The Queen v. Johnson & Johnson Inc., 94 DTC 6125, [1994] 1 CTC 244 (FCA)

Hugessen, J.A. (Pratte, Desjardins, JJ.A., concurring):—

Introduction

In tax law timing is everything. This case raises two quite separate timing issues, the first as to when a refund of overpaid taxes becomes receivable, the second as to when such refund should be taken into account for income tax purposes.

The facts

The respondent is a manufacturer and distributor of health care products, including in particular sanitary napkins for feminine hygiene. From at least April 1975 to August 1981 the respondent paid federal sales tax on sanitary napkins pursuant to the Minister's interpretation of the provisions of the Excise Tax Act, R.S.C. 1970, c. E-13. Those payments were shown as expenses in respondent's annual returns and reduced its taxable income for each of the years in question. The respondent, however, took the position that sanitary napkins were exempt from sales tax under Schedule III of the Act and made an application to the Tariff Board under section 59 of the Act. That application was successful and by its decision dated October 15, 1980, the Tariff Board declared sanitary napkins to be not subject to sales tax. An appeal to this Court from that decision was dismissed on September 21, 1981.

The Minister having decided not to seek to appeal the matter further, the respondent applied in November 1981 for a refund of the taxes paid in respect of the period April 1975 to August 1981. What happened next is set out in an agreed statement of facts filed in the Trial Division ({1992] 2 C.T.C. 86, 92 D.T.C. 6373) (references to "plaintiff" are to the present respondent, and to "defendant" to the present appellant) (C.T.C. 88-89; D.T.C. 6374):

9. The audit of the said refund claims was performed by Gilles Maheu ("Maheu"). Maheu was assigned to the plaintiff's refund claim file on or about December 1, 1981. At all relevant times for purposes of the present Action, Maheu was a senior auditor in the Customs and Excise Division of the Department of National Revenue (the "Department"). The responsible minister of the Crown in respect of the administration and enforcement of the Excise Tax Act is the Minister of National Revenue.

10. As a senior auditor in the Department, Maheu reported to a Supervisor. Maheu’s Supervisor at all relevant times for purposes of this Action was N.A. Veillette ("Veillette").

11. The chain of command within the Department was that Veillette reported to the Department's District Manager (C. Lamouteux [sic]), who in turn, reported to the Regional Chief—Audit (A. Rizk), who reported to the Regional Director (P.V. Bartolini), who reported to the Assistant Deputy Minister (L.R. Huneault).

12. Maheu completed his audit of the plaintiff's refund claims on or about December 16, 1981. He forwarded his report and recommendation to his supervisor (Veillette), who reviewed it and indicated his approval of the report and recommendation by initialling the report on or about December 23, 1981. A copy of the refund claims evidencing the procedure and the working papers of Maheu are attached hereto as Appendix 4. The amount in issue in this Action consists of the aggregate of two refund claims (bearing, respectively departmental identification numbers 008034 and 009214) in the amounts ultimately approved, of $4,525,689.61 and $1,716,671.14, making a total of $6,242,360.75.

13. By letter dated December 24, 1981, Maheu wrote to the plaintiff with respect to the refund claims. The letter may have been mailed on December 24, 1981, but it is possible that it was mailed only on December 27, 1981. It was, in any event, not received by the plaintiff until January 4, 1982. A copy of Maheu's letter is attached hereto as Appendix 5.

14. It has not been possible for the defendant to locate the file concerning the plaintiff's refund claim. The defendant believes the file may have been destroyed in accordance with the usual policy applicable within the Department in respect of old files.

15. It appears likely that, once the auditor's report had been approved by the auditor's supervisor, the refund claim would have been forwarded, along with a Y-7 production report (which has not been located) to the secretary of the District Manager of the Department, who would have transferred the claim and the report to the Regional Office, where a payment list (departmental form E56-1) would be prepared in order for the Department of Supply and Services to issue the appropriate refund cheque. The approval procedure is also subject to the corroboration of the Refunds Manager at the time the E56-1 cheque requisition list is signed. The parties agree that, were Maheu to be called as a witness in these proceedings, Maheu would testify that the description of the process referred to above reflects what actually happened in respect of the refund in issue.

16. A requisition for a refund cheque payable in respect of the plaintiff's applications for refund of the federal sales taxes in respect of the sanitary napkins was made, in accordance with the above-noted procedures, on January 4, 1982. The reference, in the documents attached hereto as Appendix 4, on the last line thereof, to “42069” is a reference to the number of the departmental cheque requisition list (form E56-1) prepared on January 4, 1982. A cheque, signed (mechanically) by the Deputy Receiver General of Canada, was issued on January 4, 1982. The amount of the cheque was $6,242,360.75.

The respondent's 1982 taxation year ended on January 3, 1982. The Minister takes the position that the entire amount of the sales tax refund was receivable and taxable as income in the 1982 taxation year. The respondent asserts that the amount only became receivable in its 1983 taxation year (which ended January 2, 1983) and that in any event it is not taxable as income. The matter came to the Trial Division, and is now before us, as an appeal by the respondent (plaintiff) against the assessment by the Minister (defendant) in respect of the 1982 taxation year.

The issues

Both here and in the Trial Division the parties were in agreement that the issues raised by these facts are, first to know whether the sales tax refund was receivable by respondent in its 1982 taxation year and second, whether such refund was required to be included in computing income from the respondent's business. At page 91 (D.T.C. 6376) the trial judge restated the second question as "whether the refund constitutes income for tne purposes of the Act" but that, in my view, was an over-simplification which resulted in there being some confusion in the conclusion that he reached. I shall expand on this in due course.

Issue 1: Was the refund receivable in 1982?

The respondent's right to receive payment of the amounts of sales tax which it had wrongly been obliged to pay in the period April 1975 to August 1981 was governed by section 44 of the Excise Tax Act, the relevant provisions of which read as follows:

44(1) A deduction from, or refund of, any of the taxes imposed by this Act may be granted

(a) where an overpayment has been made by the taxpayer;

(b) where a refund or adjustment has been made to the taxpayer by a licensed air carrier under Part Il for the taxes collected or paid on any transportation of a person by air that has not been provided or only partially provided by the air carrier or that has been collected in error by the air carrier;

(c) where the tax was paid in error;

(d) where the original sale or importation was subject to tax, but exemption is provided on subsequent sale by this Act;

(e) where goods are exported, under regulations prescribed by the Minister;

(f) where, due to changes in statutory rates of tax or for other reasons, stamps are returned for exchange; or

(g) where the original receipt of marketable pipeline gas of natural gas liquids was subject to tax under Part IV.1, but exemption is provided on subsequent use by that Part.

(7) No refund of or deduction from any of the taxes imposed by this Act shall be granted, and no payment of an amount equal to tax paid shall be made, under this section as a result ot

(a) a declaration under section 59,

(b) an order or judgment of the Federal Court or any other court of competent jurisdiction, or

(c) a decision of the Minister or other duly authorized officer respecting the interpretation or application of this Act,

in respect of taxes paid prior to such declaration, order, judgment or decision unless application in writing therefor is made to the Minister by the person entitled to the refund, deduction or amount within 12 months after the later of the time the taxes became payable or the time the refund, deduction or amount first became payable under this section or the regulations.

(7.1) Subject to subsection (7), no refund of moneys paid or overpaid in error, whether by reason of mistake of fact or law or otherwise, and taken into account as taxes imposed by this Act shall be granted under this section unless application in writing therefor is made to the Minister by the person entitled to the refund within four years after the time the moneys were paid or overpaid.

(7.2) An application under subsection (6), (7) or (7.1) shall be made in such form and in such manner as the Minister may prescribe.

(7.3) Where the Minister rejects in whole or in part an application under subsection (6), (7) or (7.1) for a refund, deduction or amount, the application ceases to have effect, for the purposes of determining whether the refund, or deduction may be granted or the amount may be paid, ninety days after notice of the rejection is sent to the applicant, unless, within that ninety day period, an application in respect of the refund, deduction or amount is made to the Tariff Board under section 59 or to the Federal Court under section 28 of the Federal Court Act.

(7.4) Where the Minister approves an application under subsection (6), (7) or (7.1) for a refund, deduction or amount, the application ceases to have effect, for the purposes of determining whether the refund or deduction may be granted or the amount may be paid, ninety days after payment of the refund, deduction or amount is sent to the applicant, unless, within that 90 day period, an application in respect of the refund, deduction or amount is made to the Tariff Board under section 59 or to the Federal Court under section 28 of the Federal Court Act.

As can be seen this statutory provision imposes strict time limits on a claimant, both forward, from the time of the Tariff Board decision or Court judgment giving rise to the right to seek the refund (subsection (7)), and backward from the time of the application to a maximum of four years (subsection (7.1)). The decisionmaking power is conferred specifically on the Minister and is made subject to judicial review (subsections (7.3) and (7.4)).

In my view, it is apparent from the scheme of the section that there is no right to receive a refund, and hence no “receivable”, until a favourable decision has been made by the Minister. In reaching that decision the Minister is required to make findings of fact, reviewable on application to the Tariff Board, and to determine questions of law, reviewable on a section 28 application to this Court. In short, the Minister acts classically as a quasi-judicial tribunal whose decisions are not merely declaratory but determinative of rights.

On the agreed facts of the present case it is equally clear that the Minister actually did act in this way. A part of the respondent's claim in respect of the period October 1977 to August 1981 was increased by approximately $72,000 because of the Minister’s findings in respect of certain quantity discounts (Appeal Book, pages 90, 94, 98). Another part of the claim was disallowed on the basis of the Minister's finding that certain of the goods covered (tampons) were not in fact the same as the goods dealt with in the Tariff Board declaration (Appeal Book, page 99). And yet another part of the claim, totalling just under $3.5 million, was rejected because it was the Minister's view that it related to a period prior to November 1977 and was therefore statute-barred (Appeal Book, page 98). In my view, none of these facets of the Minister's decision can be described as purely administrative or mechanical and each required a determination of relevant facts and the application of a body of law to them.

It is clear, of course, in the present case that the Minister did not act personally and it is not suggested that he is required to. Where, however, in the exercise of quasi-judicial powers which are determinative of rights, the Minister acts through his subordinate officials, he cannot be said to have made his decision (which the statute does not give him any power to review or revise of his own motion) until he has given some public and irrevocable indication thereof. The decision creates rights and starts time running and it is as much in the public interest as in that of those immediately concerned that there be a basic minimum of certainty as to when it is made and what it is. A decision in pectore would be an abomination in law.

On the agreed facts in the present case it is clear to me that there was no ministerial decision on the respondent's refund claim prior to January 4, 1982. The letter written by Mr. Maheu dated December 24, 1981 (paragraph 13, supra) does not purport to be a ministerial decision and is manifestly not irrevocable. It is written in the first person and can bind no one but its author. It was not, in any event, received by respondent until January 4, 1982.

Paragraph 15 of the agreed statement of facts demonstrates that the auditor's report, prepared by Maheu and approved by his supervisor, could equally not qualify as a decision. The report did not become definitive until it was "transferred" to the Regional Office and a "payment list” (form E56-1) made and signed with the "corroboration" of the Refunds Manager and the issuance of a refund cheque. Paragraph 16 makes it plain that none of these steps happened prior to January 4, 1982. In my view, therefore, that is the earliest date at which it can be said that the Minister, through his subordinates, had taken a public and irrevocable step indicating the nature and extent of his decision to give effect to the respondent's claim for a refund. Since that date was after the end of the respondent's 1982 taxation year the refund should not have been treated by the Minister as a receivable in that year. The trial judge correctly so found.

The foregoing is in theory enough to dispose of the appeal to this Court. There are three reasons, however, which make it desirable that we should deal with the second issue which has been raised. In the first place, the matter may go further. Secondly, although the trial judge was only seized of an appeal in respect of the respondent's 1982 taxation year his formal judgment referring the matter back to the Minister quite improperly contains a direction that "the refund amount should have been included in the plaintiff’s 1983 taxation year" (page 95 (D.T.C. 6379)). That statement, while it may constitute a reason for the trial judge having concluded as he did, simply has no place in the formal judgment of the Court which did not have the respondent's 1983 taxation year before it. It is also, in my opinion, wrong. Finally, as will appear, I am of the view that the judge's finding on the first issue is not dispositive of the assessment for the 1982 taxation year.

I turn accordingly to the second issue.

Issue 2: Was the refund required to be included in the computation of respondent's business income?

As indicated earlier, this issue seems to have been understood by the trial judge, perhaps abetted by some of the submissions of counsel, as whether the receipt of the refund “was” or "constituted" income from the respondent's business.

In normal circumstances it is usually an acceptable form of legal shorthand to refer to a receipt or a receivable as being income. To do so, however, tends to mask the reality that under the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), what is taxed is not simply income but rather income "for a taxation year". Subsections 2(1) and 2(2) read:

2(1) An income tax shall be paid as hereinafter required upon the taxable income for each taxation year of every person resident in Canada at any time in the year.

(2) The taxable income of a taxpayer fora taxation year is his income for the year plus the addition and minus the deductions permitted by Division C.

[Emphasis added.]

"Income" is itself an undefined, and perhaps undefinable, concept. Respondent's counsel expended considerable time and energy both here and below in attempting to argue that the refund payments did not have the “character of income” and did not come from any "source" recognized by the Act. The trial judge rejected that argument at page 92 (D.T.C. 6377):

I agree that in a very strict sense the refund may not be tied to the plaintiff's business of manufacturing and distributing of health care products, in that it was not derived from the manufacture of the goods. However, it was linked to plaintiff's income earning process as it was income that came from the plaintiff's business. It is clear that the price at which the plaintiff sold its products included the federal sales tax and that the plaintiff credited to the calculation of gross income the amount passed on to its customers. Further, from a practical business point of view I do not think that it can be disputed that the plaintiff reduced its profit in each year by claiming deductions in respect of sales tax paid and when the amount was refunded it was included as a receivable and the plaintiff made an adjustment to its retained earnings. Retained earnings are basically accumulated profits of the business.

In my view, the trial judge was right. Indeed I would go further and assert that even in “a very strict sense" the refund of sums paid and claimed as expenses incurred in the respondent's business is derived from that business and must be taken into account in the computation of the income therefrom. If the refund had been received in the year in which the sales tax had been wrongly paid, there is simply no room for doubt that it must be taken into account in that year. A change in the timing does not change the "character" of the payment.

It is at this point, however, that the oversimplification to which I referred earlier can be seen to be misleading. The income from a business is not merely its receipts or receivables. Subsection 9(1) reads:

9(1) Subject to this Part, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.

[Emphasis added.]

The underlined words make it plain that in the computation of income expenses must be deducted from receipts and that both receipts and expenses must

e related to a specific year.

Normally, of course, and as a general rule, both receipts and expenses are brought into the calculation of income in the year in which they are received or incurred. Where, however, a business receives a payment, not as compensation for the goods or services which it provides but rather as a reimbursement for an expenditure which was not due and should never have been paid, the situation is different. In effect what has happened is that what was formerly thought to have been an expenditure is now recognized to be so no longer. Accordingly, it is not the year of receipt which is relevant for the determination of profit, but the year of the expenditure which is now found to have been no expenditure at all.

I emphasize here that we are not talking of the recovery of expenses in the ordinary business sense of attempting to recoup what one has laid out by what one can get in. Rather, it is the reversal of what was thought to have been an expenditure due to the recognition, forced or voluntary, by the original payee that he should never have had the money in the first place. This is what distinguishes the present case from the decision of this Court, much relied on by the appellant, in Canada v. Mohawk Oil Co., [1992] 1 C.T.C. 195, 92 D.T.C. 6135 (F.C.A.). That case simply decided, amongst other things, that that part of compensation for damages for breach of contract which included both lost profits and expenditures thrown away was to be included in the computation of a business’ taxable income. The question of timing was not addressed at all, but if it had been I do not think the Court would have had any difficulty in concluding that the year of receipt was the relevant year for computation purposes. Expenditures thrown away and then recouped as damages do not lose their original character. It is otherwise with expenditures which are refunded because they were wrongly paid in the first place.

The whole concept of a tax based upon an annual calculation of profit has inherent in it the requirement that it may become necessary to reopen accounts and to recalculate income for prior years in the light of subsequent events. Subsection 152(4) specifically recognizes (and recognized during the years here in issue) the Minister's right to reassess, even in the absence of fraud or misrepresentation . It may not be entirely coincidental that the four-year period stipulated in this text would have permitted a reassessment in respect of any refunds not statute-barred by the provisions of section 44 of the Excise Tax Act.

It may be, of course, that the Minister is now out of time to reassess the respondent in respect of [1] those taxation years for which he, the same Minister, granted sales tax refunds on January 4, 1982; it is certain, however, [2] that he could ave done so at the time the refunds were granted, and his failure to do so timely can surely not affect the result of the present appeal.

In short, it is my view that the refund of taxes, which have been charged as expenses in the year of payment but which should never have been paid at all, must be brought into the computation of income for the years in which they were paid and charged. On the facts of the present case, those are the respondent's taxation years covered by the period October 1977 to August 1981. Only a relatively small part of that period, however, is covered by the 1982 assessment which is in issue here. The precise amount will have to be determined by the Minister on a reconsideration.

This view is consonant not only with the scheme of the Act but also with relevant case law.

In the English case of English Dairies Ltd. v. Phillips (1927), 11 T.C. 597 (K.B.), the taxpayer had been forced by government authority to pay a levy on the price of its milk as a condition of its license; the levy was subsequently judicially determined to have been illegal and was refunded three years after it had originally been paid. [3] Rowlatt, J. held that the accounts for the earlier year should be reopened so as to reduce the expenses originally charged and thereby increase the profits for that year. A like result was reached in rather similar circumstances in Isaac Holden & Sons Ltd. v. C.I.R. (1924), 12 T.C. 768 (K.B). Both cases were cited with apparent approval by the House of Lords in British Mexican Petroleum Co. v. Jackson (1932), 16 T.C. 570 (K.B), and the fact that a different result was reached in that case is simply illustrative of the distinction between a refund of moneys illegally extracted and a release of a debt properly incurred; the latter is, in my view, analogous to the recovery of expenses or the payment of compensation to which I have already referred in discussing the decision in Mohawk Oil, supra.

Counsel for the Minister sought to rely on the Australian case of Sinclair & Sons Pty. Ltd., 10 A.I.T.R. 3 (H.C.), and the American case of Hillsboro National Bank v. Commissioner, 460 U.S. 370 (S.C.) (1982). Both cases reveal, however, that the statutory schemes there being considered made no provision for reassessment in the absence of fraud or similar circumstances. In Sinclair & Sons, supra, Taylor, J, referring apparently to the English cases just cited, said at page 4:

However, it was contended that it would be more appropriate to treat the payment to the appellant as a diminution of its business out-goings in the earlier years rather than as assessable income for the year in question. Problems bearing some similarity to that which arises in this case have not infrequently been dealt with in this manner in England and, no doubt, it would in many cases be more equitable to reopen the earlier assessments and make the appropriate adjustments. But in England, where the relevant legislation permits this course, the matter seems to have been treated not so much as a question of business accounting as an appropriate method of adjusting the taxpayer's liability to tax. However, there is no power to adopt this course in Australia except in circumstances which do not present themselves in this case, and I do not think the English cases by any means require the conclusion that, under the provisions of the Australian Act, the refund in this case was not assessable income of the appellant in the year of its receipt.

[Emphasis added.]

Likewise, in Hillsboro National Bank, supra, O'Connor, J. said at pages 377-79:

The government in each case relies solely on the tax benefit rule — a judicially developed principle that allays some of the inflexibilities of the annual accounting system. An annual accounting system is a practical necessity if the federal income tax is to produce revenue ascertainable and payable at regular intervals. Burnet v. Sanford & Brooks Co. (1931), 282 U.S. 359, 365. Nevertheless, strict adherence to an annual accounting system would create transactional inequities. Often an apparently completed transaction will reopen unexpectedly in a subsequent tax year, rendering the initial reporting improper. For instance, if a taxpayer held a note that became apparently uncollectible early in the taxable year, but the debtor made an unexpected financial recovery before the close of the year and paid the debt, the transaction would have no tax consequences for the taxpayer, for the repayment of the principal would be recovery of capital. If, however, the debtor's financial recovery and the resulting repayment took place after the close of the taxable year, the taxpayer would have a deduction for the apparently bad debt in the first year under subsection 166(a) of the Code, 26 U.S.C. subsection 166(a). Without the tax benefit rule, the repayment in the second year, representing a return of capital, would not be taxable. The second transaction, then, although economically identical to the first, could, because of the differences in accounting, yield drastically different tax consequences. The government, by allowing a deduction that it could not have known to be improper at the time, would be foreclosed from recouping any of the tax saved because of the improper deduction. Recognizing

and seeking to avoid the possible distortions of income, the courts have long require the taxpayer to recognize the repayment in the second year as income.

[Emphasis added.]

In my view, the existence of the provisions of the Income Tax Act allowing the Minister to reopen the accounts of prior years and to reassess them serve to distinguish his position from that of his counterparts in Australia and the United States. It is, I think, both unnecessary and undesirable for the Courts of this country to judicially legislate an equivalent of the tax benefit rule and I would not do so.

Conclusion

From what precedes it follows that I would dismiss the Crown's appeal. As earlier indicated, however, the trial judge, in his formal judgment ordered that the refund should be included in the respondent's 1983 taxation year. That was, as I have attempted to demonstrate, wrong. Accordingly, I would correct the judgment appealed from so as to read:

The appeal is allowed. The reassessment is vacated and the matter is referred back to the Minister for reconsideration and reassessment on the basis that the refund of sales taxes received January 4, 1982 should not be taken into account in the plaintiff's 1982 taxation year, save insofar as it relates to sales taxes paid in that year.

The respondent is entitled to its costs to be taxed.

Appeal dismissed.