Perini Estate v. The Queen, 82 DTC 6080, [1982] CTC 74 (FCA)

LeDain, J:—This is an appeal from a judgment of the Trial Division dismissing an appeal from a decision of the Tax Review Board which had dismissed an appeal from a reassessment in respect of the 1969 taxation year of the late Roy J Perini by which the amount of $14,031.19 was included as interest in the calculation of his income. It is one of three related appeals which raise the same issue, the other two being A-118-78 and A-119-78, which relate to reassessments in respect of the taxpayer’s 1970 and 1971 taxation years by which the amounts of $28,431.74 and $119,262.60 respectively were included as interest in the calculation of his income. The three appeals were heard together on common evidence in the Trial Division and in this Court. The reasons in this appeal will serve to dispose of the issue in the other two. The appeals have been continued by the executor and trustee of the late Mr Perini.

The issue is whether the sum of $14,031.19 paid to Mr Perini under the term of an agreement for the sale of shares, in which the payment in question is referred to as “interest”, was an income or capital receipt. The issue turns on the fact that the principal amount upon which the payment referred to as “interest” was to be calculated had not been determined at the date from which the interest was to run. The agreement, entered into as of November 14, 1968, provided for the sale by Mr Perini of all of the issued shares in the capital stock of All Records Supply of Canada Ltd (“ARS”) to Columbia Records of Canada Ltd (“CRC”) “at a price determined pursuant to paragraph 1.3” of the agreement, which reads as follows:

1.3 As full payment for the Sale Shares, CRC will pay Seller as follows:

(i) At the Closing $660,000 (all sums herein are expressed in Canadian dollars);

(ii) Following receipt of an audited financial statement for the year ended April 30, 1969 — a payment equal to the lesser of (A) $400,000 and (B) the result obtained by dividing the post-tax net profits of ARS for such year by $186,000 and multiplying the result by $400,000;

(iii) Following receipt of an audited financial statement for the year ended April 30, 1970 — a payment which shall cause the total payments under this clause

(iii) and the preceding clause (ii) to equal the lesser of (A) $800,000 and (B) the result obtained by dividing the net aggregate of the post-tax net profits (after deducting losses) of ARS, as determined by said audited financial statement, for the two fiscal years ended April 30, 1969 and 1970 by $372,000 and multiplying the result by $800,000;

(iv) Following receipt of an audited financial statement for the year ended April 30, 1971 — a payment which shall cause the total payments under this clause

(iv) and the preceding clauses (ii) and (iii) to equal the lesser of (A) $1,200,000 and (B) the result obtained by dividing the net aggregate of the post-tax net profits (after deducting losses) of ARS, as determined by said audited financial statement, for the three fiscal years ended April 30, 1969, 1970 and 1971 by $558,000 and multiplying the result by $1,200,000.

(v) To each payment of principal pursuant to clauses (ii), (iii) and (iv) above there shall be added interest thereon at the rate of 7% per year from the Closing Date to the date of payment. The right to receive payments pursuant to clauses (ii), (iii) and (iv) of this paragraph shall be personal to Seller, may not be transferred by him and shall terminate upon his death and payments shall not be prorated for the period prior to his death. The post-tax net profits (losses) of ARS for purposes of the above payments shall be determined on a pro forma basis as though ARS had filed a separate tax return as a non-associated Canadian corporation for the respective years involved. All audited financial statements referred to above shall be prepared by the auditors referred to in paragraph 9.6 hereof.

It will be seen from the foregoing provisions that the price for the shares was to consist of an initial payment of $660,000 on the closing date, which was November 27, 1968, and additional payments based on the post-tax net profits, if any, of ARS as determined by audited financial statements for the fiscal years ending on April 30th in 1969, 1970 and 1971. The total of such additional payments was not to exceed $400,000 by 1969, $800,000 by 1970, and $1,200,000 by 1971. To these additional payments was to be added an amount specified as “interest” and provided for in clause (v) of paragraph 1.3 as follows: “To each payment of principal pursuant to clauses (il), (iii) and (iv) above there shall be added interest thereon at the rate of 7% per year from the Closing Date to the date of payment.” The amount of $14,031.19, which is in issue in this appeal, and the amounts of $28,431.74 and $119,262.60, which are in issue in appeals A-118-78 and A-119-78 respectively, were paid pursuant to this provision.

The Minister reassessed the taxpayer on the basis that these amounts were interest within the meaning of paragraph 6(1)(b) of the Income Tax Act which provides:

6. (1) Without restricting the generality of section 3, there shall be included in computing the income of a taxpayer for a taxation year

(b) amounts received in the year or receivable in the year (depending upon the method regularly followed by the taxpayer in computing his profit) as interest or on account or in lieu of payment of, or in satisfaction of interest.

The payments were held to be interest by both the Tax Review Board and the Trial Division, and the taxpayer’s appeals were accordingly dismissed.

It is the appellant’s contention that despite the name given to them in the agreement the payments were not interest but were part of the purchase price and were therefore not of an income nature. The contention is that while they are called interest, are calculated like interest, and serve the purpose of interest, they lack an essential characteristic of interest in that they did not accrue from day to day on an existing principal amount. The principal amount on which the sum referred to as “interest” was based did not come into existence until it had been determined by an audited financial statement following the close of the fiscal year. Until then there was no principal amount on which interest could accrue.

It is elementary, of course, that the name given by the parties to an amount payable pursuant to clause (v) of paragraph 1.3 of the agreement is not conclusive of its nature. See Commissioners of Inland Revenue v Wesleyan & General Assurance Society, 30 TC 11 at 16 and 25. Counsel for the appellant cited several authorities as indicating the essential characteristics of interest. He relied particularly on what was said about the nature of interest in the Supreme Court of Canada in Reference as to the Validity of Section 6 of the Farm Security Act, 1944, of the Province of Saskatchewan, [1947] SCR 394, and in The Attorney-General for Ontario v Barfried Enterprises Ltd, [1963] SCR 570. In the Saskatchewan Farm Security case, Rand, J defined interest at 411 as “the return or consideration or compensation for the use or retention by one person of a sum of money, belonging to, in a colloquial sense, or owed, to another”, and at 412 he said that “interest is referable to a principal in money or an obligation to pay money.” At 417 in the same case Kellock, J said, “There can be no such thing as interest on principal which is non-existent.” Counsel for the appellant attached particular importance to this statement as expressing the essence of his contention. In the Barfried case, Judson, J, after referring to the definition of interest by Rand, J in the Saskatchewan Farm Security case, said at 575: “The day-to-day accrual of interest seems to me to be an essential characteristic.” In Tomell Investments Limited v East Marstock Lands Limited, [1978] 1 SCR 974, Pigeon, J referred at 982 and 983 to “‘interest’ properly so-called” as “a charge for use of money accruing day by day.” Thus it is appellant’s contention that the amount paid pursuant to clause (v) of paragraph 1.3 of the agreement could not be said to have accrued day by day from the date of closing because there was no principal sum in existence on which it could accrue during the period between that date and the time the additional sum payable was determined by an audited financial statement.

Counsel for the appellant also relied on the judgment of Thurlow, J, as he then was, in R G Huston et al v MNR, [1962] Ex CR 69; [1961] CTC 414; 61 DTC 1233, in which it was held that amounts paid as “interest” on awards from the War Claims Fund established after the Second World War were not interest within the meaning of paragraph 6(b) of the Income Tax Act. The awards were made in 1958, and the applicable regulation provided that interest of 3% per annum should be paid on the awards from January 1, 1946. Thurlow, J concluded that, although the amounts were called interest, were calculated like interest, and served the purpose of interest, they were not inerest because during the period from January 1, 1946 to the date of the awards the recipients were not legally entitled to a principal amount upon which interest could accrue. The essentials of the reasoning of Thurlow, J appear to me to be continued in the following passage from his reasons at 77-78 [422, 1238]:

The facts are that the appellant’s property had been partially destroyed in 1945, a misfortune for which, so far as has been made to appear, they had no right to legal redress against anyone, and, in any event, none against the Government of Canada. Vide Civilian War Claimants Association Ltd v The King [ [1932] AC 14]. Despite what was going on in the meantime, that continued to be the legal position until October 10, 1958, when the Treasury Board approved the payments, which were made to them shortly afterwards. No principal sum was payable in the meantime, nor was interest accruing on any principal sum, nor were the appellants being kept out of any sum to which they were entitled. In truth, during the whole of the intervening period they had no right to compensation for their loss, and there was neither interest accruing to them nor loss of revenue being sustained in respect to which they would be entitled to interest by way of damages or compensation.

Thurlow, J added the following observations at 78 [423, 1238], which counsel for the appellant found particularly helpful to his contention:

In this connection, it may be noted that, while the House of Lords in Riches v Westminster Bank [[1947] 1 All ER 469] overruled Re National Bank of Wales [ [1899] 2 Ch 629], it did not overrule Commissioner of Inland Revenue v Ballantine [(1921) 8 TC 595] or Simpson v Executors of Bonner Maurice [(1920) 14 TC 580] both of which appear to me to be stronger cases in this respect than the present for attributing an income nature to the sums in question, since in these cases the taxpayer’s right to the sum to which “interest” was added arose prior to or at the commencement of the period in respect to which the “interest” was computed. No case of which I am aware goes so far as to hold such an amount, call it interest or damages or compensation or any other name, to be interest or income when there was neither interest accruing in fact on the “principal” amount during the material period nor any right to the “principal” amount vested in the taxpayer during that period.

In the Bonner Maurice case, to which Thurlow, J referred, it was held that an amount awarded as compensation under the terms of the Peace Treaty for interference with the disposition of property during the First World War, and computed on the basis of interest, was not interest for purposes of income tax. Rowlatt, J, whose judgment was affirmed by the Court of Appeal, said at 593:

The Treaty gave compensation, and the tribunal which assessed the principal sum has assessed it on the basis of interest. I think this sum first came into existence by the Award, and no previous history or anterior character can be attributed to it.

The Riches case, to which Thurlow, J also referred, was one on which counsel for the appellant placed particular emphasis. In that case the issue was whether interest awarded as damages by a judgment for failure to pay a sum owing when it should have been paid was income for purposes of income tax. It was held that it was, the principal issue being whether there was any incompatibility between the notion of damages and the notion of interest. In that case the principal sum was owing on the date from which interest ran, which distinguishes it from the present case. It was also argued that the sum awarded as interest could not be interest because it had not in fact accrued from day to day but had been awarded from a past date. This argument was rejected on the ground, as I understand the reasons, that the damage for which interest was awarded had in fact accrued or been incurred from day to day. I do not find that the Riches case really answers the question in the present case.

In the present case there was in existence on the closing date an obligation to pay a price to be determined according to the formula set out in paragraph 1.3 of the agreement, but the precise amounts of the additional payments, if any, to be made pursuant to clauses (ii), (iii) and (iv) were not determined as of that date. The obligation to pay additional sums on account of the purchase price under these provisions was a conditional one or a contingent liability. It depended on two conditions which might or might not be fulfilled. There had to be post-tax net profits determined by audited financial statements, and the seller had to be living. Neither was a certainty. That was sufficient to make the liability for additional payments a contingent one. Unless and until these conditions were fulfilled there could not be an additional sum owing pursuant to clauses (ii), (iii) or (iv) of paragraph 1.3

Reference was made in the course of argument to various cases indicating the nature of a contingent liability, in particular, Winter v IRC, [1963] AC 235, in which the issue was whether a liability to pay tax on recaptured capital cost allowance was a contingent liability within the meaning of the applicable statutory provision. Both Lord Reid and Lord Guest quoted from a passage in Erskine’s Institute of the Laws of Scotland concerning the nature of a conditional obligation under Scots law, on the apparent assumption that it was equally true of a contingent liability under English law. The definition of conditional obligation in Erskine reads as follows:

A conditional obligation, or an obligation granted under a condition, the existence of which is uncertain, has no obligatory force till the condition be purified; because it is in that event only that the party declares his intention to be bound, and consequently no proper debt arises against him till it actually exists; so that the condition of an uncertain event suspends not only the execution of the obligation, but the obligation itself.

What results from the discussion of a conditional obligation or contingent liability in the Winter case is that while the debtor cannot withdraw his undertaking there is no obligation or liability to pay unless and until the condition is fulfilled or the contingency occurs. The definitions of contingent liability in Winter were applied by this Court in L H Mandel v The Queen, [1979] 1 FC 560; [1978] CTC 780; 78 DTC 6518, to the liability, on the sale of a film, for the balance of price which was to be payable out of earnings, a case obviously analogous to the present one. Ryan, J said of the liability for the balance of price at 566 [785, 6521]:

It was not, however, as to the balance, a liability to pay merely on the expiration of a period of time or on the happening of a certain event that was certain, or even likely, to occur. It was a liability (from which the purchasers admittedly could not unilaterally withdraw) to become subject to an obligation to pay the balance if, but only if, an event occurred which was by no means certain to occur. The obligation was thus contingent on the happening of the uncertain event.

What these cases do not touch on, and what appears to be the issue in the present case, is the effect, in so far as the essential characteristics of interest are concerned, that should be given to the fulfilment of the condition which makes the liability absolute. The learned trial judge concluded that the fulfilment of the condition had a retroactive effect. This conclusion is contained in the following passage from his reasons:

Once it was ascertained that the profits had been made and could be calculated and the vendor was still alive his obligation for the payments in each of the years 1969, 1970 and 1971 became due, and the condition having been fulfilled it had a retroactive effect to the date of the contract. Interest ran from that day on the payments due in accordance with the terms of the contract.

He based this conclusion on the assumption that the common law as to the effect of the occurrence of a contingency did not differ in principle from the rule in article 1085 of the Quebec Civil Code that “The fulfilment of the condition has a retroactive effect from the day on which the obligation has been contracted.”

In my respectful opinion, this was not an unreasonable assumption, given what was said in Winter about the probable similarity of a conditional obligation under Scots law and a contingent liability under English law, and the common origin, in Roman law, of both Scots law and Quebec law with respect to a conditional obligation. I note, for example, that while Erskine did not deal specifically with retroactive effect, he mentioned the rule, derived from Roman law, which is also found in the second part of article 1085 of the Quebec Civil Code, that the right created by a conditional obligation is transmitted on death. This rule was treated by Pothier, one of the sources consulted by the Quebec codifiers for article 1085 (see de Lorimier, Bibliothèque du Code civil, v 8, p 417), as a corollary of the retroactive effect of fulfilment of the condition.

In any event, given that such an effect is not clearly excluded by what we are able to ascertain from the cases of the common law concerning contingent liability, it is my opinion that it was open to the parties to the agreement of sale in this case to treat the occurrence of the contingency as having such effect, in so far as interest was concerned. Cf. Trollope & Colls, Ltd et al v Atomic Power Constructions, Ltd, [1962] 3 All ER 1035, in which it was held that parties to a contract could give their contract retrospective effect. There is no rule of law that prevented them from treating an additional sum payable on account of the purchase price under the terms of clauses (ii),

(iii) or (iv) of paragraph 1.3 of the agreement as owing, for purposes of interest, from the closing date, as they appear to have done in clause (v). There were sound business reasons for doing so since the sale had been concluded on that date and the over-all obligation to pay the purchase price contracted on that date. Because of the basis on which the balance of price, if any, was to be determined, the seller was obliged to wait for payment of the balance. Interest was the appropriate compensation for that delay. I think it is the existence on the closing date of a conditional obligation or contingent liability to pay the balance of price which the parties were entitled to treat as having become absolute with retroactive effect, for purposes of interest, that distinguishes the present case from Huston.

For these reasons I am of the opinion that the payment of $14,031.19 received by the late Mr Perini in the taxation year 1969 was interest, and therefore income, and the appeal should accordingly be dismissed with costs.