Citation: 2008TCC236
Date: 20080515
Docket: 2006-1817(IT)G
BETWEEN:
ADP CANADA CO. (SUCCESSOR TO CANADIAN
AUTOMATIC DATA PROCESSING SERVICES LTD.),
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Archambault J.
[1] ADP Canada Co. (ADP)
is appealing reassessments for the 1999 and 2001 taxation years. With respect
to the latter year, the issues are whether the Minister of National Revenue (minister)
was entitled to add to ADP's capital, for the purpose of calculating the tax on
large corporations under Part I.3 of the Income Tax Act (Act),
an amount of $1,104,129,044 ($1.1 billion) as advances, and whether
he could disallow an amount of $397,929 paid as damages by ADP to its clients.
With respect to the 1999 taxation year, the minister disallowed the carry‑back
of a surtax credit of $140,759. The success of the appeal with respect to that
taxation year depends entirely on the treatment of the $1.1 billion
adjustment to ADP’s capital.
Facts
[2] The parties filed at
the outset of the hearing an Amended Partial Agreed Statement of Facts, of which
I reproduce here the most relevant portions:
. . .
6. The Appellant carries on a business
under which it provides its clients with an integrated payroll and payroll
taxes services for a fee (the “payroll‑processing fees”).
7. The duties and obligations of the
Appellant and its clients are setout [sic] in an agreement signed by
each party.
8. The Appellant pays, on behalf of
its clients, to their employees, their salaries and pays, to the tax
authorities, the withholding taxes relating to those salaries.
9. The obligation to pay the salaries and
to make the applicable withholding tax remittances to the tax authorities is an
obligation of the clients of the Appellant, not the Appellant’s own legal
obligation.
10. The contractual obligation of the
Appellant toward its clients is limited to the payroll services, including the
payment of the salaries to its Clients’ employees and the payment of the
applicable withholding tax remittances to the tax authorities made on behalf of
its clients.
11. The only remuneration paid to the
Appellant by its clients is the payroll‑processing fees.
12. For the taxation year ended June 30th,
2001, the Appellant earned payroll‑processing fees for a total amount of
$130,520,848.
13. In addition to processing its
clients’ payroll data (i.e. calculating the amount of wages owed by its
clients to their employees as well as the amount of withholding taxes its
clients are obligated to remit to the relevant taxing authorities), the
Appellant’s payroll and tax filing services also include the making of actual
payments, on behalf of its clients, to its clients’ employees and to the tax
authorities.
14. Such payments are initiated or drawn from
the Appellant’s bank accounts, not from its clients’ bank accounts.
15. In the course of its payroll services
business, the Appellant collects funds from its clients to pay their employees
on their respective paydays and to pay, to the relevant tax authorities, the
withholding taxes relating to those salaries.
16. The Appellant’s clients are required
to pay in advance to the Appellant, up to 48 hours prior to the
initiation by the Appellant of any correlating payroll payments to its clients’
employees, all amounts associated with their payroll, including the relevant
payroll‑processing fees, plus any withholding taxes that are to be
remitted on their behalf to the respective tax authorities.
17. Those amounts are held by the
Appellant for a period of 3 to 45 days
before payment of the salaries and the appropriate withholding taxes to the
tax authorities, depending on the remittance deadline provided for each client.
18. Those amounts provide partial
protection to the Appellant regarding potential funding breaches by clients in
respect of subsequent payrolls.
19. A portion of each payment made to the
Appellant by its clients represents an amount to be paid to certain tax
authorities that do [sic] not become due until some time after the pay
date in question. However, for matters of simplicity, clients pay the Appellant
all amounts applicable to a particular payroll at one time.
20. The amounts of salaries, withholding taxes
and payroll‑processing fees paid to the Appellant by its clients are kept
in separate account of the Appellant until paid to the employees, paid
to the tax authorities or earned by the Appellant, as the case may be.
21. Those pre-funded amounts are referred
to in this Amended Partial Agreed Statement of Facts as the “Funds Held for
Clients” and the Appellant’s respective obligations toward its clients are
referred to as the “Client Funds Obligations”.
22. Whenever the Appellant receives an
amount from its clients for the payment of its payroll and appropriate
withholding taxes, the Client Funds Obligations account is credited by the
amount received and the Funds Held for Clients account is debited by the same
amount.
23. Whenever the Appellant pays salaries
and thereafter makes withholding tax remittances to tax authorities on behalf
of its clients, the Client Funds Obligations account is debited by the amount
paid by the Appellant and the Funds Held for Clients account is credited by the
same amount.
24. Whenever the payroll‑processing
fees paid to the Appellant by its clients are earned by the Appellant, the
Client Funds Obligations account and the Bank account are debited by the
amount earned and the Funds Held for Clients account and the Revenue account
are credited by the same amount.
25. In its trial balance for the fiscal
period ended June 30th, 2001, the Appellant reported a debit balance
of $1,104,129,044 in the Funds Held For Clients account and a credit balance of
the same amount in the Client Funds Obligations account.
26. Of the amount shown as Client Funds
Obligations in the Appellant’s June 30th, 2001, trial balance, only
the portion relating to the payroll‑processing fees payable to the
Appellant was eventually recognized as income for accounting and tax purposes.
27. It is the amount of $1,104,129,044
reported as Client Funds Obligations in the Appellant’s June 30th,
2001, trial balance that the Minister added, by reassessment dated
January 7th, 2005, to the Appellant’s “capital”, “taxable
capital” and “taxable capital employed in Canada” for the purposes of the
application of subsection 181.1(1) of the ITA to the Appellant’s
taxation year ended June 30th, 2001.
28. As of June 30, 2001, the Appellant
held in the Funds Held for Clients account the following amounts on account of
the fees payable by its clients that were earned and recognised as income for
income tax purposes but not yet transferred to its bank account:
|
Fees
|
$4,583,744.78
|
|
GST and HST
|
335,247.97
|
|
QST
|
89,414.33
|
|
Total
|
5,008,407.08
|
29. As a result of the increase mentioned
in paragraph 27 of this Amended Partial Agreed Statement of Facts,
made by the Minister, to the Appellant’s “capital”, “taxable capital” and
“taxable capital employed in Canada”, the Minister disallowed, by reassessment
dated January 7th, 2005, to the Appellant a carry back of unused
surtax credit of $140,759 in the computation of its tax payable under Part I.3
of the ITA, for its taxation year ended June 30th, 1999.
30. The amounts included by the Appellant
in the Funds Held for Clients account as of June 30, 2001, were in respect of
salaries and withholding tax remittances to the tax authorities that were
payable after June 30th, 2001, and payroll‑processing fees
earned by the Appellant but not yet transferred to its bank account.
31. The amounts of the Funds Held For
Clients and the Client Funds Obligations accounts were not reported in the
Appellant’s balance sheet for its fiscal period ended June 30th,
2001, filed with its 2001 tax return.
32. The financial statements filed by the
Appellant with its 2001 tax return were not audited but included a “Notice to
Reader”. No notes to the financial statements were attached.
33. According to the generally
accepted accounting principles, the Appellant’s Funds Held For Clients
and Client Funds Obligations accounts should have been disclosed as an asset
and a liability, respectively, in its financial statements or in a
note attached to those financial statements.
34. The Appellant’s payroll services
business is similar to the payroll services businesses of its sister companies.
35. The consolidated balance sheet of the
Appellant’s US parent company, namely Automatic Data
Processing, Inc., filed with its 2001 Annual Report, reported as an asset and
as a liability the “Funds Held For Clients” and “Client Funds Obligations”
accounts, respectively, of the Appellant’s sister companies.
36. The US Securities and Exchange Commission specifically requested that the “Funds
Held For Clients” and “Client Funds Obligations” accounts be treated by the
Appellant’s parent company as an asset and a liability, respectively, in its
financial statements.
37. The Appellant’s Funds Held For
Clients and Client Funds Obligations accounts are now disclosed as an asset and
a liability, respectively, in the Appellant’s financial statements since 2002.
38. The Appellant invests,
primarily in fixed‑income instruments (mostly cash equivalents and
marketable securities), the amounts included in the Funds Held For Clients
account.
39. The interests [sic] on
such investments are recognized by the Appellant in its revenues as
earned.
40. Such interests [sic] amounted to
$57,089,700 in the Appellant’s fiscal period ended June 30th,
2001.
41. In its financial statements for its
fiscal period ended June 30th, 2001, the Appellant’s [sic] reported
income before taxes of $30,280,238.
42. In its fiscal period ended June 30th,
2001, the Appellant paid, to a related US company, fees of $1,168,063 to manage the amount included in the Funds
Held For Clients account.
43. The contracts entered [into] by the
Appellant and its clients provide that when the Appellant is responsible for
missing the withholding tax remittance statutory deadline, the Appellant
shall be responsible for any penalty and interest payable related to late
remittance to the tax authorities.
44. In the course of the payroll services
provided by the Appellant, withholding tax remittances made on behalf of its
clients were occasionally made by the Appellant past the statutory deadline.
45. In its fiscal period ended June 30th,
2001, the Appellant paid $397,929 of penalties and interest with respect to
late withholding tax remittances made on behalf of its clients.
46. Such penalties and interest were paid
by the Appellant in the normal course of doing business.
47. The Appellant claimed a deduction of
this amount of $397,929 in computing its business income for its taxation year
ended June 30th, 2001.
48. By reassessment dated January 7th,
2005, the Minister of National Revenue disallowed this deduction of
$397,929.00.
[Emphasis added.]
[3] Only one witness was
heard, Mr. Brad Surminsky, who has been ADP's chief financial officer since
September 2002. Prior to that, he was vice‑president, finance and banking
affairs. His testimony revealed a few additional facts. For instance, in 2001,
ADP had 27,000 clients whose total payroll amounted to $80 billion; $56 billion
in salaries and $24 billion in government remittances. Mr. Surminsky also
described ADP's modus operandi in processing its clients’ payroll. In a
typical week, the payroll activities would be initiated by the client providing
the information to ADP on Monday. ADP would then prepare a report to the client
for its approval, which approval would normally be received the following day,
on Tuesday. The funds necessary for payment of the salaries and making the
government remittances would normally be received on Tuesday if the salaries were
payable on Thursday. Fifty‑five percent of the clients advanced the
required funds 48 hours ahead of the anticipated payment. Thirty percent
would do so 24 hours before while the remaining 15% would do so on payday.
The reason for making these payments in advance was to ensure that ADP
had the required funds in its bank account when it issued its cheques to the
clients' employees and to the various government agencies.
[4] Given the delay in
making government remittances and given the huge cash flow generated by its
clients' payroll, ADP had under its control large sums of money, a portion of
which would de facto be available to it on a permanent basis. Mr. Surminsky
estimated that approximately $500,000,000 constituted a permanent source of
funds available to ADP, and these funds were used for investment in fixed‑income
assets such as Canadian government obligations. Mr. Surminsky acknowledged that funds made available to ADP “in
advance of . . . making payment(s) to third parties”
would not be invested in risky securities. He also acknowledged that had ADP
lost any of its clients’ funds in these investments, ADP alone would have been liable. All the funds
received by ADP from its clients were put in a single segregated account. It was
from this account that ADP withdrew funds for the payment of its fees and for making
its investments. According to the contractual arrangements with its clients,
ADP was entitled to earn interest on the investment and to keep the interest so
generated of its clients’ funds. The following are some key excerpts from these
arrangements (Exhibit A‑1, Tab 8):
1. PAYROLL TAX FILING AND OTHER RELATED
SERVICES
A. Subject to the terms and
conditions of this Agreement, Canadian Automatic Data Processing Services Ltd.
(“ADP”) agrees to provide Client with any and all of the payroll, payroll tax
filing and other payroll‑related data services covered by this Agreement
or which Client may, from time to time during the term of this Agreement,
request ADP to provide to it (the “Services”).
B(1) . . .
(3) Client acknowledges
and understands that certain of the Services, including, without limitation,
Tax Filing Services, provided by ADP hereunder will require Client to remit
or otherwise make available sufficient, good funds to ADP within the
deadline established by ADP, which funds, subject to this Paragraph
1.B(3), are to be applied by ADP to satisfy Client’s third party
payment obligations covered by the Services (including, without
limitation, as applicable, Client’s payment obligations to its employees and/or
taxing authorities). . . . Client acknowledges and agrees that ADP may
commingle Client’s funds with other clients’, ADP’s or ADP administered funds
of a similar type. . . .
C. IF CLIENT IS REQUIRED TO
REMIT OR OTHERWISE MAKE ITS FUNDS AVAILABLE TO ADP IN ADVANCE OF, AND FOR
THE PURPOSE OF, MAKING PAYMENT(S) TO THIRD PARTIES AS PART OF ADP’S
SERVICES (INCLUDING, WITHOUT LIMITATION, TAX FILING SERVICES OR USE OF ADP
CHEQUES), AMOUNTS EARNED ON SUCH FUNDS, IF ANY, BETWEEN THE DATE(S) OF
ADP’S RECEIPT OF SUCH FUNDS FROM CLIENT OR ADP’S WITHDRAWAL OF SUCH FUNDS FROM
CLIENT’S DIRECT DEBIT ACCOUNT OR OTHER DESIGNATED BANK ACCOUNT AND THE DATE(S)
SUCH FUNDS ARE TO BE PAID TO THIRD PARTIES (INCLUDING, WITHOUT LIMITATION, ANY
TAXING AUTHORITIES OR EMPLOYEES OF CLIENT) WILL BE FOR THE BENEFIT, AND THE
SOLE PROPERTY, OF ADP.
[Emphasis added.]
[5] Mr. Surminsky testified that ADP did not use the funds kept in the
segregated account (which, on the balance sheet for the 2002 taxation year, appears
as “Funds held for clients” (Exhibit A‑1, Tab 7)) to pay
dividends or to pay any operating costs of ADP. They only used them to make investments
and earn interest therefrom. This interest amounted to $57,089,700 for ADP's
2001 fiscal year and represented 28% of its total gross income of $203,549,663.
After deducting its operating expenses, ADP’s net income before income taxes
amounted to $30,280,238 (Exhibit A‑1 Tab 6). It should also be
noted that ADP’s shareholders’ equity in 2001 was $22,420,462, of which $3,800,000
represented its capital stock, and the balance, retained earnings. As the
Client Funds Obligations account did not appear on the 2001 balance sheet
because it had been netted against Funds Held for Clients (an assets account),
the total liabilities amount for 2001 is $107,325,682, $91 million of
which was due to related companies.
[6] In his testimony, Mr. Surminsky also dealt with the payment by ADP of damages for
late remittances, which damages amounted to $397,929 in 2001. It was clear that
the payroll payments were made by ADP as agent for its clients and therefore it
is they who would have received the assessments for late remittances. He also added
that the tax authorities would communicate directly with ADP’s clients regarding
these matters. However, under its contractual obligations towards its clients,
ADP was responsible for indemnifying them for any interest and penalties
resulting from late remittances to the tax authorities. It is clear also that
the amount of the indemnity did not cover the taxes which should in any event have
been remitted on ADP’s clients’ behalf to the tax authorities. On this point, I
reproduce here the key portion of the contractual obligations:
7. LIMITATION OF LIABILITY
. . .
C. With respect to Tax Filing
Services only, based upon the information supplied by Client and provided that
Client has fully complied with its obligations pursuant to Paragraph 1(B)
above, ADP shall be responsible for all applicable deposits, filings and
reconciliations (not including the filing or depositing of excise, sales, use,
corporate and/or similar taxes). ADP’s sole liability to Client or any
third party for claims, notwithstanding the form of such claims (e.g.,
contract, negligence or otherwise) arising out of (i) ADP making an
error in interpretation of Federal and/or Provincial payroll tax laws,
rules or regulations or (ii) errors or omissions (other than
interpretive errors or omissions) in Tax Filing Services provided or to be
provided by ADP hereunder and caused solely by ADP, shall be to furnish a
correct report or data and to correct any of Client’s files or tax agency
filings; provided, however, that in such event, Client shall be
responsible for any additional taxes and ADP shall be responsible for any
penalties or similar charges relating to such error or omission and
provided further that with respect to any interest charges relating to such
error or omission, ADP shall be responsible for interest charges if ADP
has debited the Client’s designated account for the associated taxes and is
holding such monies prior to the occurrence of such error or omission and
Client shall be responsible for interest charges in all other situations.
[Emphasis added.]
[7] In addition to the Partial Agreed
Statement of Facts and the testimony given by Mr. Surminsky, there are statements in the
Amended Reply to the Notice of Appeal which were either admitted or denied by
counsel for ADP and which deserve comment. I refer in particular to the
following paragraphs:
22. . . .
(e) The Appellant’s
clients are required to pay in advance to
the Appellant all amounts associated with their payroll plus any source
deductions that are to be remitted on their behalf to the respective
governments. Those pre‑funded amounts are referred to herein as the
“Funds Held For Clients” and the Appellant’s respective obligations toward its
clients are referred to herein as the “Client Funds Obligations”; (admitted)
. . .
(n) The Client Funds
Obligations was money made available for use by the Appellant. (denied)
. . .
(p) The interests [sic]
earned by the Appellant on such investment are an integral and important part
of the Appellant’s business affecting significantly its profitability and its
status as a going concern; (denied)
. . .
(v) The interest earned
by the Appellant on the investment of the Funds Held for Clients amounted to
$53,469,002.00 in its fiscal period ending June 30th, 2000, and its
income before taxes reported in its financial statements was
$6,092,564.00. (no knowledge)
[Emphasis added.]
Analysis
a) Does the $1.1 billion shown in the Client Funds
Obligations account constitute advances for the purpose of the definition of
“capital” found in par. 181.2(3)(c) of the Act?
[8] The first issue to be determined is whether the minister
was justified in adding to ADP’s capital, pursuant to paragraph 181.2(3)(c)
of the Act, the $1.1 billion amount as of June 30, 2001. The relevant
provision of the Act reads as follows:
181.2(3) Capital. The capital of a corporation
(other than a financial institution) for a taxation year is the amount,
if any, by which the total of
(a) the amount of its capital
stock (or, in the case of a corporation incorporated without share capital,
the amount of its members’ contributions), retained earnings, contributed
surplus and any other surpluses at the end of the year,
(b) the amount of its reserves
for the year, except to the extent that they were deducted in computing its
income for the year under Part I,
(b.1) the amount of its
deferred unrealized foreign exchange gains at the end of the year,
(c) the amount of all
loans and advances to the corporation at the end of the year,
(d) the amount of
all indebtedness of the corporation at the end of the year represented
by bonds, debentures, notes, mortgages, hypothecary claims, banker’s
acceptances or similar obligations,
(e) the amount of any
dividends declared but not paid by the corporation before the end of the year,
(f) the amount of all
other indebtedness (other than any indebtedness in respect of a lease) of
the corporation at the end of the year that has been outstanding for more than
365 days before the end of the year, and
. . .
[Emphasis
added.]
[9] The main issue to be decided is whether the funds
received by ADP from its clients in advance of the payments of salary and government
remittances constitute “advances” within the meaning of paragraph 181.2(3)(c).
I had a chance to deal with this question in Oerlikon Aérospatiale Inc. v.
Canada, [1997] T.C.J. No 466 (QL), [1997] DTC 962. In that case, a sum
of $244,492,173 had been advanced by Oerlikon’s customers, one of these being
an affiliated corporation and the other, Martin Marietta Corporation, a U.S.
customer. As regards the former, Oerlikon had received the funds under a contract
to provide air defence and
anti-tank systems at a cost of $304,166,920. In addition, it was to supply
pieces of equipment and related services for an additional total of
$437,411,853. In Oerlikon, the taxpayer had argued that the advanced
funds, which were on account of its future income, did not constitute advances
for the purposes of Part I.3 of the Act. As the term “advances” in
paragraph 181.2(3)(c) of the Act is not defined, in my
reasons (par. 47‑50 T.C.J., pp. 971‑2 DTC) I referred to the
Dictionnaire de la comptabilité et de la gestion financière,
which provided the following three definitions, and I went on to make the
analysis also reproduced hereunder:
ADVANCE 1.
AVANCE (SUR NOTE DE FRAIS)
Management. Amount paid to a person to
enable him to make expenditures for which he will have to account at a
later date.
Syn. expense advance. See also out-of-pocket costs.
ADVANCE 2.
AVANCE; ACOMPTE; ARRHES
Commerce. Amount to be applied against the price of a contract, services or goods, paid before
the contract is performed, the services rendered or the goods delivered.
Note — The term advance is more appropriate in cases where the amount in
question is paid before any order is filled. However, the term payment on
account is used where the amount is paid by reason of the partial filling of
the order. In the case of deposits, the amount paid is not returned if there is
a breach of contract, whereas it may be in the case of an advance.
See also deposit 3; downpayment; earnest money.
ADVANCE 3.
PRÊT; AVANCE
Finance. Amount lent by one person to another or by
one entity to another, e.g., the amount advanced by a parent company to its
subsidiary.
. . .
As may be seen and as OA's accountant admitted, the
word "advance" may mean "advance in the sense of a loan" or
"advance in the sense of a payment on account".8
Since Parliament took pains to speak of loans and advances in paragraph
181.2(3)(c) of the Act, it must be concluded that the intent was to include
both loans and instalments. If
Parliament had wished to limit the application of paragraph 181.2(3)(c)
of the Act solely to loans, it would have used only the term "loan".
It would have been redundant to use a synonym for the word "loan".
Rather, there is reason to believe that Parliament wished to broaden the scope
of the word "loan" so as to include payments on account with respect
to a contract.
In Transcanada Ltd. v. Ontario (Minister of Revenue),
[1992] O.J. No. 2592 (Ont. C.A.), the court relied on the notion of
"advance in the sense of a payment on account" in defining the scope
of the word "advance" used in the Corporations Tax Act, R.S.O. 1980,
c. 97. That act levies a tax on capital similar to the large corporations tax.
The question at issue was whether payments described as "take or pay
payments" were "investments . . . in . . . [loans and] advances to
other corporations". The Court of Appeal held that those payments came
within the definition of " advance as a ‘payment [made] beforehand or in
anticipation’ and a ‘payment made before . . . the completion of an obligation
for which it is to be paid’: Dictionary of Business and Finance, (1957) p.
9". 9
In my view, the payments on account
from clients received by OA constitute advances within the meaning of paragraph
181.2(3)(c) of the Act. They are amounts paid before the contract was executed,
the services rendered or the goods delivered. The fact that the payments on
account from clients balance was deducted from income for tax purposes because
the Act requires that this balance be included in computing income for tax
purposes does not change the nature of the payments on account. They represent
"advances" which appear in a corporation's balance sheet.
[Emphasis
added.]
_________________________
8 The first meaning is not relevant for the
purposes of this appeal.
9 In Crassweller v. M.N.R., 49 DTC 1,
the Income Tax Appeal Board considered the application of section 18 of
the Income War Tax Act according to which any “loan or advance” by a
corporation was deemed to be a dividend. The Board’s Chairman, Mr. Justice
Graham, made the following comments at page 13:
Obviously this was not a “loan or advance by a
corporation” as both words “loan” and “advance” convey the idea of something
which is to be repaid at a later date or, in the case of “advance” meaning a
payment beforehand, something which will be accounted for at a later date
by the production of vouchers or receipted bills on which the moneys have been
expended for the account of the person making the advance, or something paid
to a person before the time at which the payor becomes liable to make a payment
to such person which later payment would be reduced by the amount of the
advance and thus cancel any liability of the recipient to repay the advance.
[Emphasis added.]
[10] My decision in Oerlikon was affirmed by the
Federal Court of Appeal in Oerlikon Aérospatiale Inc. v. The Queen, 99
DTC 5318. Before the Federal Court of Appeal, Oerlikon argued that only the
concept of “advance in the sense of a loan” is contemplated in
paragraph 181.2(3)(c) of the Act. After reviewing decisions dealing
with the application of similar provisions in the Quebec Taxation Act, the
Federal Court of Appeal stated, at paragraph 26, that the Ontario Court of
Appeal’s decision in TransCanada Pipelines v. Ontario (Minister of Revenue) was much closer to the facts in Oerlikon.
Here is what Justice Noël stated at paragraph 28:
[28] . . . After a brief analysis, the Court of
Appeal emphasized the fact that the payments in question:
. . . fell within dictionary definitions of
“advance” as a “payment [made] beforehand or in anticipation” and a “payment
made before . . . the completion of an obligation for which it is to be paid”: Dictionary
of Business and Finance (1957), p. 9.
and held that these amounts constituted, inter
alia, “advances” within the meaning of paragraph 54(1)(c).
[29] The appellant was unable to show how the
advances at issue in this case were distinguishable from the
advances the Ontario Court of Appeal considered in TCPL. Both cases dealt with
payments made in advance for the eventual performance of the resulting
reciprocal obligation.
[Emphasis added.]
[11] Justice Noël added at paragraph
32:
[32] The effect of an advance be it in
the sense of a payment on account or a loan, is to make the amount of
money it represents available to the person or corporation which receives
it. In the instant case, the advances were an integral part of the financial
resources available to the appellant at the end of its 1989 fiscal year
according to the financial statements it filed, and nothing either in the legislation
or the tax policy which led to its enactment indicates that Parliament intended
to exclude advances from the tax under Part I.3.
[Emphasis added.]
[12] In order to convince the Court that the decisions
rendered in Oerlikon by this Court and the Federal Court of Appeal, and in
TransCanada Pipelines by the Ontario Court of Appeal, are not applicable
here, ADP’s counsel advanced a series of arguments. First, contrary to the
situation in Oerlikon, the $1.1 billion was not described as
“advances” in ADP’s financial statements for its 2002 taxation year, but was
rather referred to as “Client Funds Obligations” in its own general ledger and
in ADP’s US parent’s consolidated financial
statements for the 2002 taxation year. In addition, the funds here do not
constitute a “payment on account” according to the definition of this phrase in
Oerlikon and in the Dictionnaire de la comptabilité. ADP’s counsel
argued that the $1.1 billion does not constitute an amount to be applied
against the price of a contract, paid before the contract is performed.
Contrary to what was the case in Oerlikon, this amount would not be
included in computing ADP’s gross income, except for the sum of $4.5 million payable
to ADP on account of its fees, which were earned at the end of the 2001
taxation year.
[13] ADP’s counsel also argued that the $1.1 billion
did not constitute working capital for ADP. Alternatively, even if it did, it represented
only an insignificant portion of about 1.2% of the $83 billion received
from ADP’s clients. The cumulative amounts of the advances received by Oerlikon
as of 1989 ($292,834,886) represented 39.5% of the total value of the contracts
to be performed by Oerlikon ($741,578,000).
[14] Counsel argued as well that the $1.1 billion did
not constitute money made available for use by ADP, because Mr. Surminsky testified that ADP would not use
these funds to pay its dividends or its operating costs, such as rent and
mortgage payments.
[15] In my view, ADP’s position is not well‑founded.
Given that the Act does not define the term “advances”, it is not surprising
that the parties referred the Court to numerous dictionaries to define its scope.
For instance, counsel for the respondent referred to 16 different
dictionaries: legal, accounting, financial and ordinary dictionaries. I will cite
only a few of them. The Canadian Oxford Dictionary offers these relevant
definitions: “advance . . . 3 a payment made before the due time. 4 a
loan.”
[16] In Le Nouveau Petit
Robert, “une avance” is defined as:
1 (1478) Somme versée par anticipation. Faire
une avance à un employé.
. . . Avance sur commande. Acompte,
arrhes, provision 2 Crédit, prêt à court terme. Avance bancaire.
[17] As can be seen from these ordinary definitions of “advance”,
the common thread is paying an amount before it is due.
The same concept can be found in the first two of the three meanings given for “advance”
in the Dictionnaire de la comptabilité, reproduced at paragraph [9] of
these reasons. The first of these is “Amount paid to person to enable him to
make expenditures for which he will have to account at a later date”, and the
second, “Amount to be applied against the price of a contract, services or goods,
paid before the contract is performed, the services rendered or the goods delivered.”
[18] If in Oerlikon I made no further reference to
the first meaning of “advance”, taken from the Dictionnaire de la
comptabilité it was, as I stated in footnote 8 of that decision,
because it was not relevant for the purposes of the appeal. The meaning of “payment
on account” was. The statement in footnote 8 was not intended to imply that the
first meaning cited, [namely, an amount paid before it is due,] was not
relevant for the purposes of the definition of “advances” in computing capital under
subsection 181.2(3) of the Act. The same can be said of the Ontario Court
of Appeal’s statement in TransCanada Pipelines that “the take or pay
payments” made in that case constituted “a ‘payment [made] beforehand
or in anticipation’ and a ‘payment made before . . . the completion of
an obligation for which it is to be paid’”.
[19] As mentioned above, if one applies the approach adopted
by the Ontario Court of Appeal, it is clear that the $80 billion was paid to
ADP by its clients on account of the clients’ obligations to pay salaries to
their employees and to make government remittances. These payments to ADP were
generally made by the clients in advance, as stated in the contractual arrangements
between them and ADP. At
the end of the year, which was the relevant time for the purposes of computing
ADP’s capital under Part I.3 of the Act, there only remained $1.1 billion
under ADP’s control. No matter how you look at it, the $1.1 billion
constituted money advanced by ADP’s clients before they had to be disbursed by
ADP on their behalf. However, the contractual arrangement between ADP and its
clients provided that these funds were available to ADP for the purpose of
making investments, and ADP was clearly entitled to retain the interest earned
on such investments, as stated in its contracts with its clients (Exhibit A‑1,
Tab 8, 1C).
[20] In my view, the significance of the amount is not
relevant for the purposes of the definition of capital found in
subsection 181.2(3) of the Act. If an amount constitutes a loan, whether
it is one thousand, one million or one billion dollars, that amount has to be
added to capital, as required by that provision. The same applies to advances. When
asked to put forward an argument justifying the view that it would be improper to
include the $1.1 billion as advances, given the legislative purpose of the
provision, ADP’s counsel was unable to provide any convincing argument that it
would.
[21] Although strictly speaking, there is no requirement in
that regard, it is comforting to realize that the $1.1 billion in advances
existing at the end of the 2001 taxation year did indeed represent a
significant financial resource available to ADP. The advances received during
the entire course of the year allowed ADP to earn more than $57 million in
interest, which represented 28% of its gross revenue. As pointed out by counsel
for the Minister, without this interest earned from the advanced funds, ADP would
have incurred a loss. This was indirectly acknowledged by Mr. Surminsky, who testified
that had it not been allowed to invest the advances made available to it in
contemplation of the payment of its clients’ obligations with regard to salaries
and government remittances, ADP would have been required to modify its business
model and increase its fees.
[22] Finally, it is worth
noting that the balance sheet for ADP for the year ended June 30, 2001, shows a
capital stock of $3.8 million and retained earnings of $18.6 million.
So the advances from ADP’s clients, which are described in its accounting
records as Funds Held for Clients and Client Funds Obligations in its
accounting records and which amounted at the end of its 2001 fiscal year to $1.1 billion,
do constitute a significant asset and liability at the end of its taxation
year. Mr. Surminsky also stated that a core amount of $500 million was a more
or less permanent asset and liability of ADP. In his argument, counsel for ADP
also contended that these funds allowed ADP to make long‑term investments,
although this fact had not necessarily been put into evidence. Therefore, I do not have any doubt in
concluding that the $1.1 billion constitutes advances referred to in the
definition of “capital” in paragraph 181.2(3)(c) of the Act.
b) The
deduction of the $397,929 in late payment penalties.
[23] The other issue remaining
to be decided is whether the prohibition under paragraph 18(1)(t)
of the Act is applicable. If it is not, counsel for the Minister admitted, the above
amount would be deductible by ADP in computing its income pursuant to
section 9 of the Act. Paragraph 18(1)(t) read as follows in 2001:
18(1) General limitations −
In computing the income of a taxpayer from a business or property no
deduction shall be made in respect of
. . .
(t) any amount paid or payable under
this Act (other than tax paid or payable under Part XII.2 or Part XII.6);
[Emphasis added.]
[24] In order for the amount in question of $397,929 to be non‑deductible
under the Act, it must be an amount paid or payable under the Act. Here, in my
view, it is clear that this amount was not paid by ADP to the federal government
under the Act as interest or penalties for late remittances. It was ADP’s
clients, which were assessed by the minister as a result of ADP’s failure to
make the remittances on their behalf, that were required by the Act to make the
payments of interest and penalties. The amounts which were paid by ADP were
paid to its clients in order to indemnify them for the amounts that they had paid
under the Act. Therefore, paragraph 18(1)(t) of the Act would
clearly have applied to ADP’s clients had they attempted to deduct these
amounts. ADP, however, was not required by the Act to make the payments it made.
Rather, they were made pursuant to its contractual obligations towards its
clients as a result of its failure to fulfill its contractual obligation to pay
the government remittances on time.
[25] The fact that the
contractual damages paid were computed by reference to the amount of interest
and penalties paid by ADP’s clients under the Act is not relevant. A
distinction must be made between the damages themselves and the method for
determining them. This approach was followed, for example, in Canadian
National Railway v. M.N.R., 88 DTC 6340, at 6343, where Justice Strayer in
determining whether such damages could constitute income in the hands of the
person receiving them, stated: “The measure employed for calculating compensation
is not always determinative: potential lost income may be taken into account in
calculating a capital sum to be paid.”
[26] In my view, even if
one were to interpret the phrase “in respect of” found in paragraph 18(1)(t)
of the Act as liberally as that same phrase was interpreted in the Nowegijick
v. The Queen, [1983] 1 S.C.R. 29, it would not alter the fact that the sum
of $397,929 was paid in respect of contractual damages and not in respect of an
amount payable under the Act.
[27] I conclude that the
prohibition found in paragraph 18(1)(t) of the Act is not
applicable and ADP is therefore entitled to deduct the amount of $397,929 in
computing its income for the 2001 taxation year.
[28] For these reasons, ADP’s
appeal for the 1999 taxation year is dismissed. The appeal for the 2001
taxation year is allowed and the reassessment for that year is referred back to
the minister for reconsideration and reassessment on the basis that ADP is
entitled to deduct $397,929 in computing its income.
[29] Given that the issue
respecting the calculation of the tax on large corporations monopolized most of
the hearing time before the Court, I conclude that the respondent is entitled
to ¾ of her costs.
Signed at Ottawa, Canada, this 15th day of May 2008.
“Pierre Archambault”
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