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Citation: 2004TCC454
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Date: 20040625
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Docket: 2002-2615(IT)G
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BETWEEN:
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TRANSOCEAN OFFSHORE LIMITED,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Lamarre Proulx, J.
[1] This is an appeal from an
assessment made pursuant to Part XIII of the Income Tax
Act (the "Act") and, more precisely,
pursuant to paragraph 212(1)(d) of the
Act.
[2] The issue is whether an amount of
US$40,000,000 paid to the appellant was paid as, on account or in
lieu of payment of, or in satisfaction of, rent or a similar
payment.
[3] At the outset of the hearing of
this appeal, a Statement of Agreed Facts was filed. It reads as
follows:
1. The
Appellant is a corporation incorporated in the Cayman Islands. At
all material times, the Appellant was in the business of
chartering off-shore drilling apparatus and providing
related ancillary services. At all material times, the Appellant
was resident in the Cayman Islands and not resident in Canada for
Canadian tax purposes.
2. Transocean
Offshore Inc. ("TOI") was a corporation
incorporated under the laws of the state of Delaware. At all
material times, TOI was in the business of chartering
off-shore drilling apparatus and providing related
ancillary services. At all material times, TOI was resident in
the United States and not resident in Canada for Canadian tax
purposes.
3. Transocean
Offshore Ventures Inc. ("TOVI") is a corporation
incorporated in the United States. TOVI was in the business of
chartering off-shore drilling apparatus and providing
related ancillary services. TOVI contracted to provide certain
drilling services to the parties described in paragraph 7
below.
4. At all
material times, the Appellant and TOVI were affiliates of TOI and
were indirectly controlled by TOI.
5. At all
material times, the Appellant was the owner of the
"Transocean Explorer" (the
"Explorer"), a semi-submersible
off-shore drilling rig.
Picture of "Transocean Explorer", Joint
Book of Documents, Tab 1.
6. At all
material times, the Explorer was physically located in the North
Sea and was under contract to Marathon Oil U.K. Ltd.
("Marathon").
7. On May 15,
1997, Petro-Canada, on behalf of itself and a number of
co-venturers, (collectively, the
"Co-Venturers") entered into a Bareboat
Charter with TOI and a Drilling Services Contract with TOVI under
which the Co-Venturers agreed to charter the Explorer and
secure certain services for a period of approximately 2 years in
connection with the Co-Venturers' "Terra
Nova" project (collectively, the
"Charter"). The Terra Nova project was to take
place in Canada, off the coast of Newfoundland.
Bareboat Charter between Co-Venturers and
TOI,
Joint Book of Documents, Tab 2.
Drilling Services Contract between
Co-Venturers and TOVI,
Joint Book of Documents, Tab 3.
8. It was the
intention of TOI and the Appellant that the Appellant would make
the Explorer available to TOI to permit TOI to charter it to the
Co-Venturers.
9. The
Bareboat Charter provided the Co-Venturers exclusive
possession, control, command and quiet enjoyment of the Explorer
during the term of the agreement. The Drilling Services Contract
provided for the delivery of services, personnel and equipment
for the purposes of operating and maintaining the Explorer (the
"Drilling Services").
10. Under the terms of the
Charter, the Co-Venturers were obligated to make the
following payments to TOI or TOVI:
(a) Day
Rates - Under the Bareboat Charter, the
Co-Venturers were obligated to pay US$60,000 to TOI for
each day that the Explorer was in actual use. The total amount
that would have been paid under the Bareboat Charter for the
two year period of the Charter was US$43,800,000. Under the
Drilling Services Contract, the Co-Venturers were obligated
to pay US$45,000 to TOVI for each day that Drilling Services were
provided to the Co-Venturers (collectively, the
"Day Rates");
Bareboat Charter between Co-Venturers and
TOI, Article VII,
Joint Book of Documents, Tab 2.
Drilling Services Contract between
Co-Venturers and TOVI, Article VII,
Joint Book of Documents, Tab 3.
(b) Upgrade
Payments - In addition to the ongoing obligation to pay
the Day Rates, the Co-Venturers were also obligated to pay
for a host of specified upgrades on the Explorer (the
"Upgrades"). The Upgrades were initially
expected to cost the Co-Venturers approximately
US$52 million and were aimed at making the Explorer fit for
the purposes of executing the drilling program contemplated by
the Charter. Specifically, the Upgrades were aimed at: (i)
modernizing the Explorer; (ii) ensuring that the Explorer could
be operated under harsh environmental conditions; and (iii)
enabling the Explorer to satisfy stricter Canadian regulatory
standards.
Under the Bareboat Charter, the Co-Venturers would
retain title to all of the Upgrades and, at the end of the
agreement, TOI had the option to purchase all of the Upgrades for
an amount equal to the book value of the Upgrades (computed using
an eight year depreciation in accordance with generally
accepted accounting principles) less the cost to, as soon as
reasonably possible, remove the Upgrades from the Explorer and
return the Explorer to the same good order and condition as it
was in prior to the commencement of the Upgrades. If TOI chose to
waive its right to purchase the Upgrades, the Co-Venturers
had the option to waive their rights in the Upgrades or to remove
the Upgrades and return the Explorer in its original good order
and condition; and
Bareboat Charter between Co-Venturers and
TOI, Article 2.2 and 2.3
Joint Book of Documents, Tab 2.
(c) Mobilization
Fee - Finally, the Co-Venturers were required to
pay a "Mobilization Fee" of US$11 million to cover all
costs and expenses related to the mobilization of the Explorer
from its existing location in the North Sea to the shipyard in
Canada at which the Upgrades were to be performed.
Bareboat Charter between Co-Venturers and
TOI, Article 2.1,
Joint Book of Documents, Tab 2.
All payments made by the Co-Venturers under the Bareboat
Charter were to be made on an after-tax basis. The
Co-Venturers were further required to reimburse TOVI for
any Canadian tax, above a stated threshold, that was levied on
payments made under the Drilling Services Contract.
Bareboat Charter between Co-Venturers and
TOI, Article 7.6,
Joint Book of Documents, Tab 2.
Drilling Services Contract between
Co-Venturers and TOVI, Article 5.17,
Joint Book of Documents, Tab 3.
11. The Charter was to
commence on the completion of the contract with Marathon for the
Explorer (the "Marathon Contract"), but no
earlier than December 31, 1997 (the "Mobilization
Date").
12. However, at the
request of the Co-Venturers, the Marathon Contract was
extended and ultimately was not completed until the end of
December, 1998. As a result, the Charter would not have commenced
until the end of December, 1998 at the earliest.
Letter Agreement between Transocean Offshore (North
Sea) Limited and Marathon,
dated October 28, 1997, Joint Book of Documents,
Tab 4.
Letter Agreement between Petro-Canada and
TOI,
dated October 30, 1997, Joint Book of
Documents, Tab 5.
Letter from Travis Fitts, Jr., TOI to Greg Lever,
Petro-Canada,
dated November 4, 1997, Joint Book of Documents,
Tab 6.
13. In the period
following the signing of the Charter, the scope and complexity of
the Upgrades significantly increased. At the same time, the
availability of higher specification rigs significantly increased
and the day rates charged for such rigs decreased. The
Co-Venturers became increasingly concerned with the
escalating costs of the Upgrades and attempted to get TOI to
agree to either charter another rig to the Co-Venturers in
place of the Explorer or "cap" the
Co-Venturers' liability for the Upgrades. By December,
1998, the projected cost of the Upgrades had increased to as much
as US$75 million.
14. In late November,
1998, prior to the Mobilization Date, the Co-Venturers
informed TOI that they were "very uncomfortable with the
existing arrangements for the Explorer" and that they did
not believe they were the "best solution" for any of
the parties.
Letter from Gary Bruce, Petro-Canada to W. Dennis
Heagney, TOI,
dated November 30, 1998, Joint Book of Documents,
Tab 7.
15. From December 3, 1998
through December 21, 1998, TOI (on behalf of itself and its
affiliates) and the Co-Venturers engaged in settlement
negotiations with a view to determining the amount that the
Co-Venturers would pay to TOI and TOVI as a consequence of
the Co-Venturers' repudiation of the Charter.
16. On December 7,
1998, the Co-Venturers made a "Without Prejudice"
offer to TOI (the "First Settlement Offer"). The
First Settlement Offer proposed that the Co-Venturers would
charter another, more modern vessel from TOI on certain specified
terms and provide TOI with a payment of US$30 million in
exchange for TOI and TOVI agreeing to release the
Co-Venturers from their obligations under the Charter.
17. On December 11,
1998, TOI made a counterproposal to the Co-Venturers (the
"Counterproposal"). The Counterproposal
envisioned the Co-Venturers making a payment of
US$65 million to TOI and agreeing to charter another
Transocean rig on certain specified terms in exchange for TOI and
TOVI agreeing to release the Co-Venturers from their
obligations under the Charter.
18. Finally, on
December 21, 1998, following further negotiations among TOI,
TOVI and the Co-Venturers, Petro-Canada, on behalf of
itself and the Co-Venturers, entered into a Deed of
Settlement and Release (the "Deed of
Settlement") with the Appellant, TOI, and TOVI under
which the Co-Venturers were released from their obligations
under the Charter. The Co-Venturers agreed to pay
US$40 million to the Appellant as full and final
consideration for voluntary termination of the Charter. The
Co-Venturers were also required to pay to TOVI
US$1,931,868.18 to cover upgrade team expenses.
Deed of Settlement between the Co-Venturers,
TOI, TOVI and the Appellant,
dated December 21, 1998, Joint Book of
Documents, Tab 8.
Press Release by TOI, dated December 22, 1998,
Joint Book of Documents, Tab 9.
19. Mobilization of the
Explorer, as contemplated in Article II, section 2.1 of
the Bareboat Charter did not occur.
20. Subsequent to the
execution of the Deed of Settlement, the Co-Venturers
solicited new tenders for drilling rigs to be used in connection
with the Terra Nova project. TOI tendered a bid for the new Terra
Nova contract, but was ultimately not selected as the successful
bidder.
21. From the completion of
the Marathon Contract to the present date, the Explorer has
remained idle in the United Kingdom and has not been chartered to
another party.
22. When making the
Settlement Payment, 25% or US$10 million (Cdn.$15,260,000)
was withheld by the Co-Venturers and remitted to the Canada
Customs and Revenue Agency (the "CCRA").
23. On February 1,
1999, the Appellant made an application to the CCRA for a refund
of the Cdn.$15,260,000 withheld and remitted.
Refund Application to the CCRA, dated
February 1, 1999,
Joint Book of Documents, Tab 10.
24. On July 17, 2000,
the CCRA issued a Notice of Assessment (the
"Assessment") to the Appellant, denying the
refund requested on the basis that the Appellant was liable to
tax on the Settlement Payment under Part XIII of the
Income Tax Act (Canada).
Notice of Assessment of the Appellant - Assessment
#1385191, dated July 17, 2000, Joint Book of Documents, Tab
11.
25. The Appellant duly
filed a Notice of Objection to the Assessment.
Appellant's Notice of Objection, dated
October 10, 2000,
Joint Book of Documents, Tab 12.
26. On April 17,
2002, the CCRA confirmed the Assessment.
Notice of Confirmation of Assessment #1385191,
dated April 17, 2002,
Joint Book of Documents, Tab 13.
[4] A joint book of documents was
filed as Exhibit A-1.
[5] In summary, on May 15, 1997,
Petro-Canada for itself, and for and on behalf of its
co-venturers, entered into a bareboat charter agreement
(the "Bareboat Charter") with Transocean Offshore
Inc. with respect to the offshore drilling rig Transocean
Explorer (Tab 2 of Exhibit A-1). There was also a
drilling services agreement between Petro-Canada and
Transocean Offshore Ventures Inc. (Tab 3 of
Exhibit A-1).
[6] In the fall of 1998, Petro-Canada
and its co-venturers decided not to go through with the
agreements. A deed of settlement and release was entered into
with Transocean Offshore Inc., Transocean Offshore Ventures Inc.
and Transocean Offshore Limited, the Appellant (Tab 8 of
Exhibit A-1). Section 2 of that agreement deals
with the voluntary termination of the Bareboat Charter. The
pertinent part of that section reads as follows:
2. The
Charterer shall pay to TOL, as owner of the Transocean Explorer
and in consideration for voluntary termination of the Bareboat
Charter, by wire transfer sent by noon Toronto time on
December 23, 1998, the sum of U.S.$40 million, payable
by U.S.$30 million to TOL and U.S.$10 million into an
escrow account maintained by . . .
[7] Section 3 of the same
agreement specifies that the drilling services contract is
terminated in accordance with section 2.2(d) of that
contract. That section gave Petro-Canada the right to
terminate the contract if the Bareboat Charter was
terminated.
[8] As for the reasons for the
assessment, a letter dated July 17, 2000, accompanying the
assessment (both documents appear at Tab 11 of
Exhibit A-1) stated that the payment of US$40,000,000
was taxable in accordance with paragraph 212(1)(d) of
the Act.
[9] There was no oral evidence adduced
as to the basis of the calculation of the amount of
US$40,000,000. There was no apportionment of that amount in the
documentary evidence either.
[10] The pertinent part of
paragraph 212(1)d) of the Act reads as
follows:
212 Taxation of
non-residents
(1) Every
non-resident person shall pay an income tax of 25% on every
amount that a person resident in Canada pays or credits, or is
deemed by Part I to pay or credit, to the non-resident person as,
on account or in lieu of payment of, or in satisfaction of,
. . .
(d) Rents,
royalties, etc. - rent, royalty or similar payment, including,
but not so as to restrict the generality of the foregoing, any
payment
(i) for the
use of or for the right to use in Canada any property, invention,
trade-name, patent, trade-mark, design or model, plan, secret
formula, process or other thing whatever,
. . .
but not including
. . .
(ix) a rental payment for
the use of or the right to use outside Canada any corporeal
property,
. . .
Argument
[11] The appellant's principal argument
is that the Bareboat Charter never became operative, that the
Transocean Explorer was never used in Canada and that no payments
under the Bareboat Charter, including any rental payments by the
co-venturers ever became due.
[12] Counsel for the appellant reminded the
Court that the appellant's assessment was made under
paragraph 212(1)(d) of the Act, which requires
a non-resident person to pay an income tax of 25% on any amount
that a person resident in Canada pays to the non-resident person
as, on account or in lieu of payment of, or in satisfaction of,
rent or a similar payment for the use in Canada of a property.
Counsel referred to subparagraph 212(1)(d)(ix), which
provides, for greater certainty, that a rental payment for the
use of, or the right to use, outside Canada, any corporeal
property is exempt from taxation in Canada.
[13] Counsel questioned the decision by
which, despite the Transocean Explorer never having been
physically in Canada, the Minister of National Revenue
(the "Minister") imposed a 25% withholding tax on
the US$40,000,000 in question on the basis that it was paid as,
on account or in lieu of payment of, or in satisfaction of, rent
for the use of the Transocean Explorer in Canada.
[14] Counsel indicated that the issue is not
whether the amount in question would be considered income under
Part I of the Act, which could well be the case.
Indeed, counsel acknowledged, the caselaw has consistently held
that damages may be income or capital, depending on what the
damages replace.
[15] Counsel argued that the issue concerns
Part XIII of the Act, which imposes tax on
non-residents with respect to very specific types of
payments such as interest, dividends, rent and royalties. In the
present case, the assessment can only stand if the payment is a
payment as, on account or in lieu of payment of, or in
satisfaction of, rent. According to counsel, the caselaw has also
consistently held that damages paid for breach of contract do not
take on the specific character of the object those damages
replace. Thus, damages for termination of an employment contract
are not remuneration or a benefit from employment, and a payment
in respect of future interest on early repayment of a loan is not
interest. Counsel therefore submitted that damages in respect of
the termination of a lease are not rent.
[16] In this regard, counsel referred to the
decision of the Federal Court of Appeal in The Queen v.
Atkins, 76 DTC 6258, in which it was held that damages
for wrongful dismissal were not income from employment, and to
the decision of the Supreme Court of Canada in Schwartz v. The
Queen, 96 DTC 6103, [1996] 1 S.C.R. 254, in which
it was held that damages for breach of an employment contract
prior to the commencement of the employment were not taxable. The
Federal Court of Appeal has confirmed, in Girouard v. The
Queen, 80 DTC 6205, The Queen v. Pollock,
84 DTC 6370 and Buccini v. The Queen, 2000 DTC 6685,
that damages for wrongful dismissal are not income from
employment.
[17] Regarding damages paid for unearned
interest, counsel referred to Puder v. M.N.R., 62 DTC
555, a decision of the Tax Appeal Board reversed by the Exchequer
Court, 63 DTC 1282. The Tax Appeal Board (composed of five
members) had found that the unearned interest paid with respect
to the balance of a three-year contract was a payment on
account in lieu or in satisfaction of interest and should be
included in income. Thurlow J. of the Exchequer Court
reversed that decision on the basis that unearned interest is not
interest. Counsel for the appellant referred to the following
excerpt from page 1284 :
It was said that under the mortgage the appellant had but two
claims, one to the principal sum, the other to interest, that the
amount in question was not principal but had the quality of
interest and could only be a sum received as interest or in lieu
of interest, and that the amount would have been interest if
earned and its quality as income would not change because of its
having been received in a lump sum payment.
In my opinion this contention cannot succeed. It disregards
the fact that the appellant had other rights besides those to
repayment of the principal and interest at the time when the
release was requested and it overlooks as well the fact that the
amount in question was never earned as interest. Interest, in my
opinion, is essentially compensation for the use or retention of
money for a period of time (vide Riches v. Westminster
Bank, [1947] A.C. 390) and here this element is lacking. The
amount in question was not paid or received for or in respect of
the use or retention of the principal sum for the period of
fifteen months or thereabouts during which the mortgage was in
effect. Nor on the other hand was it paid or received for or in
respect of the use of the principal sum for the remainder of the
three-year period provided for in the mortgage for throughout
that period the appellant had his principal sum and presumably
the use of it as well and the mortgagor had neither. Though
called interest the amount was accordingly not interest in fact
and as it was not interest I do not think it can be regarded as
having been "received as interest" within the meaning
of s. 6(1)(b). In this respect the case resembles that
which I had occasion to consider in R. G. Huston v.
M.N.R., [1962] Ex. C.R. 69 [61 DTC 1233], and I adhere to the
opinion therein expressed. Nor in my opinion can the amount
properly be regarded as having been received "on account of
or in lieu of payment of, or in satisfaction of interest"
within the meaning of s. 6(1)(b) since no part of the
amount ever accrued as interest and no part of it was paid in
lieu of or in satisfaction of any amount that ever accrued as
interest.
[18] Counsel for the appellant concluded by
saying that, similarly, unearned rental payments where the use of
the equipment rented has not begun cannot be considered as being
in the nature of payments for rent. Therefore, the amounts in
question were not paid as, on account or in lieu of payment of,
or in satisfaction of, rent or similar payments.
[19] For her part, counsel for the
respondent argued that a review of income tax case law shows that
payments made as damages for the termination or the breach of
rental contracts are frequently referred to as payments in lieu
of rent. The first case to illustrate this fact is Grader v.
M.N.R., 62 DTC 1070 (Ex. Ct.). The issue there was
whether amounts paid upon the cancellation of a lease were
income. The appellant contended that the sum he had received was
a capital receipt, being compensation for a capital loss. The
Exchequer Court, however, found that, taking into account all of
the circumstances of the case, the payments received by the
appellant should be regarded in his hands as rental received or
payments in lieu of rental, or as being in the nature of casual
profit derived from a property, and thus constituted income
rather than amounts received on capital account.
[20] Counsel referred to the decision of the
Tax Review Board in Berlin Motels Limited v. M.N.R.,
73 DTC 137. In Berlin, a lease agreement between the
appellant as lessor and Mileyan Hotels Limited as lessee called
for the latter to deposit $75,000 with a trustee, which sum was
to be forfeited in case of default in making the rental payments.
In due course, the lessee did default and the sum was seized by
the appellant. The Minister contended, in Berlin, that the
sum was received in satisfaction of the guarantor's covenant
to pay the rent on default by the tenant and that it was rent or
a payment in lieu of rent. It was submitted for the appellant, on
the other hand, that the appellant was not ordinarily engaged in
the business of leasing property, that it had leased a business
as a going concern and that the amount in question was received
as liquidated damages for deterioration of capital assets of the
business. The Board came to the conclusion that the $75,000
received by the appellant was not for liquidated damages arising
out of the deterioration of capital assets, but was received as a
payment in lieu of rent.
[21] Counsel referred as well to Monart
Corporation v. M.N.R., 67 DTC 5181 (Ex. Ct.), in which
the appellant accepted $75,000 to cancel a lease for the
remainder of its term. The question was whether that payment was
on account of capital or income. The Court concluded in the
following terms at page 5186, that the payment was on
account of income:
. . . since the sum of $75,000 paid to appellant . . . was in
lieu of future rent in respect of the demised premises . . . and
was also in the nature of profit derived from a property or a
business of the appellant.
[22] Respecting the submission that no
obligations to make any payments under the Bareboat Charter had
arisen, counsel for the respondent in the present case argued
that the obligations were created when the contract was signed.
Had there been no obligations, there would have been no reason
for any payment of damages. Damages are paid for amounts that
would have been due in the future.
[23] Counsel for the respondent stated that
the case of Atkins (supra) and the court decisions
that applied its ratio decidendi have no application to
the present situation. The principles they set out only apply in
the context of employment contracts and not to general business
contracts. They are an exception to the general rule that damages
are taxable. The fact that the principles from the Atkins
line of cases are not relevant to ordinary business contracts was
noted by Strayer J. in Zygocki v. The Queen,
84 DTC 6283 (F.C.T.D.). Relying on the obiter dictum
of the Supreme Court of Canada in the case of Jack Cewe
Ltd. v. Jorgenson, 80 DTC 6233, Strayer J. held
that the payment received by the plaintiff pursuant to a
settlement was income received from a business.
[24] Counsel submitted that the principles
in Schwartz (supra) did not apply to the present
situation. The decision in Schwartz, she argued, turned on
the definitions of "employment", "employee"
and "retiring allowance". She submitted that
Schwartz does not stand for the principle that if the
duties under the contract have not commenced, damages received
for breach of contract do not take on the specific character of
amounts or rights received under a contract.
[25] The appellant's argument, according
to counsel for the respondent, ignores the case law regarding the
tax treatment of damages, which treatment is clearly stated in
London and Thames Haven Oil Wharves, Ltd. v. Attwooll
(Inspector of Taxes), [1967] 2 All E.R. 124. The
principles enunciated in that decision clearly form the
foundation of the state of the law today.
[26] Counsel for the respondent argued that
the appellant relied on the decision of the Exchequer Court in
Puder v. M.N.R. (supra) in support of the assertion
that damages for breach of contract taking place prior to the
time performance of the obligations under the contract was to
begin are not payments made on account of those obligations.
Counsel for the respondent stated that the principles in
Puder are only relevant to cases where the obligation is
to pay interest. The essential nature of interest is that if it
does not in actual fact accrue upon an existing principal amount,
it cannot be called interest.
Conclusion
[27] Regarding the principles applicable
with respect to the taxation of damages, I will begin by quoting
Hogg, Magee and Li from their work Principles of Canadian
Income Tax Law, 4th ed., Chapter 4.7(a),
pages 91-93 (footnotes omitted):
4.7 Damages and
settlements
(a) The
"surrogatum principle"
A person who suffers harm caused by another may seek
compensation for (a) loss of income, (b) expenses incurred, (c)
property destroyed, or (d) personal injury, as well as punitive
damages. For tax purposes, damages or compensation received,
either pursuant to a court judgment or an
out-of-court settlement, may be considered as on
account of income, capital, or windfall to the recipient. The
nature of the injury or harm for which compensation is made
generally determines the tax consequences of damages.
Under the surrogatum principle, the tax consequences of
a damage or settlement payment depend on the tax treatment of the
item for which the payment is intended to substitute. Generally,
compensation for a loss of income is taxed as income. For
example, compensation for a finder's fee, loss of profits, or
lost wages or earnings have all been held to be taxable as
income. The recovery of an expense is not income, unless the
expense was deducted. A payment for damaged or destroyed property
is treated as an amount received in a sale or exchange of the
property. A payment for the loss of capital is treated on account
of capital. A capital receipt is generally not income. However,
compensation on account of capital may be taxable if it is
considered as [an] "eligible capital amount", or if
there is a "disposition" of a "property"
where the payment is made in exchange for the discharge of a
legal right. Damages for personal injuries and punitive damages
are generally excluded from income for lack of a productive
source.
[28] In the decision of the Supreme Court of
Canada in Schwartz (supra), the application of the
surrogatum principle as the basis of an assessment was
discussed at pages 6114-15:
(b) The Surrogatum Principle and Unenumerated
Sources
The Crown relies on the principle developed by Diplock, L.J.
in London & Thames, supra, and argues that the
portion of damages received by Mr. Schwartz relating to lost
salary and stock options constitutes income from a source. In
London & Thames, Diplock, L.J. had this to say, at p.
134:
Where, pursuant to a legal right, a trader receives from
another person, compensation for the trader's failure to
receive a sum of money which, if it had been received, would have
been credited to the amount of profits (if any) arising in any
year from the trade carried on by him at the time when the
compensation is so received, the compensation is to be treated
for income tax purposes in the same way as that sum of money
would have been treated if it had been received instead of the
compensation.
The Minister, quite correctly, noted that this principle was
adopted and applied by the Federal Court of Appeal in
Manley, supra. There the Minister had assessed
damages received by the taxpayer in compensation for a
finder's fee he was entitled to pursuant to a commercial
agreement as constituting profit from a business taxable under s.
9(1) of the Act. Mahoney, J.A., for the court, after citing
relevant excerpts from London & Thames, stated, at p.
219:
In the present case, the respondent was a trader; he had
engaged in an adventure in the nature of trade. The damages for
breach of warranty of authority, which he received from Benjamin
Levy pursuant to a legal right, were compensation for his failure
to receive the finder's fee from the Levy family
shareholders. Had the respondent received the finder's fee it
would have been profit from a business required by the Income
Tax Act, to be included in his income in the year of its
receipt. The damages for breach of warranty of authority are to
be treated the same way for income tax purposes.
In the present case, the Federal Court of Appeal applied this
principle and found that, since part of the damages received by
the appellant replaced lost salary and stock options which, if
they had been paid to Mr. Schwartz, would have constituted income
from employment taxable under s. 5(1), such damages had to be
treated in the same manner for tax purposes, i.e., as income from
[an] office or employment taxable under s. 5(1) of the Act.
The solution arrived at by the Federal Court of Appeal is in
contradiction with the findings in the Atkins case,
supra, where the same court held that such damages could
not be characterized as income from [an] office or employment
under s. 5(1). The correctness of the conclusion arrived at in
Atkins was reaffirmed in 1984 by the Federal Court of
Appeal in Pollock, supra, despite the doubts
expressed in an obiter dictum by Pigeon, J. in
Jack Cewe Ltd. v. Jorgenson, [1980]
1 S.C.R. 812, at pp. 815-16.
However, the correctness of Atkins is not at issue
before us since the Minister, as I have explained, is not arguing
that the amounts are taxable as income from employment, but
submits, rather, that they are income from an unenumerated source
taxable under the general provision of s. 3(a) of the Act.
. . .
[29] The surrogatum principle would
appear to have been put aside in the above decision because the
Minister had assessed the amounts received as damages not as
income from employment but as income from an unenumerated source.
The Court found that the surrogatum principle was in
contradiction with the Atkins and the Pollock cases
but made no decision on the merit of the principle or on the
validity of the two cases mentioned. It based its decision on the
meaning of the expression "retiring allowance".
[30] I wish to refer to the analysis of
Strayer J. in Zygocki, supra, at
page 6285, regarding the tax treatment of monies received as
damages:
There are numerous authorities on the question of when monies
received as damages, or in settlement, for breach or termination
of contract should be treated for taxation purposes as income and
when they should be treated as capital. It is unnecessary to
recite all of these. One of the leading statements is that of
Diplock, L.J. in London and Thames Haven Oil Wharves, Ltd. v.
Attwooll, [1967] 2 All. E.R. 124 (C.A.) at 134, 136. He said
in effect that if a trader receives from another person
compensation because of his failure to receive another sum of
money which, had it been received, would have been credited to
profits, then the compensation should be regarded as income. If
on the other hand a compensation is paid because of the
destruction or permanent deprivation of a capital asset, then it
should be treated as capital for taxation purposes. In
Commissioners of Inland Revenue v. Fleming & Co.
(Machinery), Ltd. (1951), 33 Tax Cases 57 at 63 (C.S.), Lord
Russell had said essentially the same thing in stating that if
such payments were "no more than a surrogatum for the
future profits surrendered" then they should be treated as
income. If however "the rights and advantages surrendered on
cancellation are such as to destroy or materially to cripple the
whole structure of the recipient's profit-making apparatus .
. . the compensation represents the price paid for the loss or
sterilisation of a capital asset" and therefore compensation
paid for such rights should be treated as capital. Distinctions
of this nature have been applied in this Court: see, e.g.,
Minister of National Revenue v. Import Motors Limited, [73
DTC 5530], [1973] C.T.C. 719; Packer Floor Coverings Ltd. v.
Her Majesty The Queen. [82 DTC 6027], [1981] C.T.C. 506.
[31] From the foregoing doctrinal and
judicial writings, I reach the conclusion that, as stated by
counsel for the respondent, the case law regarding damages for
breach of an employment agreement and with respect to unearned
interest (if that case law is correct, which has been put in
doubt by Cewe, supra), that is the basis of the
appellant's position, does not apply to trade agreements. To
those it is the surrogatum principle, aptly described by
Strayer J. in Zygocki above, that applies.
[32] The Minister assessed the entire amount
of damages in question on the basis that it had been paid as, on
account or in lieu of payment of, or in satisfaction of, the rent
or a similar payment for the use of, or the right to use, in
Canada, the Transocean Explorer, an offshore drilling rig.
[33] In his argument counsel for the
appellant referred to obligations other than the payment of rent
that arose from the Bareboat Charter and suggested that the
payment of the negotiated sum of US$40,000,000 avoided payment of
obligations that would have totalled US$138,666,669. These
obligations are described in paragraph 10 of the Statement
of Agreed Facts reproduced at paragraph 3 of these reasons. From
my reading of the obligations, I would find it difficult to
accept that, following the breach of the agreement, the lessee
would have been required to compensate the lessor with respect to
any obligations other than the obligation to pay rent under the
agreement.
[34] At any rate, no evidence was adduced to
contradict the Minister's assumption of fact that the amount
of US$40,000,000 was paid as damages for loss of rental revenue
arising from the breach of the Bareboat Charter. That assumption
of fact appears very reasonable and, taking into account that the
burden of proof is on the appellant, I consider it an accurate
assumption of fact. So much more when I read sections 2 and
3 of the Deed of Settlement and Release (Tab 8 of
Exhibit A-1), referred to at paragraphs 6 and 7
of these Reasons.
[35] Much was said about the meaning of the
expression "in lieu of" not being comprised in the
meaning of the French expression "au titre de".
I do not wish to comment more specifically on that matter except
to say that in the context of paragraph 212(1)(d) of
the Act, the meaning of the former expression is comprised
in the meaning of the latter. I should also think that
compensatory damages for breach of a contract are paid as, on
account or in lieu of the object of the contractual
agreement.
[36] It is of interest to note that the
principles respecting the taxation of damages that have been
developed in Great Britain and in Canada are also those
followed in the United States. In the United Tax Reporter,
Volume 3A at paragraphs 614.168, 614.164 and 615.171,
it is stated that, regarding an amount received as damages, the
test is to look to the nature of the item for which damages are a
substitute. The principal decision in this regard is Hort v.
Com., 41-1 USTC 255, which is to the effect that to
determine whether, and to what extent, an amount received as
damages, whether by compromise or as a result of a judgment,
should be considered income, it is necessary to look at the
nature of the item for which those damages are a substitute.
Thus, if they are a substitute for rent, they are income, just as
rent would have been if collected in ordinary course of
things.
[37] In American law, the same principles
apply, with the same results, to the taxation of
non-residents (see paragraph 14,415.07 of Vol. 12
of the same collection). The basic decision in this regard is
Com. v. Wodehouse, 49-1 USTC 479. In holding that
amounts received in advance and in full by a non-resident alien
author for exclusive serial or book rights in the U.S. were
taxable as royalties, the Supreme Court rejected contentions that
(1) the amounts in question represented proceeds from the sale of
a property interest in copyright, and (2) that a lump-sum
payment was not "annual" or "periodical"
income. The Court observed that a single advance payment to cover
an entire 28-year period of copyright falls within the
reach of revenue laws just as much as, or even more so than, two
or more partial payments of same sum.
[38] To conclude, I find that the damages
paid to the appellant were so paid to compensate for the rent
that would have been paid under the Bareboat Charter if it had
not been repudiated. In accordance with the caselaw on the
taxation of amounts of damages received as compensation for
breach of trade agreements, I therefore find that the
compensatory monetary amount here in question was paid as, on
account or in lieu of payment of, or in satisfaction of, rent or
a similar payment for the use of, or for the right to use in
Canada, a property.
[39] The appeal is dismissed with costs to
the respondent.
Signed at Ottawa, Canada, this 25th day of June, 2004.
Lamarre Proulx, J
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