suggested by the
author of the Carter Commission on Taxation (Canada, Report of
the Royal Commission on Taxation (Ottawa: Queen's Printer,
1966)), commonly referred to as the Carter Commission, that a
philosophy - worthy of adoption - was to afford equal treatment
to all incoming revenue on the basis that "a buck is a buck
is a buck." That proposal did not gain acceptance and, as a
result, practitioners of various dark arts within the arcane
world of taxation - and their loved ones - continue
to be assured of a steady supply of jam with their tea.
[28] Having
regard to the evidence - including the Agreed Facts -
and the relevant jurisprudence, I find the appellant was
justified in treating the Settlement Amount as a non-taxable
receipt. Therefore, there are no proceeds of disposition and the
assessment of the Minister is incorrect. I conclude there is no
requirement in the Act - generally or specifically - that
the appellant deduct the Settlement Amount of $4.8 million
received from ASEA from the capital cost of the system and that
said amount does not otherwise reduce the UCC of the
appellant's class 29 or class 39 depreciable property.
The appeal is allowed with costs and the assessment of September
21, 1999 is referred back to the Minister for reconsideration and
reassessment in accordance with this conclusion.
Signed at Toronto, Ontario, this 5th day of March 2002.
« Rowe, T »
D.J.T.C.C.
COURT FILE
NO.:
1999-5040(IT)G
STYLE OF
CAUSE:
IPSCO Inc. and Her Majesty the Queen
PLACE OF
HEARING:
Calgary, Alberta
DATE OF
HEARING:
November 20, 2001
REASONS FOR ORDER
BY:
the Honourable Deputy Judge D.W. Rowe
DATE OF
JUDGMENT:
February 5, 2002
APPEARANCES:
Counsel for the Appellant: Ken S. Skingle
Counsel for the
Respondent:
Margaret Irving
COUNSEL OF RECORD:
For the
Appellant:
Name:
Ken S. Skingle
Firm:
Felesky Flynn
Calgary, Alberta
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
1999-5040(IT)G
BETWEEN:
IPSCO INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on November 20, 2001 at Calgary,
Alberta, by
the Honourable Deputy Judge D.W. Rowe
Appearances
Counsel for the
appellant:
Ken S. Skingle
Counsel for the
respondent:
Margaret Irving
JUDGMENT
The
appeal from the assessment made under the Income Tax Act
1994 taxation year is allowed, with costs, in accordance with the
attached Reasons for Judgment.
Signed at Toronto, Ontario, this 5th day of March 2002.
D.J.T.C.C.
Email this Content