Borstad Welding Supplies (1972) Ltd. v. The Queen, 93 DTC 5457, [1993] 2 CTC 266 (FCTD)

Reed, J.:—The issue in this case is very narrow: whether a disposition occurred on June 1, 1985, as defined by paragraph 13(21)(c) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). [1] The alleged disposition relates to certain refillable gas cylinders which are used in welding.

Sometime in 1984 the plaintiff ("Borstad") decided to sell much of its business to Union Carbide (” Union"). [2] Negotiations ensued and a master sales agreement dated June 1, 1985, was signed. That agreement provided that Union would purchase “all of the working assets" of Borstad. The "working assets" were defined in the agreement to mean:

The business as a going concern and all property and assets owned or leased by the vendors and used in the business as at the effective date excepting only the retained assets and liabilities.

The gas cylinders were not listed as retained assets.

The aggregate purchase price was expressed to be $2,971,955.60 and listed as part thereof was $800,000 for the refillable cylinders. The agreement provided that, the cylinders would be purchased over the course of five years, one-fifth of their number being purchased each year. The agreement also provided that Union would lease the cylinders until they were purchased, at a monthly rental of $1.51 per cylinder, payable in arrears, annually on the anniversary date of the agreement in accordance with a master cylinder lease agreement.

Insofar as the purchase of the cylinders was concerned paragraph 4.03 of the master sales agreement provided:

The vendors agree to sell to the new company and the purchaser agrees to cause the new company to purchase one-fifth of the vendor owned cylinders, free and clear of all encumbrances or adverse claims save and except the master cylinder lease and permitted encumbrances on each of the first through fifth anniversaries of closing date and to pay the vendors the sum of one hundred fifty dollars and eighty three cents ($150.83) by way of purchase price for each of the vendor owned cylinders purchased and conveyed. Upon conveyance of title as herein provided to each one-fifth of the vendor owned cylinders, the lease pursuant to the master cylinder lease of that one-fifth of the vendor owned cylinders shall be merged with the conveyance of title to that one-fifth of the vendor owned cylinders, and no further monthly rental shall be payable to the vendors with respect thereto.

The master cylinder lease provided:

3. The lessor [Borstad] agrees to lease to the lessee [Union] and the lessee agrees to lease from the lessor the cylinders subject only to the permitted encumbrances defined in the master sales agreement and to the cylinder leases.

4. The term of this agreement shall commence on the June 1, 1985 and shall continue for a term of five (5) years at a monthly rental equal to $1.51 per cylinder payable in arrears on each anniversary date thereof.

5. The lessee, subject to the cylinder leases and to provisions hereof, shall at all times keep the cylinders in its sole possession and control.

6. The lessee shall, during the continuance of this agreement, at its expense, keep the cylinders in the same working order and condition and make the same adjustments, repairs and replacements necessary to meet the same standards as the lessee maintains with the cylinders owned by it and shall not use or permit the cylinders to be used for any purpose for which the cylinders are not designed or reasonably suitable.

7. The cylinders, subject to the provisions hereof, shall at all times remain the property of the lessor, and the lessor may affix tags or decals to the cylinders indicating the lessor's ownership.

8. The lessor and the lessee shall keep the cylinders free of all liens and encumbrances save and except the permitted encumbrances, the cylinder leases and any sub-leases by the lessee.

10. The lessor shall have free access to the cylinders at all reasonable times for the purposes of inspection.

11. The lessor shall not transfer, assign or grant a security interest in all or part of this agreement, the cylinders or the sums payable hereunder to any third party without the prior written consent of the lessee which consent may not be unreasonably withheld. Notwithstanding any assignment, transfer or grant by the lessor and so long as the lessee is not in default hereunder neither the lessor nor any such third party shall interfere with the lessee's quiet possession of the cylinders.

12. During the term hereof, the cylinders shall be at sole risk of the lessee, and the lessee shall indemnify and save harmless the lessor from any claims with respect thereto arising out of the negligence of the lessee or breach of clause 6 hereof.

16. The lessor agrees to sell to the lessee and the lessee agrees to purchase one- fifth of the cylinders, free and clear of all encumbrances or adverse claims save and except the cylinder leases and the permitted encumbrances on each of the first through fifth anniversaries of the December 16,1985 and to pay the lessor the sum of one hundred fifty dollars and eighty three cents ($150.83) by way of purchase price for each of the cylinders purchased and conveyed. Upon conveyance of title as herein provided to each one-fifth of the cylinders, the lease of that one-fifth of the cylinders shall be merged with the conveyance of title to that one-fifth of the cylinders, and no further monthly rental shall be payable to the lessor with respect thereto.

17. The lessee shall be in default hereunder, and there shall be a breach of this agreement, if:

(a) the lessee fails to pay any installment of rent when the same becomes due and payable; or

(b) the lessee shall fail to observe or perform any of the other obligations required to be observed or performed by the lessee hereunder and such failure shall continue uncured for ten (10) days after written notice thereof to the lessee by the lessor; or

(c) the lessee ceases doing business as a going concern, makes an assignment for the benefit of creditors, admits in writing its inability to pay its financial obligations as they become due, files a voluntary petition in bankruptcy, is adjudicated a bankrupt or an insolvent, files a petition seeking for itself any reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar arrangement under any present or future statute, law or regulation or filed an answer admitting the material allegations of a petition filed against it in any such proceeding, consents to or acquiesces in the appointment of a trustee, receiver, or liquidator of it or of all or any substantial part of its assets or properties, or if it or its shareholders shall take any action looking to its dissolution or liquidation; or

(d) within 30 days after the commencement of any proceedings against the lessee seeking reorganization, arrangement, readjustment, liquidation, dissolution or similar relief under any present or future statute, law or regulation, such proceedings shall not have been dismissed, or if within thirty (30) days after the appointment without the lessee's consent or acquiescence of any trustee, receiver or liquidator of it or of all or any substantial part of its assets and properties, such appointment shall not be vacated.

In the event that the lessee is in default hereunder, then, in any such event, the lessor may at its option do any or all of the following:

(i) by notice to the lessee terminate this agreement as to all or any cylinders,

(ii) whether or not this agreement is terminated as to all or any cylinders, take possession of any or all of the cylinders which have not been purchased wherever situated, and for such purpose, enter upon any premises without liaibility [sic] for so doing;

(iii) sell, dispose of, hold, use or lease any cylinders which have not been purchases as the lessor in its sole discretion may decide, without any duty to account to the lessee.

The lessee shall in any event remain fully liable for reasonable damages as provided by law and for all costs and expenses incurred by the lessor on account of such default including all court costs and reasonable legal fees. The waiver by the lessor of any breach of any obligations of the lessee shall not be deemed a waiver of such obligation or of any subsequent breach of the same or any other obligation. The rights afforded the lessor under this paragraph shall not be deemed to be exclusive, but shall be in addition to any rights or remedies provided by law.

18. This agreement shall be deemed to have been made in the Province of Alberta and shall be governed in all respects by the laws of such Province.

Transactions occurred as contemplated by the agreements. Borstad accounted for the revenue earned from the rental of the cylinders in each of the five years and for the sale of one-fifth of the cylinders each year. The transaction between Union and Borstad was an arm's length one and the staggered sales were agreed to as a result of a request by Union, not Borstad. The Minister does not allege that the arrangement was agreed upon for any" sham" purpose but merely that it is one of those situations in which a taxpayer structured his affairs in a way which had unforeseen tax consequences.

The Minister contends the cylinders were disposed of by Borstad on June 1, 1985. Borstad contends that they were disposed of over the course of five years, as set out in the agreement.

The Minister argues that a disposition of property occurs when either title to the property in question passes or when the purchaser has acquired all the incidents of title even though legal title may remain in the vendor. Reference was made to M.N.R. v. Wardean Drilling Ltd., [1969] C.T.C. 265, 69 D.T.C. 5194, at page 271 (D.T.C. 5197-98) (Exch. Ct.); R. v. Henuset Brothers Ltd. (No. 1), [1977] C.T.C. 227, 77 D.T.C. 5169 (F.C.T.D.), Olympia and York Developments Ltd. v. The Queen, [1980] C.T.C. 265 , 80 D.T.C. 6184, at pages 276-78 (D.T.C. 6192-94) (F.C.T.D.) and Kirsch Construction Ltd. v. The Queen, [1988] 2 C.T.C. 338, 88 D.T.C. 6503, at pages 340-41 (D.T.C. 6504) (F.C.T.D.).

The Wardean case dealt with the acquisition of oil drilling equipment. Even though the equipment had been ordered and invoices received therefor in one fiscal year, it was held that acquisition did not take place until the equipment was delivered to the purchaser. Property did not pass to the purchaser under the Alberta Sale of Goods Act, until that time. The quotation in that decision upon which the Minister relies, in making his argument, in this case is:

. . . a purchaser has acquired assets of a class in Schedule B when title has passed, assuming that the assets exist at that time, or when the purchaser has all the incidents of title, such as possession, use and risk, although legal title may remain in the vendor as security for the purchase price as is the commercial practice under conditional sales agreements.

[Emphasis added.]

The Henuset case does not add much to the debate except for the proposition that the way a payment is described by the vendor and purchaser in their agreement, which was entered into prior to the tax issue arising, is persuasive. In the Henuset case the taxpayer had bought and sold, within a few months, a hospital. A certain sum of money was described in the second agreement of purchase and sale as "interest". The taxpayer attempted to argue that it was part of the purchase price and the Court found that the taxpayer had not adduced evidence to prove that the payment was other than as described by the parties in their agreement.

Although not relied upon in oral argument, I think I should also consider the decision in R v. Henuset Bros. Ltd. (No. 2), [1977] C.T.C. 228,77 D.T.C. 5170 (Exch. Ct.). That case concerned the purchase of a number of tractors. It was held that the taxpayer had acquired the tractors on December 30, 1971, since at that date it had constructive possession of them and had assumed all the risks incidental to ownership thereof. The retention of legal title as security for payment of the balance of the purchase price was held not to alter the fact that an acquisition had occurred. The tractors were not delivered to the taxpayer until several months later.

In the Olympia and York case the purchase of an apartment building was under consideration. The parties had structured that agreement so that title would not be conveyed until much of the purchase price had been paid. It was held that the rights which the vendor retained were kept as protection that the balance of the purchase price would be paid (in fact it was not). It was held that the rights retained were comparable to those that would normally be retained by a mortgagee and thus a disposition of the building was said to have occurred. This is one of several decisions in which judges have found it necessary to struggle with the differences between the common law concepts relating to real property and the civil law concepts found in the Civil Code of Quebec.

The Kirsch decision does not add a great deal to the present debate. That case dealt with the purchase of a road paver which had been ordered and for which cheques had been written in one fiscal year although the paver was not delivered until the following fiscal year. The Court held that the acquisition did not occur until the paver was delivered because it was only at that point that property in the goods passed.

Counsel for the Minister agrees that the determination of when title passed in this case is governed by the Sa/e of Goods Act, R.S.A. 1985, c. S-2. There is no dispute that property did not pass on June 1, 1985. Thus, the question becomes whether a disposition occurred because of the second branch which has been developed in the jurisprudence: whether the purchaser had acquired all the incidentals of title . . . although legal title might remain in the vendor. Counsel for the Minister refers particularly in this regard to the decision in Fortin & Moreau Inc. v. M.N.R., [1990] 1 C.T.C. 2583, 90 D.T.C. 1450 at page 2596 (D.T.C. 1460) (T.C.C.) and Robert Bédard Auto Ltée v. M.N.R., [1985] 2 C.T.C. 2354, 85 D.T.C. 643 (T.C.C.).

Fortin & Moreau dealt with a purchase of some trucks and trailers for use in the taxpayer's business. The taxpayer would have preferred to buy the vehicles outright but could not afford to do so. He therefore entered into a lease purchase agreement pursuant to which the vehicles were" rented" for a period of time. At the end of that time the vendor had been paid the full purchase price plus an additional amount and the purchaser had “the option to purchase the vehicles". The Court characterized this as an acquisition which occurred at the start of the rental agreement. I note that for the first time, at least in the jurisprudence cited to me, the test applied by the Court is no longer one which requires that the purchaser have acquired "all the incidents of title, such as possession, use and risk”. Rather it is stated that "a taxpayer who has possession and the use of a thing and has assumed all the risks relating thereto has acquired the thing . . .” (pages 2596 (D.T.C. 1460) and 2599 (D.T.C. 1462) of the decision). This case is one in which there is an extensive discussion of the differences between the common law and civil law concepts of ownership.

The Bédard decision is also a case to which the Civil Code of Quebec applied. That case involved the sale of an automobile dealership. This included a lease of lands and buildings for a five-year term. The lessee was obliged to purchase these but the time of that purchase was not identified. The purchaser was unsure as to when he would be able to afford to pay the purchase price. Thus he was given a five-year lease. The land and buildings could be purchased at any time before the end of the five-year term period but had to be purchased no later than on that date. The test applied to characterize the transaction as an acquisition at the beginning of the lease was that as of that date that the purchaser assumed possession, use and risk of the property.

In the present case, because of the nature of the business, the cylinders in question are almost always in the possession of, used by, and are at the risk of someone other than the owner. In order to illustrate this it is useful to describe the way the plaintiff's business operated prior to its sale to Union.

Prior to selling the business, the plaintiff owned a certain number of gas cylinders (those which are the subject of the present litigation). It also rented others from Union. Whether owned or rented the cylinders were in turn rented or leased by the plaintiff to its customers. While the plaintiff distinguished between renting (on a monthly basis) and leasing (on a yearly basis) there is no significant difference between the two concepts except for the length of the term. The cylinders, which are filled with gas, are rented to customers. When the gas is used the customer returns the empty cylinders and picks up other cylinders which are full of gas.

If a cylinder had been filled with oxygen the plaintiff would have refilled the empty cylinder itself. If the cylinder had been filled with acetylene, the plaintiff took the empty cylinder to Union's premises in Edmonton for refilling. In this latter case, the plaintiff left the empty cylinders at the Union premises and picked up a comparable number of full ones. There was no record kept of any specific cylinder as between Union and the plaintiff or between the plaintiff and its customers. This was so regardless of whether the cylinders were vendor owned (i.e. by the plaintiff) or rented by the plaintiff from Union. The cylinders were fungible both insofar as the plaintiff and Union were concerned and insofar as the plaintiff and its customers were concerned.

The cylinders which were rented by Union to the plaintiff were at the plaintiff's risk; any damage or loss was paid for by the plaintiff. The cylinders, whether vendor owned or rented by the plaintiff from Union, when in the hands of the plaintiff's customers were held at the customers' risk. A clause of the cylinder lease agreement entered into by the plaintiff's customers stipulated :

It is understood that the cylinders remain the property of the distributor and no title passes to the purchaser [ie., of the gas]. The purchaser agrees to be responsible for all cylinders so leased while in the purchasers' possession, and will pay the distributor on demand for all loss or damage to any cylinder resulting from any cause while in the purchasers’ possession.

The plaintiff also points out that such a risk clause is a common element in a chattel lease agreement. A rental agreement for a hand stapler which the plaintiff entered into was filed in evidence. The relevant clause in that agreement states:

CARE: Customer agrees to properly protect all equipment from weather by suitable housing: to provide competent operators and return the equipment in as good condition as received, normal wear and tear excepted. The company shall have access to said equipment at all times for inspection. The risk and liability for any injury or damage to said equipment from any source or cause whatsoever until the equipment is returned to the company, shall be borne by the customer, and the amount of such damage shall be paid to the company by the customer upon demand. Should the equipment be destroyed or cease to exist for any cause whatsoever during the terms of this agreement, the customer hereby agrees to pay the aforementioned valuation price to the company on demand.

The plaintiff argues that the rental agreement which was subsequently entered into with Union, when the plaintiff decided to sell its business, was not unlike these agreements. It is argued that possession, use and risk in the hands of someone other than the owner does not always mean that a disposition of the property for tax purposes has taken place.

Counsel for the defendant argues that the agreement entered into by the plaintiff and Union was in reality a purchase of the cylinders on June 1, 1985 because it formed part of the master sales agreement of that date and the plaintiff did not expect to take repossession of the cylinders. As far as the plaintiff was concerned it was hoped that the cylinders had been disposed of for good. Counsel for the Minister argues that the staggered purchases were in fact staggered payments for the cylinders as a whole because a separate amount was not charged for the different types or sizes of cylinders and there was no provision as to which cylinders became the property of Union on each anniversary date.

The plaintiff does not dispute that it hoped that the contract would be completed as agreed upon and that it did not expect to take repossession of the cylinders. Insofar as the price paid is concerned the plaintiff states that a lump sum divided by five was a way of making the negotiations and arrangements as simple as possible. Mr. Borstad gave evidence that he expected that title to one-fifth of each type of cylinder would be taken by Union at the date of each purchase.

I do not think the Fortin & Moreau and the Bédard decisions stand for the proposition that whenever possession, use and risk coalesce in one person there has been a disposition or acquisition of property, as the case may be. I think something more is required. The earlier cases expressed the test as being one in which all the incidents of title passed except those retained for the purpose of securing payment of the balance of the purchase price (e.g., held by a mortgagee or conditional sales vendor).

In the present case the parties expressly contracted that property was to remain in Borstad during the period of the lease and that Borstad could attach tags to specific cylinders to identify them if it wished. Union was obligated to indemnify Borstad for any claims arising out of the negligence of Union or the failure of Union to keep the cylinders in repair. Union was required to retain the cylinders in its sole possession and control. If Union defaulted on any term of the contract, for example neglecting to pay rent, Borstad could immediately terminate the agreement respecting the cylinders. I do not think that the provisions of the agreement are consistent with a conclusion that Union acquired all the incidents of title to the cylinders except legal title. On June 1, 1985, Union acquired rights in a contract relating to property, it did not acquire the property itself.

Most important is the fact that while the parties intended a sale of the cylinders to occur they did not intend it to occur on June 1, 1985. They intended that there be five sales with one-fifth of the cylinders being purchased on each occasion. The purchase price for each one-fifth did not become payable until then. The plaintiff could not have sued for payment of any or all of the purchase price for the cylinders on June 1,1985. The parties did not enter into a conditional sale or a chattel mortgage with respect to the cylinders. There was no question of the property in the goods being retained as security for payment of the purchase price. The monthly rent which was paid for the cylinders prior to their sale approximated market price. The fact that. there was no itemized listing of different prices for different types and sizes of cylinders I do not consider significant. The plaintiff has satisfactorily explained why global amounts were agreed upon.

The parties thought they were entering into an agreement for the rental of the cylinders until such time as they were purchased, one-fifth of the total number of cylinders to be purchased in each of five consecutive years. I cannot characterize their agreement as other than what it purports to be. I cannot conclude that a disposition occurred on June 1, 1985.

Until the time of the trial the parties had proceeded on the assumption that if a disposition of the cylinders did not occur on June 1, 1985, the rental income received therefrom was to be considered active business income. At the end of the trial I was asked to make no ruling until the parties had had an opportunity to submit written representations on this issue. Accordingly, the defendant shall be given three weeks from the date of this order to file such representations and the plaintiff shall have two weeks after receipt of those representations to reply thereto.

Order accordingly.