The Queen v. Browning Harvey Ltd., 90 DTC 6105, [1990] 1 CTC 161 (FCTD)

Martin, J.:—This is a de novo appeal by the plaintiff from that portion of the January 28, 1988 decision of the Tax Court of Canada (Browning Harvey Ltd. et al. v. M.N.R., [1988] 1 C.T.C. 2209; 88 D.T.C. 1164) allowing the defendant's appeal against the plaintiff's disallowance of the defendant's claim to deduct the cost of certain refrigerators known in the trade as visi- coolers ("coolers").

The plaintiff disallowed the defendant's claimed deduction on the grounds that the costs were capital outlays as opposed to current expenses and, furthermore, regardless of the form of the agreements between the defendant and the shopkeepers to whom the coolers were sold, the substance of the matter was that ownership and title to the coolers resided in the defendant during its 1980, 1981, 1982 and 1983 taxation years and that the defendant did not dispose of the coolers at the time of the execution of the agreements with the shopkeepers.

The defendant is a manufacturer and distributor of soft drinks in the province of Newfoundland. It is to its advantage to have its brands of soft drinks held and displayed for sale in coolers at various retail stores in the province. As the competition among soft drink manufacturers intensified in the late 1970s the trade practice of the manufacturer providing the coolers to the shopkeepers at no cost, but for the exclusive use of the manufacturer's product, developed.

The defendant, which had, prior to this development, sold coolers to the shopkeepers was forced to meet the competition. This it did by selling coolers costing about $1500 to the individual shopkeepers for two dollars, one dollar of which was payable at the time of the execution of the agreement and the remaining dollar at the end of a seven-year term. The agreements were in the following terms:

EQUIPMENT AND PRODUCT PURCHASE AGREEMENT RE VISI-COOLER PLACEMENTS

THIS AGREEMENT made the day of , A.D. 19 between BROWNING HARVEY LIMITED (herein called the Vendor), of the first part and

(herein called the Purchaser), of the second part.

NOW THEREFORE THIS AGREEMENT WITNESSETH that in consideration of the mutual convenants herein contained, and upon the terms and conditions hereinafter set forth, the parties hereto agree as follows:

1. Vendor hereby sells, transfer and assigns and the Purchaser hereby buys one

, Serial No. (referred to herein as the "Beverage Cooler") on the terms and conditions herein stated.

2. PURCHASE PRICE: The purchase price for the Beverage Cooler shall be two dollars ($2.00) and other valuable consideration including but not limited to Purchaser's promises, herein contained to use the Beverage Cooler for the seven

(7) years following the date of this Agreement, only for the sale of Browning Harvey Limited beverages (which term, as used herein, means only beverages manufactured or distributed by the Vendor.)

3. SATISFACTION OF PURCHASE PRICE: The Purchaser shall pay the purchase price of two dollars ($2.00) by paying one (1) dollar on the date hereof and by paying one (1) dollar at the end of the seven (7) year period following the date of this Agreement. The Purchaser shall have no right of prepayment of the last instalment of the purchase price.

4. TITLE: The Purchaser agrees that the Beverage Cooler and title thereto, notwithstanding delivery, shall belong to and be vested in the Vendor until the last instalment of purchase price is paid in accordance with Section 3 hereof and until all other obligations are performed hereunder. The Vendor shall have the right to inspect the Beverage Cooler at any time during normal business hours.

5. RESTRICTIONS ON USE BY PURCHASER:

(a) The Beverage Cooler will be located at . During the term of this Agreement, Purchaser shall inform the Vendor in Writing of any proposed change in the exact address and location at which the Beverage Cooler will be situated and shall not change such address without the prior consent of the Vendor.

(b) At no time during the seven (7) years following the date of this Agreement shall Purchaser use or permit the use by others of the Beverage Cooler for any purpose other than the offer of sale of the Vendor's Beverages.

(c) Purchaser shall not, during the term of this Agreement, purport to sell, lease or otherwise dispose of the Beverage Cooler to any person other than the Vendor in accordance with the terms of this Agreement and shall not mortgage, pledge, charge or otherwise encumber, in whole or in part, Purchaser's right, title and interest in and to the Beverage Cooler to secure any money borrowed from any person or otherwise.

6. PURCHASE OF VENDOR’S BEVERAGES: The Purchaser hereby agrees to purchase during the term of this Agreement all the Purchaser's requirements of Vendor's Beverages for sale in the Beverage Cooler.

7. DEFAULT:

(a) If the Purchaser fails to comply with any of the provisions of this Agreement, the Vendor shall have the right, but not the obligation, to repossess the Beverage Cooler upon giving the Purchaser ten (10) days notice in writing and in such event the Purchaser shall peaceably give up possession of the Beverage Cooler to or to the order of the Vendor.

(b) The Purchaser acknowledges that in view of the consideration to be received by the Vendor hereunder, an award of money damages will not provide an adequate remedy for the Vendor in the event of default by the Purchaser and that the Purchaser shall not oppose any application made by the Vendor following default, for an order of specific performance of the Purchaser's obligation to return and deliver the Beverage Cooler to the Vendor or damages in lieu thereof.

8. INSURANCE: The Purchaser agrees to keep the said property insured against loss or damage by fire, wind, theft and accident in an insurance company satisfactory to the Vendor, in an amount not less than the replacement cost to the Vendor, such insurance to be payable to the Vendor as his interest may appear, and the policies therefore shall be delivered to and retained by the Vendor until the purchase price is paid in full. If the Purchaser fails at any time to provide such insurance, the Vendor may insure the property as aforesaid and the Purchaser shall forthwith pay the cost of such insurance.

9. TERM: The term of this Agreement shall be seven years from the date hereof and thereafter from year to year until terminated by either party on one month notice in writing.

10. ASSIGNMENT: Purchaser may not, without the prior written consent of the Vendor assign or otherwise transfer the benefit of the whole or any part of this Agreement to any person. Vendor may assign its interest in this agreement and the rights and duties of its performance hereunder to any corporation controlled by it.

11. GOVERNING LAW: This Agreement shall be governed and construed in accordance with the laws of the Province of Newfoundland.

IN WITNESS WHEREOF the parties hereto have hereunder affixed their respective corporate seals, attested by the hands of their respective officers duly authorized in that behalf this day of , ÀA.D., 19

During the defendant's 1980 to 1983 taxation years it sought to expense its cost of the coolers as follows:

1980: $334,750

1981: $280,583

1982: $395,490

1983: $277,438

Subsection 18(1) of the Income Tax Act provides as follows:

(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;

(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part;

It is not disputed that the total costs to the defendant of the coolers during the taxation years under consideration were outlays made for the purpose of gaining income from its business within the meaning of paragraph 18(1)(a). The plaintiff contends that the costs were outlays or payments on account of capital within the meaning of paragraph 18(1)(b), while the defendant claims that the loss on the sales of the coolers, i.e. the difference between the cost of the coolers to the defendant and the first of the two one dollar payments, were current expenses in the years in which the coolers were sold to the shopkeepers.

The first issue for determination is whether the costs of the coolers were allowable income expenses or capital outlays. In this respect counsel for the defendant made no representations. He seemed content to accept that the costs of the coolers were capital expenditures and to rely upon the assertion that the sale of the coolers to the shopkeepers gave rise to a terminal deductible loss. This issue will be addressed later in the reasons for my decision.

On the first issue I am satisfied that the costs of the coolers represented capital outlays. The costs were amounts paid to bring into existence physical assets which were used as tools of the defendant's trade. The expenditures for the coolers were made with a view to obtain an enduring benefit of trade in the sense that the shopkeepers who used them would use them exclusively for the defendant's products for a minimum of seven years (Firestone v. The Queen, [1987] 2 C.T.C. 1; 87 D.T.C. 5237, at page 5 (D.T.C. 5240) (F.C.A.), and M.N.R. v. Haddon Hall Realty Inc., [1962] S.C.R. 109; [1961] C.T.C. 509; 62 D.T.C. 1001, at page 511 (D.T.C. 1002) (S.C.C.)).

The Tax Court judge placed some reliance on the decision of Lord Pearce in B.P. Australia Ltd. v. Commissioner of Taxation of the Commonwealth of Australia, [1966] A.C. 224, [1965] 3 All E.R. 209 as referred to by Estey, J. in Johns-Manville Inc. v. The Queen, [1985] 2 S.C.R. 46; [1985] 2 C.T.C. 111; 85 D.T.C. 5373 at page 117 (D.T.C. 5377) in the following terms:

The Privy Council there determined that a payment made by the taxpayer as an inducement to a service station operator to sign an exclusive agency contract was an income expenditure and not a capital outlay. The contract had a life of five years and thus was an asset of sorts which amounted to an opportunity by the taxpayer to market its gasoline exclusively through the operator's outlet. Nonetheless Lord Pearce concluded at 260:

B.P.'s ultimate object was to sell petrol and to maintain or increase its turnover. There can be no doubt that the only ultimate reason for any lump sum payment was to maintain or increase gallonage.

In that case however Lord Pearce made it plain that he did not regard it appropriate to compare the expense of the machinery and tools of a factory with the contractual obligation of a retailer to order his petroleum requirements from B.P. when he observed, at pages 267-68:

In support of his argument that this was an enduring benefit Mr. Menhennit stresses the fact that B.P. secured a valuable chose in action, namely, the contractual obligation of the retailer to order from B.P. and to allow them to advertise at his station. Once an asset outlives its year of acquisition, its proper place, he contends, must be in the balance sheet as a capital asset. He relies inter alia on the observations of Lord Reid in Hinton v. Maden and Ireland Ltd.,²⁵ where expenditure on knives which were used in machinery and had an average life of three years (but sometimes a life of only one year) was held to be a capital expenditure. But the observations were directed to tangible tools and such assets do not form a safe analogy when dealing with choses in actions. The plant and machinery and tools of a factory and other tangible assets are prima facie durable objects and part of the structure within which the profit-yielding process is carried out. By convention and practice they are placed in the balance sheet and their diminution in value is acknowledged and accommodated by a system of capital depreciation for revenue purposes. No such clear practice or convention exists with respect to choses in action and their Lordships cannot accept the contention that a chose in action must be a capital benefit if its value outlives the year of accounting.

²⁵ [1959] 1 W.L.R. 875, 884;

In my view the coolers were tangible tools of the trade of the defendant employed by it to earn income. I can see no difference between the outlays made for these coolers and outlays made for signs or delivery trucks. The assets so acquired were capital assets and the outlays made to acquire them were capital outlays.

Assuming that I am correct in my finding that the costs of the coolers were Capital costs or expenses then by reason of paragraph 20(1)(a) of the Act and Regulation 1100(1)(a) the coolers were Class 8 assets and the defendant was entitled to claim as a deduction against taxable income 20 per cent of the undepreciated capital cost annually.

Because the coolers were depreciable property then pursuant to subparagraph 39(1)(b)(i) there can be no capital loss claimed on their disposition except in certain limited circumstances contemplated by subsection 20(16). Under this subsection a terminal loss may be claimed by the taxpayer where he has an unclaimed, undepreciated capital cost balance in respect of a class of assets and has disposed of all of the assets of that particular class at the end of a taxation year. In this respect counsel for the plaintiff has directed me to the capital cost allowance schedules of the defendant in its tax returns filed for each of the years under consideration. I note that in the schedules for each year there are Class 8 assets present at the end of that year. That being so the defendant cannot qualify for the terminal loss within the provisions of subsection 20(16) because, for each of the periods for which the losses were claimed, the defendant continued to own some Class 8 property other than the coolers.

The plaintiff submits, in the alternative, that the defendant is not entitled to claim a terminal loss because it has not disposed of the coolers so as to give rise to a disposition of property or the proceeds of disposition within the meaning of paragraphs 13(21)(c) and (d) which provide as follows:

(c) "disposition of property" includes any transaction or event entitling a taxpayer to proceeds of disposition of property;

(d) "proceeds of disposition” of property includes

(i) the sale price of property that has been sold,

(ii) compensation for property unlawfully taken,

(iii) compensation for property destroyed and any amount payable under a policy of insurance in respect of loss or destruction of property,

(iv) compensation for property taken under statutory authority or the sale price of property sold to a person by whom notice of an intention to take it under statutory authority was given,

(v) compensation for property injuriously affected, whether lawfully or unlawfully or under statutory authority or otherwise;

(vi) compensation for property damaged and any amount payable under a policy of insurance in respect of damage to property, except to the extent that such compensation or amount, as the case may be, has within a reasonable time after the damage been expended on repairing the damage,

(vii) an amount by which the liability of a taxpayer to a mortgagee is reduced as a result of the sale of mortgaged property under a provision of the mortgage, plus any amount received by the taxpayer out of the proceeds of such sale, and

(viii) any amount included in computing a taxpayer's proceeds of disposition

of the property by virtue of paragraph 79(c);

In this respect the defendant submits that the conditional sales of the coolers to the shopkeepers are sales entitling the defendant absolutely to the sale price even though the payment of the final one dollar portion of it is postponed for a period of seven years and that the defendant made dispositions of the coolers at the time it entered into the agreements with the shopkeepers.

The plaintiff, on the other hand, submits that the arrangements between the defendant and the shopkeepers do not constitute a disposition of the coolers because the transactions did not, at the time they were entered into, entitle the defendant to the sale price of the coolers which were sold. Under the terms of the agreement the defendant received one half the sale price at the time the agreement was entered into but was not entitled to the remaining half of the sale price until the passage of seven years and on condition that the shopkeepers had complied with the several conditions set out in the agreement. Alternatively, in respect of this submission, the plaintiff says that even if the defendant, by reason of executing the agreement with the shopkeepers, became entitled to the $2 consideration, there had not been a sale of the coolers because property or ownership in them did not pass at the time of the execution of the agreement but upon the expiration of seven years after that time.

It is with some hesitation that I accept the plaintiff's submission on the first point, i.e. the defendant's lack of entitlement to the full sale price. It is one thing to say that the defendant's entitlement is postponed for seven years and quite another to say that there is no present entitlement to the postponed amount or that the entitlement might be removed by a subsequent event. On the other hand the agreement is clear that the shopkeeper's obligation and right to pay the remaining portion of the purchase price and obtain ownership and title to the cooler is postponed for seven years and is conditional upon his complying with all of his obligations set out in the agreement. As I read the agreement the defendant's entitlement to the balance of the purchase price does not arise until the shopkeeper has complied with all his non-monetary obligations set out in the agreement for a period of seven years from the date of the execution of the agreement. On that construction of the agreement I have concluded that at the time of the execution of the agreement between the defendant and the storekeeper the defendant was not entitled to the proceeds of the disposition.

If I am wrong in this finding it is my view that the defendant cannot bring itself within the meaning of paragraphs 13(21)(c) and (d) for the reason that the agreements between the defendant and the shopkeepers do not constitute a sale of the coolers at the time of the execution of the agreement. For a sale to have taken place at the time of the execution of the agreement the shopkeeper must have, by reason of the agreement, acquired title to the cooler or to all of the normal incidents of title.

The Tax Court judge was aware of this principle when he noted the reservation of title clause in the agreement, and the plaintiff's claim that regardless of the form of the agreement between the shopkeepers and the defendant, the substance of the agreement was that the ownership and title to the coolers remained in the defendant throughout the currency of the agreement.

Based on the decision of Cattanach, J. in M.N.R. v. Wardean Drilling Ltd., [1969] C.T.C. 265; 69 D.T.C. 5194, at page 271 (D.T.C. 5197), the Tax Court judge found that although legal title remained in the defendant during the term of the agreement the shopkeepers, under the agreement, had acquired all the incidents of legal title, namely possession, use and risk. He found that the shopkeepers were responsible for maintaining insurance and were able to use the coolers subject to certain conditions but that those conditions were not sufficient to warrant the conclusion that the shopkeepers did not have beneficial ownership.

The quotes from the decision of Cattanach, J. upon which the Tax Court judge relied are as follows:

In my opinion the proper test as to when property is acquired must relate to the title to the property in question or to the normal incidents of title, either actual or constructive, such as possession, use and risk.

and at 271 (D.T.C. 5198):

As I have indicated above, it is my opinion that 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. In my view the foregoing is the proper test to determine the acquisition of property. . .

Counsel for the plaintiff does not take issue with the proposition that where a purchaser has all the incidents of title, such as possession, use and risk, property in the goods may pass notwithstanding the reservation of title but says, in this case, that the shopkeepers did not have all the incidents of title.

It is true that the shopkeepers had possession of the coolers but it was a limited possession. It was limited by the right of the defendant to retake possession in the event that the shopkeeper failed to comply with any of the several conditions set out in the agreement.

The shopkeepers' use of the coolers was also limited. The shopkeepers could only use the coolers for the purpose of storing and displaying for sale soft drinks manufactured by the defendant and they could only use the coolers for that purpose at the shopkeepers' premises identified in the agreement unless the defendant consented to the shopkeepers using the coolers at some other location.

Although the shopkeepers were required to keep the coolers insured against loss or damage by fire, wind, theft and accident it does not follow from that that the defendant was bearing all the risks usually associated with the ownership of the coolers. The loss, for example, under the policy was required to be made payable to the defendant as its interest might appear which tends to show that the defendant retained an interest in the owner ship of the coolers. Furthermore during the term of the agreement any repairs required were covered by the manufacturer's warranty given to the defendant for the first five years and during the last two years of the agreement the defendant itself paid for the cost of any necessary repairs.

In dealing with the question of whether title had passed in given circumstances, Marceau, J. of the Federal Court of Appeal in Saskatchewan Wheat Pool v. The Queen, [1985] 1 C.T.C. 31; 85 D.T.C. 5034, at page 36 (D.T.C. 5038), referred to the test of having the attributes or incidents of title or ownership in the following terms:

In my view, the Pool does not become the owner of the grain. The Pool's title may have some of the attributes of ownership, namely possession, use and risk, but, regardless of their striking limitations here, these are attributes attached to many other legal titles (namely that of a bailee), and much more significantly, the Pool never acquires those attributes which are exclusively attached to ownership, i.e. the right to use as one pleases and for one's own personal advantage, the right to consume, to destroy or to dispose of, and conversely the “obligation” to assume the risk of loss due to any cause including, of course, force majeure.

In the same way, in this matter, the shopkeepers had, under the terms of the agreement with the defendant, acquired some of the incidents of ownership but they did not acquire the right to use the coolers as they pleased for their personal use. They were not entitled to destroy the coolers, to dispose of them, or to use them as security for loans. In my view it is clear from the terms of the agreement that the defendant reserved to itself ownership in and title to the coolers for the full seven-year term of the agreement and by placing the limitations on the use of them which the defendant did in the agreement it refused to give to the shopkeepers sufficient of the essential incidents of ownership as would cause me to find that the parties to the agreement intended by its terms that property in the coolers would pass from the defendant to the shopkeepers at the time of the execution of the agreement. In my view a fair reading of the agreement shows an intention by the parties to it that the property in the cooler would not pass from the defendant to the shopkeeper until the expiration of the seven-year term set out in the agreement. Put another way, I find that at the time of the execution of the agreement there was not and the parties to the agreement did not intend there to be an acquisition of the property in the cooler by the shopkeeper or a disposition of the property in the cooler by the defendant and that the property in the cooler was not intended to pass from the defendant to the shopkeeper until the expiration of the seven-year term set out in the agreement upon payment by the shopkeeper of the balance of one dollar of the purchase price and on condition that the shopkeeper had, during the seven-year term, complied with all of its obligations under the terms of the agreement.

In summary I have accepted the plaintiff's submissions with respect to the taxation years of the defendant under consideration;

(a) that the costs of acquiring the coolers were not fully deductible in the years in which they were acquired by the defendant;

(b) that the costs of acquiring the coolers were outlays of a capital nature;

(c) that the coolers so acquired were properly characterized as Class 8 assets of the defendant in respect of which the appropriate capital cost allowance could be claimed;

(d) that being depreciable property the defendant cannot deduct from its taxable income a capital loss because of the prohibition contained in paragraph 39(1)(b) of the Act;

(e) that the defendant cannot claim a terminal loss in respect of the coolers at the time of the execution of the agreement of sale because

(i) at the relevant times the defendant always owned Class 8 property or, alternatively,

(ii) there had been no disposition of the coolers by the defendant.

Counsel for the defendant dealt at some length with the income tax consequences of a possible repossession of the coolers and with the right, largely of oil companies, to insert collateral covenants in their financing documentation with service station operators the benefit of which covenants would run beyond the possible payment by the mortgagor service station operator of the amount due under the mortgage.

I have reviewed counsel's remarks as well as his written submissions and the cases cited with respect to the above-noted subjects and must confess that I cannot see the relevance of them. In this matter I am not concerned with the tax consequences of a repossession nor am I concerned with collateral agreements which might continue after the payment in full of the amount due under a mortgage. The covenants given by the shopkeepers in this case are a part of the consideration for the acquisition of the coolers.

Counsel for the defendant cited the Tax Court of Canada decision in Waserman Furs Ltd. v. M.N.R., [1985] 1 C.T.C. 2375; 85 D.T.C. 309, as authority for the proposition that property and title to goods passed in the conditional sales agreements executed in that case even though title and ownership of the goods remained in the taxpayer until the sale price had been paid in full. In my view that case is distinguishable from the present case on its facts. The only limitation on the normal attributes of ownership placed upon the purchasers of the goods in the Waserman case, in addition to the reservation of title, was that the goods were not to be taken out of the province. In the present case, as already indicated, the defendant placed far more restrictions on the rights of ownership of the shopkeepers to the coolers.

Finally I should add that my inability to find the relevance of a significant portion of the defendant's submissions is not intended as a criticism of counsel for the defendant for it may well be that his submissions were relevant and that I just did not understand the thrust of them. If that be the case I, like all trial judges, am consoled by the fact that the Appeal division exists to correct any error which may have thereby arisen.

For the reasons given that portion of the decision of the Tax Court of Canada already referred to will be set aside and the plaintiff's appeal allowed with costs. Pursuant to paragraph 337(2)(b) of the Federal Court Rules, counsel for the plaintiff is directed to prepare a draft of the formal judgment and to submit the same to counsel for the defendant for approval as to its form and then to me for review and, if accepted, for entry.

Appeal allowed.