Citation: 2008 TCC 461
Date: 20080815
Docket: 2004-3710(IT)G
BETWEEN:
SNC TECHNOLOGIES INC. (FORMERLY LES TECHNOLOGIES
INDUSTRIELLES SNC INC.),
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH
TRANSLATION]
REASONS FOR JUDGMENT
Jorré J.
Issue
[1] The appellant, SNC Technologies Inc.,
manufactured defence products for the Department of National Defence and
received progress payments from the Department for the reimbursement of certain
expenses incurred. Those progress payments were recorded as liabilities on the appellant’s
balance sheets.
[2] The issue is the following:
Was the Minister of National Revenue
justified in adding to the appellant’s taxable capital in calculating the tax
on large corporations (Part I.3 of the Income Tax Act (the ITA)) the
amounts recorded in the “progress payments on accounts payable” and “progress
payments on inventory” accounts under liabilities on the appellant’s balance
sheets for the 1995 to 1998 taxation years?
[3] For the reasons that follow, I find that the
amounts in question must be included in the appellant’s taxable capital.
Facts
[4] The parties reached a partial
agreement on the fact which is reproduced in part below:
[TRANSLATION]
1. During the years in issue, namely the 1995,
1996, 1997 and 1998 taxation years, the appellant, a Canadian corporation,
operated a business manufacturing defence products.
2. During those years, most of the appellant’s
contracts were with the Department of National Defence (. . . “DND”).
3. The contracts between the appellant and the
Government of Canada are “defence contracts” within the meaning of the Defence
Production Act . . . .
4. Each year, the appellant and DND negotiated a
comprehensive agreement governing most DND orders in a taxation year, as
indicated in the comprehensive agreement for the 1998 taxation year, attached
hereto as Appendix 1, and forming part hereof.
5. In accordance with the contracts, the appellant
claimed from DND progress payments for the reimbursement of certain expenses
incurred by presenting forms identified as “Claims for Progress Payment.”
6. The contracts are cost-plus agreements.
7. At different times during a taxation year, DND
placed orders with the appellant to put a product in production, which orders
specified the quantity and the estimated cost of production.
8. Under the contracts between the appellant and
DND, the latter undertook to make payments related to the contracts in the
following situations:
·
A claim is submitted by the presentation of
forms identified as “Claims for Progress Payment”, supported by vouchers
approved by DND, for the reimbursement of certain expenses incurred, including
the reimbursement of intangible expenses such as labour costs and
manufacturing overhead (progress payment). The amounts are included in the
“progress payments on inventory” item.
·
A claim is submitted for the reimbursement of
progress payments made to authorized suppliers or subcontractors (progress
payment). The amounts are included in the “progress payments on accounts
payable” item.
·
Following invoicing by the appellant and after inspection
of the finished products (final payment).
9. In accordance with the contracts entered into
with DND, the appellant regularly submitted the “Claims for Progress Payment” forms
for the manufacturing costs incurred, without the product being finished or
physically transferred to DND, however.
10. The amounts paid by DND pursuant to the
“Claims for Progress Payment” included intangible expenses such as labour costs
and manufacturing overhead.
11. Progress payments, whether on inventory or
accounts payable, did not usually include any element of profit.
12. With respect to these payments, the appellant
recorded the following amounts as liabilities on its balance sheets for the
taxation years in issue, as indicated in the financial statements attached to
this agreement as Appendix 2 and forming part hereof:
|
|
1995
|
1996
|
1997
|
1998
|
|
Progress payments on accounts payable
|
$ 3,256,213
|
$3,019,929
|
$5,473,603
|
$11,713,637
|
|
Progress
payments on inventory
|
$46,941,675
|
$68,310,727
|
$21,503,276
|
$78,603,587
|
|
Total
|
$50,197,888
|
$71,330,656
|
$26,976,879
|
$90,317,224
|
13. The appellant did not report those amounts in
its taxable capital in calculating Part I.3 tax for the taxation years in issue
. . . .
14. The appellant received the progress payments
listed in paragraph 12 at various stages of the production of products that
were not yet finished, with the obligation to deliver the said products, when
finished, within the deadline.
15. The amounts shown as liabilities on the appellant’s
balance sheet under “progress payments on accounts payable” are of exactly the
same nature as the amounts shown on the appellant’s balance sheet for all the
years in issue under “progress payments on inventory”: they are amounts
invoiced to the Government of Canada by the appellant with respect to supplies purchased
by the latter in the performance of the said contracts with the Government of
Canada.
16. The only difference between the “progress
payments on accounts payable” and the “progress payments on inventory” is that
the former involve goods ordered by the appellant but not delivered, for which
the appellant must make payment.
17. During the years in question, the appellant
adopted as a method of accounting with respect to its income the completed
performance method, which consisted in reporting income generated from the
contracts at the time of delivery of the finished products.
18. According to the appellant, the amounts
received are progress payments that must be excluded from the calculation of
income for the purposes of Part I tax and are not progress payments but rather
income generated from sales for the purposes of calculating Part I.3 tax.
19. Those progress payments were not included in
the income of the appellant, which reported its income, for accounting
purposes, by adopting the completed performance method. According to the appellant,
the income shown on the financial statements already took into account that
non-inclusion and the progress payments are not part of its taxable income for
the purposes of Part I of the Act.
20. Under the contracts entered into with DND, the
latter only purchased products that were finished and not products that were at
the manufacturing stage, even though DND made progress payments (advances)
guaranteed by material already produced.
21. The contracts between the appellant and DND
stipulated that the title to the goods covered by the “progress payments on
accounts payable” was transferred to the Government of Canada at the time of
payment, but also provided that the appellant retained possession of the
products at the manufacturing stage, thus assuming the risks associated with
the possession of the products and responsibility for the delivery of the
product when it was finished.
22. [This paragraph
contains contract provisions that are reproduced in paragraph 8 i) below.]
23. The transfer of property mentioned in
paragraph 21 did not constitute acceptance by the Government of Canada of
materials, work in process or finished work.
24. In calculating the appellant’s capital for the
purposes of Part I.3 tax, the Minister of National Revenue included progress
payments received for each of the years in issue as loans or advances . . . .
27. On February 5, 2003,
the respondent issued a Notice of Reassessment to the appellant for its
taxation year ending December 31, 1996, making therein the following changes to
the calculation of Part I.3 tax:
|
|
Reassessment
|
Amount Reported
|
Difference
|
|
Taxable capital employed in
Canada
|
$ 164,843,318
|
$93,212,662
|
$ 71,630,656
|
|
Gross amount of
Part I.3 tax
|
$370,897
|
$209,728
|
$161,169
|
|
Surtax credit
|
($225,611)
|
($209,728)
|
($15,883)
|
|
Part I.3 tax
|
$145,286
|
$0
|
$145,286
|
. . .
[5] For all the years in issue, Note 6 to the
financial statements
states as follows [TRANSLATION]: “The progress payments on inventory, in the
amount of $ . . . from the Government of Canada, are guaranteed by an
assignment of inventory.”
[6] No evidence was presented pertaining to
generally accepted accounting principles.
[7] The parties filed the eight appendices that
form part of the partial agreement (Exhibit I-2). By consent, the respondent’s
book of documents was filed (Exhibit I-1). A witness, Jacques Saint-Martin, an
accountant, provided explanations with respect to the respondent’s book of
documents. Excerpts from the examinations for discovery of Lyne Bouchard were
filed by the respondent.
[8] It is useful to reproduce certain contract
provisions
of which I have underlined certain parts:
a) purpose
of the contract:
A.2 . . .
2.1 To supply various types of ammunition
(Small and Large Calibre) listed at Appendix "A” and related items for the
Government fiscal year 1998/99. . . . .
b) defence
contract:
A.6 . . .
6.1 This Contract is a
Defence Contract within the meaning of the Defence Production Act and shall
be read accordingly.
c) Payments
— fixed costs and overhead, variable costs:
D.1 COST
1.1 Fixed Overhead and
General and Administrative Overhead Expenses
[The contract provides for a fixed amount every month.]
1.2 Related Profit on Fixed Expenses
[The contract provides for four fixed payments. The three first
payments are to be made at the end of each of the first three quarters. The fourth
is not payable until after final verification by the government, after agreement
on costs, and after all the work has been completed under the comprehensive
agreement.]
D.2 PROGRESS PAYMENTS
2.1 Progress payments for Variable Costs shall
be made not more frequently than twice a month and will be made upon the
following terms . . . .
. . .
2.4 For each unit delivered by the Contractor,
the Profit on Variable Costs calculated in accordance with Appendix
"C.1", will be payable upon delivery and acceptance by Canada.
2.5 Upon delivery and acceptance of the last item
of the total items of each Work Order, any remaining balance of volume
overheads on the Work Order, shall be claimable in full on a progress claim. .
. .
D.4 . . .
4.3 Progress payments shall be regarded as
interim payments only and the Minister shall have the right to conduct
interim cost and time verifications or audits and to make adjustments from time
to time during the performance of the Work. Any overpayment whether
resulting from such progress payments or otherwise shall be promptly
refunded to Canada . . . .
d) payments
to subcontractors:
D.5 CONTRACTOR’S
DOWNPAYMENTS TO SUBCONTRACTORS
5.1 Following release of a Work Order for a
requirement requiring a downpayment to its suppliers and submission of a duly
completed claim for progress payment . . . the Contractor shall be allowed to
claim for the downpayment to its suppliers. The Contractor certifies that, the
funds to be paid in accordance with such claims for progress payment will be
paid solely for the purpose of the Work Order. . . .
5.2 The Contractor shall not claim for payments in
support of downpayments to subcontractors until an irrevocable Letter of Credit
from a Canadian Bank in favour of Canada is in place and accepted by the Contracting Authority.
e) reduction or suspension
of payments:
D.7 REDUCTION OR SUSPENSION OF PAYMENT
7.1 Notwithstanding anything contained in this
Contract, if the Contracting Authority has determined that:
a) the Contractor has failed to perform or
discharge any term or condition of the Contract; or
b) the Contractor has failed to pay the cost of
performance of the Contract on a current basis in the ordinary course of
business including all payments to Suppliers and Subcontractors; or
c) the amount of the allowable costs incurred by
the Contractor is less than the aggregate of the amount of progress payments
made to the Contractor. Then, the Contracting Authority may reduce or suspend
any payment otherwise payable to the Contractor, until the cause of such
reduction or suspension has been resolved to the satisfaction of the
Contracting Authority.
f) final
payment:
D.8 . . .
8.1 No final payment
shall be made to the Contractor until:
a) all commercial invoices,
certificates of conformity and related documents have been submitted in
accordance with this Contract;
b) all such commercial invoices, certificates of
conformity and related documents have been verified by DAPM-3 and the
Contracting Authority; and
c) the Contractor certifies that all the Work is
free from claims, demands, charges, liens or other encumbrances, including
those of any government, in respect of taxes, charges or otherwise.
g) acceptance:
E.5 . . .
5.1 Acceptance of the
deliverables shall be effected through the execution by a DND Representative of
the Quality Assurance Certificate of Inspection and Release . . . . Acceptance
and delivery are conditions precedent to the obligation of Her Majesty to pay
the amount claimed in any progress claim or invoice submitted by the
Contractor.
h) general
conditions — definitions:
GENERAL CONDITIONS DSS-MAS 9601
9601 01 (16/02/98) Interpretation
In the Contract, unless the context otherwise
requires . . .
“Government Property” means all materials, parts,
components, specifications, equipment, software, articles and things supplied
to the Contractor . . . for the purposes of performing the Contract
and anything acquired by the Contractor in any manner in connection with
the Work the cost of which is paid by Canada under the Contract
and, without restricting the generality of the foregoing, includes Government
Issue as defined in the Defence Production Act, R.S.C. 1985, c. D-1,
Government Furnished Equipment and Government Supplied Materiel; . . .
“Work” means the whole of the activities, services,
materials, equipment, software, matters and things required to be done,
delivered or performed by the Contractor in accordance with the terms of
the Contract. . . .
3. If the Contract is a defence Contract within the
meaning of the Defence Production Act, R.S.C. 1985, c. D-1, it is
subject to that Act and shall be governed accordingly. . . .
i) title:
GENERAL CONDITIONS DSS-MAS 9601
9601 19 (04/01/94) Title
1. Except as otherwise provided in the Contract
including the intellectual property provisions, and except as provided in
subsection 2, title to the Work or any part thereof shall vest in Canada upon delivery and acceptance
thereof by or on behalf of Canada.
2. Except as otherwise provided in the
intellectual property provisions of the Contract, upon any payment
being made to the Contractor for or on account of materials, parts,
work-in-process or finished work, either by way of progress payments or
accountable advances or otherwise, title in and to all materials, parts,
work-in-process and finished work so paid for shall vest in and remain in Canada
unless already so vested under any other provision of the Contract.
3. Notwithstanding any vesting of title referred
to in this section and except as otherwise provided in the Contract, the
risk of loss or damage to the materials, parts, work-in-process or finished
work or part thereof so vested shall remain with the Contractor until
their delivery to Canada in accordance with the Contract. The
Contractor shall be liable for any loss or damage to any part of the Work
caused by the Contractor or any subcontractor after such delivery.
4. Any vesting of title referred to in
subsection 2 shall not constitute acceptance by Canada of the
materials, parts, work-in-process or finished work, and shall not relieve the Contractor
of its obligation to perform the Work in accordance with the Contract.
5. Where title to any materials, parts,
work-in-process or finished work becomes vested in Canada, the Contractor
shall, upon the Minister's request, establish to the Minister's
satisfaction that the title is free and clear of all claims, liens,
attachments, charges or encumbrances and shall execute such conveyances thereof
and other instruments necessary to perfect that title as the Minister
may request.
6. If the Contract is a defence Contract
within the meaning of the Defence Production Act, R.S.C. 1985, c. D-1,
title to the Work or to any materials, parts, work-in-process or
finished work shall vest in Canada free and clear of all claims, liens,
attachments, charges or encumbrances, and the Minister shall be entitled
at any time to remove, sell or dispose of it or any part of it in accordance
with section 20 of that Act. . . .
9601 21 (04/01/94) Government Property
1. Unless otherwise provided in the Contract,
all Government Property shall be used by the Contractor solely
for the purpose of the Contract and shall remain the property of Canada, and . . . .
2. The Contractor shall take reasonable
and proper care of all Government Property . . . and shall be
responsible for any loss or damage resulting from its failure to do so other
than loss or damage caused by ordinary wear and tear.
3. All Government Property, except such
as is installed or incorporated into the Work, shall, unless otherwise
specifically provided in the Contract, be returned to Canada on demand. . . .
j) default by the
contractor:
9601 26 (04/01/94) Default by the Contractor
1. Where the Contractor is in default in
carrying out any of its obligations under the Contract, the Minister
may, upon giving written notice to the Contractor, terminate for default
the whole or any part of the Contract, either immediately, or . . . .
2. Where the Contractor becomes bankrupt
or insolvent, makes an assignment for the benefit of creditors, or . . . the Minister
may, to the extent permitted by the laws of Canada, upon giving notice to the Contractor, immediately terminate
. . . .
3. Upon the giving of a notice provided for in
subsection 1 or 2, the Contractor shall have no claim for further
payment other than as provided in this section, but shall be liable to Canada
for any amounts, including milestone payments, paid by Canada and for
all losses and damages which may be suffered by Canada by reason of the
default or occurrence upon which the notice was based, including any increase
in the cost incurred by Canada in procuring the Work from another
source. The Contractor agrees to repay immediately to Canada the portion of any advance
payment that is unliquidated at the date of the termination. Nothing in this
section affects any obligation of Canada under the law to mitigate damages.
4. Upon termination of the Contract
under this section, the Minister may require the Contractor
to deliver to Canada, in the manner and to the extent directed by
the Minister, any completed parts of the Work which have
not been delivered and accepted prior to the termination and any materials,
parts, plant, equipment or work-in-process which the Contractor has
acquired or produced specifically in the fulfilment of the Contract.
5. Subject to the deduction of any claim that
Canada may have against the Contractor arising under the Contract
or out of the termination, Canada shall pay or credit to the Contractor
the value, determined on the basis of the Contract Price including
the proportionate part of the Contractor’s profit or fee included in the
Contract Price, of all completed parts of the Work delivered
to Canada pursuant to a direction under subsection 4 and accepted by
Canada, and shall pay or credit to the Contractor the cost to
the Contractor that the Minister considers reasonable in respect
of all materials, parts, plant, equipment or work-in-process delivered to Canada
pursuant to a direction under subsection 4 and accepted by Canada, but
in no event shall the aggregate of the amounts paid by Canada under the Contract
to the date of termination and any amounts payable pursuant to this subsection
exceed the Contract Price.
6. Title to all materials, parts, plant,
equipment, work-in-process and finished work in respect of which payment is
made to the Contractor shall, upon such payment being made, pass to and
vest in Canada unless already so vested under any other provision of the
Contract, and such materials, parts, plant, equipment, work-in-process
and finished work shall be delivered . . . .
[9] Jacques Saint-Martin testified,
providing explanations regarding the table he prepared (found at Tab 7 of
Exhibit I-1). The purpose of the table is to reconcile the source of the
progress payments shown on the balance sheet with the following three sources:
a) the progress payments
received on accounts payable,
b) the portion of the
progress payments on inventory that is reflected in the progress payments
(clause D.2 of the contract); and
c) the portion of the
progress payments on inventory that are reflected in the fixed costs (clause
D.1 of the contract).
[10] Mr. Saint-Martin was unable to completely
reconcile the sum of $78 million shown on the 1998 balance sheet as
“progress payments on inventory” with the documents he received from the appellant;
he was, however, able to establish that more than $30 million came from
progress payments. We can conclude that the progress payment amounts for fixed costs
were also significant.
Statutory provisions
[11] The tax on large corporations applies to
certain corporations. This tax is a specified percentage of “taxable capital.” The
“taxable capital” is equal to the corporation’s “capital” less the “capital
deduction.”
[12] In the case of corporations that are not
financial institutions, “capital” is defined in subsection 181.2(3) of the
ITA and includes, inter alia, in paragraph (c):
(c) the amount of all loans and advances to the
corporation at the end of the year.
[13] No other element of the
subsection is pertinent to this dispute and the sole issue is whether the
amounts in question are “advances” within the meaning of
subsection 181.2(3) of the ITA.
[14] Subsection 181(3) of the ITA must
also be taken into account in analyzing this issue. The relevant portions of that
subsection read as follows:
(3) For the
purposes of determining the carrying value of a corporation’s assets or any
other amount under this Part in respect of a corporation’s capital . . .
. . .
(b) . . . except as otherwise provided in this Part, the
amounts reflected in the balance sheet
(i) presented to the
shareholders of the corporation . . . or, where such a balance sheet was not prepared in
accordance with generally accepted accounting principles or . . . the amounts that
would be reflected if such a balance sheet had been prepared in accordance with
generally accepted accounting principles . . . .
[15] Finally, section 20 of the Defence
Production Act provides as follows:
20 If, by the
terms of a defence contract, it is provided that title to any government issue
or building furnished or made available to a person or obtained or constructed
by the person with money provided by Her Majesty . . . remains vested or vests in Her Majesty . . . free
and clear of all claims, liens, prior claims or rights of retention within the
meaning of the Civil Code of Québec or any other
statute of the Province of Quebec, charges or encumbrances, then, despite any
law in force in any province,
(a) the title to the
government issue or building remains vested or vests in accordance with the
terms of the contract free and clear of all claims, liens, prior claims or
rights of retention within the meaning of the Civil Code of
Québec or any other statute of the Province of Quebec, charges or
encumbrances; and
(b) subject to any provisions
in the contract, Her Majesty or the associated government in whom the title is
vested is entitled at any time to remove, sell or dispose of the government
issue or building.
[16] The same Act defines “government issue” and
“defence supplies” as follows in section 2:
“government issue” means
machinery, machine tools, equipment or defence supplies furnished by the
Minister . . . or acquired or purchased on behalf of Her Majesty . . . with
funds provided by the Minister . . . .
“defence supplies” means
(a) arms, ammunition, implements of war, vehicles,
mechanical and other equipment . . . articles, materials, substances and things
required or used for the purposes of the defence of Canada or for cooperative
efforts for defence being carried on by Canada . . .
. . .
(c) articles, materials, substances and things of all
kinds used for the production or supply of anything mentioned in paragraph (a) or (b) or for the construction
of defence projects.
Parties’ positions
[17] The appellant submits that the progress
payments received on accounts payable, as well as the portion of the progress
payments on inventory that is reflected in the portion of the progress payments
related to the cost of inventory (clause D.2 of the contract), are not
“advances,” and therefore, are not to be taken into account in calculating the
taxable capital under paragraph 181.2(3)(c) of the ITA. On the other
hand, the appellant recognizes that the portion of the progress payments on
inventory related to the fixed costs must be included in calculating the
capital (clause D.1 of the contract).
[18] According to the appellant, the amounts in
question represent the acquisition cost paid by Canada to obtain title to the
materials, parts or finished products purchased by SNC, to the work in process
and, ultimately, to the finished products before acceptance and delivery of the
end product (hereinafter: inputs and intermediate products). Accordingly, the
amounts cannot be “advances.”
[19] The respondent submits, first, that,
considering the balance sheet and subsection 181(3) of the ITA, the
amounts in question are advances and, second, that the progress payments in
question are not derived from sales and are advances, even if
subsection 181(3) is disregarded. The respondent also submits that what we
have here is a guarantee and not an absolute transfer of title.
Analysis
[20] There are accordingly two questions to
consider:
a) If
subsection 181(3) of the ITA is disregarded, are the amounts in question
payments for the acquisition of inputs and intermediate products that cannot be
considered “advances”?
b) Must those amounts be
treated as advances under subsection 181(3) of the ITA?
The resolution of this dispute is to be found in the answer
to the second question. The analysis of that question begins at paragraph 38
below.
Acquisition/sale?
[21] The contract herein is quite unique in that it
provides that all inputs and intermediate products become the property of
Canada as soon as the appellant receives the progress payments related to the
purchases or work in question.
The result of the contract, as well as of section 20 of the Defence
Production Act, is that those goods, once acquired by Canada, cannot in any
case become the property of the appellant.
[22] Are the amounts in question
payments for the progressive acquisition of all the goods as they are purchased
or manufactured? Is there a sort of ongoing sale of all the goods?
[23] The following factors support such an
interpretation:
a) as described in
paragraph 21 above:
i) the ongoing acquisition
of title to inputs and intermediate products, which acquisition takes place
before the government accepts anything;
ii) the fact that the
contract does not provide for any circumstances under which title to the goods
could vest in the appellant;
b) section 20 of the Defence
Production Act providing that Canada is free to
remove or dispose of the goods;
c) the fact that the
contract provides that, when ammunition is sold to third parties other than Canada (a situation that does not apply in the present case),
the appellant acquires title to the ammunition just before the completion of
the sale by the appellant to the third party.
[24] However, the following factors must
also be taken into consideration:
a) it
is stipulated in the contract
that the progress payments are interim payments that are subject to
verification and adjustment; there is therefore a possibility of reimbursement;
b) the appellant cannot claim
amounts related to the payments made to subcontractors until an irrevocable
letter of credit in favour of Canada has been issued; the respondent contends
that this is a form of guarantee;
c) acceptance and delivery
are preconditions to any obligation to pay any amount claimed as a progress
payment;
d) in
provision 9601 19, paragraph 4, of the contract, it is provided
that the acquisition of title to inputs and intermediate products by Canada does not constitute an acceptance of the goods;
e) the purpose of the
contract is to sell ammunition and not inputs or intermediate products in the
ammunition manufacturing process;
f) in the normal course of
things, Canada would never take possession of inputs and
intermediate products that are transformed during the production of goods;
g) the fact that the risk
is on the appellant until delivery.
[25] In both civil law and common law, the basic
components of a sale are the same.
It is a contract whereby the vendor and the purchaser agree to the transfer of
the ownership of property to the purchaser by the vendor in consideration of a
price in money to be paid by the purchaser.
[26] Although the purpose of the contract herein is
the supply of ammunition and not of inputs and intermediate products, the
provisions of the contract very clearly state that there is to be a transfer of
ownership of the inputs and intermediate products in consideration of the
payment of a sum of money. Although the consideration may be adjusted after
verification, there is nonetheless a consideration. There is therefore a sale.
It is not a guarantee.
[27] The other considerations listed in paragraph
24 do not change this finding.
a) The progress payments,
which represent the price at each step in the acquisition of inputs and intermediate
products are not fixed, but are determinable. Given that they are determinable,
it is normal that there could be adjustments, but that does not alter their
nature.
b) That acquisition is not
acceptance does not change the fact that there is a sale, considering that
nowhere is it provided that the appellant can acquire ownership of the
ammunition.
c) As for the risk, it is
possible for two parties to agree to have the person who has possession of the property
assume the risk in the owner's place.
d) Likewise, the purchaser
of an input or intermediate product is entirely free to give it to another
person to transform it.
e) As for the payments made
to subcontractors, the mere fact that they are subject to the issuance of a
letter of credit does not alter the fact that there is a sale. There is however
a specific aspect of progress payments to suppliers that I will address in
paragraph 35 below.
[28] Clause E.5.1 seems to run
counter to the concept of a sale. It stipulates that delivery and acceptance
are conditions precedent to any obligation to make a progress payment.
Considering that acceptance and delivery occur only with respect to the finished
product, that would imply that all progress payments made prior to acceptance
would be voluntary.
[29] Reading the contract as a whole, specifically
clauses D.2, D.3 and D.4,
it is impossible for me to conclude that the progress payments are voluntary
prior to acceptance. With the exception of the profit related to the variable
cost that is payable only after delivery and acceptance, the contract states
that there is an obligation to make the progress payments over a fixed period, provided that
the appellant meets the various conditions, in particular with regard to
documentation. The payments may then be verified and, possibly, reimbursed, but
that does not release Canada from its obligation to make the payments.
[30] The payments in question also serve to finance
the overall process of the production of the ammunition that is the object of
the contract. This is not inconsistent with the fact that they are
consideration for the purchase of inputs and intermediate goods.
[31] The parties brought to my attention most interesting
case law concerning Part I.3 of the ITA.
In light of my conclusion that the answer to the second question contains the resolution
of this dispute, I will simply make two comments. First, once a sale has actually
taken place, that case law cannot lead to the conclusion that there was an
advance—again leaving aside subsection 181(3) of the ITA. Second, the facts in
the present case are quite unique. I note that in Oerlikon Aérospatiale Inc.
v. Canada,
the contractual relationship was different.
[32] To conclude, I agree with the appellant that
the progress payments are payments made in consideration of the acquisition of
inputs and intermediate products. This may seem surprising in that Canada’s ultimate purpose was the purchase of ammunition.
However, it is the result of the specific contractual structure that Canada put
in place—no doubt in order to have the greatest amount of control possible over
ammunition and anything that could be used to manufacture ammunition.
[33] Leaving aside subsection 181(3) of the
ITA, we could conclude that the amounts in question were payments and that,
therefore, they could not be advances.
[34] Nevertheless, even if that did resolve the
issue, certain nuances would have to be taken into account in making a
reassessment.
[35] First, the situation regarding the progress
payments on accounts payable is different from that with respect to the
progress payments on inventory that are reflected in the progress payments. The
amounts are related to goods ordered by the appellant, but not delivered. The contract
between the government and the appellant is not binding on the subcontractors. Consequently,
none of the provisions stipulating that Canada acquires title to the goods can
have effect until the property is transferred from the subcontractors to the appellant.
The Minister would have to determine which portions of those progress payments,
at the end of the fiscal year, represent amounts laid out for goods that are no
longer the property of the supplier; only those portions would be excluded from
capital.
[36] Second, as the appellant has conceded, it
would also be necessary to apportion the progress payments on inventory between
the portion related to fixed costs and the portion related to inventory; only
the portion related to inventory would be excluded.
[37] Finally, we would have to take into account the
concession made by the appellant in recognizing that the Minister was correct
in adding to capital for the 1996 fiscal year an amount of $300,000 that is not
related to this dispute.
Subsection 181(3) and accounting treatment
[38] The progress payments in question were
included on the balance sheet as advances and were not treated as income in the
financial statements. The respondent contends that, accordingly, subsection
181(3) of the ITA has the effect of including those amounts in capital for the
purposes of the tax on large corporations.
[39] The appellant responds that Note 6 to the
balance sheet, which note is part of the financial statements, clearly
indicates that there was a transfer of goods and that the inventory in question
no longer belongs to the appellant. The balance sheet presented stems from the
fact that the taxpayer uses the completed performance method to report its
income. As for the fact that Note 6 also mentions a guarantee, the appellant
submits that one must look at the contract and determine its true nature.
[40] The appellant also submits that it is
necessary to consider this issue in the specific context of defence, taking
into account not only section 20 of the Defence Production Act, but
also the will of the government to exercise the greatest amount of control
possible over hazardous materials, namely ammunition.
[41] Before considering those submissions, it would
be useful to look at the applicable law.
[42] Subsection 181(3) of the ITA provides for the
use of amounts
. . . reflected in the balance sheet . . . presented to the
shareholders of the corporation . . . or, where such a balance sheet was not
prepared in accordance with generally accepted accounting principles or . . . the amounts that would
be reflected if such a balance sheet had been prepared in accordance with
generally accepted accounting principles . . . .
[Emphasis added.]
One must therefore take the balance sheet as the
starting point unless it is demonstrated that the balance sheet is not
consistent with generally accepted accounting principles.
[43] In the decision Ford Credit Canada Ltd. v.
Canada,
of the Federal Court of Appeal, Ryer J.A. wrote as follows:
27 . . . provided that the
balance sheet in question has been prepared in accordance with GAAP and
otherwise complies with the specific provisions of Part I.3, that balance sheet
must be accepted for the purposes of the determination of the LCT liability of
the corporation.
28 This is not to say that the
Minister or the courts are precluded from any consideration of a balance sheet
that is said to have been prepared in accordance with GAAP. It
would always be open to the Minister to argue that the balance sheet
description of a particular item was not in fact in accordance with GAAP. The
courts would then be required to adjudicate the question, having regard to
expert accountancy evidence. . . .
30 It is undisputed that the
amounts reflected in the balance sheets of Ford Credit in respect of the Class
C Shares . . . were
properly characterized as liabilities of Ford Credit under GAAP. Moreover,
there was no suggestion that any provision of Part I.3 specifically mandated an
alternate characterization. Accordingly, for the reasons given, those amounts
are not required to be included in the capital of Ford Credit, for the purposes
of Part I.3 of the ITA, in any of those taxation years.
[44] Accordingly, the balance sheet
has to be used to calculate the tax on large corporations,
a) unless another specific
provision respecting the tax on large corporations applies; or
b) unless the evidence
establishes that the balance sheet is not consistent with generally accepted
accounting principles.
[45] Here, there is no other provision that applies
and there is no accounting evidence that the appellant’s balance sheet was not
prepared in accordance with generally accepted accounting principles.
[46] What is the impact of Note 6 to the
financial statements? Note 6 is contradictory; it speaks of a “transfer”,
which appears to suggest a sale of inventory; however, it also speaks of a
guarantee, which appears to suggest that what is involved is a means of
financing and that the appellant did not do everything that was required in
order for the progress payments in question to be considered income.
Note 6 does not settle the debate.
[47] What is significant is the very fact that the
progress payments in question were recorded as a liability on the balance sheet
rather than being treated as income. That was an accounting choice; the evidence
does not allow us to know the accounting reasons behind that choice. Subsection
181(3) dictates that the balance sheet must be accepted.
[48] It is perhaps surprising that, leaving aside
subsection 181(3) of the ITA, the result is different from that which
would be obtained through the application of that subsection, but that is the
consequence of the choice made by Parliament.
[49] I must conclude that for the purposes of the
tax on large corporations, the Minister was correct in adding to the appellant’s
taxable capital the amounts recorded in the “progress payments on accounts
payable” and “progress payments on inventory” accounts under liabilities on the
appellant’s balance sheets for the 1995 to 1998 taxation years.
[50] Accordingly, the appeal must be dismissed.
Before signing the judgment, I will ask the Registry to contact the parties to
ask them if they would like to make any submissions on the matter of costs.
[51] Finally, I would like to thank counsel for the
parties for their excellent presentation of the case.
Signed at Ottawa, Canada, this
15th day of August 2008.
“Gaston Jorré”
Translation
certified true
on this 16th day
of July 2009.
Erich Klein,
Revisor
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