Canadian Liquid Air Ltd. v. Minister of National Revenue, [1992] 2 CTC 2170, 92 DTC 1822

Tremblay, T.C.C.J.:—This appeal was heard on November 26 and 27,1991 at Montreal, Quebec. The transcript was received by the Court on January 27, 1992.

1. Point at issue

The point at issue is whether the appellant company is correct in the computation of its income for the years 1985 and 1986 to consider as capital gain the profit resulting from the disposition of over 3500 specialized cylinders used to deliver medical and industrial gas. Customers paid the appellant for those cylinders damaged or lost each year. These proceeds of approximately $560,000 for 1985 and $490,000 for 1986 are considered by the appellant as proceeds of disposition of capital property under the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), giving rise to capital gain, equal to the excess of those proceeds over the adjusted capital cost of that property.

Pursuant to the respondent, the amounts of $560,000 and $490,000 represent business income for the years involved.

2. Burden of proof

The burden of proof which is on the appellant's shoulders concerns the facts. In the present case, the facts are not at issue. Basically, they are admitted by both parties. The only point at issue concerns the interpretation of the law in respect of the agreed facts: it is the burden of the judge.

3. Facts

3.01 At the beginning of the trial, the Court was informed that, generally speaking, the facts are not in dispute and there is no issue of quantum or number arisen. That issue will be settled between the parties, if the appeal is allowed.

3.02 The appellant filed 46 exhibits, that is to say exhibits numbered 1 to 30, filed in three volumes and 16 other exhibits in the course of the trial. The summary description of the 30 first exhibits of the three volumes is as follows:

Volume I

A-1	Certificate of Amalgamation of Canadian Liquid Air Ltd., December 31, 1986.
A-2	Canadian Liquid Air's Income Tax Return (T-2) for its 1985 taxation year.
A-3	Canadian Liquid Air's Income Tax Return (T-2) for its 1986 taxation year.

A-4 Agreement between Schaeffer-Townsend Construction Co. Ltd. and Canadian Liquid Air dated 5 March 1953 and invoice dated 16 February 1988.

A-5 Agreement between Canadian Liquid Air and Canadian Westinghouse Co. Ltd. dated 10 March 1964.

A-6 Service and Supply Agreement between Canadian Liquid Air and Canadian Westinghouse Co. Ltd. dated 29 April 1966 and invoice dated 19 February 1966.

A-7 Authorized Distributor Agreement between Canadian Liquid Air and TriCounty Welding Supplies Ltd. and P.J. Filiatrault and schedules dated 1 September 1967 and invoice dated 13 June 1985.

Volume II

A-8 Cylinder Supply Agreement between Canadian Liquid Air and Slater Steel Industries Ltd. dated 5 February 1971.

A-9 Cylinder Service Supply Agreement between Bell Canada dated 1 April 1982 and invoice dated 4 December 1984.

A-10 Distributor Agreement between Canadian Liquid Air and Durham Hardware & Equipment Ltd. dated 1 September 1983 and invoice 13 May 1985.

A-11 Agreement between Canadian Liquid Air and Ferranti Packard Transformers Ltd. dated 1 March 1984.

A-12 Cylinder Product Agreement between Canadian Liquid Air and Gulf Canada Ltd. dated 1 October 1984 as revised on 11 November 1986 with revised schedules and invoice dated 17 June 1985.

A-13 Canadian Liquid Air's Cylinder inventory Management Guide (Appendix 1).

A-14 Canadian Liquid Air’s Damaged Cylinder Report (Appendix 2). time of manufacture (Appendix 4).

A-15	Canadian Liquid Air's Visual Inspection Report (Appendix 3).
A-16	Compressed Gas Association's Pamphlet C-11 re Inspection of Cylinders at

A-17 C.T.C.—Regulations for the Transportation of Dangerous Commodities by rail (Appendix 5).

A-18 Compressed Gas Association—Methods for Hydrostatic Testing of compressed Gas Cylinders (Appendix 6).

Volume III

A-19 Canadian Liquid Air—Operating and Safely Instructions (Appendix 7).

A-20 Compressed Gas Association—Guidelines for periodic visual inspection and requalification of acetylene cylinders (Appendix 8).

A-21 Canadian Liquid Air—Production Instruction (Appendix 9).

A-22 Canadian Liquid Air—Test report dated 10 October 1988 (Appendix 10).

A-23 Reassessments for Canadian Liquid Air, 1985 and 1986 taxation years dated 21 October 1988.

A-24 Notices of objections against reassessments for income tax dated 13 December 1988.

A-25 Confirmation by the Minister of National Revenue dated 16 November 1989.

A-26 Liquid Air in Canada 1911-1986.

A-27 Photographs.

A-28	Schedule I—Acquisitions of cylinders.
A-29	Schedule II—Proceeds from disposition of cylinders.
A-30	Schedule III—Cylinder gas business.

The summary description of exhibits A-31 to A-46 is as follows:

A-34 Photo. Bulk nitrogen. Food freezing tunnel. Typical application food freezing.

A-35	Photo. Oxygen/fuel/torch. Typical application hand cutting.
A-36	Photo. Automatic cutting machine.
A-37	Photo. Typical high and low pressure cylinders.
A-38	Chart of the Canadian Liquid Air "Assets".
A-39	Photo. Example of cylinders handling by Liquid Air distributor.
A-40	Report Canadian Liquid Air's compressed gas cylinders.
A-41	Excerpt (page 20) of "General requirements of specifications for cylinders,

spheres and tubes” prepared by Canadian Standard Association.

A-42 Organization chart of the appellant in North America.

A-43 Annual report of the Air Liquid Group 1990 (world-wide level).

A-44 Curriculum vitae of Mr. Michael Onwood.

A-45 Non-Consolidated Audited Financial Statements, Canadian Liquid Air Ltd. December 31, 1985 and 1984.

A-46 Non-Consolidated Audited Financial Statements, Canadian Liquid Air Ltd., December 31, 1986 and 1985.”

3.03 The respondent filed three exhibits:

l-1 Cylinder Product Agreement to which it is referred to in subparagraph 6(e) of the Reply to Notice of Appeal. See paragraph 65 below.

I-2 and I-3 Invoices sent to customers for lost cylinders to which it is referred to in subparagraph 6(l) of the Reply to Notice of Appeal. See paragraph 65 below.

3.04 The appellant produced four witnesses:

1. Mr. Guy Murray, Business Manager for the appellant for which he has been working since 1959, starting as a sales trainee. (Curriculum vitae A-31).

2. Mr. Mohand Abdelli, Technical Director of the appellant produced as an expert. Objection by the respondent taken under reserve.

3. Mr. Jean-Pierre Gagnon of Transport Canada mainly involved in tank wagons.

4. Mr. Michael Onwood, Treasurer and Controller of the appellant.

3.05 The facts adduced in evidence are well described in the appellant's notes of argument (A.N.A.), from paragraph 4 to 64 as follows:

C.L.A/s Business

4. Canadian Liquid Air was a corporation duly incorporated under the laws of Canada and was part of the world-wide Air Liquid Group of companies, headed by L'Air Liquide S.A. of France (herein "L'Air Liquide"), a leader in the international industrial gas market, which operated in 58 countries on five continents.

Exhibit A-1, volume I, page 1.

Exhibit A-26, volume III, page 457.

5. From its headquarters in Montreal, C.L.A. operated its business through a network of 28 branches, approximately 130 distributor locations and had approximately 1,200 employees. Regional offices were located in Dartmouth, Nova Scotia; Montreal, Quebec; Bramalea, Ontario; and Vancouver, British Columbia (now, Calgary, Alberta).

6. C.L.A. operated a large number of air separation units (merchant plant) across Canada at least six of which constituted C.L.A. major manufacturing plants. These plants were located in Moncton (N.B.), Winnipeg (Man.), Varennes (Que.), Hamilton (Ont.), Edmonton (Alta.) and St. John (Nfld.).

7. At all relevant times, C.L.A.'s business was essentially concentrated in two main areas, namely the manufacture, production, sale and distribution of gases and welding products ("soudage") directly through C.L.A.’s sales organization and through C.L.A/s 75 distributors across Canada.

Welding business

8. C.L.A/s welding business could be broken down into two components namely consumables and equipment. Consumables would include for example stick welding electrodes (“baguettes souder") which are consumed as they are being used. Welding equipment includes electric welding machines (” source de pouvoir pour soudage à l"arc").

9. These products, both consumables and equipment were used in welding activities such as maintenance of machinery and metal fabrication of ships and bridges, etc., all manufactured in Quebec in either of its three plants (including the plant in Ville d"Anjou).

Gas business

10. C.L.A. manufactured, packaged, sold and distributed a variety of gases such as oxygen, nitrogen ("azote"), argon, acetylene, hydrogen and carbon dioxide (CO ) to a variety of industries. In addition, a wide range of specialty, high and ultra high-purity gases (zenon and cryton), medical gases and custom-made gas mixtures were also produced. These gases were used in applications that range from freezing and chilling foods to enhanced oil recovery, the manufacture of computer chips, oxygen enrichment of air in electric arc furnaces and welding.

11. The main gas products that C.L.A. manufactured and marketed for commercial use included oxygen, nitrogen, argon, carbon dioxide and acetylene.

12. C.L.A. provided its own air separation plants available for the production of oxygen, nitrogen and argon. The oldest and most commonly used process is cryogenic distillation. New technologies such as absorption (PSA/VSA) and permeation (membranes), are revolutionizing the industry by presenting, in some instances, economically viable alternatives to the more traditional cryogenic processes.

13. C.L.A.'s gas products were the result of highly specialized manufacturing processes and warranted specialized care for handling, distribution and use. For example, the temperature of liquid nitrogen (azote) is -320° F (or —197° C) so that its handling and distribution required specialized equipment and containers. These processes, equipment and containers vary with each gas product and require significant capital investment.

Exhibit A-40, Mohand Abdelli's Report

14. Gases were sold in either liquid or gaseous form through four different distribution means which varied according to volume requirements or customer needs. These four means were:

(a) pipeline,

(b) on-site plants ("usine en clientèle"),

(c) bulk ("vrac"), and

(d) cylinder (“ bouteille”).

15. The means of distribution described above were all owned by C.L.A. because of their highly specialized nature and because of the high capital investment cost associated therewith which C.L.A. customers were and are disinclined to bear.

Pipeline customers

16. Customers whose gas needs exceeded approximately 15 tons a day were more economically supplied through pipelines. Such customers had to be located Within a radius of 5 kilometres from a C.L.A. gas separation plant. Such customers would generally include steel mills, chemical processing plants and foundries and other such heavy industries. For example, Stelco’s steel plant supply needs were approximately 2000-3000 tons per day and its plant was within 5 kilometres of a C.L.A. gas plant located in Hamilton, Ontario.

17. Gases sold and distributed through such pipelines would include oxygen and nitrogen ("azote") in gaseous forms.

Bulk customers ("vrac")

18. Customers who required lesser quantities of gas were supplied in bulk ("en vrac") by way of C.L.A. tanks located on customer premises. These tanks had a 1 to 40 metric tons of product and were supplied on site by C.L.A. gas trailers. The gases so supplied were essentially in liquid form. Customers supplied in bulk would include steel fabricators, microchip manufacturers, food processing plants and hospitals. The bulk tank, depending on the customer's needs, would include its own vaporizer so as to allow the product to be used in gaseous form (hospitals). In other cases, the gases may be used in liquid form (food processors). Bulk gases would generally include oxygen, nitrogen ("azote"), argon and carbon dioxyde (CO ), hydrogen and M.A.P.P. (combustible) gas which may replace acetylene, which cannot be sold in bulk.

19. From the merchant plants, the product in liquid state is transported by C.L.A.'s extensive fleet of road and rail cryogenic tankers to the bulk liquid customer locations.

On-site customers ("usine en clientèle")

20. A customer whose gas volume requirements were the same as the customer supplied in bulk but, because of his remote location (e.g., pulp paper mills in Northern British Columbia and in Espanola, Ontario) would be more economically supplied through on-site plants.

Exhibit A-26, volume III, page 487

21. The on-site plants were owned, operated and managed by C.L.A. and were dedicated to supplying the needs of a particular customer by adjacent pipeline. The plants were usually automated and monitored by “modem” connected with the closest C.L.A. facility or with C.L.A.'s head office in Montreal.

Cylinder gas customers ["bouteilles?')

22. The end-use application and volume requirement of a customer would dictate the use of cylinders as a means of distribution. For example, in the Newfoundland Hibernia oil project, the volume of gas was significant but its end-use application was spread over such a considerable geographical area that volume could not be efficiently and economically supplied from one bulk storage tank but had to be spread out in smaller quantities over the entire site. Other examples were construction sites or the Canadian National Railway (herein "C.N.R.") which utilized cylinder gas products in the maintenance of its railway networks and, as a result, C.N.R. required thousands of cylinders strategically located throughout its railway network.

23. Another example was Bell Canada who had entered into an agreement whereby approximately 9,000 cylinders were put into service for the pressurization of its telephone lines, located mostly in Quebec and Ontario.

24. The compressed gases which C.L.A. produced and sold to its customers had to be packaged in specifically designed containers in order to ensure safely at all levels of use and handling for C.L.A. and its customers. The design, manufacture and use of these specialized containers were highly and strictly regulated by governmental authorities and controlled by C.L.A.

Exhibit A-40, Mohand Abdelli’s Report

25. Cylinders came in a great variety of types and sizes, and contained relatively small amounts of gas when compared to other means of gas distribution, such as gas trailers, pipelines, tanks, etc.

26. Cylinders could be divided into two broad categories:

(a) high pressure cylinders (Service pressure of 6.9 M.P.a.-/1000 psig or over);

and

(b) low pressure cylinders (Service pressure less than 6.9 M.P.a./11 000 psig).

27. These cylinders were refilled on a timely basis at C.L.A. cylinder filling plants located across the country.

28. High pressure cylinders are designed for an indefinite life expectancy. Low pressure cylinders are used for low pressure liquefied gases (such as MAPP, propane, etc.). Their thinner metal construction makes them more susceptible to denting. The foot rings have also been the source of corrosion on many designs. Their basic construction is such that they should resist as many cycles as seamless cylinders. For the reasons mentioned above (metal corrosion), their life expectancy is closer to 30 to 50 years.

Exhibit A-40, Mohand Abdelli's Report

29. C.L.A.'s cylinder gases were sold and distributed either directly through C.L.A.'s own sales organization (direct sales which accounted for 35% of cylinder gases volume of sales) and through a network of distributors that operated across Canada in specifically allocated geographical areas (which represented 65% of volume of cylinder gas sales).

30. The distributors generally dealt with volume cylinders business for small to medium size customers. Using either channel of distribution, all products were marketed and labelled with the C.L.A. logo and bore the C.L.A. trademark. Both C.L.A. and C.L.A. distributors sell gases to a wide variety of customers across the industrial board.

C.L.A. contract—Direct sales

31. Throughout the relevant taxation years, C.L.A. entered into agreements with its customers for the purchase of compressed cylinder gases. Typically, these agreements (as may be relevant to these appeals) provided for the following terms and conditions, namely:

(a) 5-year renewable term,

(b) a contract price, for the gas products being sold, with a price adjustment clause on an annualized basis.

Exhibit A-11, volume II, pages 207 et seq.

32. The price for the cylinder gas products being sold was arrived at as a result of negotiations with C.L.A.'s customers and was a factor of application, volume and market conditions.

33. With respect to the cylinders, the standard provisions in all agreements provided essentially as follows:

25. CYLINDERS

A) All of BUYER'S requirements of PRODUCT shall be supplied by LIQUID AIR in LIQUID AIR's own cylinders (the "CYLINDERS"). LIQUID AIR shall use all reasonable care to ensure that the CYLINDERS are manufactured, equipped and labelled in conformity with applicable laws and regulations.

B) The CYLINDERS and any part or accessory thereof are and shall remain at all times the sole and exclusive property of LIQUID AIR, left in the custody, care and control of BUYER. BUYER shall not pledge, lend, dispose or part with the CYLINDERS. BUYER shall not create. suffer or permit any lien or encumbrance upon the CYLINDERS and shall, if any, promptly remove and procure the release of any such lien or encumbrance.

C) Unless otherwise specified herein. BUYER shall return the CYLINDERS, transportation prepaid, to LIQUID AIR's point of shipment.

D) Until the CYLINDERS are returned by BUYER to LIQUID AIR, all risk of loss or damage to the CYLINDERS or to any part or accessory thereof (including withdrawal of unnecessary quantities of acetone from acetylene cylinders), even though such loss or damage is attributable to force majeure, is hereby assumed by BUYER, unless such loss or damage is shown to have been caused by the negligent act or omission of LIQUID AIR. For CYLINDERS (including any part or accessory thereof) lost or damaged beyond repair BUYER shall pay to LIQUID AIR, on demand, the full replacement value of the cylinders and/or said part or accessory, at LIQUID AIR's then current valuation, and for damages to CYLINDERS (including any part or accessory thereof) that LIQUID AIR is able to have repaired, BUYER shall pay the actual cost of all repairs thereto. LIQUID AIR shall be the sole judge of whether the CYLINDERS (including any part or accessory thereof) are damaged and whether or not such demand(s) can be repaired.

E) LIQUID AIR shall, at its own cost and expense, test, maintain and repair the CYLINDERS, in accordance with good industrial practice. BUYER shall notify LIQUID AIR immediately of any damage to or malfunction of the CYLINDERS.

F) BUYER shall not, nor shall BUYER allow any third party to alter, adjust, repair or tamper with the CYLINDERS or any part or accessory thereof. BUYER agrees, even in the case of force majeure, not to have the CYLINDERS recharged with any product, gas, liquid or other material whatsoever by any person, firm or corporation other than LIQUID AIR without the prior written consent of LIQUID AIR.

G) LIQUID AIR shall not entertain any claims for loss of content based on defective valves or other CYLINDER imperfections unless same are made within fifteen (15) days after receipt of the respective CYLINDERS by BUYER and unless the CYLINDER is returned to LIQUID AIR with a tag attached stating the defect within said fifteen days.

6. DEMURRAGE

The CYLINDERS, excepting those loaned on prepaid demurrage, are loaned for the free period herein mentioned. BUYER undertakes to pay demurrage to LIQUID AIR, on demand, on all CYLINDERS out of LIQUID AIR's possession beyond the said free period computed as follows: BUYER shall be credited with one calendar month, in days for each CYLINDER shipped during the calendar month. At the end of each calendar month, BUYER shall be debited with one calendar month, in debit days for each CYLINDER on hand. LIQUID AIR shall invoice BUYER and BUYER shall pay to LIQUID AIR Demurrage Charges thus computed at the rates specified in LIQUID AIR's then current published price list for each debit day. The said Demurrage Charges will be computed and assessed for all CYLINDERS combined, except acetylene, stabilized methylacetylene-propadienne and E size and smaller CYLINDERS, which will be computed and assessed separately" ("our emphasis”).

Exhibit A-11, Vol. Il, page 207 et seq. See also Exhibits A-4 to A-6, pages 136 to 142, Exhibits A-8 and A-9 pages 165 to 188, A-12 page 219 et seq. Exhibit 1-1.

34. There are no provisions anywhere in these agreements whereby ownership or title of these cylinders would be transferred or passed to C.L.A. customers.

35. The C.L.A. customer is bound to return the cylinder after the free period (typically 30 days), as was the practice in the industry. At the end of the 30-day period, the C.L.A. customer will start paying demurrage fees, a form of penalty which is used by C.L.A. as an incentive to prompt its customers to return its cylinders. This is done in order to significantly enhance C.L.A. through the optimized use of its existing assets.

36. With respect to gases sold in cylinders, C.L.A. invested approximately $3 in capital for every $1 of gas sales. The replacement value of C.L.A.'s investment is X 3 annual sales.

37. Upon the destruction or loss of the C.L.A. cylinder, the customer was bound by contract to compensate C.L.A. for its loss by paying an amount equal to the then replacement value of the cylinders for which it was invoiced.

Exhibits 1-2 and I-3

C.L.A.—Distributor sales

38. The standard C.L.A. distributor agreement provided, inter alia, that C.L.A. supplied to its distributors the gas and the cylinders labelled with C.L.A.'s logo as for direct sales.

Exhibit A-7, volume I, page 146

Exhibit A-10, volume II, page 189

39. The standard agreement required (as far as is relevant to these appeals) that cylinders be made available to C.L.A. distributors on essentially the same terms and conditions as in the case of direct sales to C.L.A. customers, with the exception of the 30-day free period to which distributors were not entitled to.

C.L.A. Cylinder Management Policy

40. Through its seventy-five (75) year history, C.L.A. did not and does not sell or advertise for sale its cylinders because these cylinders were specialized and costly assets which were not for sale. It has never been C.L.A.'s policy to sell or advertise for sale any of its cylinders and this was the practice in the industry. C.L.A. did not, according to its permanent cylinder records relating back to the 1920's, sell or advertise any such cylinders for sale.

41. At the time of manufacture, each C.L.A. cylinder was individualized. Each cylinder was an individualized entity bearing its own unique serial number and C.L.A. Registered Ownership Mark ("A.I.S.") permanently stamped on the cylinder shoulder.

42. C.L.A. purchase orders specified which individualized and different serial numbers the manufacturer had to use and stamp on each individual cylinder and confirmed each cylinder specification (in the case of high pressure) as an integral part of the purchase order. Manufacturing documents on every cylinder were and are sent to C.L.A.'s head office where they were kept indefinitely. Cylinders were tracked and traced through the use of these individualized serial numbers. These records were kept in the event specific information on a given cylinder was required such as at time of retest or in the event of a problem such as a recall of a batch of cylinders. The A.L.S. mark, which is a C.L.A. Ownership Mark registered with the Compressed Gas Association ("CGA") was and is stamped on every cylinder. C.L.A.'s own cylinder specifications required that any high pressure cylinder purchased by C.L.A. must carry a 12-year minimum warranty.

43. In 1988, C.L.A. introduced, through the investment of a substantial amount of time and money, a bar coding program to enhance its cylinder tracing and tracking ability. In addition to C.L.A.'s ownership mark and serial numbers, it was anticipated that each cylinder would bear, at the time of completion of the bar code program, two bar codes (similar to that found on many consumer goods) which enable virtually instantaneous recognition of the identity of the particular cylinder wherever it may be.

Exhibit A-13, volume II, page 216

44. C.L.A.'s policy was and is to purchase a sufficient number of cylinders to maintain, replenish or increase its cylinder supply. C.L.A. cylinders, through a closely supervised quality control process, were and are kept in use for an indefinite period of time as per their life expectancy or until such time as they had to be scrapped.

45. Some of the oldest C.L.A. cylinders still in use today were manufactured during World War I. After 1985, C.L.A., as a policy decision unrelated to the life expectancy of the particular cylinders, as they became due for retesting, decided to remove gradually, from service any cylinder made prior to 1919 because it was felt by C.L.A. at the time that the controls over the design and manufacture of such cylinders during the first Great War may not have been as thorough as would be expected in Peace time though the fact that those cylinders were still in active service in 1985 and today may tend to prove otherwise. This decision was made at the head office level and applied throughout the countries where the L'Air Liquide companies carried on business and were using similar cylinders. Cylinders manufactured after the 1918 cut-off period are still in active service. On May 9,1991, such a cylinder manufactured in April 1918 was scrapped. The resilience of cylinder is evidenced by the fact that a cylinder manufactured in 1920 has been successfully retested and returned to service.

Exhibit A-14, volume II, page 218

Exhibit A-15, volume II, page 219

46. C.L.A. has always refused to sell its cylinders to its customers though occasionally solicited by its customers to so sell.

47. C.L.A. purchased and purchases cylinders to replace either permanently damaged or lost cylinders and to increase its supply of cylinders to meet projected increases in customer demands. C.L.A. purchased and purchases its cylinders from a number of manufacturers approved by both the governmental authorities and C.L.A.

48. C.L.A. was not in the business of selling cylinders for many reasons:

(a) historically, it has never been the practice in this industry in general and for C.L.A. in particular to sell its cylinders;

(b) C.L.A.'s policy and practice and that of its competitors was and is to own and control its supply means for safety and economic reasons;

(c) C.L.A. was not in the business of buying cylinders and selling them and it would not be profitable for C.L.A. to start competing with the cylinder manufacturers;

(d) cylinders require specialized care and repair and can be potentially very hazardous if not handled properly; and

(e) customers were reluctant to support the investment costs necessary to purchase the requisite pool of cylinders to supply their needs.

49. Normally, C.L.A. conducted audits of its customers. Such an audit would be performed at least once annually to determine whether cylinders are lost or damaged, and if so, how many.

50. When such audits were completed, the customer was advised as to the amount he was bound to pay as compensation for the lost or damaged cylinder usually equal to the lost or destroyed cylinders’ replacement cost.

51. C.L.A. had a policy of educating its customers on cylinder management and to induce them to promptly return the cylinders even before demurrage costs are incurred because:

(a) C.L.A.'s objective was and is to maximize its sales of gases while minimizing its overall capital investments, e.g., with the smallest number of cylinder units in circulation;

(b) C.L.A. was not in the business of selling cylinders; and

(c) lack of cylinder management would cause serious problems for C.L.A. because it may lack the appropriate number of cylinders to meet the demand for its gases.

52. For its 1985 and 1986 taxation years, C.L.A. has been compensated for the loss or destruction between approximately 0.4% and 0.5% of its entire cylinder pool.

Accounting and income tax treatment

53. The cost of the cylinders at time of acquisition were recorded in C.L.A.'s books as fixed assets depreciated over twenty (20) years on a straight line basis according to generally accepted accounting principles. The total cost of cylinders was $56,798,000 (rounded in 000’s) for C.L.A.'s 1985 taxation year and $59,393,000 for C.L.A.'s 1986 taxation year respectively. [1] The total cost of these cylinders was in turn included in C.L.A.’s balance sheet as “property plant and equipment” which totaled $278,000,000 (rounded numbers) and $311,000,000 (rounded numbers for each of C.L.A.'s 1985 and 1986 taxation years respectively.

54. The proceeds from destruction or loss were recorded in C.L.A.'s books. The difference between the proceeds of disposition and net book value (original cost less accumulated depreciated) were recorded as gains or losses on disposal of assets and were included in other income after operating profits.

55. In the course of its 1985 and 1986 taxation years, C.L.A. received the following proceeds for the loss or destruction of the following cylinders:

				1985	1986
Proceeds				$543,631	$485,470
Number of Cylinders				3,937	3,487
Exhibit A-29, volume III, page 501
56. In addition, C.L.A. purchased cylinders in the following amounts:
Year of		Average			Average
acquisition	Quantity	Cost	Cost	cost
1985	7,864		$ 970,057		$123.35
1986	20,243		2,595,190		128.20
1987	16,312		2,483,342		152.24
1988	24,521		3,343,802		136.36
1989	24,410		3,274,431		134.14
1990	13,052		2,186,669		167.54
Exhibit A-28, volume III, page 500

57. Up to and including C.L.A.’s 1986 taxation year (which ended 31 December), C.L.A. treated the full amount of proceeds from disposition of cylinders as a reduction of its class 29 pool assets. The results of these operations were that the full amount of proceeds would enter into income over 3 years, due to the accelerated pace of class 29 assets depreciation (which was 25% - 50% - 25%).

58. In late 1987, after the filing of its 1986 income tax return, C.L.A. realized that the treatment of the gain on disposition of cylinders was inconsistent with the gain on disposition of fixed assets, i.e. excess of proceeds over original cost was capital gain.

59. Upon realizing the discrepancy, C.L.A. consulted with its tax advisors Thorne Ernst and Whinney, C.A. (herein "T.E.W.") and C.L.A. was advised that for income tax purposes, it was T.E.W.'s opinion that these gains should be reflected as capital gains.

60. Acting on T.E.W.'s opinion, C.L.A. filed its 1987 income tax return on the basis of capital gains treatment for the excess of the proceeds of disposition over cost.

61. In addition, as C.L.A.'s income tax returns for its 1985 and 1986 taxation years were in the course of being audited, C.L.A. raised with Revenue Canada's auditors the issue of reclassification of these proceeds as capital gains.

62. Revenue Canada ultimately denied C.L.A.'s request at that level. With respect to the cylinders, the reassessments were issued on the basis of the income tax returns as filed.

Exhibit A-23, volume III, page 436

63. Notices of objection were subsequently filed with Revenue Canada, disputing the income tax treatment of the proceeds of the lost or destroyed cylinders.

Exhibit A-24, volume Ill, page 447

64. The notices of reassessment were upheld and C.L.A. appealed.

Exhibit A-25, volume III, page 455

In the notice of appeal, the figures of the appellant’s position in the years involved are as follows:

65. In reassessing C.L.A. for income tax for its 1985 and 1986 taxation years, the respondent relied on the following facts. C.L.A.'s position in relation thereto is noted in bold and in brackets:

(a) During the years in issue, the appellant's business was the manufacturing of

medical and industrial gases, welding equipment and supplies; (admits)

(b) Those products were delivered in specialized cylinders supplied and owned by the appellant; (ignores as framed)

(c) The appellant owned approximately 800,000 cylinders, certain of which were more than 40 years old; (admits)

(d) The majority of the cylinders would normally be picked up by the appellant and returned to the appellant; (ignores as framed)

(e) The appellant would enter into a Cylinder Product Agreement (Schedule I attached hereto to form an integral part of this Reply) with its customers which states that such cylinders will be returned to the appellant within a specified period of time; (ignores the agreement referred to in this subparagraph as it is incomplete and in any event speaks for itself)

(f) If the cylinders are not returned within the specified period of time, the Cylinder Product Agreement provides that demurrage is charged on a monthly

basis until the cylinders are returned:the demurrage charges totalled 18.5 millions of dollars during 1986; (admits in part with the exception of the amount which it ignores)

(g) The demurrage charges represent a common practice in this industry; (admits)

(h) The demurrage fees represented business income for the appellant and were considered as such by the appellant; (admits)

(i) If a cylinder is lost or damaged beyond repair, the customer is obliged under the said Cylinder Product Agreement to pay to the appellant the full replacement value of such cylinders at the then current replacement cost; (admits subject to the comments made with respect to the completeness of the agreement and In any event the agreement speaks for itself)

(j) When a cylinder is lost, a charge is made by the appellant to its customer and the demurrage fees are then stopped; (admits)

(k) In the event that a lost cylinder is subsequently found, the customer would return it to the appellant who would, in return, issue a credit note to its customer; (admits)

(l) A typical example of how the appellant would invoice its customers in respect of lost cylinders is to be found in schedules II and III (attached hereto to form an integral part of this paragraph); (ignores the agreement referred to In this subparagraph as it Is incomplete and in any event speaks for itself)

(m) The amounts received by the appellant for lost cylinders totalized $558,631

and $491,470 for the 1985 and 1986 taxation years respectively; (denied)

(n) The amounts of $558,631 and $491,470 represent business income of the appellant for its 1985 and 1986 taxation years; (denied)

(o) The amounts received for lost cylinders were credited by the appellant to class 29 as proceeds of disposition of those cylinders: such a credit to class 29 has the same effect that if the appellant would have included those amounts in its business income; (denied as framed)

4. Law—cases at law—analysis

4.01 Law

The main provisions of the Income Tax Act involved in the present case are section 3, subsection 9(1) and paragraph 54(c).

4.02 Cases at law

The cases at law to which counsel for the parties referred are as follows:

1. Ammonia Soda Company Ltd. v. Chamberlain, [1918] 1 Ch 266;

2. Anthes Equipment Ltd. v. M.N.R., [1987] 1 C.T.C. 2117, 87 D.T.C. 59 (T.C.C.);

3. Atherton (H.M. Inspector of Taxes) v. British Insulated & Helsby Cables, Ltd., [1926] A.C. 205, 10 T.C. 188;

4. Border Fertilizer (1972) Ltd. v. M.N.R., [1981] C.T.C. 2780, 81 D.T.C. 6340 (F.C.T.D.);

5. Canadian National Railway v. M.N.R., [1988] 2 C.T.C. 111, 88 D.T.C. 6340 (F.C.T.D.);

6. Californian Copper Syndicate (Ltd. and Reduced) v. Harris (Surveyor of Taxes) (1904), 5 T.C. 159 (Ct. of Ex. (Scotland));

7. Canadian Kodak Sales Ltd. v. M.N.R., [1954] C.T.C. 375, 54 D.T.C. 1194 (S.C.C.);

8. The Queen v. Compagnie Immobilière BCN Ltée, [1979] C.T.C. 71, 79 D.T.C. 5068 (S.C.C.);

9. Commissioners of Inland Revenue v. Fleming & Co. (Machinery) Ltd. (1951), 33 T.C. 57 (H.L.);

10. Frankel Corporation Ltd. v. M.N.R., [1959] S.C.R. 713, [1959] C.T.C. 244, 59 D.T.C. 1161;

11. Golden Horse Shoe (New), Ltd. v. Thurgood (H.M. Inspector of Taxes) (1933), 18 T.C. 280 (U.K.C.A.);

12. Harry Ferguson (Motors) Ltd. v. C.I.R. (1951), 33 T.C. 15;

13. Hinton v. Maden & Ireland, Ltd. (1959), 38 T.C. 391;

14. Johns-Manville Canada Inc. v. The Queen, [1985] 2 S.C.R. 46, [1985] 2 C.T.C. 111, 85 D.T.C. 5373 (S.C.C.);

15. Smith John & Son v. Moore, [1921] 2 A.C. 13, 12 T.C. 266;

16. London and Thames Haven Oil Wharves Ltd. v. Attwooll (H.M. Inspector of Taxes), [1967] 43 T.C. 491 (U.K.C.A.);

17. Malloney's Studio Ltd. v. M.N.R., [1979] C.T.C. 206, 79 D.T.C. 5124 (S.C.C.);

18. Olympia and York Developments Ltd. v. The Queen, [1980] C.T.C. 265, 80 D.T.C. 6184 (F.C.T.D.);

19. Glenboig Union Fireclay Co. Ltd. v. The Commissioners of Inland Revenue, [1922] S.C. 112, 12 T.C. 427 (H.L.);

20. Van Den Berghs, Ltd. v. Clark, [1935] A.C. 431, 19 T.C. 390;

21. Les Entreprises de Pipe-Line Universel Ltée v. M.N.R., [1988] 2 C.T.C. 2002, 88 D.T.C. 1431;

22. Imperial Tobacco Co (of Great Britain and Ireland) Ltd. v. Kelly (1943), 25 T.C. 293;

23. Valley Camp Ltd. v. M.N.R., [1974] C.T.C. 418, 74 D.T.C. 6337;

24. Gloucester Railway Carriage & Wagon Co. v. Commissioners of Inland Revenue, [1925] A.C. 469, 12 T.C. 720;

25. B.P. Australia Ltd. v. Commissioners of Taxation of the Commonwealth of Australia, [1966] A.C. 224;

26. Hollick (W.) v. M.N.R. (1950), 3 Tax A.B.C. 125, 50 D.T.C. 489;

27. Green v. J. Gliksten & Son, Ltd., [1929] A.C. 381, 14 T.C. 364.

4.03 Analysis

4.03.1 Appellant's submission

A. General principle

4.03.1 (1) Counsel for the appellant first stated that there is no infallible test for settling the question of whether an amount received is of income nature or of capital nature and that each case must depend on its particular facts, referring to Harry Ferguson (Motors) Ltd. (4.02(12)), Van Den Berghs Ltd. (4.02.120)) and Californian Copper Syndicate (4.02(6)). He also then referred to the Lord Peace's test in B.P. Australia Ltd. (4.02.25)) often quoted but among others, by Mr. Justice Estey in the Johns-Manville Canada Inc. (4.02.14)) case:

The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so Clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in border line cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree. That answer: “depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process”.

4.03.1 (2) Counsel for the appellant argued as follows:

Despite this flexible approach, there are, however, two distinctive tests which emerge from the cases dealing with what constitutes income and what constitutes capital which are helpful as a starting point in reaching an answer to the question raised by this appeal. These tests are:

(a) the distinction between receipts which relate, and those which do not relate, to assets forming part of the permanent structure of the business, the former being capital receipts and the latter being income receipts; and

(b) the distinction between fixed and circulating capital, receipts in respect of the former being capital and those in respect of the latter being income.

The application of these tests, it is submitted, clearly establish that:

(a) these gas cylinders were assets which formed part of the permanent structure of C.L.A.'s business; and

(b) as fixed capital in C.L.A.'s business the receipts in respect of lost or destroyed gas cylinders should, therefore, be treated as capital.

The cylinders, contends counsel for the appellant, are not part of the inventory. Indeed, the cylinders are not goods or movables to be sold. They are long-lasting assets subject to capital cost allowance. They are part of fixed capital in the appellant’s business.

4.03.1 (3) B. Fixed and capital assets

Counsel for the appellant referred to the Hinton v. Maden and Ireland Ltd. (4.02(13)) in which it was decided by Lord Reid and Lord Jenkins that the knives and lasts in a manufacture of shoes and slippers were "plant or machinery” although they last only three years. The expenditure was considered to be on capital account.

In defining the word "plant", Lord Reid adopted the often-quoted words of Lord Lindley, L.J. in Yarmouth v. France, 19 Q.B.D. 647 (U.K.C.A.):

In its ordinary sense, it includes whatever apparatus is used by a businessman for carrying on his business—not his stock-in-trade which he buys or makes for sale; but all goods and chattels, fixed or moveable, live or dead, which he keeps for permanent employment in his business.

Lord Reid went on to say in his own words:

. .. I have no doubt that these knives and lasts are plant in the ordinary sense of the word. It is true that they are numerous, small and cheap. But one trader may have to use a few large articles while another may have to use a large number of small articles, and I see no good ground for distinguishing between them as regards investment allowance. The one point is the durability of these articles.

Lord Jenkins in concurring with Lord Reid clearly found it difficult to separate the concept of plant and capital expenditure stating:

. . . broadly speaking, I think that subject to the requisite degree of permanence an appliance which satisfies Lindley, L.J.’s definition of plant is well on its way to attaining the status of a capital asset, the cost of providing which may properly be regarded as capital expenditure.

Lord Jenkins also said:

The Company does not deal in knives and lasts. It acquires knives and lasts for retention and use as part of its means of manufacturing shoes and slippers.

I repeat that if each knife or last endured forever I can see no ground for holding that it would not be a capital asset.

4.03.1 (4) As first point, counsel for the appellant, applying the same principle, submitted that cylinders cannot be said to have been stock-in-trade of C.L.A.'s gas manufacturing business:

C.L.A. traded in gases and the cylinders were merely the means by which such gases were conveyed to its customers, much in the same way as an oil company uses tankers to transport oil. However, whereas in the latter case the oil might be syphoned into the customer's tank and the tanker returned immediately, in C.L.A.'s case, the gas cylinders were kept by the customer until the gas supply is exhausted. However, this practice was necessitated by the very nature of gas which could not be easily passed from one container to another. Clearly, the oil tankers are capital assets of the oil company’s business and, bearing in mind that C.L.A.'s gas cylinders are used again and again, and can be used for up to 1000 years [at east in the case of the high pressure cylinders), there is no reason to treat them differently merely by virtue of the fact that the customer retains possession of them until the gas supply is exhausted.” (A.N.A. No. 81)

C.L.A. further submits that the fact that C.L.A. has earned substantial demurrage fees which it declared as business income does not in any way transform its cylinders into stock in-trade, the same way that oil tankers remain a capital asset though chartered out.” (A.N.A. No. 82)

Finally then, in view of the facts, how would the reasonable man view these cylinders? He would have no alternative, it is submitted, but to reach the conclusion that they are, in the words of Lindley L.J. "for permanent employment" in and form part of the permanent structure of C.L.A.’s business and on that basis must be capital assets." (A.N.A. No. 86)

4.03.1 (5) To confirm his position, counsel for the appellant referred to the Anthes Equipment Ltd. case (4.02(2)) rendered by Mr. Justice Christie, A.C.J.T.C. The facts and the decision are well summarized by C.T.C. at page 2117:

The taxpayer corporation carried on the business of the sale and rental of scaffolding and shoring equipment, for use in construction. In dispute was the tax treatment of the revenue from three types of sales: (1) of exhausted rental equipment for scrap; (2) of rental equipment to the lessee on the insistence of the lessee (such sales being unsolicited and reluctantly made); and (3) of rental equipment damaged or lost by the lessee; in these circumstances the taxpayer demanded a replacement payment of twice its replacement cost and even after negotiations, the settlement figure usually exceeded the replacement cost. The corporation reported the profits from all such sales as capital gains. The Minister assessed on the basis that the transactions represented sales of inventory and resulted in business income.

HELD:

(1) The sale of exhausted or obsolete equipment was a disposition of the remnant of a capital asset; the revenue therefrom was a capital receipt.

(2) It was well established that a capital asset could be converted into a trading asset. The case of Canadian Kodak Sales Ltd. v. M.N.R., governed these circumstances. The fact that these sales were made reluctantly was irrelevant. On the decision to make such a sale and the subsequent fact of sale, the equipment ceased to be a capital asset of the corporation's rental operation and became part of its business inventory.

(3) Sale transactions in respect of lost or damaged rental equipment were in effect negotiated settlements for the breach of a condition of the bailment contract that governed the relation between lessor and lessee. The payment that resulted could be either a capital or income receipt. If, as here, the payment were made to compensate for the loss of a capital asset, it was capital in nature. The facts that such sales produced predictable and significant revenues from year to year and that the amount recovered was often in excess of replacement cost did not affect the conclusion that such revenue were capital in nature. Appeal allowed in part.

At page 2122 (D.T.C. 63), Mr. Justice Christie says:

Little need be said regarding disposition in the first category. This equipment ab initio forms part of the rental pool and it remains there until it becomes unserviceable by reason of wear and tear in the course of being rented or until it becomes obsolete, whereupon it is disposed of. This is clearly the disposition of the remnants of capital assets and the revenue therefrom is a capital receipt. Indeed, if l understood him correctly, counsel for the respondent conceded this during argument. The appellant succeeds on this issue”.

[Emphasis added.]

4.03.1 (6) Counsel for the appellant also referred to the Hollick case (4.02(26)). In that case (T.A.B.), Mr. Fabio Monet, then Assistant Chairman, decided that while the receipts from the sale of farm products constituted income, the proceeds from the sale of farm equipment were capital in nature. At page 126 (D.T.C. 470), he said:

The appellant was not and had never been in the business of buying or selling horses or cattle, and the amount he received for his horses and cattle upon his ceasing to farm was purely a return of capital and not income.

4.03.1 (7) Counsel for the appellant then made the following comments:

These cylinders were continuously and regularly employed (throughout their life) as a means to package and distribute the various gases which C.L.A. manufactured and sold. There is no evidence to support that C.L.A. ever intended to sell its cylinders and derive any profit from such sale. On the contrary, C.L.A.'s policy (as the Cylinder Product Agreement readily attests), was to have all cylinders returned, generally within a thirty (30) day period and, for that purpose, it actively pursued a policy where its customers were induced to return all C.L.A. cylinders.

A typical Cylinder Product Agreement provides a monetary disincentive, by way of demurrage charges, for a customer to retain cylinders beyond such thirty (30) day period. The demurrage charges, coupled with the periodic "cylinder audits” conducted by C.L.A., clearly attest to C.L.A.'s policy was to recover all cylinders, not to profit from the proceeds received as a result of their loss or destruction beyond repair.” (A.N.A. No. 89 and 90)

C. Fixed and circulating capital

4.03.1 (8) Counsel for the appellant referred to and quoted many decisions (Johns-Manville Canada Inc. (4.02(14)), John Smith and Son v. Moore (4.02(15)), Ammonia Soda Company Ltd. (4.02(1)), Golden Horse Shoe (New), Ltd. (4.02(1 1)), Hinton v. Maden and Ireland, Ltd. (4.02(13)), to determine the distinction between fixed and circulating capital. I retain this excerpt of Mr. Justice Romer in the Golden Horse Shoe (New), Ltd. at pages 300-301:

The question to be decided in this case is whether the dumps are to be regarded as fixed capital or as circulating capital . . . Unfortunately, however, it is not always easy to determine whether a particular asset belongs to the one category or the other. It depends in no way upon what may be the nature of the asset in fact or in law. Land may in certain circumstances be circulating capital. A chattel or a chose in action may be fixed capital. The determining factor must be the nature of the trade in which the asset is employed. The land upon which a manufacturer carries on his business is part of his fixed capital. The land with which a dealer in real estate carries on his business is part of his circulating capital. The machinery with which a manufacturer makes the articles that he sells is part of his fixed capital. The machinery that a dealer in machinery buys and sells is part of his circulation capital, as is the coal that a coal merchant buys and sells in the course of his trade.

[Emphasis added.]

Counsel for the appellant made the following comments:

The real question however is what role the cylinders play in C.L.A.'s business. Whilst the cylinders are not in Romer, L.J.'s words "the machinery with which a manufacturer makes the articles that he sells", they are, due to the nature of the gas products, a necessary part of the manufacturing and supply process and are quite clearly not "the machinery that a dealer in machinery buys or sells.” In addition, it cannot be said that C.L.A. makes money by parting with the cylinders. On the contrary, it makes money by parting with the gases in the cylinders and actively discourages sales of these cylinders. C.L.A. required the cylinders in order to be able to part with the gas and make money, and on this basis, one must conclude that the cylinders form part of C.L.A.'s fixed rather than circulating capital.” (A.N.A. No. 95)

D. Payments In compensation of capital assets

4.03.1 (9) Concerning the payments received by a trader in compensation of capital assets directly from another person or through his insurance company following a legal action or not, counsel for the appellant referred to the basic principles in two British cases: London & Thames Haven Oil Wharves Ltd. v. Attwooll (4.02(16)) and Green v. J. GHksten & Son, Ltd. (4.02(27)).

4.03.1 (10) In the London & Thames Haven Oil Wharves Ltd. v. Attwooll case (4.02(16)), Lord Diplock stated the relevant rule as follows at pages 515-17:

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 profit (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.

Those cases are to be contrasted with cases where compensation is paid for the destruction or permanent deprivation of the capital asset used by a trader for the purposes of his trade. Here the asset thereafter ceases to be one by the use or exploitation of which the trader carries on his trade. As a result of such destruction or deprivation the trader ipso facto abandons that part of his trade which involves the use of the capital asset of which he has been deprived by destruction or otherwise, and profits which he would but for its destruction have made by its use or exploitation will thereafter no longer form part of the profits arising from the trade which he continues to carry on. Even if the compensation payable for loss of the capital asset has been calculated in whole or in part by taking into consideration what profits he would have made had he continued to carry on a trade involving the use or exploitation of the asset, this does not alter the identity of what the compensation is paid for, to wit, the permanent removal from his business of a capital asset which would otherwise have continued to be exploited in the business.

4.03.1 (11) In the GHksten case (4.02(27)), the House of Lords decided that insurance proceeds received by a timber merchant in respect of stock of timbers destroyed by fire were revenue receipts.

Lord Dunedin said at pages 384-85:

The whole point is that the business of the Company is to buy timber and to sell timber, and when they sell timber they turn it into money. This particular timber was turned into money, not because it was sold, but because it was burned and they had an insurance policy over it. The whole question comes to be whether that is a turnover in the ordinary course of their business. I think it was. They had that amount of timber, which they got rid of and for which they got a certain price, and then they could begin again. The more times you have a turnover, that is to say, the more sales you can get, provided that you are carrying on business at remunerative prices, the better for you. The result of this fire was that they got rid of so much timber and got the insurance money at that figure, and that seems to me precisely in the same position as if they got rid of it by giving it to a customer.

Moreover, Lord Lawrence agreed with the saying of Mr. Justice Rowlatt who rendered the judgment which was in appeal:

I agree with Mr. Justice Rowlatt that the insurance money ought to be treated, for the purposes of ascertaining the balance of profits or gains, as an ordinary trading receipt in the same manner as the proceeds of the sale of the stock would have had to be treated had the stock been sold.

4.03.1 (12) Concerning the point that a compensatory payment may be not considered as a sale, counsel for the appellant contends that it is at least a "proceed of disposition” as described in subparagraphs 54(h)(iii) and 13(21)(d)(iii):

54(h)(iii) and 13(21 )(d)(iii)" Proceeds of disposition".—' proceeds of disposition" of property includes,

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

According to counsel for the appellant, payments in lieu of capital assets such as lost or destroyed cylinders are of capital character.

4.03.2 Respondent's submission

4.03.2 (1) The respondent's main contention is that the amounts paid by the customers for lost cylinders are income because it is provided in the cylinder product agreement (2.03, I-1 and 2.05 No. 33) between C.L.A. and its customers. The conditions of the payment for the gas, for the demurrage charge and for the lost cylinders are in the same agreement. This charge for the lost cylinders is at the same level as the demurrage charge, and the price of the gas.

Counsel for the respondent says that the main purpose of the company is to make money. The cylinder product agreement is basically a contract of gas supply. It is a business agreement. The appellant's right to charge the three amounts (price of gas, demurrage and, lost cylinder) has its source in that agreement and they are all business income.

4.03.2 (2) It is not relevant, according to counsel for the respondent, to decide whether the cylinder is part of the inventory or part of the assets or plant of the company.

I do not sell an asset, I charge to my customer an amount pursuant to an agreement. I charge an amount to my customer for gas. I charge a penalty for demurrage. I don’t want to know which cylinder I have not received. I want to know nothing but what it is paid to me pursuant to the agreement.” (S.N. page 121) [Translation]

To base such affirmation, counsel for the respondent explains that there are many ways to charge a customer. First, it can be an average general charge including all the aspects of the product. Also, the average general charge can be detailed in gas, demurrage and lost cylinders. But in fact, with a general charge, the vendor does not care whether a cylinder is returned or not, from the moment he is paid. He is not paid because he sold an asset, it is not relevant: the vendor is paid because there is an agreement which says: "You owe me such sum of money in such circumstances." (S.N. page 125)

4.03.2(3) According to counsel for the respondent, cases at law referred to by counsel for the appellant concerning capital and circulating assets, concerning capital and current expenses and concerning damages are not relevant because they do not help to resolve the actual problem.

If we ask the question: what is the appellants business? Mr. Murray in his testimony affirmed many times: “It is the sale of gas. We want to sell the maximum of gas with the minimum of cylinders in view to maximize the profit.”

The method used to recuperate the cylinders as fast as possible is the demurrage charge and the cost of the lost cylinders. It is part of the business, even if the business itself is not in the purchase and resale of cylinders.

4.03.2 (4) The cost of each cylinder being between $200 to $300, therefore, the cost of the packing is more expensive than the price of the gas sold in it. However, cylinders remain packing.

But it is not important if they are part of the inventory or part of the assets. This will not help the Court. Counsel for the respondent says the main point is that the appellants business is the sale of gas. The other points (demurrage and cost of cylinder) are incidental and the nature of the amounts received concerning them is of the nature of those received for gas: they are of business nature.

4.03.2 (5) Can the payment of the cost of the lost cylinders be considered as damages? There is no breach of contract. The cost of the lost cylinders being provided in the agreement between the appellant and its customers, it is not damages but income.

4.03.2 (6) As there are costs of good or property which can be deductible either directly in the computation of the income or through its capitalization and capital cost allowance, what is the solution?

Counsel for the respondent suggests looking at the nature of the business. Cylinders are an integral part of the business of selling gas. It is not a good which is rented or sold as in the Anthes Equipment Ltd. case (4.02(2)) quoted above by counsel for the appellant. Therefore, there is no breach of contract and no damage.

The appellants business principle is the more quickly the cylinders are returned empty by a customer, the more quickly they are returned full to another customer; the more gas C.L.A. sells, the more money it makes.

If there are incentives, as in the present case, for returning the cylinders more quickly, the receipts originating from those incentives are of business nature, just like the payment for gas.

4.03.2 (7) Counsel for the respondent referred to the Californian Copper Syndicate (Ltd. and Reduced) v. Harris (Surveyor of Taxes) case (4.02(6)), in particular to the often-quoted passage of Lord Justice Clark at page 165:

It is quite a well settled principle in dealing with questions of assessment of Income Tax, that where the owner of an ordinary investment chooses to realise it, and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit in the sense of Schedule D of the Income Tax Act of 1842 . . . . But it is equally well established that enhanced values obtained from realisation or conversation of securities may be so assessable, where what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business.

And further at page 166, Lord Justice Clark stated:

What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being—Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?

It is clear, according to counsel for the respondent, that in the present case, the proceeds received by the appellant in respect of each lost or damaged cylinder pursuant to a five-year agreement is a gain made in an operation of business in carrying out a scheme for profit-making”.

4.03.2 (8) Counsel for the respondent also referred to the Valley Camp Ltd. case (4.02(23)). The facts are summarized at page 418 (D.T.C. 6337) as follows:

The taxpayer contracted with CN to provide and operate on certain property owned by CN and for CN's exclusive use, complete facilities for the unloading of railway cars containing iron ore concentrate pellets, the stockpiling of such pellets and their loading into vessels for further carriage. During the 25 year term of the agreement, CN paid the taxpayer a handling charge in accordance with a rate schedule. In addition, CN paid the taxpayer an annual payment equal to 10 /4% per cent of the final actual capital cost of the facilities without any right of CN to cancel, reduce, abate, counter-claim against, delay the payment of, set off against, or withhold any amount even if CN took over the operation of the facilities as a result of the taxpayer's breach of the contract. The agreement also provided that at the end of the 25 years CN would not be the owner of the facilities even if it had fully paid for them, but it would have the exclusive option to purchase the facilities at a price mutually agreed upon by the parties, or by arbitration. In case of arbitration, the price would be the value of the facilities plus any insurance proceeds held and receivable by CN. If CN did not exercise its option, the taxpayer had 12 months to remove the facilities, otherwise title would vest in CN. In 1958, CN paid the taxpayer $520,655 which the taxpayer included as income. Subsequently, the taxpayer filed an amended income tax return for 1968 and the respondent revised the taxpayer's 1968 taxable income and claimed a tax payable in the sum of $1,202.66. The taxpayer appealed this reassessment which was confirmed by the Tax Review Board. The taxpayer then went to the Federal Court, alleging that the payment of $520,655 should not have been included in computing its taxable income for 1968 since it was a capital payment made to reimburse the taxpayer for the construction of the facilities and was not an income receipt. It relie bY analogy on paragraph 20(6)(h) of the Act stating that the word subsidy" meant the same as "capital contribution”.

Held: The appeal was dismissed. The fact that CN did not own the facilities at the end of the agreement but might purchase them at an adjusted replacement cost figure clearly disproved the claim that the annual payments were repayments of capital advanced by the taxpayer, specially when the agreement throughout requires the taxpayer to provide and operate the facilities, to maintain, repair and keep the facilities in good condition and to insure the facilities. The whole transaction was a commercial one in which CN acquired the loading and unloading expertise of the taxpayer for which CN paid the handling charges and the amount required to reimburse the taxpayer for the outlays it needed to be able to provide the facilities for the service to be performed. Paragraph Paragraph 20(6)(h) does not apply to ordinary business arrangements negotiated by both parties to the contract for business reasons, but only to a case the taxpayer has acquired property at a capital cost to him and has also received a subsidy or other assistance from public authority in respect of or for the acquisition of property.

Mr. Justice Urie of the Federal Court of Canada, Trial Division, said at pages 422-23 (D.T.C. 6340):

It is quite apparent that CN required the loading and unloading expertise of the appellant for which it was willing to pay charges not only for the actual handling of the pellets but also for the amount required to reimburse the appellant for the outlays it was required to make "to provide” the facilities for the services to be performed.”

The whole transaction was clearly a commercial one in which Valley Camp prudently ensured the recovery of its expenditures for this apparently single purpose facility whereas CN assured itself of facilities provided and operated by experts, in part at least at a predetermined annual cost.

Therefore, the payments in both paragraphs 9 and 10 are, in my view, revenue in nature.

The payments here were not made apart from the trade or business operations of the appellant but were made as part of them as consideration for providing and operating the pellet facilities.

According to counsel for the respondent, it is the same thing in the present case. The proceeds at issue were received in the normal operation of the selling gas business and pursuant to the cylinder product agreement.

4.03.2 (9) A decision of Mr. Chief Justice Couture of the Tax Court of Canada, Les Entreprises de Pipe-Line Universel Ltée (4.02(21)), was also quoted by counsel for the respondent. In this case, the facts are summarized in Canada Tax Cases at page 2002 as follows:

The taxpayer corporation was engaged in the business of assembling and installing industrial and mechanical piping. In 1977, the corporation formed a joint venture (DUJV) with another company in order to bid on a contract for the construction of an atomic power plant in New Brunswick. Their bid was successful, and contractual negotiations with the Power Commission ensued. The final agreement provided for two forms of payment for services provided. The first was a lump sum of $15 million for personnel on the site as well as all equipment belonging to DUJV used to perform the work. The second was a reimbursable amount of $14,180,000, principally for wages for locally hired and trained personnel. The agreement provided for an adjustment mechanism in the event that these amounts proved unrealistic.

The project in fact proved far more costly than originally estimated, and the parties undertook negotiations to rectify the situation. DUJV proposed that the Commission rent its equipment at construction association rates. The Commission rejected this proposal on the ground that over a period of time rental payments would exceed the replacement value of the equipment. Instead, the parties agreed that the Commission would purchase the equipment on May 29, 1979. The book value of the corporation's interest in the equipment purchased was $72,000, and it received $734,000 in proceeds of disposition, thus realizing a gain of $662,000. DUJV did not exercise its option to buy back the equipment from the Commission when work was completed in 1982. The corporation reported the proceeds of disposition as a capital gain received in its 1981 taxation year. The Minister assessed on the basis that the proceeds were business income derived from carrying out the contract with the Commission, and that they were received in the corporation's 1979 taxation year. The corporation appealed the assessment, although it conceded at trial that the proceeds were received in its 1979 taxation year.

Pursuant to the evidence presented, Chief Justice Couture arrived at a first observation that the involved parties, DUJV and the Commission, had at a certain point a problem which they had to resolve. At page 2008 (D.T.C. 1388-89) of said judgment, Chief Justice Couture stated that:

It was necessary to find a solution to the problem, which would accommodate both parties by allowing DUJV to increase its revenues without at the same time causing financial prejudice to the Commission by imposing additional costs on it which would be difficult to justify.

I think that this is the essence of the motivation of the parties at the time they were negotiating an amendment to the tender. It was a question for them of finding terms of payment by the Commission to DUJV which would enable them to achieve their respective aims. It thus seems that this boiled down either to an increase in the rental for use of the equipment or to the purchase of the equipment at its replacement cost as proposed by the Commission. The result of the two options was the same for the appellant, namely an increase in the amount to be collected from the Commission after the work specified in the tender had been performed, and thus in the course of carrying on its business. What emerges from all the negotiations between the parties is the fact that they were undertaken for the sole purpose of improving DUJV’s position vis-a-vis its commitment and obligations toward the Commission, without adding to the latter's obligations unduly. The solution which could meet both objectives was purchased by the Commission of the equipment in question. I think that it is correct to say that purchase of the equipment was not an aim in itself for the parties but served as a catalyst in overcoming the impasse between them. This is made evident by an examination of a document prepared by the appellant but filed by the respondent entitled "Trucks and Trailers Sold NB Power”. This is the list of equipment it owned that was sold to the Commission.

	Purchase		Book		Profit on
	Cost	Depreciation	Value	Sale Price Sale Sale
Chevy Truck	$ 649	$ 539.87	$109.13 $15,807.96 $15,698.83
Chevy Pick-up	400	303.96	96.04	6,031.80	5,935.76
Chevy Pick-up	412.50	313.47	99.03	7,111.80	7,012.77
Tool Trailer	3,024	2,775.23	248.77	11,797.92	11,549.15
Office Trailer	1,123.20	853.94	269.26	6,415.20	6,145.94

The list continues giving the same information. This information indicates, in my view, that this was a transaction of accommodation. Even between parties dealing at arm's length, I have trouble believing that a purchaser would pay $15,807.96 for a truck which had cost the seller $649, thus allowing him to make a profit on its book value of $15,698.83. This same reasoning applies to the other items in this list. This leads me to conclude that for DUJV this was not a sale in the commercial sense of the term but rather a scheme implemented by the parties to allow the appellant to increase its revenues from the performance of the contract.

Mr. Justice Couture also referred to Californian Copper Syndicate (Ltd. and Reduced) (4.02(6)) and Valley Camp Ltd. (4.02(23)) cases and concluded that the sale was "an operation of business in carrying out a scheme for profitmaking".

Counsel for the respondent submits it is the same thing as in the present case in which the proceeds from the lost cylinders are received by the appellant pursuant to agreements with numerous customers. It is an operation of business in carrying out a scheme for profit-making.

4.03.2 (10) In the Imperial Tobacco Co. Ltd. case (4.02(22)) referred to by counsel for the respondent, the material facts are summarized as follows:

The appellant Company carried on the business of tobacco manufacture, for which large quantities of tobacco leaf were purchased in the United States, where the Company maintained a large buying organisation. To finance the purchases and the expenses of this organisation the Company bought dollars in the United Kingdom through its bankers who remitted them to banking accounts of the Company in the United States, and it was the practice of the Company to accumulate a large holding of dollars each year before the leaf season commenced. The Company never bought dollars for the purpose of resale as a speculation.

On the outbreak of war, in September, 1939, the appellant Company, at the request of the Treasury, stopped all further purchases of tobacco leaf in the United States, and, as a result, the Company had on hand a holding of dollars which had been accumulated between January and August, 1939. On 30th September, 1939, the Company was required under the Defence (Finance) Regulations, 1939, to sell its surplus dollars to the Treasury, and, owing to the rise which had occurred in the dollar exchange, the sale resulted in a profit for the Company. This profit was included in assessments upon the Company to Income Tax under Schedule D, Case 1, and to National Defence Contribution.

Lord Greene said at page 300:

We have here a finding of fact as to the purpose for which the dollars were bought. The purchase of the dollars was the first step in carrying out an intended commercial transaction, namely, the purchase of tobacco leaf. The dollars were bought in contemplation of that and nothing else. The purchase on the facts found was, as I say, a first step in the carrying out of a commercial transaction, which would be completed by the purchase and delivery of the leaf and payment of the dollar purchase price for it.

At page 301, after referring to another case, he added:

In the present case it is truly said that it was no part of the Company's business to buy and sell dollars. But in each case the commodity (in the one case the coal and in the other case the dollars) was acquired for the purpose of transactions on revenue account and nothing else. In each case there was a surplus which was not needed for the purposes of those transactions. In each case the surplus was realised at a profit.

The learned judge concluded that the profit of the company on the sale of surplus dollars had to be included in the computation of the profits of its trade. The appeal was dismissed.

Counsel for the respondent submitted that by analogy the cylinders being used in the sale of gas, like dollars in the sale of tobacco, it is "business income".

4.03.2 (11) The Gloucester Railway Carriage and Wagon Company case (4.02(24)) also referred to by counsel for the respondent, the facts are summarized as follows by C.T.C. at page 720:

A company manufactured railway wagons and dealt with them either by selling them (outright or under hire purchase agreements) or by letting them on hire. In the books of the company the wagons owned by the company and let on hire were capitalized at a sum which included a calculated sum added as profit on manufacture and a certain amount was written off the value year by year for depreciation. The company, having decided to sell all the wagons used for letting on hire, sold them at sums larger than the sums at which the wagons then stood in the books. In assessing the company to corporation profits tax the surplus obtained from the sale of these wagons was included as a trade profit of the company, and on appeal the Special Commissioners, in affirming the assessment, found that the business of the company was a single business—namely, to make a profit in one way or another out of manufacturing wagons:

Held, that the surplus in question was not a capital accretion, but was rightly included as a trade profit for the purposes of the corporation profits tax.

Lord Dunedin, at pages 474-75, said:

The appellants argue that this is really a capital increment; and to say so they call these wagons plant of the hiring business. I am of opinion that in calling them plant they really beg the whole question. The Commissioners have found—and I think it is the fact—that there was here one business. A wagon is none the less sold as an incident of the business of buying and selling because in the meantime before being sold it has been utilized by being hired out. There is no similarity whatever between these wagons and plant in the proper sense, e.g., machinery, or between them and investments the sale of which plant or investments at a price greater than that at which they had been acquired would be a capital increment and not an item of income. I think that the appeal fails.

Once again, counsel for the respondent submitted that in the present case, incidental income such as proceeds from lost cylinders provided in the same agreement as proceeds from sale of gas to customers are in the normal commercial operation of the business of selling gas and the proceeds must be considered as business income.

4.04 Court's decision

4.04.1 The main contention of the respondent is based on the reason that as in the same agreement provides demurrage charges, required payments for lost cylinders and the price of gas, consequently the gain is made in an operation of business in carrying out a scheme for profit-making.

Moreover, it is not necessary, according to the respondent, to decide whether the cylinder is part of the inventory or part of the assets or plan (4.03.2(2)).

4.04.2 Whether an amount received is of income nature or of capital nature must depend on the particular facts of each case. The criterion of the classifica- tion of the property at issue can be done in the involved business. As part of the stock-in-trade or part of the permanent capital assets, this criterion must first be applied. Sometimes another approach must be done. It is not always easy, as explained Mr. Justice Estey in the Johns-Manville Canada Inc. case (4.03.1(1)).

4.04.3 In the Valley Camp Ltd. case (4.02(23), 4.03.2(8)) and Les Entreprises de Pipe-Line Universel Ltée (4.02(21), 4.03.2(9)), the courts had to use another approach. In both cases, in fact, one party passed the transaction at issue to help financially the other party. Considering all the facts involved, the courts came to the conclusion that the transactions were business ones resulting in business income for the vendors.

4.04.4 In the Gloucester Railway Carriage & Wagon Co. (4.02(24)) referred to by the respondent, Lord Dunedin quoted above (4.03.2(11)) said "The appellants argue that this is really a capital increment, and to say so they cali these wagons plant of the hiring business. I am of opinion that in calling them plant, they really beg the whole question''.

[Emphasis added.]

Therefore, for Lord Dunedin, it was important to determine the nature of property at issue in respect to the business: is it part of the plant or part of the inventory? This is "the whole question”.

4.04.5 In the present case, in my view, it is easy to determine that the cylinders are part of the capital asset. They were one form of distribution by which gases were sold (3.05(14) to (27)) such as pipelines, on-site-plants, and bulk by way of tanks which undoubtedly are part of the capital assets, part of the plant, the length of the life of these assets being taken into consideration (3.05 No. 14).

4.04.6 In my view, many factual similarities exist between the present case and Anthes Equipment Ltd. (4.02(2)) such as:

(a) C.L.A. retained legal ownership of all gas cylinders in question;

(b) C.L.A.'s customers are by contract bound to return the gas cylinders to C.L.A., usually within thirty (30) days of delivery;

(c) the contractual arrangement between C.L.A. and its customers reveals an express obligation to the customer to promptly return the cylinders to C.L.A. and, if not so returned, an implied condition to exercise the degree of care of a prudent person in respect of such cylinders. C.L.A.'s policy was to prompt its customers to return its cylinders by way of imposing, inter alia, demurrage charges;

(d) the amounts to be received upon the loss or destruction of C.L.A. cylinders are provided for in the agreement between C.L.A. and its customers; and

(e) the payments received by C.L.A. in respect of such lost or damaged cylinders are in settlement of a breach of contract to compensate for the loss of a capital asset of C.L.A.

4.04.7 In reviewing the legal relationship governing the parties, Christie, A.C.T.C.C.J. held that there existed a contract of bailment in which the taxpayer who leased its equipment was the bailor and the customer the bailee and he held that the payments received in breach of the contractual provisions were, on their true construction, negotiated settlements made in respect of lost or damaged equipment made to compensate a capital asset. Accordingly, the proceeds received were held to be capital in nature. At pages 61-62, Judge Christie says:

[Lost and damaged equipment]. In these proceedings these transactions have been variously referred to as "penal sales", "forced sales", "involuntary sales", "loss or damage sales" and “ shortage sales". This multiplicity of characterizations probably arises because they are not sales of any kind. In Black's Law Dictionary, 5th (1979) ed., there is a good definition of the word "Sale" and the transactions do not fall within it. It reads:

A contract between two parties, called, respectively, the"seller" (or vendor) and the "buyer" (or purchaser) by which the former, in consideration of the payment or promise of payment of a certain price in money, transfers to the latter the title and the possession of property. Transfer of property for consideration either in money or its equivalent.

As I see it. the relationship that exists between the appellant and those who lease its equipment is that of bailor and bailee. Hire of chattels is a class of bailment. Under the general law of bailment the duty of care imposed on a lessee of chattel is that which a prudent person would exercise in relation to his own property of a similar kind. This duty can, however, be made more stringent by a specified term in the contract of bailment. In the absence of an express undertaking it is an implied term of the bailment that at the expiration of the lease the bailee must return the property: paragraphs 42 and .43 Bailment” vol. 2, 3rd ed., Canadian Encyclopedic Digest (Ontario).

In my opinion on the basis of the evidence before me these transactions, on their true construction, are negotiated settlements for the breach of the second condition of the contracts of bailment previously cited or, in those few cases where there may have been a social contract other than the standard invoice that did not specifically deal with standard of care or return of the equipment, for breach of the implied terms in this regard.

Payments received in settlement of a breach of contract may be either capital or an income receipt. If payment is made to compensate for loss of anticipated profits from a taxpayer's business, what is received is business income: Fleck Manufacturing 119591 Ltd. v. M.N.R. 62 D.T.C. 580; M.N.R. v. Bonaventure Investment Co., 62 D.T.C. 1083 and Brussels Steel Corp. v. The Queen, 86 D.T.C. 6077. If payment is made to compensate for the loss of a capital asset, what is received is capital in nature.

The payments received by the appellant in respect of the third category of dispositions are capital receipts. In support of his contention that the payments are trading receipts, counsel for the respondent stressed, and the evidence supports him, that revenues from these dispositions were predictable and significant from year to year. He also underscored the fact that what the appellant initially sought to recover was much in excess of the cost to it of replacing the lost or damaged equipment and that what was in fact recovered normally, if not invariably, exceeded that cost. I do not regard these things as leading to the conclusion that what would otherwise be regarded as capital receipts should be labelled business

income. Up to the time of loss or damage rendering it unfit for rent, the equipment was Clearly capital assets in relation to the appellant's business of renting scaffolding and shoring material. The appellant claimed and was allowed capital cost allowance in respect of it while it constituted part of the rental pool. The existence of this course of action was discussed at the hearing, but its correctness was not called into question. Further, where there is a bona fide negotiated settlement of a claim for breach of contract the amount laid and received is compensation for breach of contract. It does not become something else simply because it exceeds or is less than the actual loss suffered by the breach. The appellant is entitled to succeed on this aspect of the appeal.

[Emphasis added.]

In my view, the same reasoning may apply to the present case.

4.04.8 Finally, I must say that I cannot agree with the respondent's argument that because the same agreement provides the conditions for the payment of the gas, for the demurrage charge and for the lost cylinders, the proceeds from those three items are ipso facto of the same nature as the gas (4.03.2(1)).

Once again, in my view, when the classification of the property at issue may be done in respect with the involved business, this criterion must be used. In the present case, cylinders are of capital nature and cannot be part of inventory (3.05 No. 46 to 51).

4.04.9 The Court does not consider Mr. Abdelli as an expert.

Conclusion

The appeal is allowed with costs and the reassessment is referred back to the respondent for reconsideration and reassessment in accordance with the attached reasons for judgment.

Appeal allowed.