Macmillan Bloedel (Alberni) Ltd. v. MNR, 73 DTC 5264, [1973] CTC 295 (FCTD)

Collier, J:—This appeal was heard at the same time as another appeal (MacMillan Bloedel Industries Limited v MNR, p 299). In this case there are two points to be decided. In the other case there is only one point io be decided but it is identical to one of the points in this appeal. To that extent it was agreed that the evidence adduced would be common to both appeals.

I shall deal first with the issue peculiar to this appeal: whether amounts of interest received by the apellant in 1966 and 1967 ought to be included in its income for the purpose of calculating logging tax deductions or credit pursuant to section 41A of the Income Tax Act.” [1]

Counsel have agreed that the relevant statutory provisions are as follows:

41 A. (1) There may be deducted from the tax otherwise payable by a taxpayer under this Part for a taxation year an amount equal to the lesser of

(a) 2/3 of any logging tax paid by the taxpayer in respect of income for the year from logging operations in the province; or

(b) 6 2/3% of the taxpayer’s income for the year from logging operations in the province referred to in paragraph (a).

(2) In subsection (1),

(a) “income for the year from logging operations in the province” has the meaning given to that expression by regulation;

Regulation 700.(1) . . . “income for the year from logging operations in the

province” means the aggregate of

(d) where standing timber is cut in the province by the taxpayer or logs cut from standing timber in the province have been acquired by the taxpayer, if the taxpayer operates a sawmill, pulp or paper plant or other place for processing logs in Canada, the income of the taxpayer for the year from all sources minus the aggregate of

(i) his income from sources other than logging operations and other than the processing and sale by him of logs, timber and products produced therefrom,

The precise point is whether the interest was income from sources other than logging operations and ought to have been deducted from the calculation in order to arrive at the logging tax cerdit. The appellant did not deduct the amounts. The Minister by reassessment did so.

Prior to January 1, 1966, the appellant (under a slightly different name) carried on integrated logging operations on Vancouver Island. It controlled timberlands and carried on logging, a sawmill, a shingle and plywood plant, and a pulp and paper mill, all in the Alberni area. For reasons not relevant to this case it sold as a going concern its pulp and paper mill to a wholly owned subsidiary, Alberni Pulp and Paper Ltd. Thereafter the latter company carried on the pulp and paper operation. The purchase price was $76,077,140.18. A demand promissory note dated December 30, 1966 was given for that amount by the purchaser to the vendor. The interest rate was 6%.

In 1966 the sum of $4,564,628 interest was paid. In 1967 the sum of $4,552,300 was paid. In 1966 as well the appellant received amounts totalling $2,625 described as interest from loans to independent log- gers and other miscellaneous rental income. In 1967 these sums amounted to $1,659. The respondent in his reassessment deducted all of these amounts for the years in question.

Counsel for the appellant contends it is not sufficient to look at the mere receipt or description of the money, and from that to say it was income of the taxpayer “. . . from sources other than logging operations . . .” and therefore must be deducted from its total income. Counsel contends one must look through the transaction and determine the real source of the funds. In this case it is said the real source was from the logging operations of the purchaser subsidiary and the other payers of interest or rent. Reference is made to two cases in support of the contention that one may look beyond the mere receipt of income in order to characterize its source.* [2]

Those two cases are quite different on their facts and on the sections of the Income Tax Act under consideration. I do not find them of much assistance in respect of the issue here.

lt seems to me the appellant’s contention can be answered in a number of ways.

(1) There is no evidence that the moneys paid were actually generated by logging operations. The large amounts paid by the subsidiary company may, for all I know, have come from bank loans. I think, however, it is fair to infer the moneys paid were realized from the proceeds of logging operations.

(2) I shall assume the moneys paid to the appellant were ail realized from logging operations carried on by the purchaser and the borrowers or renters. As I interpret subparagraph 700 (1)(d)(i), the income which need not be deducted is income which came from logging operations carried on by the taxpayer (in this case the appellant and not the subsidiary company). Here the appellant did not process logs or timber and sell the products produced. The subsidiary did and the income referred to in the subparagraph was its income, not “his” income (“his” meaning in this case the appellant).

(3) I cannot think it was intended that the income to be deducted by the taxpayer by virtue of the subparagraph in question should be determined by the particular type of business carried on by some third person or company which is indebted to the taxpayer and out of those third person profits payment of those debts is made. Investment income in the everyday sense in which that term is used would seem automatically to be deducted by virtue of the subparagraph, but if the appellant here had invested in the shares of and received dividends from a company in the logging business, then if the appellant’s argument is correct, those particular dividends would not be excluded. In my view, the “sources” referred to are the sources carried on or operated by the taxpayer and not some third person.

The appeal in respect of the first issue is therefore dismissed.

I turn now to the second issue here which, as I have said, is the only issue in the other appeal. During 1966 and 1967 the appellant purchased new logging trucks and other units. These were delivered fitted with tires. The appellant sought to deduct as an expense under paragraph 12(1)(a)t [3] the initial cost of the tires. In 1966 this amounted to $140,350.16, in 1967 the cost was $52,756.97.1: [4] The respondent, in his reassessments, disallowed the deductions and added the amounts into the Class 10 assets of the appellant, on the basis the new tires were part of automotive equipment, and the taxpayer could then, if it desired, claim capital cost allowance under paragraph 11(1)(a) of the Act and section 1100 of the Regulations.

Prior to 1966 the appellant had, in fact, treated new tires which came with new equipment in the way the respondent maintains they should be treated for the years in question. In 1966 the appellant determined that in its logging division where these units operated over very rough roads tires lasted on the average slightly over twelve months. The figures given were 12.2 or perhaps 12.7 months. The initial cost of the tires fitted on the new unit was roughly 10% to 15% of the total cost of the truck (which averaged $50,000 to $60,000 each in the years under review).

The appellant contends that because of the short life of the tires on these particular units their initial cost and replacement cost is a recurring annual expense which is deductible. Mr Rushton, the Manager of the Tax Section of the appellant and its associated companies, and also a chartered accountant, expressed the view that treating the initial cost of the tires as an expense incurred in the year of purchase of the unit was in accordance with ordinary commercial principles or well accepted principles of business and accounting practice. The appellant says its method is in accordance with the “matching” principle, that is the proper matching of revenue and expense in the years in question.

In my view, the method adopted by the appellant here is not a true application of the matching principle. It is not disputed that the logging units are capital assets. They cannot function without tires. It is also admitted there is other equipment or materials that require replacement or repair within the first year. Some examples are fan belts and lubricating oil of various kinds. No attempt has been made by the appellant to claim those items as an initial expense, presumably because the cost is small in respect to the overall cost of the unit. In my view it is purely an arbitrary procedure to segregate these tires from the rest of the unit. This equipment was purchased as a package, not as a number of individual parts later assembled to form an operational machine.

In its financial statements to its shareholders in the years in question the units were all shown as a capital cost, including the initial cost of the tires. It is true that the way a transaction is handled in the books of a taxpayer is not determinative of the result from an income tax point of view. Mr Rushton conceded that the Minister’s contention is in accordance with generally accepted accounting practice. This is further apparent by the way the appellant itself treated the tires in its own financial statements.

It is unnecessary to cite any authority for the proposition that the assessment of the Minister is wrong. In this case the assessment by the Minister is based on acceptable commercial principles and generally accepted accounting practices. The appellant has not, in my view, discharged the onus of showing that the use of those methods in this particular case is wrong.

The appeal on this issue therefore dismissed.