Strayer J.T.C.C.: —
Relief Requested
This is an appeal and a cross-appeal from the judgment of the Tax Court of Canada of January 31, 1995 in which the Court referred back to the Minister of National Revenue for reconsideration and reassessment the assessments made in respect of the appellant.
Facts
The facts are set out in more detail in the judgment of the Tax Court.
In the late 1960s or early 1970s the appellant adopted a deliberate and elaborate scheme for defrauding the Canadian revenue by falsifying the value of goods imported by it into Canada. In the period in question in this proceeding, namely March 26, 1974 to January 28, 1980, it is not disputed that the appellant Amway undervalued, for duty and excise tax purposes, goods it imported to the amount of $84,295,461.33 (hereinafter “$84.3 million”) thereby avoiding the payment of customs duties and excise taxes in the amount of $28,825,708.39 (hereinafter “$28.8 million”).
I will summarize briefly the statutory provisions relevant to the imposition and enforcement of customs duties and excise tax. It is common ground that the relevant statute is the Customs Act in force at the time of these events, as any applicable excise tax would be enforceable under the provisions of the Customs Act. Various provisions require importers of goods to declare, and declare correctly, the value of those goods upon their entry into Canada. By way of enforcement of these requirements, paragraphs 192(l)(b) and (c) provide that if any person presents a fraudulent invoice or in any way attempts to defraud the revenue by avoiding the payment of any part of the duty on goods
Such goods, if found shall be seized and forfeited, or if not found but the value thereof has been ascertained, the person so offending shall forfeit the value thereof as ascertained....
The “value” of any goods is defined by section 2 of the Customs Act as meaning the “duty-paid value”, it being common ground that this includes the customs duties and excise tax which would have been payable on the goods had they been declared at their proper value. In the definition of “seized and forfeited”, “liable to forfeiture”, or ‘subject to forfeiture” reference is made to “the penalty of forfeiture”, forfeiture being treated as a penalty. By subsection 249(1) all penalties and forfeitures may “in addition to any other remedy provided by this Act or by law” be sued for and recovered in the Federal Court or any other superior court. There is a special procedure for dealing with forfeitures provided in section 160 and immediately following sections of the Act. Section 161 requires that a notice be served on the owner of the goods as to the forfeiture. Section 163 provides for the Minister remitting some portion of the forfeiture after the owner has had an opportunity to make submissions.
There is a separate provision in the Customs Act with respect to the collection of the customs duties themselves (equally applicable to excise taxes). Section 102 says that the true amount of duties payable on goods imported into Canada constitutes a debt due and payable upon that importation, which debt may be recovered by Her Majesty by suit in any court of competent jurisdiction.
It is then necessary to summarize briefly the enforcement action actually taken in this case. In 1979 and 1980 Revenue Canada served notices of seizure and/or ascertained forfeiture on Amway and its U.S. parent in a total amount of $155,925,432.90. This sum was made up of over $118,000,000 in the entire value of the goods imported and over $37,000,000 in duties and taxes payable on those goods, the total being therefore the duty-paid value of the goods within the meaning of “value” as referred to in subsection 192(1) which forfeits that duty-paid value to the Crown in the circumstances of this case. (This total was later corrected downward to $148,018,478.48). As Amway provided no deposits in respect of the payment of these forfeited sums Her Majesty then commenced four actions in the Federal Court in 1980. These actions collectively covered the periods from May 6, 1977 to January 28, 1980. In each case the statement of claim recited the amount of the duty-paid value for the period covered by that statement of claim and stated that there was a forfeiture in that amount. Each statement of claim also noted that the defendants were also liable to Her Majesty for the additional duties and taxes payable pursuant to section 102 of the Customs Act. However, in each case the prayer for relief specifically asked only for the amount of the duty-paid value “by way of forfeiture” while also including the usual request for “such further and other relief as to this Honourable Court may seem just”. In 1984 Her Majesty commenced a further action in the Federal Court in respect of the period March 26, 1974 to January 10, 1977 in which it specifically sued for payment of the debt due under section 102 for “customs, duties and sales taxes shortpaid” in the precise amount of the unpaid duty and sale taxes on goods imported during that period. That amount was $7,882,096 (hereinafter “$7.9 million”). The different subject-matter of these various actions flowed, it appears, from the different limitation periods applicable to suits for forfeiture under section 249 and suits for debt under section
102.
Years of interlocutory proceedings then ensued including various appeals to this Court and one to the Supreme Court of Canada. The decisions will be referred to later.
On August 21, 1984, the Minister of National Revenue specifically used his power under section 163 (which relates to the remission of penalties or forfeitures, not of duties and taxes) to remit a portion of the forfeiture, leaving a balance of $105,234,808.71 unremitted and owing. The unremitted portion was calculated, as I understand it, by adding to the actual undervaluation of some $84.3 million the duties and taxes that would have been payable on that amount, some $20.9 million. This remission did not resolve the problem nor lead to payment of any sum by Amway.
After many interlocutory proceedings in the five actions and lengthy negotiations a final settlement was reached in 1989, set out in the terms of a letter of September 13, 1989 from the Department of Justice to counsel for Amway. This letter has as its reference line the court numbers of these actions and opens with the words
We have been instructed to make the following settlement proposal in relation to the aforementioned five Federal Court actions brought against Amway Corporation and Amway of Canada, Limited....
This settlement proposal, which was agreed to by Amway, provided for Amway paying Her Majesty the sum of $45,000,000. Upon payment of that amount Her Majesty undertook to discontinue the specific five actions referred to above. Amway had to undertake to withdraw certain Tariff Board proceedings. No mention was made of any possible section 102 proceedings. The only other relevant term for present purposes was an undertaking by Her Majesty to execute and deliver a release in a form attached to the settlement offer with Amway being obliged to execute a form of release also attached. The release executed on behalf of Her Majesty contained the usual general terms inter alia releasing the appellant Amway
...of and from any and all claims, demands, actions, suits, causes of action, obligations, controversies, debts, costs, expenses, accounts, damages, judgments, losses and liabilities, of whatsoever kind or nature...arising out of or connected with the importation of goods into Canada prior to January 28, 1980, including those issues which were the subject-matter of Federal Court actions [citing the numbers of the actions previously referred to].
The essential question arising out of these events, for present purposes, is whether some part, and if so how much, of the $45,000,000 paid by Amway to the Crown by way of settlement represents the payment of a penalty. If any of it does, then the further question arises as to whether the cost of paying a penalty is deductible from the business income of Amway for the taxation years in question of 1977 and 1978. It is of course not in dispute that amounts paid as payment of duties and taxes are deductible as business expenses.
The Minister of National Revenue in assessing Amway for its 1977 and 1978 taxation years accepted that $7.9 million of the $45,000,000 settlement payment was in respect of the payment of duties and taxes because it settled the 1984 action which was specifically brought under section 102 to enforce a debt arising under that section in respect of duties and taxes during a period preceding that covered by the four actions commenced in 1980. The Minister however considered the remainder of the $45,000,000 settlement to have been made in respect of penalties. In reassessing Amway’s income for 1977 and 1978 he characterized the 1980 actions, also settled by the payment of $45,000,000, as actions for the enforcement of the penalty of forfeiture.
Amway appealed that assessment to the Tax Court of Canada. Essentially it argued that the sum of $28.8 million, equivalent to the total of all duties and taxes unpaid by it, must be taken to have been paid in full by the $45,000,000 settlement and therefore only the remaining $16.2 million should be treated as penalty. Further, it argued that whatever amount is characterized as a penalty should also be deductible as a business expense.
The learned judge of the Tax Court of Canada allowed the appeal in part. It not being disputed that $7.9 million of the $45 million represented the duties and taxes claimed in the 1984 action, he apportioned the remaining $37.1 million by a formula based on the assumption that this part of the settlement represented part payment of the penal amounts of the forfeitures arising under sections 180 and 192 of the Customs Act as well as part payment of the duties and taxes enforceable as a debt under section 102 of the Act. He reached this conclusion essentially on two bases. Firstly he concluded that the 1980 actions were in part claims for duties and taxes as such and not just for forfeiture penalties. Secondly he concluded that, because the release, provided as a result of the settlement, clearly relieved Amway of any further liability for the duties and taxes, the amount paid by Amway under this settlement must be seen as attributable in part to the payment of any claim for duties and taxes. The learned Tax Court judge thus proceeded to apportion the remaining $37.1 million of the settlement as between duties/taxes and penalties arriving at the figure of $7,387,127.57 as the proportion representing duties and taxes. He then in turn apportioned these amounts to the taxation years in question, namely 1977 and 1978. For reasons which will become apparent there is no necessity for me to address more precisely the trial judge’s mathematical apportionments.
The trial judge appears not to have addressed the issue of whether penalties are deductible as business expenses, but assumed they were not.
Amway appeals to this Court arguing that the $45,000,000 settlement must be taken to represent the whole of the $28.8 million owing in duties and taxes (this latter sum including the $7.9 million attributable to settlement of the 1984 action for duties and taxes). In the alternative Amway argues a different formula for crediting it for past payments as taxes and duties. Finally it contends that whatever amounts were paid as penalties should be deductible as business expenses.
Her Majesty cross-appeals contending that no part of the remaining $37.1 million of the settlement amount should be treated as the payment of duties and taxes. In the alternative the Crown contends that the trial judge used an inappropriate method of apportionment of that amount between duties/taxes and penalties. In the further alternative the Crown supports the findings below.
Issues
There thus appear to me to be two issues to be resolved:
1. Was any portion, and if so what portion, of the remaining $37.1 million of the settlement payment attributable to the payment of duties and taxes?
2. Is the portion paid as penalty deductible from Amway’s gross income as a business expense?
Analysis
What portion of the $$37.1 million if any, was payment of duties and taxes?
While the matter is not without difficulty, I have concluded that none of the balance of the settlement payment of $37.1 million represented payment of duties and taxes.
The position of the appellant Amway is bold and imaginative: it asserts that as it ultimately paid a large sum of money to the Crown in 1989 it should be treated for income tax purposes just as if it had paid in proper fashion the duties and taxes required by law at the time they were due, namely in the period from 1974 to 1980. Unfortunately it did not do so and the payment of $37.1 million which it did make in 1989 must be analyzed as to its essential character at that time and in those circumstances.
It is not in dispute that the total sum of $45,000,000 was paid, in part, to settle the four actions commenced in 1980 and the fifth action commenced in 1984. Nor is it in dispute that $7.9 million of the total must be allocated to the settlement of the 1984 action, an action clearly and solely for recovery of duties and taxes. But I respectfully disagree with the learned trial judge that the 1980 actions were for both the recovery of a penalty and the recovery of duties and taxes. The statements of claim in those four actions do not support this view as they contain no prayer for relief for recovery of the duties and taxes as such. Furthermore, for the same reasons as were given by the Federal Court of Appeal on two appeals in interlocutory decisions in these four actions, R. v. Amway of Canada Ltd./Amway du Canada Ltée sub nom. Amway Corp. v. R. [1987] 1 C.T.C. 97 at page 99, reversed (sub nom. R. v. Amway Corp.) [1987] 1 S.C.R. 21, [1989] 1 C.T.C. 255, 56 D.L.R. (4th) 309; R. v. Amway of Canada Ltd./Amway du Canada Ltée (sub nom. Amway of Canada Ltd. v. R.) [1987] 1 C.T.C. 105 at pages 107-08, leave to appeal to S.C.C. refused, (sub nom. Canada v. Amway of Canada Ltd.) 86 N.R. 266 I conclude that these were actions for the recovery of a penalty. Whether or not those earlier decisions are binding on us in the present case they are in my view highly persuasive. On appeal to the Supreme Court of Canada the latter Court was prepared to assume, without deciding, that these were penal actions and said nothing to bring into question that characterization. R. v. Amway Corp. [1989] 1 S.C.R. 21, [1989] 1 C.T.C. 255, 56 D.L.R. (4th) 309 at page 33 (C.T.C. 261, D.L.R. 318). I thus believe that the learned trial judge erred in concluding that the 1980 actions were also for the recovery of the duties and taxes as such. Further I believe this was a reviewable error. The trial judge himself characterized his decision on this point as one of law. As such it is open to full review by this Court. I therefore conclude, contrary to the views of the learned trial judge, that the four 1980 actions were, as a matter of law, for the recovery of the penalties based on forfeiture and to the extent the settlement money stands in lieu of an award in those actions it represents the payment of a penalty.
A related question remains, however, as to whether the trial judge was right in treating the $45,000,000 settlement not just as being paid for the settlement of the five actions but also as being paid for the settlement of any potential actions for duties and taxes relevant to the period covered by the four actions commenced in 1980. While it is true that the release signed by Her Majesty as a result of the settlement payment absolved Amway from any further claims arising out of importations up to 1980 that was not, it appears to me, the legal basis for the settlement. The terms of the settlement agreement in the reference line and opening words of the Department of Justice letter of offer refers only to the five existing actions. It goes on to specify only the discontinuation of certain proceedings by both parties, including the five actions brought by Her Majesty. Those included the four 1980 actions brought under section 249 with respect to enforcement of a penalty, and the fifth action commenced in 1984 brought under section 102 of the Act with respect to collection of a debt for duties and taxes. The release subsequently signed on behalf of Her Majesty by its general language also precludes any further action by the Crown under section 102 to collect duties and taxes as such for the period of 1977- 1980 covered by the four 1980 actions, but it is necessary to consider what the parties had in mind in signing such a release. Brunswick of Canada Ltd. v. “Varda”(The) [1972] F.C. 637 at 640, and authorities cited there (F.C.T.D.). There is nothing to indicate that further section 102 actions were in anyone’s contemplation at the time this release was signed. This signing, after all, was over twelve years after that period commenced and no such action had ever been brought for the recovery of duties and taxes as such. Instead, the release bears all the marks of a general discharge which any prudent litigant would exact when paying for the settlement of actions already in existence. Certainly the payment of $45,000,000 was treated by Revenue Canada not as a receipt of taxes but of a penalty. Further on the occasion of the payment of $45,000,000 Revenue Canada wrote off $60,000,000 as an uncollectible penalty, being the difference between the amount received and the $105,000,000 which was the reduced penalty fixed through the remission referred to earlier.
In passing I would also disassociate myself from certain views of the learned trial judge upon which he based his formula of apportionment, namely that the $105,000,000 figure established as the result of the remission of penalties on August 21, 1984 included some $20.9 million in duties and taxes. This, it seems to me, is a misconception in law of the nature of a forfeiture under subsection 192(1), even as adjusted by remission under section 163. As indicated earlier, when there is forfeiture of a sum because of the false declaration of value of imported goods, the forfeiture 1s of the “value” which is the duty-paid value including not only the market value of the goods but also an amount equal to the duty and taxes which should have been paid had the goods been declared at their proper value. Just because the total penalty is measured in part by reference to the amount of unpaid duties and taxes that should have been paid, this does not convert that part of the penalty into duties and taxes. Therefore, it flows from my conclusions that the sums claimed in the four penal actions did not include duties and taxes per se.
Are Penalties Deductible as Business Expenses?
This is a question on which there appears to be no authority binding on this Court in respect of the particular circumstances of this case.
There emerges in the jurisprudence and the literature a recognition of two possible criteria for deciding whether amounts expended for the payment of fines or penalties should be deductible as a business expense. The first test is whether it was an expense incurred for the purpose of earning income. In essence this means the expense must be deductible within the meaning of paragraph 18(1 )(a) of the Income Tax Act which provides as follows:
18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of
(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property....
The second criterion sometimes invoked is that of public policy: that is, even if the expense was incurred to produce income would it be contrary to public policy to allow a taxpayer to reduce his net income, and thus save taxes, by virtue of having been obliged to pay a fine or penalty for some wrongdoing?
With respect to the first criterion a seminal decision was that of the English Court of Appeal in Commissioners of Inland Revenue v. Von Glehn, [1920] 2 K.B. 553. It involved penalties paid by an exporter under customs legislation for not having taken adequate care that its exports not reach enemy countries during war time. The Court held that the penalties paid were not deductible. The various reasons given by the judges, while perhaps not entirely clear, all conclude that the penalty imposed under the customs law was not an expenditure “connected with or arising out of such trade....”. An observation made by Lord Sterndale, M.R. is of interest given the later developments in Canadian jurisprudence. He stated:
Now what is the position here? This business could perfectly well be carried on without any infraction of the law at all. This penalty was imposed because of an infraction of the law and that does not seem to me to be, any more than the expense which had to be paid in the case of Strong v. Woodifield (1) 5 T.C. 215 appeared to Lord Davey to be, a disbursement or expense which was laid out or expended for the purpose of such trade, manufacture, adventure or concern; nor does it seem to me, though this is rather more questionable, to be a sum paid on account of a loss connected with or arising out of such trade, manufacture, adventure or concern.
This concept of avoidability of a penalty, as a test of whether its payment amounts to a business expense, has been developed, I believe correctly, in decisions of the Federal Court Trial Division. The first of these is Day & Ross Ltd. v. R., [1976] C.T.C. 707, 76 D.T.C. 6433 where Dubé J. held that fines paid by a trucking business for its trucks being loaded above weight restrictions were deductible as a business expense. He noted that it was virtually impossible for the business to ensure that its trucks were not overloaded as it had to rely on weights declared by shippers when loads were picked up, there being no scales immediately available to verify the size of the loads. Violations being unintentional and fines being virtually inevitable from time to time, he found that they were incurred for the purpose of earning income. He did also make reference to the public policy test, observing that as it was possible to obtain special permits in advance to carry loads over the normal permitted weight the occasional unintended violations of those limits were “obviously not outrageous transgressions of public policy”.
This decision was followed by Cullen J. in TNT Canada Inc. v. R., [1988] 2 C.T.C. 91, 88 D.T.C. 6334. The fines involved there had been paid under the Customs Act and the Excise Tax Act for various trucking violations committed by the plaintiff, a common carrier by road. These fines had been imposed upon the plaintiff for having repair work done on its trucks in the United States and the purchase of parts there without paying Canadian sales and excise tax; and for using a foreign carrier in Canada who made more than one stop in this country. Cullen J. appears to have held that these expenses, as in the Day & Ross case, were unavoidable and therefore they met the test of having been incurred for the purpose of earning income. He then proceeded to consider the public policy criterion which he held to be an additional and necessary test beyond the requirement of meeting the test of paragraph 18(1 )(a) of the Act in order to establish deductibility. He concluded that there was no violation of public policy in allowing deductibility, apparently on the basis that the taxpayer was not intentionally flouting the law. He emphasized that there had been only very few contraventions arising out of some 80,000 dispatches of trucks.
With respect to the first criterion I believe that one legitimate test of whether fines should be deductible as a business expense is that of avoidability of the offences. I believe there is support for this not only in the jurisprudence mentioned, but by analogy in a decision of the Exchequer Court involving deductibility of damages paid for a marine collision. In Imperial Oil Ltd. v. Minister of National Revenue, [1947] C.T.C. 353, 3 D.T.C. 1090 the taxpayer as a major petroleum producer operated a fleet of oil tankers. One of these tankers collided with another vessel while bringing a cargo of petroleum from South America. It was sued for damages and eventually settled the claim out of court. In finding that the cost of the settlement was a deductible expense, Thorson P. emphasized that marine transport of petroleum products was a normal part of the taxpayer’s business and “that the risk of collision between vessels is a normal and ordinary hazard of marine operations generally....”. He went on to say that negligence on the part of the taxpayer’s servants in the operation of its vessels was a normal and ordinary risk and incidental to its business.
In adopting this test of avoidability of the offences leading to fines, and thus the avoidability of this particular type of expense, I do not purport to pronounce a more general rule concerning the deductibility of other types of expense. The question here is not: could the taxpayer have run his business more cheaply? It is: could the taxpayer have reasonably been expected to run his business in consistent conformity to this kind of law?
On the facts of the present case it would have been impossible for the trial judge to have concluded that this deliberate and fraudulent scheme to avoid payment of higher duties and taxes to the revenue of Canada was an unavoidable incident in the operation of Amway’s business of importing goods and selling them in Canada. There was nothing to suggest that this was other than an intentional and cynical scheme to mislead Canadian customs officials as to the value of the goods, a scheme which was well documented in agreed statements of fact filed in the Ontario court before Evans C.J. in the course of the conviction of Amway for fraud in respect of the same activities. Nor was any evidence brought to our attention that the nature of the taxpayer’s business was such that chronic undervaluation of its goods for importation purposes was unavoidable.
With respect to the public policy criterion, it has been argued with some force by learned commentators that undefined notions of public policy should not preclude the application of the simple principle that income tax is owing only on the net income of a taxpayer. These arguments are premised on the assumption that in a given case the fine or penalty was incurred for the purpose of producing income. As I have concluded above, a fine or penalty cannot be considered to have been incurred for the purpose of producing income unless in all the circumstances the incurring of the fine or penalty must be seen as an unavoidable incident of carrying on the business. Secondly, in my view it is contrary to public policy to allow the deduction of a fine or penalty as a business expense where that fine or penalty is imposed by law for the purpose of punishing and deterring those who through intention or a lack of reasonable care violate the laws. In a case such as the present the penalties are fixed by statute (albeit that the Minister first remitted about one third of the penalty and ultimately settled for less than one third of the total penalty owing under statute). It would frustrate the purposes of the penalties imposed by Parliament if after paying those penalties exigible by law a taxpayer were then able to share the cost of that penalty — and the higher his marginal rate of taxation the more he could share — with other taxpayers of Canada by treating it as a deductible expense and thus reducing his taxable income. Such a result would, I believe, clearly be contrary to public policy. Suggestions that instead a court imposing a penalty can augment it in anticipation of the accused being able to deduct the fine from his taxable income are not applicable to a situation such as this where the penalties are specifically defined by statute. Nor do I believe that sentencing courts should be required to anticipate the value of an income tax deduction to a penalized party. For this reason I think that the deductibility of penalties set by courts exercising their discretion should be subject to the same rules as I have elaborated above in respect of a penalty set by statute.
Disposition
The appeal should therefore be dismissed and the cross-appeal be allowed on the basis that the judgment below be set aside and the reassess- ment by the Minister be confirmed to the effect that the balance of $37,117,904, remaining after the deduction from the total settlement of $45,000,000 of the sum of $7,882,096 attributable to the settlement of the 1984 action, be regarded as the payment of a penalty and not deductible from gross income as an expense incurred for the purpose of gaining or producing income.
Costs should be awarded to the respondent in the Tax Court, and in this Court in both the appeal and the cross-appeal.
Appeal dismissed; cross-appeal allowed.