Citation: 2008 TCC 509
Date: 20081024
Docket: 2006-1806(IT)G
BETWEEN:
GROUPE TVA INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH
TRANSLATION]
REASONS FOR JUDGMENT
Bédard J.
[1]
The
Appellant is appealing under the General Procedure from reassessments made May
26, 2000, in its regard by the Canada Customs and Revenue Agency (CRA), for the
taxation years 1995 and 1996, the notices of which are numbered 7002038 and 7002041.
[2]
The
reassessments were confirmed by the Minister of National Revenue (the Minister)
by Notice of Confirmation
dated March 21, 2006.
[3]
In
support of the reassessments, the Minister is relying on sections 3, 9,
18, 38, 39 and 50 of the Income Tax Act, R.S.C. 1985, c. 1 (5th
Supp.) ("the Act"), to disallow the deductions claimed by the
Appellant of $5,868,431 and $1,248,707 for the taxation years 1995 and 1996,
respectively, because these amounts constituted capital expenditures and
business investment losses ("amounts at issue").
[4]
The
amounts were paid by the Appellant following a judgment of the Quebec Court of Appeal dated
May 19, 1995 (rectificatory judgment dated September 18, 1995), ordering the
Appellant to pay these amounts to the National Bank of Canada pursuant to a
surety bond entered into February 8, 1982,
by the corporations prior to the Appellant in the course of carrying on the
Appellant’s business.
List of parties’
admissions
[5]
The
parties agreed to the following list of admissions that I have reproduced here in its
entirety:
i) The Appellant, Groupe TVA inc., is a major
Canadian company active in, among others, the area of television and production
and the broadcasting of entertainment and general-interest programs;
- Notice of Appeal,
paragraph 4
-
Reply to the Notice of Appeal, paragraph 4
ii) The Appellant is the successor to Télé-Métropole
inc. and Télé‑Métropole International inc.;
-
Notice of Appeal, paragraph 4
-
Reply to the Notice of Appeal, paragraph 4
iii) Télé-Métropole International inc. was, during the
relevant periods, a wholly-owned subsidiary of Télé‑Métropole inc, with a
research and development mandate to offer the technical services of the group
of companies to independent producers to the full extent of its market;
- Notice of Appeal,
paragraph 6
-
Reply to the Notice of Appeal, paragraph 4
iv) During the relevant periods, Sonolab inc. was a
wholly-owned subsidiary of Télé‑Métropole inc., and provided technical
services in the television and film production area;
- Notice of Appeal,
paragraph 5
-
Reply to the Notice of Appeal, paragraph 4
v) During the relevant periods, Sonolab’s services
were used for technical projects in relation to the production of a film called
“The Neighbour”;
- Notice of Appeal,
paragraph 9
-
Reply to the Notice of Appeal, paragraph 7
vi) The film was produced by Les Films du Neighbour
inc., a subsidiary of Les Productions Claude Léger inc.;
- Reply to the Notice of
Appeal, subparagraphs 12 (c) and (d)
vii) For a number of reasons, financing for the film
proved to be difficult;
- Notice of Appeal,
paragraph 10
-
Reply to the Notice of Appeal, paragraph 7
viii) On January 4, 1982, Les Productions Claude Léger
inc. obtained a letter of credit for $3,150,000 from the bank Albert de Bary
& Co NV (Netherlands), with certain conditions;
- Exhibit A‑1
ix) However, due to the financial difficulties
experienced by Les Films du Neighbour inc. in the production of the film, the
Mercantile Bank of Canada demanded guarantees for the required financing;
- Reply to the Notice of
Appeal, subparagraph 12 (c)
x) On February 4, 1982, an agreement was reached
between Télé-Métropole International inc., Les Films du Neighbour inc. and Les
Productions Claude Léger inc., whereby Télé‑Métropole International
inc. agreed to issue a surety bond to the Mercantile Bank of Canada with
respect to the production of the film under certain conditions;
-
Reply to the Notice of Appeal, subparagraph 12 (d)
xi) The agreement signed by the parties on February 4,
1982, mentions, among other things, that Télé‑Métropole International
inc. received the following in exchange for the surety bond:
a) $50,000
in fees;
b) A settlement of all debts owed to Télé‑Métropole
inc. and its affiliates;
c) Commitment to continue using the services of Télé‑Métropole
International inc. and its affiliates’ for the production of the film;
d) A $200,000 advance for services to be rendered by
Sonolab inc.;
e) A 12% to 34% interest in the net profit of the
film (depending on the circumstances); and
f) Option to purchase the film (with certain
conditions)
- Notice of Appeal,
paragraph 12
-
Reply to the Notice of Appeal, paragraph 7 and subparagraph 12 (e)
-
Exhibit A‑1, tab 12
xii) Neither Télé‑Métropole
inc. nor Télé‑Métropole International inc. exercised the option to
purchase the film;
- Reply to the Notice of Appeal, paragraph 12 (m)
xiii) On February 8, 1982, Télé‑Métropole
International inc. signed a surety bond with the Mercantile Bank for Canada for
a maximum of $3,150,000, payable March 1, 1983;
- Notice of Appeal,
paragraph 11
-
Reply to the Notice of Appeal, paragraph 7 and subparagraph 12 (f)
-
Exhibit A‑1, tab 16
xiv) On February 8, 1982, Télé‑Métropole inc.
undertook to meet all obligations and commitments of Télé‑Métropole
International inc. to the Mercantile Bank of Canada in the amount of
$3,150,000;
- Reply to the Notice of
Appeal, subparagraph 12 (g)
-
Exhibit A‑1, tab 17
xv) At the same time, Mercantile Bank of Canada loaned
Les Films du Neighbour inc. $3,150,000, with terms;
- Exhibit A‑1, tab
15
xvi) In 1983, the Mercantile Bank of Canada did not
collect the entirety of its loan to Les Films du Neighbour inc. and
required Télé‑Métropole inc. or Télé‑Métropole International inc.
to honour the surety bond in accordance with the terms of the bond;
- Notice of Appeal,
paragraph 13
-
Reply to the Notice of Appeal, paragraph 7 and paragraph 12 (i)
-
Exhibit A‑1, tab 19
xvii) Télé‑Métropole inc. and Télé‑Métropole
International inc. refused to pay;
- Reply to the Notice of
Appeal, subparagraph 12 (i)
xviii) A judgment of the Superior Court of Quebec dated
May 29, 1989, then a judgment of the Quebec Court of Appeal dated May 19, 1995
(rectificatory judgment: September 18, 1995) ordered Télé‑Métropole inc.
and Télé‑Métropole International inc. to remedy the situation by paying
the National Bank of Canada (plaintiff in continuance of suit by the Mercantile
Bank of Canada) $5,868,431 in 1995 and $1,248,707 in 1996;
- Notice of Appeal,
paragraph 14
-
Reply to the Notice of Appeal, paragraph 7 and subparagraphs 12 (j) and
(k)
-
Exhibit A‑1, tabs 25 and 26
xix) The amounts were paid by Télé‑Métropole inc.
and were deducted as current expenses, both for tax and for accounting purposes;
- Notice of Appeal,
paragraph 15
-
Exhibit A‑1, tabs 1, 2, 20, 21, 23 and 24
xx) On May 26, 2000, the
Minister issued two (2) Notices of Reassessment against the Appellant, who was
the successor to Télé‑Métropole inc. and Télé‑Métropole International
inc., for the 1995 and 1996 taxation years, respectively numbered
7002038 and 7002041;
- Exhibit A‑1,
tabs 3 and 4
xxi) On August 25, 2000, the Appellant objected to the
said assessments;
- Notice of Appeal,
paragraph 17
-
Reply to the Notice of Appeal, paragraph 10
-
Exhibit A‑1, tabs 5 and 6
xxii) On September 21, 2000, the Appellant amended his
Notices of Objection;
- Notice of Appeal,
paragraph 17
-
Reply to the Notice of Appeal, paragraph10
-
Exhibit A‑1, tabs 7 and 8
xxiii) On March 21, 2006, the Minister confirmed the
assessments, hence this appeal;
-
Notice of Appeal, paragraph 17
-
Reply to the Notice of Appeal, paragraph 10
-
Exhibit A‑1, tab 9
xxiv) In making the assessment, the Minister accepted that
a) The amounts paid by Télé‑Métropole
inc. were paid in the course of carrying on a business and for the purpose of
gaining or producing income;
b) The amounts
represented capital expenses that could not be deducted as current expenses;
c) The amounts are
eligible as “business investment losses”;
-
Notice of Appeal, paragraph 16
xxv) The only issue in this case is the following: in view
of the circumstances, are the Appellant’s expenses in 1995 and in 1996 on
account of income, as claimed by the Appellant, or on account of capital, as
claimed by the Respondent?
Testimony
[6]
André Fleury
and Michel Éthier testified in support of the Appellant’s position. Only
Denis Audet testified in support of the Respondent’s.
André Fleury’s testimony
[7]
According
to the highly credible testimony of André Fleury, an electrical engineer who is
now retired,
i)
towards
the end of the 1960s, Mr. Fleury formed Sonolab inc. (Sonolab) for the purpose
of buying assets of Trans-World Film, which the provided technical services,
such as dubbing, for television and film productions. The first Sonolab
shareholders were Mr. Fleury and Mr. DeSèves, who held 60% and 40% of the
company’s shares respectively. Mr. DeSèves was then the primary shareholder of
Télé‑Métropole inc. (TM) in addition to being the chairman and chief
executive officer;
ii)
In
the early 1970s, at the request of Mr. DeSèves, still president and majority
shareholder of TM, Mr. Fleury created and supervised the assembly of a
production and post-production studio for films and television series;
iii)
following
Mr. DeSèves’ death, Roland Giguère was appointed president of TM. At Mr.
Giguère’s request, Mr. Fleury sold his Sonolab shares in 1978 and took charge
of all film and television series production and post-production activities as
well as sales and technical services to independent producers at TM;
iv)
the
CRTC having strongly urged TM (as part of the renewal of its licence as a
broadcaster) to participate in the development of the film industry in Quebec,
TM created a subsidiary in 1980, called Télé‑Métropole International inc.
(TMI), with a research and development mandate to offer the technical services
of the TM group of companies to independent producers to the full extent of its
market. Mr. Fleury also explained that TMI was a co-producer of films.
Finally, he testified that TM constantly had to fund TMI, which was not
financially independent;
v)
Les
Productions Claude Léger inc. (Les Productions Léger) was always a good client of TM and
its subsidiaries, even well before the production of the film “The
Neighbour”;
vi)
TMI
initially refused to help finance the film “The Neighbour”. Mr. Fleury
explained that TMI systematically refused to invest in films produced by
independent Quebec producers because Quebec films are, by and large, unprofitable;
vii)
the
production of the film “The Neighbour” was interrupted due to financial
difficulties experienced by the Les Films Du Neighbour inc. (Les Films
Neighbour). When the production of the film was interrupted, Les Films
Neighbour owed TM and its subsidiaries $200,000 to $300,000 for services
rendered;
viii)
the
granting of the surety bond by TM allowed Les Films Neighbour to resume
production of the film “The Neighbour”;
ix)
during
the surety bond negotiation, Mr. Fleury was a senior executive of TM, receiving
instructions directly from Mr. Giguère, chairman and chief executive officer,
who had authority not only over TM, but also over Sonolab and TMI. In other
words, Mr. Giguère managed TMI and Sonolab as though they were divisions of
TM. Following Mr. Giguère’s instructions, Mr. Fleury was to arrange for a
surety bond such that the cash inflows from various sources and activities of
TM and its subsidiaries would continue. Mr. Fleury therefore negotiated in the
name of each entity in the TM group as a whole and did not make any distinction
in the revenues that might be generated by them individually. To use Mr.
Fleury’s expression, it was all treated like a "melting pot". In
other words, Mr. Fleury had to ensure, during the surety bond negotiation, that
TM and its subsidiaries as a whole did not lose the revenues for past and
future work in favour of Les Films Neighbour and Les Productions Léger, which
was a long-standing client of TM and its subsidiaries;
x)
after
being assured by TM’s legal advisors that the financial risks for TMI and TM
with respect to their surety bond were practically non-existent and after
assuming that the surety bonds directly and indirectly generated substantial
cash inflows in TM and its subsidiaries, Mr. Fleury had recommended to TM to
grant the surety bond. In this regard, Mr. Fleury explained that the
production of the film “The Neighbour” generated only $500,000 in revenues for
Sonolab. Mr. Fleury finally declared that, as part of the agreement reached on
February 4, 1982, between TM, Les Productions Léger and Les Films Neighbour,
TM, TMI and Sonolab got $220,201, $155,402 and $239,632 respectively.
Michel Éthier’s testimony
[8]
Moreoever,
Michel Éthier’s testimony, which dealt primarily with the tax and accounting
treatment of the amounts at issue, revealed the following information:
i)
the
Appellant, which is the successor to TM, TMI and Sonolab, is a subsidiary of
Quebecor Média;
ii)
Mr.
Éthier is a chartered accountant and is Vice-President, Taxation at Quebecor
Média. He did not participate in the transactions and negotiation with regard
to the surety bond;
iii)
Mr.
Éthier was responsible for auditing and dealt directly with the CRA with
respect to matters related to the case at issue. Even though more than five
years had elapsed between the Appellant’s Notices of Objection and the
Minister’s confirmation of the reassessments, the only question at issue
remained the same: determining whether the expenses incurred to honour the
surety bond were current or capital.
The CRA never suggested the amounts at issue be divided among TM, TMI and
Sonolab.
Denis Audet’s testimony
[9]
The
following was revealed in Denis Audet’s testimony:
i)
Mr.
Audet is a certified general accountant (CGA) employed by the Agency since
1988;
ii)
Mr.
Audet was selected by the CRA to audit the Appellant’s 1995 and 1996 taxation
years. The audit took place in 1999 and 2000;
iii)
during
his audit, Mr. Audet met Mr. Éthier. At no time did Mr. Audet try to meet one
of the Appellant’s senior executives (like Mr. Fleury) who had personal
knowledge of the purposes of the surety bond and the related events and
consequences;
iv)
Mr.
Audet’s explanations about the rationale and reasons underlying the
Respondent’s position to the effect that the amounts at issue are current
expenses were simply incomprehensible. Indeed, Mr. Audet explained that the
CRA’s position was based on a two-step analysis; first, he scrutinized the
original intent of the taxpayer and, second, he evaluated the taxpayer’s
conduct. With respect to the first step, Mr. Audet also explained why, in his
view, TM granted the surety bond: [TRANSLATION] “ultimately, the whole group
[TM and its subsidiaries] will benefit.”
With respect to the step concerning the taxpayer’s conduct, Mr. Audet said:
[TRANSLATION] “If we granted a surety bond and then did care about the 12% and
the 34%, it is because somewhere, we were simply interested in having our
accounts receivable reimbursed and then blithely proceeding and obtaining what
we call notoriety.”
v)
the
CRA never considered the possibility of breaking down the amounts at issue
among TM, TMI and Sonolab;
vi)
even
though Mr. Audet made ample reference to the clause in the surety bond contract
providing for TM’s interest in the net profit of the film (under certain
conditions), his testimony is contradictory in this regard. During his
cross-examination, counsel for the Appellant asked him if the potential
revenues from the sale of the film were taken into account by the CRA in making
the reassessments. His response was as follows: [TRANSLATION] “We took
that into account when we determined the taxpayer’s conduct.” Following this, counsel for the
Appellant asked him essentially the same question but phrasing it as follows:
[TRANSLATION] “Télé-Métropole, as a group, was entitled to 12% and 34% in
royalties. Does this, as far as you are concerned, make it a capital or a
current expense? Or is that not relevant?” Mr. Audet’s response was as
follows: [TRANSLATION] “For us, it was not relevant because Télé-Métropole had
come to an end because Télé-Métropole’s conduct did not show that any measures
would be taken that would save the production.”
vii)
Mr.
Audet also seems to understand that the surety bond was primarily destined to
allow the completion of the production of the film “The Neighbour” ended and the
reimbursement of the overdue accounts.
Issue
[10]
The
only issue is whether the amounts the Appellant paid to the National Bank of
Canada, pursuant to the Quebec Court of Appeal judgment dated May 19, 1995
(rectificatory judgment: September 18, 1995) ordering the Appellant to honour a
surety bond granted February 8, 1982, are expenses on account of income, as
argued by the Appellant, or expenses on account of capital, as claimed by the
Respondent.
Respondent’s position
[11]
The
Respondent argued, basically relying on the Federal Court of Appeal decision in
Easton, that there is a
rebuttable presumption that a loss sustained following a surety bond like the
one granted by TM is a capital loss. I would point out that, in Easton,
the issue was whether a payment made by a shareholder as guarantor of a loan
contracted by a corporation of which he or she was a shareholder was to be treated
as a current expense. I would like to emphasize that, in that case, the
Federal Court of Appeal first reiterated the basic principle propounded by the
Supreme Court of Canada in Steer,
when it made the following comments:
16 As a general proposition, it is safe to conclude that an advance or
outlay made by a shareholder to or on behalf of the corporation will be treated
as a loan extended for the purpose of providing that corporation with working
capital. In the event the loan is not repaid the loss is deemed to be of a
capital nature for one of two reasons. Either the
loan was given to generate a stream of income for the taxpayer, as is
characteristic of an investment, or it was given to enable the corporation to
carry on its business such that the shareholder would secure an enduring
benefit in the form of dividends or an increase in share value. As the law presumes
that shares are acquired for investment purposes it seems only too reasonable
to presume that a loss arising from an advance or outlay made by a shareholder
is also on capital account. The same considerations apply to shareholder
guarantees for loans made to corporations. In Minister
of National Revenue v. Steer, [1967] S.C.R. 34, it was held that a
guarantee given to a bank for a company's indebtedness by the taxpayer in
consideration for shares in the company was to be treated as a deferred loan to
the company and that monies paid to discharge that indebtedness were to be
treated as a capital loss. That case, however, does not stand for the
proposition that every time a corporation fails to reimburse a shareholder with
respect to an advance, outlay or payment on a guarantee that the loss is
necessarily on capital account. There is only a rebuttable presumption of such. [Emphasis added.]
I would also point out
that in Easton, the Federal Court of Appeal specified that there were
two exceptions to this rule:
17 There are two recognized exceptions to the general proposition that
losses of the nature described above are on capital account. First, the taxpayer may be able to establish that the loan was made
in the ordinary course of the taxpayer's business. The classic example is the
taxpayer/shareholder who is in the business of lending money or granting
guarantees. The exception, however, also extends to cases where the advance or
outlay was made for income-producing purposes related to the taxpayer's own
business and not that of the corporation in which he or she holds shares. For
example, in Berman, L., & Co. Ltd. v. M.N.R.,
[1961] CTC 237 (Ex. Ct.) the corporate taxpayer made voluntary payments to the
suppliers of its subsidiary for the purpose of protecting its own goodwill. The subsidiary had defaulted on its obligations and as the taxpayer
had been doing business with the suppliers it wished to continue doing so in
future. (Berman was cited with apparent approval in the Supreme Court
decision in Stewart & Morrison Ltd. v. M.N.R.,
[1974] S.C.R. 477, at page 479.)
18 The second exception is found in Freud.
Where a taxpayer holds shares in a corporation as a trading asset and not as an
investment then any loss arising from an incidental outlay, including payment
on a guarantee, will be on income account. This exception is applicable in the
case of those who are held to be traders in shares. For those who do not fall
within this category, it will be necessary to establish that the shares were acquired
as an adventure in the nature of trade. I do not perceive this
"exceptional circumstance" as constituting a window of opportunity
for taxpayers seeking to deduct losses. I say this because there is a
rebuttable presumption that shares are acquired as capital assets: see Mandryk
(O.) v. Canada , [1992] 1 C.T.C. 317 (F.C.A.), at pages 323-324. [Emphasis added.]
[12]
More
specifically, the Respondent contended that the Appellant cannot benefit from
the first exception of the basic rule laid down by the Federal Court of Appeal
in Easton because TM did not grant the surety bond for income-producing
purposes related to its own business. On this, counsel for the Respondent
should be quoted:
[TRANSLATION]
. . .
I submit that…in general, by agreeing to grant the surety bond, Télé-Métropole strengthened
the corporate structure by bailing out its subsidiaries; it was augmenting its
asset base. My colleague was saying that there was no income- generating
structure acquired or obtained by Télé-Métropole by agreeing to grant the
surety bond. There was perhaps nothing new as such but what is it was doing,
was maintaining its assets, which were TMI and Sonolab.
Ultimately, if
these assets increase in value, Télé-Métropole wins: either in terms of
dividends, or through the subsequent sale of the companies. One thing is
certain, when the subsidiaries increase in value, Télé-Métropole gains.
[13]
Moreover,
counsel for the Respondent maintained in his submission that the evidence
clearly shows that the two TM subsidiaries earned business income and received
all the benefits related to their activities following the granting of the
surety bond and this income had nothing to do with TM’s activities during the
relevant period.
[14]
Finally,
though he maintained his position throughout his submission that the surety
bond did not serve two purposes (that it was granted by TM to produce income
both for its own business and for that of its subsidiaries), counsel for the
Respondent, relying on the Federal Court of Appeal’s decision in Forest, argued that the
Court was satisfied that the surety bond did serve two purposes and had to break
down the losses sustained following the surety bond as there was positive
evidence allowing it to identify on a reasonable basis the composition of a global
amount.
Analysis
[15]
The
amounts at issue paid by the Appellant in 1995 and 1996 constituted damages
paid by the Appellant within the meaning of civil law. However, the Act does
not specifically provide for the tax treatment of the damages; we have to refer
to the general provisions on the computation of income, that is, sections 3, 9
and 18. According to paragraph 3(a) of the Act, the income of a
taxpayer, for a taxation year for the purposes of Part I is determined by
computing all amounts each of which is the taxpayer’s income for the year from
a source inside or outside Canada, including the income from each business and
property. Subsection 9(1) of the Act provides that a taxpayer’s income from a
business or property in a taxation year is the taxpayer’s profit from that
business or property for the year. More specifically, paragraph 18(1)(a)
of the Act provides that, in the computation of the taxpayer’s income from a
business or property, the expenses are not deductible unless they are incurred by
the taxpayer for the purpose of gaining or producing income from the business
or property. Moreover, pursuant to paragraph 18(1)(b) of the Act, a
payment on account of capital is not deductible when the income from a business
or property is computed. It can be seen from the foregoing that, for an
expense to be deductible in the computation of the business income of a
taxpayer, this expense must be
a)
made
incurred for the purpose of gaining income; and
b)
current
not capital.
In the present case, it
is admitted that the amounts at issue were paid for the purpose of gaining
business income. The only issue is therefore to determe whether it is a
capital expense or not.
[16]
To
determine the nature of the expense, the starting point for the analysis is, in
my view, Tsiaprailis v. Canada, [2005] 1 S.C.R. 113, a case decided by
the Supreme Court of Canada in 2005. In her reasons, on behalf of the majority
in Tsiaprailis, Madame Justice Charron explains that an amount paid as
damages is inherently neutral for tax purposes and the assessment of whether
monies are taxable depends on what they are intended to replace. Charron J.
expressed herself as follows at pages 117 and 118, paragraph 7:
... awards of damages and settlement payments are inherently neutral for
tax purposes. My colleague takes no issue with this principle. As
she explains, in assessing whether the monies will be taxable, we must look to
the nature and purpose of the payment to determine what it is intended to
replace. The inquiry is a factual one. The tax consequences of the
damage or settlement payment is then determined according to this
characterization. In other words, the tax treatment of the item will
depend on what the amount is intended to replace. This approach is known
as the surrogatum principle. As noted by Abella J., it was defined
in London and Thames Haven Oil Wharves, Ltd. v. Attwooll, [1967] 2 All
E.R. 124 (C.A.), ….
Further in her opinion,
at page 120, paragraph 15, Charron J. sets out two questions that must be asked
to determine the tax treatment of damages:
The determinative questions are: (1)
what was the payment intended to replace? And, if the answer to that
question is sufficiently clear, (2) would the replaced amount have been taxable
in the recipient’s hands? …
[17]
The
principle above is derived from a leading British case London and Thames
Haven Oil Wharves, Ltd. v. Attwooll, [1967] 2 All E.R. 124 (C.A.), in
which Lord Willmer made the following comments at page 127:
In the course of
the argument we have been referred to a considerable number of authorities, to
some of which I shall have to refer in the course of this judgment. It seems,
however, to me that the question which we have to decide is eminently a
question of fact, which depends on the answer to the question: what did the sum
of £21,404 represent? To adopt a phrase used
in one of the authorities to which we have been referred, what place in the
economy of the tax payer company’s business does this payment take?
[18]
Lord
Willmer therefore invites us to determine the place the payment holds in the
economy of the taxpayer’s business. To do so, his learned friend, Lord Harman,
invites us to take a more in-depth look at each fact relevant to the issue in
question, at page 133:
Questions relating
to capital and income are among points that in my experience arise no less in
the region of fiscal law, in which we are here involved, that in that of
inheritance, where they are as thick as autumn leaves; and it is tempting to
try to classify them and to decide whether they fall on one side of the line or
the other. The judge in the court below seems at one time to have been tempted
to farm out the authorities in this way; but as he rightly reminds himself in
his judgment (29):
“Judges have from
time to time been careful to say that no clear and comprehensive rule can be
formulated, and no clear line of demarcation can be drawn, by reference to
which it can be determined in every case whether the sum received should be
regarded as a capital receipt or as a revenue receipt to be taken into account
in arriving at the profits or gains of the recipient’s trade. Each case must be
considered on its own facts.”
[19]
Even
though the case law cited above dealt with a situation in which the tax
treatment of damages from the perspective of the recipient had to be
determined, the surrogatum principle also applies for the purposes of
determining the tax treatment from the point of view of the person responsible
for paying the damages, more particularly for determining if the payment of
damages is deductible pursuant to subsection 9(1) and paragraphs 18(1)(a)
and 18(1)(b) of the Act. The Exchequer Court propounded that principle
in Imperial Oil Ltd. v. M.N.R., [1947] 3 D.T.C. 1090 (Exchequer
Court). More recently, in McNeil v. The Queen, [2000] 2 C.T.C. 304
(F.C.A.), the Federal Court of Appeal confirmed the payment of damages as a
deductible expense pursuant to subsection 9(1) and paragraphs 18(1)(a)
and 18(1)(b) of the Act insofar as it replaces a current expense and not
a capital expense. Therefore, for the payment of damages to be deductible in the
computation of the business income of a taxpayer, the expenses that the damages
replace must meet the conditions set out in subsection 9(1) and paragraphs
18(1)(a) and 18(1)(b) of the Act.
[20]
In
the case at bar, the damages paid by the Appellant result from a surety bond
granted by TM. It must therefore be determined what tax treatment is
appropriate in relation to damages resulting from a surety bond, and whether
the damages are a current expense or a capital expense. We can find in the
case law a number of examples that can guide us in this case in determining
the tax treatment of damages resulting from a surety bond:
i)
L.
Berman & Co. Ltd. v. M.N.R., [1961] C.T.C. 237 (Exchequer Court), is to the
effect that
1)
if
the payment is related to the taxpayer’s business, it is deductible;
2)
if
the payment is deductive pursuant to the generally accepted business
principles, it is deductible for tax purposes;
3)
if
the payment is made in the course of an activity destined to generate income,
it is deductible;
4)
the
fact that no income was generated that, the granting of the guarantee (or loan)
had disastrous results or that the payment significantly exceeded the income
generated has no impact on its deductibility;
ii)
M.N.R.
v. Freud, [1969] S.C.R. 75 is to the effect that if the guarantee is speculative,
it cannot be considered a capital expense;
iii)
The
Queen v. F.M. Jones Tobacco Sales Co. Ltd., [1973] C.T.C. 784 (F.C.A.), and Panda
Realty Ltd. v. M.N.R., 86 D.T.C. 1266 (T.C.C.) decided that if the
guarantee (or the loan) is granted to avoid losing the current or future
revenue of a client, the expense is deductible. In other words, if the
guarantee (or loan) is granted to avoid losing a client and this client does
business with a competitor, the expense is current;
iv)
The
Queen v. Lavigueur, [1973] C.T.C. 773 (F.C.T.D.) decided that if the
guarantee (or the loan) is granted to keep a business running when the client
is experiencing financial difficulty, the expense is current;
v)
Lavigueur and Easton,
supra, decided that if the guarantee (or the loan) does not end in the
acquisition or creation of a property or permanent structure, the expense is
current;
vi)
finally,
F.H. Jones Tobacco Sales Co. Ltd., supra, decided that the situation
must be considered from the point of view of the businessperson who makes the
decision to grant the guarantee.
[21]
To
determine the nature of the expense pursuant to paragraph 18(1)(b) of
the Act, in my opinion, the taxpayer’s reason for incurring the expense must be
determined. In the case at bar, TM’s reason for undertaking on February 8,
1982, to meet all obligations and commitments of its subsidiary TMI to
Mercantile Bank must be determined.
[22]
It
seems evident to me, in the light of Mr. Fleury’s testimony and the documentary
evidence (Exhibit A-1, tabs 12 and 18), that TMI granted the surety bond so as
not to lose income for past and future activities, for the benefit of Les Films
du Neighbour and its parent company, Les Productions Claude Léger. By granting
the surety bond, TM wanted, among other things, to ensure it would be paid by
Les Films du Neighbour inc. and Les Productions Claude Léger for all the
accounts that were due to it by them. Did the evidence not reveal that
following the surety bond, TM received $156,402 in payment of its accounts
payable? The evidence also shows that TM wanted to ensure, with this bond, the
continued operation of its own business by helping Les Films du Neighbour, a
customer experiencing financial difficulties. The evidence also shows that TM
wanted to be assured, with this bond, that Les Productions Claude Léger and Les
Films du Neighbour did not do business with a competitor in the future. It
must be recalled that these two corporations were TM’s clients and that TM
rents their equipment, studios, offices, and sets. I would also point out that
the business relationship between TM and Claude Léger and/or Les Productions
Claude Léger had existed long before the production of “The Neighbour”. The
evidence showed among other things that TM had retained the services of Claude
Léger to produce the film Lucky Star, well before the film “The Neighbour”.
[23]
There
is no doubt that the evidence also shows that TM granted the surety bond to
prevent its two subsidiaries from losing income from future and past activities,
to the benefit of Les Films du Neighbour and Les Productions Claude Léger.
This appears from a letter dated February 4, 1982 between the surety bond
parties. Furthermore, this agreement reveals that TMI received fees of
$50,000. Sonolab received $200,000 for technical services that it had rendered
and that it would render for the production of the film “The Neighbour”.
Moreover, the agreement also shows that both TM subsidiaries would receive all
outstanding accounts owing to it as of February 4, 1982, by Les Films du
Neighbour and Les Productions Claude Léger. In other words, by granting the
bond, TM also wanted to ensure the continued operation of the two subsidiaries’
businesses by helping a client (Les Films du Neighbour), which was experiencing
financial difficulties. TM also wanted to ensure that Les Films du Neighbour
and Les Productions Claude Léger continued to use both subsidiaries’ services
and did not do business with any competitors. It should also be recalled that
the business relationship between Sonolab and Les Productions Claude Léger had existed
long before the production of the film “The Neighbour”. Counsel for the
Respondent also stressed the fact that the surety bond gave TMI an interest in
the net profit generated by the film “The neighbour” in addition to an option
of buying the film, under certain conditions. In this regard, it should be noted
immediately that Mr. Fleury’s testimony revealed that the future interest in
the net profit generated by the film was in no way an element considered by TM
in its decision to grant the bond as it knew that the chances of a Quebec film
being profitable at the time were practically non-existent. Moreover, Mr.
Audet’s testimony shows that, this interest in the profit was not taken into
consideration when the decision was made.
[24]
Contrary
to what the Respondent is alleging, it can be found, in the light of the
evidence submitted, that the surety bond was granted by TM for income-producing
purposes related to its business and to that of its two subsidiaries. In other
words, it can be found that the surety bond had two objectives or a dual
purpose. Consequently, the Respondent’s argument that the Appellant did not
meet the first exception to the basic rule propounded by the Federal Court of
Appeal in Easton because TM did not grant the surety bond to produce
income in relation to its business does not stand up to analysis. In my view, Easton
cannot be read as holding that a taxpayer can deduct the loss sustained
further to a guarantee only if it was granted exclusively or principally
for the purpose of producing income with respect to its own business. I
am rather of the view that a taxpayer may deduct the loss sustained further to
a guarantee if there is a sufficient nexus between the guarantee and its own
income-producing activity. In the case at bar, the evidence shows that there
was such a nexus and that it was direct and significant. I would like to add
that, by using in Easton the phrase “income-producing purposes”,
the Federal Court of Appeal also wanted to reiterate the principle that income
need not be generated further to the guarantee for the loss further to the
guarantee to be deductible. I would point out that, according to Berman,
the fact that no income was generated, that the granting of a guarantee (or
loan) had disastrous results, or that the payment significantly exceeded than
the income generated has no impact on its deductibility.
[25]
I
would like to point out that, at the hearing, counsel for the Respondent stood
by his position that the surety bond did not have a dual purpose and added,
referring to Forest, that if the Court was satisfied that the bond had a
dual purpose, then the losses sustained would have to be broken down to the
extent that there is some proof by which the composition of the total amount
can be ascertained. In this regard, counsel for the Respondent suggested that
the letter dated February 10, 1982, supported his position. Having read that
letter, I note that at the end of the bond TM, TMI and Sonolab, received
$156,402 (or 25% of the total), $239,632 and $220,201 respectively. A
breakdown made on this basis would dictate that 25% of the amount at issue is
current, which is the portion of income generated directly by TM. However, I
am of the view that this letter cannot constitute an objective basis on which
to proceed with a reasonable breakdown. This letter does not establish what
proportion of the surety bond was granted by each of the participating
entities, where applicable. On the contrary, the testimony evidence reveals
that there was never any breakdown. This letter does not reveal what the
parties took into account to arrive at the bond. This letter does not show
exchanges between the parties bearing on a breakdown, not even indirectly. This
letter merely shows that there was a cash in flow following the granting of the
surety bond, a few days after it was finalized. This letter does not indicate
that it was a final payment or if other payments followed. In this regard, Mr.
Fleury’s testimony suggests that it was not a final payment. In a nutshell,
this letter contains highly fragmented information and is not reliable enough
to serve as an objective basis for a fair breakdown, on a balance of
probabilities. Finally, I emphasize that evidence of the breakdown must be
made by the party that raises it, also on a balance of probabilities. It is the
Respondent in this case who has this burden and she did not discharge this
burden. It is very interesting to note that the Respondent never tried to make
a breakdown, whether during the audit, assessment, objection or confirmation,
even going so far at the appeal stage to conclude that the only issue is to
determine if the expenses incurred in 1995 and 1996 are on account of income or
capital.
[26]
In
my view, in cases where a guarantee has two purposes, as in this situation, the
loss sustained further to the bond can be broken down in law only if the
purpose of the guarantee is purely objective. For example, if in the present
case, TM had granted the bond for the sole purpose of preventing itself and its
subsidiaries from losing money for past works, a breakdown would have been
possible. However, when a guarantee has two purposes and is both subjective
(for example, preventing the client from doing business with a competitor in
the future) and objective (avoiding losing income for past work), it seems
evident that a breakdown is not possible and the following basic rule applies:
the taxpayer may deduct all losses sustained further to a guarantee that has
two purposes if there is a sufficient link between the guarantee and its own
income-generating activities. In the case at bar, I find that there was such a
nexus and that it was direct and significant.
[27]
For
these reasons, the appeal is allowed with costs.
Signed at Ottawa, Canada, this 24th day of October
2008.
Paul Bédard
Translation
certified true
on
this 12th day of May 2009.
François
Brunet, Reviser
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