McKee v. The Queen, 77 DTC 5345, [1977] CTC 491 (FCTD)

Addy, J:—The plaintiff is a member of and an owner of a 1/16th interest In a motion picture syndicate, known as the Heyman Syndicate (hereinafter referred to as “the Syndicate’’).

By a special agreement dated October 26, 1970, but actually executed in the fall of 1971, the Syndicate purchased, partly for cash and partly for credit, certain moving picture script rights with corresponding rights of ownership of the pictures when produced, consisting essentially of rights in four scripts or plays which were to be produced as moving pictures. (These rights are hereinafter referred to as “the properties’’.) Only one of these properties entitled “Divorce His—Divorce Hers’’ and also known as “Separation” was actually produced as a moving picture. There is no evidence that anything was done in so far as the other three scripts are concerned.

The total price to be paid was to be the actual costs of producing the four pictures but was not to exceed, in any event, a total fixed amount for each film, the total cost of the four being $8,500,000. The amount to be paid in cash by the Syndicate, and which in fact was paid, was $400,000. The plaintiff contributed his 1/16th share to the cash payment, which share consisted of $25,000.

It was contemplated that all films would be completed by 1972, yet the agreement provided that the balance of the purchase price would only be payable in October 1980 or when the productions were all completed whichever was the later. As to the date of completion, Exhibit 1 shows that the date of delivery of the last film was expected to be February 1972.

There was no obligation on the part of the Syndicate to pay the said balance, but if it failed to do so it would forfeit the $400,000 cash payment and all rights to the productions. This was specifically stated in the agreement as being the only recourse available against the purchaser by the vendors. The witness Aitken, called on behalf of the plaintiff, admitted under cross-examination that essentially the Syndicate would have at least until 1980 to decide whether to buy, failing which it would forfeit the $400,000, although the agreement provided that the purchase of the properties was taking place at the time of execution.

The plaintiff claimed capital cost allowances in respect of the four properties as follows:

The capital cost allowance claimed was based on the allowance of 60% provided for in Class 18 of Schedule B to the Regulations which reads as follows:

Property that is a motion picture film other than a television commercial message.

All of the above amounts were disallowed by the Minister, resulting in the present appeal.

One of the issues raised was whether the capital cost allowance claimed unduly or artificially reduced the plaintiff's income or, more specifically, whether subsection 137(1) applied. That subsection reads as follows:

137. (1) In computing income for the purposes of this Act no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

The case of Louis J Harris v MN Ft, [1966] CTC 226; 66 DTC 5189, a decision of the Supreme Court of Canada, contains the following passage at page 241 [5198]:

If, contrary to the views I have expressed, we had accepted the appellant’s submission that the transaction embodied in the lease was one to which section 18 applied and that on the true construction of the lease and the terms of that section the appellant was prima facie entitled to make the deduction of the capital cost allowance of $30,425.80 claimed by him, I would have had no hesitation in holding that it was a deduction in respect of an expense incurred in respect of a transaction that if allowed would artificially reduce the income of the appellant and that consequently its allowance was forbidden by the terms of Section 137(1). The words in the subsection ‘‘a disbursement or expense made or incurred” are, in my opinion, apt to include a claim for depreciation or for capital cost allowance,* [1] and if the lease were construed as above suggested the arrangement embodied in it would furnish an example of the very sort of “transaction or operation” at which Section 137(1) is aimed.

The case was decided on other grounds and the statement is, of course, obiter dicta and is therefore not strictly binding upon me. In view of its authorship however and of the fact that the judgment was concurred in by the remainder of the members of the Court who were sitting at that time, that particular interpretation of subsection 137(1) caused me some concern. The question, in my view, must be squarely faced in the case at bar.

I have searched several dictionaries including The Shorter Oxford English Dictionary, 3rd edition revised, Britannica World Language Dictionary, Funk & Wagnall’s New Standard Dictionary of the English Language, The Random House Dictionary of the English Language, The Living Webster Dictionary and Thorndike-Barnhard (American dictionary). It seems abundantly clear that the common ordinary meaning of the word “expense” pertains to a payment, an outlay of money and expenditure or that which has created a liability or which might have necessitated the transfer of some assets in payment therefor. It can also mean the cost of a thing or whatever must be given up or surrendered for it. The word “disbursement” is even more indicative of an immediate outlay or payment and signifies an expenditure. Nowhere could I find that these words are even remotely used to indicate something in the nature of an allowance. On the contrary, the sole affinity between the word “allowance” and these two words occurs when the latter is used as a set-off against or to pay for, compensate for, or counterbalance an expense or disbursement. Far from being in any way a synonym of either of these two words it constitutes, if anything, an antonym.

The Crown itself called, on another matter, as an expert accountant, one Mr Bonham, who apparently possessed considerable academic and professional qualifications and a considerable practical experience in accounting. This witness, in the course of his evidence, referred with approval to several recognized texts and papers in accounting including Terminology for Accountants CICA 1962, Accounting Terminology Bulletin No 4 AICPA 1957 and The Canadian Accountants Handbook 1968. From these publications and the definition of costs, expense and expenditure therein contained, including some recommended changes in terminology, it is abundantly clear that in accounting also the distinction is clearly maintained between an “allowance” and an “expense” or “disbursement”.

In the Income Tax Act itself the word “expense” is found in numerous sections and nowhere there is it used to indicate an “allowance”. It is for instance used in the sense of an outlay or expenditure in sections 5, 11, 12, 12A, 13, 18 and 20 and is used in the sense of something which counterbalances or is offset against or is used to compensate for an expense in such sections as 5(1)(b), 5(2)(b), 11 (6)(b) and others.

I must therefore conclude that not only in their common ordinary meaning, but also in the technical language of accountancy and, more importantly, everywhere else in the Act itself wherever the words are employed, they are never used nor are they intended to be used as being synonymous to the word "allowance” but that, on the contrary, they are often directly used to indicate an expenditure which one may or may not be permitted to compensate for by an allowance according to the particular provisions of the Act.

In subsection 137(1) itself the words ‘‘capital cost allowance” themselves describe an allowance to compensate for the cost or expense. Surely, this allowance itself cannot be the cost, expense or expenditure for which it is intended to provide some tax relief.

In view of the above and also in view of the general principle that wherever ambiguity exists, although I can really find no ambiguity here, a taxing statute must be interpreted against the taxing authority, I can find no reason why the words “‘a disbursement or expense made Or incurred” can be taken to include an allowance which a taxpayer is permitted to claim under the Regulations to compensate for the cost or capital expenditure made in acquiring an asset.

Subsection 137(1) is therefore of no assistance to the Crown.

Another issue raised is whether, under the wording of Class 18 of Schedule B to the Regulations, which I have already quoted, any capital allowance whatsoever can be claimed for the rights in the three plays which were never produced as a motion picture and, in so far as the film "Separation” is concerned, what allowance if any can be claimed.

In my view, the wording of the Schedule is clear and unambiguous: "Property that is a motion picture” can certainly not by any stretch of the imagination be taken to include a play or a book or any other type of script which may eventually be turned into a moving picture, no matter how sincerely one might intend to eventually create a moving picture production. The extremely high rate of 60% per annum for capital cost allowances in the case of films is obviously because the income-producing life span of a moving picture film, with the possible exception of re-runs for television purposes, is normally of very short duration and also because the moving picture business itself is an extremely high risk enterprise. There can therefore be no depreciation allowance under Class 18 of Schedule B for the three properties which remained plays or scripts.

In so far as the movie "Separation” is concerned, it undoubtedly qualifies as a property capable of attracting an annual capital cost allowance of 60% under Class 18. It was substantially completed in 1972 and, therefore, would qualify for such a capital cost allowance for that year.

The question of whether a capital cost allowance can be claimed depends, of course, on the actual cost of the property to the taxpayer who must be the owner thereof and be holding it or using it for the bona fide intention of producing income.

The question in the case before me might well depend on what part, if any, of the possible liability of some $8,500,000 can be properly considered, in accordance with the ordinary and generally accepted principles of commercial accountancy, as a capital expenditure or true capital liability during each of the years under appeal.

The plaintiff produced no audited statements whatsoever nor did he call any accountant to give expert evidence in this respect. The defendant, on the other hand, called one Mr Bonham as an expert in accountancy. His qualifications and experience were quite impressive.

Questions such as whether a particular disbursement or a particular deduction or allowance is justified at all, or whether the item in question is accountable in the capital or in the revenue accounts or whether it is to be taken into account either wholly or partially or not taken into account at all in any particular accounting period, are, in the final analysis, questions of law. However, in deciding such a question in any particular case before it, the Court must almost invariably have recourse to the ordinary principles of commercial accountancy. In order to decide the nature of these principles and their application to the issues before it, the expert evidence and opinion of qualified accountants is generally of very great assistance and at times might even prove to be indispensable. The issue can generally be resolved by deciding what would be the sound and generally accepted accounting practice in any particular set of circumstances, in the absence of course of any applicable statutory provision to the contrary.

However, as in the case of any other evidence, whether factual or expert, the trial court is entitled to accept or reject any part of the evidence of an expert accountant because it is shouldered with the sole responsibility of making all required findings of fact and of drawing all necessary conclusions therefrom and of applying thereto all the appropriate legal principles. (Refer: ECC Quarries Limited v Watkis (1975), 36 TR 185 at 193-5; Publishers Guild of Canada Limited v MNR, [1956-60] Ex CR 32 at 49, 50; [1957] CTC 1 at 17; 57 DTC 1017 at 1026; and Lawrence H Mandel v Her Majesty the Queen, [1976] CTC 545 at 566; 76 DTC 6316 at 6330.)

It is with these principles in mind that I considered the evidence of Mr Bonham tendered by the defendant.

The following facts are of considerable importance on the issues pertaining to the film “Separation”:

1. According to an unaudited report filed at trial by the plaintiff and furnished to his Syndicate by the vendors, the latter incurred the following production costs in relation to that film:

It is important to note, however, that those costs were never passed on to, claimed from or paid by the Heyman Syndicate presumably because as stated previously they would not be called upon to pay anything before 1980 at the earliest if and when they did decide to pay rather than to forfeit the down-payment of $400,000 and their rights to the four properties. There are no figures for any years subsequent to 1973.

2. By a supplementary agreement dated May 1973, the vendors agreed to pay to the Heyman Syndicate the sum of $456,000 in stipulated instalments from June 30, 1973 to December 31, 1974. These amounts were in fact paid by the vendors and the Heyman Syndicate had by December 1974 been reimbursed in full its original down payment plus $56,000.

3. As of the date of trial, in June 1977, the moving picture had been shown only once, namely on the ABC Television Network in February 1973 and nothing whatsoever had been done with the other three scripts to produce pictures from them. It appears from the unaudited statements produced that there may be a loss of some $600,000 incurred by the vendors with regard to the film “Separation”.

Mr Bonham, the accountant, testified that from his knowledge of accounting and from the information which he had relating to the case, which information I find to have been accurate, proper recognized accounting practice would have required that, in 1970, the plaintiff should have recorded as an asset the rights acquired in the properties at a cost of $25,000 and that in 1973, as a reduction of the same asset, there should have been recorded the sum of $28,500 (being 1/16th of $456,000) which the vendor had undertaken to pay the purchasing Syndicate and the excess between $28,500 and the depreciated cost of the original investment should be reflected in the 1973 income. He further stated and I quote:

In 1972 and 1973, if it then appears likely that the debt on account of the purchase price will be paid by the purchaser group when that debt becomes due under the agreement, an appropriate liability together with the accompanying production costs may then be recognized in the accounts of each purchaser. Otherwise, accounting recognition on the books of the purchasers of all such additional production costs should be deferred until such time, if ever, as payments are actually made against the purchase price.

As of the date of the trial, the evidence establishes that on a clear balance of probabilities the purchase price will not be paid. Nothing whatsoever has been done with the other three properties over a period of seven years and nothing had been done with the film "Separation” except to show it once to a TV audience over a period of four years. There is also the question of the apparent loss of some $600,000 suffered by the vendors in the production of the film "Separation”. It is true that one must not judge in 1977 by hindsight what would have been a proper entry in 1972 or 1973 but, in my view, the plaintiff has failed to establish that as of 1972 or 1973 it was likely that the purchase price would ever be paid by the Heyman Syndicate.

At that time the liability, if it can be termed to be one, was highly contingent and even more in the realm of pure speculation than the liability considered by my brother Walsh, J in the above-mentioned case of Mandel v The Queen wherein he held that the liability was of such a contingent type as not to be allowable until the events actually occurred if they ever did. As in that case, there is uncertainty not only when the amount will be paid but whether it ever will be and also uncertainty as to the amount itself. The facts in the case at bar are even less favourable to the taxpayer than those in the Mandel case. In the latter case, the liability depended on the happening of certain events which, if they occurred, would create the liability, while in the case at bar no matter what might happen in the future the purchasers are absolutely free to refrain from paying any amount whatsoever. It is not even a true liability but rather a mere right to choose at some time in tne future whether an undetermined amount will be paid or not and is therefore even more tenuous and nebulous than what is commonly considered a contingent liability.

Having regard to the above, I am prepared to find, in accordance with the principles enunciated by the witness Bonham, that any production costs which the plaintiff purchaser might pay must be deferred, from an accounting standpoint, until actually paid. No depreciation can therefore be claimed on any such part of this contingent liability.

There remains the question of the $25,000 actually paid. Up until 1972 no amount beyond the portion of the down-payment of the $25,000 attributable to the purchase of the film ‘‘Separation’’ could be considered as cost to the plaintiff of the film property (as to the requirement of the cost being cost to the taxpayer, see Ottawa Valley Power Company v MNR, [1969] CTC 242 at 253; 69 DTC 5166 at 5173; and also Lord Mayor, Aldermen and Citizens of the City of Birmingham v Barnes (Inspector of Taxes), [1935] AC 292). In 1972, he was considered as reimbursed by the above referred to reimbursement agreement signed by the vendor at that time. There was nothing whatsoever of a contingent nature about the vendor’s liability to pay under that agreement and the amounts were in fact paid. Finally, as to the $25,000 itself, the plaintiff has failed to establish what part of same might truly be attributable to the purchase of the rights in the film "Separation” which was a script at the time of purchase as opposed to the purchase of the other three properties.

For the above reasons the appeal is dismissed with costs and the assessments of the Minister are confirmed.