St-Romuald Construction Ltée v. Her Majesty the Queen, [1989] 1 CTC 205

Pinard, J. [Translation]:—The appeal at bar is an action under subsections 172(1) and 175(3) of the Income Tax Act, S.C. 1970-71-72, c. 63 and its amendments, which was lodged by the taxpayer St-Romuald Construction Ltée following a decision rendered in the Tax Court of Canada on October 16, 1985, which dismissed the plaintiff's appeal concerning a tax reassessment notice from the Department of Revenue Canada for the 1978 tax year.

The case essentially involves determining if the amount of $227,000 paid to the plaintiff following the cancellation of a subcontract does or does not constitute income from a business, within the meaning of subsection 9(1) of the Act, which stipulates:

Section 9: Income or loss from a business or property

Subject to this Part, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.

The plaintiff ran a construction business during the 1978 taxation year. At that time Les Constructeurs K.B.R. (KBR) was involved in construction work on a diversion structure at Eastmain Opinaca as part of James Bay development activities, and did so pursuant to a contract concluded with the Société d’énergie de la Baie James.

With respect to this contract, KBR awarded a subcontract in the spring of 1977 to the plaintiff to provide materials and to complete the works necessary for producing the concrete structures of the Eastmain Dam spillway, at a cost of about $3.6 million.

Shortly after the plaintiff began this work, in the summer of 1977, conflicts developed between the former and KBR over the speed with which these works were to have been progressing. In early February 1978, following this disagreement, KBR decided to avail itself of the provisions of Article XVIII(b) of the subcontract to give the plaintiff notice to remedy the situation within five days or to have the subcontract cancelled and the execution of the works involved taken over by KBR. Article XVIII(b) of the subcontract stipulates the following:

b) If the sub-contractor fails to comply with the provisions herein concerning the manner in which the works are to be performed, or the deadlines for doing so, and if it fails to remedy this situation within five days of a written request to do so by the contractor, the latter may, by sub-contract or otherwise, and without prejudice to any other right or recourse, withdraw the execution of the subcontract from the sub-contractor and conclude or have the work concluded itself at the sub-contractor's cost; or, without withdrawing the sub-contract, it may provide the required materials and hire the labour required to remedy the situation, at the sub-contractor's cost. If the contractor takes over the execution of the work pursuant to this paragraph, it is understood that it may take over the facilities, materials, tools and equipment of the subcontractor that it finds on the job site in order to conclude the work provided by this sub-contract.

Subsequently, on February 20, 1978, the plaintiff and KBR signed a transaction to conclude the subcontract and allow KBR to take over the execution of the works concerned.

According to the terms of this transaction, KBR agreed, in particular, to pay the plaintiff an amount of $129,720 for extras and holdback on the contract; however, KBR maintained a balance of $76,535.02 “as an agreed amount to cover repairs, remedial work, holdback on S.R.C.'s subcontracts, and holdback on grouting work." ("S.R.C." designates the plaintiff St- Romuald Construction Ltée).

Pursuant to this transaction, the plaintiff agreed to devote the time and energy necessary, as well as the trips required, to ensure the transfer to KBR of leases covering certain pieces of equipment and its own subcontracts with third parties; the plaintiff also guaranteed that the agreed-upon prices in said leases and subcontracts would be maintained. This appears in article 5(c) of the transaction, which states:

5. (c) S.R.C. will co-operate fully in arranging a prompt and orderly transfer of such leases and sub-contracts, devoting thereto such time, effort and travel as may be reasonably required. S.R.C. guarantees consent of the lessors and subcontractors to transfer at the prices originally agreed by S.R.C., failing which an adjustment shall be made as contemplated in paragraph 6b) hereof.

In addition, through this transaction, KBR agreed to pay the plaintiff an amount of $21,504 for materials left at the job site. Then, in accordance with article 6 of the transaction, KBR agreed to pay the plaintiff a sum of $227,000, under the heading of additional compensation; that is the amount which is the subject of the appeal at bar. Said article 6 of the transaction stipulates:

6. a) As compensation for cancellation of the sub-contract K.B.R. will pay to S.R.C., subject to sub-paragraph b) hereof, the sum of $227,000.00, in consideration of which S.R.C. renounces any other recourse in this connection; and K.B.R. renounces any other recourse against S.R.C., except as herein provided, by reason of the partial execution of the work and the cancellation of the sub-contract, assuming for its own account, except as herein specified, the job site as it now is and as if K.B.R. had executed the work from the beginning.

b) Of the said sum of $227,000, $200,000 shall be payable within ten days hereof, and the remaining $27,000 on 31 July 1978 unless K.B.R. can prove substantial lack of the co-operation or lack of the consents referred to in paragraph 5c) hereof.

Finally, it is essential to reproduce articles 7 and 8 of the transaction:

7. This transaction is made without admission of default or breach of contract by either party, and both undertake to not take advantage of this transaction with SEBJ, Federal Insurance Company, nor any other person as if it were an admission of a default, failing which recourse in damages will be available;

8. Grouting work which the parties agree that S.R.C. should continue will be the subject of a new and separate sub-contract.

[Emphasis mine.]

On one hand, the plaintiff submitted that the amount of $227,000 received from KBR pursuant to the above transaction essentially constitutes compensation for damages and that said amount is, consequently, non- taxable; it specified that this sum constituted a payment of damages for the sterilization of a major portion of its business.

On the other hand, the defendant contended that the amount of $227,000 was paid to the plaintiff in consideration of the value of the works that had been completed, of the works that remained to be done, and also for a share of future profits; thus, it maintained that this amount is part of plaintiff's earnings for its 1978 taxation year under the provisions of sections 3 and 9 of the Income Tax Act.

In defence of its position, the plaintiff contended that KBR unilaterally terminated its contract, although it had, nevertheless, been able to meet the work deadlines to which it was committed. The plaintiff submitted that because of this “breach of contract” KBR caused serious prejudice to its reputation and brought on the eventual closing of its large civil engineering division.

Mr. Vital Soucy, president of the plaintiff company from 1968 to 1985, testified to the effect that this company had started out, from 1964 to 1969, by specializing in swimming pool construction, concrete injection and the repair of concrete structures; during its busy season, it hired from 30 to 35 employees; and its earnings rose from $348,000 in 1967 to about $1,000,000 by the end of 1969. Mr. Soucy indicated that the plaintiff developed a civil engineering division in 1969, and that from 1972 until the signing of its subcontract with KBR, civil engineering work constituted 90 per cent of its commercial activitiy. From 1974 to 1978, the plaintiff employed as many as 375 individuals, only about 60 of whom worked in the area of concrete injection, while the others worked in the civil engineering divisions. All of this sug- gested to Mr. Soucy that the plaintiff's future revolved around civil engineering, when it signed two contracts in the spring of 1977 with KBR, the first being the one for $3.6 million with which we are concerned here, and the other involving a concrete injection contract for a total amount of $209,060. The $3.6 million contract turned out to be of the utmost importance, because it nurtured a valuable business relationship with KBR, a very large contractor, particularly with respect to James Bay energy development work, and that it would additionally enable the plaintiff to prove itself and make itself well known in the field of civil engineering with many other contractors. According to witness Soucy's testimony, the loss of this contract, in early 1978, resulted in considerable prejudice to his firm’s reputation and led to the eventual closing of its civil engineering division in 1982. In defence of this last claim, the plaintiff began by producing a list that indicated its earnings for each of the years 1972 through 1983 inclusively, thus:

In addition, the plaintiff produced the letter it had sent its engineer Paquin dismissing him as of the beginning of 1979.

Mr. Donald Donovan, the plaintiff company's vice president, gave similar testimony.

In short, the plaintiff maintained that because of the common knowledge on a huge construction site that its contract was prematurely terminated with KBR, its credibility among contractors was so seriously impaired that it ultimately had to close its civil engineering division. It would have had to sell its heavy equipment in 1979, and because of difficulties obtaining guarantees, would not have been able to subsequently bid on civil engineering contracts. All of this presumably led to a loss of morale among its seven to eight engineers who, one after the other, left the company between 1978 and 1982.

It was this attack on the very structure of its business that the plaintiff stated would have been compensated by the amount of $227,000 stipulated in the transaction of February 20, 1978.

The above claim is fundamental in terms of the applicable authorities and law. [1] However, because of the plaintiff's burden of proof in this matter, this claim does not withstand an analysis of the evidence presented, considering the latter's gaps and other elements it comprises.

Indeed, it is essential to begin by emphasizing that the evidence concerning the plaintiff's timetable for carrying out the work is not satisfactory. On one hand, the latter claimed that it was supposed to start this work at the beginning of the summer of 1977, interrupt it during the winter and resume it in the spring of 1978 to complete it in mid-September of 1978; on the other hand, the president of KBR categorically denied that this was the timetable agreed upon and testified that the work was to have been completed in July 1978, explaining that both parties had originally agreed on the kind and quantity of work to be performed on a weekly basis. Moreover, the plaintiff maintained that, despite the fact that the job sites were not made available to it in the agreed-upon condition, causing it serious problems, it was nonetheless on schedule in performing its work when KBR gave it official notice on February 2, 1978. The president of KBR, on the other hand, claimed that because of poor planning and bad management, the performance of the work by the plaintiff suffered from unjustifiable delays, resulting in numerous meetings and discussions between the parties, which proved to be in vain; consequently official notice was given on February 2, 1978. The verbal evidence in this matter is thus contradictory. As to the subcontract, it expressly stipulates:

ARTICLE 2: The Sub-contractor agrees:

a) (text struck out by both parties)

b) to begin, perform and complete the above-mentioned work according to

the rules of the trade in accordance with the Contractor's schedule,

so as to ensure the completion of the works as scheduled without delaying the works of the Contractor or other Sub-contractors.

Indeed, this "Contractor's schedule”, has never been filed, the plaintiff, through its attorney, insisting that said schedule was identical to the schedule of work stipulated in the main contract between KBR and the Société d'énergie de la Baie James, a contract which was not filed, either.

Thus, considering this gap and these contradictions in the evidence, I cannot conclude that the plaintiff met the schedule for its works at the time it was given official notice, on February 2, 1978. Nor can I conclude that KBR decided to terminate its subcontract with the plaintiff without valid cause. The above is sufficient, in my opinion, considering the above-mentioned article 7 of this transaction as well, to render inapplicable to the case at bar the judicial decision in The Queen v. Robert B. Atkins ([1976] C.T.C. 497; 76 D.T.C. 6258); the latter affair, which concerned a discharge without reasonable notice involved an unjustified breach of contract by the party subject to the payment of compensation. The Chief Justice of this court stated, at page 498 (D.T.C. 6258):

Once it is conceded, as the appellant does, that the respondent was dismissed "without notice”, monies paid to him (pursuant to a subsequent agreement) “in lieu of notice of dismissal” cannot be regarded as “salary”, "wages" or "remuneration" or as a benefit “received or enjoyed by him . . . in respect of, in the course of, or by virtue of the office or employment". Monies so paid (i.e., “in lieu of notice of dismissal”) are paid in respect of the “breach” of the contract of employment and are not paid as a benefit under the contract or in respect of the relationship that existed under the contract before that relationship was wrongfully terminated.

[Emphasis mine.]

Next, the evidence that the sterilization of a large portion of the plaintiff's company was a direct result of the cancellation of its subcontract with KBR is not much more convincing.

In its letter of October 25, 1978, to the engineer Paquin, the plaintiff explained, as follows, its intention to reduce civil engineering works to a minimum:

After having evaluated current market strategies for civil engineering work, as well as the economic and political situation, we advised you that it was our intention to reduce civil engineering work to the minimum and even to withdraw somewhat from this field, for a certain period of time.

Moreover, despite these economic and political circumstances, the plaintiff acknowledged that between the date of the transaction and 1982, it was able to obtain as many as six civil engineering contracts for more than $500,000 each, and that two or three of these contracts involved amounts greater than $1 million each. The latter included a $4.1 million civil engineering contract awarded to the plaintiff in 1981, concerning site LG-4 in James Bay village.

In view of these facts, I have great difficulty believing that the cancellation of the subcontract resulted in such substantial prejudice to the plaintiff's credibility. I am more inclined to conclude that the gradual decrease in the plaintiff's activities in civil engineering resulted basically and primarily from the causes that it specified itself in its letter to engineer Paquin, these being market conditions in civil engineering along with the then-current economic and political situation. Furthermore, it is common knowledge that a recession occurred and had a serious impact on the economy in 1981 and 1982.

Furthermore, no evidence has been presented that the damage to the very structure of the plaintiff's company was, at the time of the transaction, a factor considered in calculating the amount to be paid to the plaintiff.

It is useful, in this respect, to refer to A. Janin & Cie Ltée, supra, in which the Supreme Court of Canada confirmed the prior decision of the Exchequer Court of Canada to the effect that the Minister of National Revenue had been correct in considering the full payment of $2 million received by the taxpayer as income. As the Exchequer Court had ruled, this payment included no compensation for damages to the reputation of the appellant; the sum of $2 million had been paid for the execution of the works and the supply of materials. In this case, it was obvious reading the settlement agreement that damages sustained by the parties had not been considered in the agreement reached. Dumoulin, J., in the decision of the Exchequer Court, at page 162 (D.T.C. 5118), stated that he concurred with the following observations of the Tax Appeals Commission:

I am also in accord with the following:

It is not contested that damages were suffered on both sides. That is not the issue. If the parties to the suit, in making their settlement, did not allow for the damages that were suffered and waived such claims between themselves, as was in fact the case, these damages cannot now be invoked to deny the assessment. In the first place, these damages were not liquidated during the years under appeal. An assessment is not based on what may occur in the future, but rather on the concrete result of current accounting for each taxable year.

As to the actual reasons for the payment of a compensation of $227,000, it should also be realized that, at the date of the transaction, the plaintiff had, in partially completing its subcontract with KBR, actually spent some $1.8 million although it had only billed about $1.5 million. This had been done, even though, according to the terms of the subcontract, KBR had at that time made all required payments to the plaintiff. Moreover, the latter, in this letter of January 24, 1978 to KBR, acknowledged that it had sustained losses of more than $350,000, as is evident in the following extract of this letter:

Nevertheless, under pressure, we tried to meet your schedule in 1977 and suffered losses in excess of $350,000 due to excessive heating and hoarding costs, low labour productivity due to rainy weather in August and very cold weather in November and December 1977, changes in rock-cleaning methods and concretepouring schedules at the start, delays in rebar delivery, etc.

Indeed, the president of KBR testified to the effect that he had studied the plaintiff's documents concerning these losses and had considered the latter prior to agreeing to the $227,000 compensation. He explained in greater detail the reasons behind the payment of the different amounts stipulated in the transaction of February 20, 1978, in a letter that he addressed to his own counsel, on February 28, 1978. The following extract of this letter merits reproduction here:

This agreement essentially buys for us their materials on site at a reasonable price, which we can use; it also allows us to take over their equipment rental agreements for which equipment we will use. In addition, it locks in their three subcontractors to work for us under the same contractual relation that they were working for SRC.

For purposes of obtaining SRC's co-operation, eliminating a law suit, generating bad publicity with the owner and public in Quebec, and generally doing what we wanted to do, all of this is costing us $227,000, which is equivalent to the loss which SRC has suffered to date on his subcontract. This premium payment also goes a long way to insure that we can get in now and complete this work in a time frame acceptable to our overall schedule.

[Emphasis mine.]

This makes it clear that the sum of $227,000, for all practical purposes, primarily served to cover the real losses sustained by the plaintiff in its partial completion of the subcontract at issue. From my point of view, it is inconceivable that such a modest sum could have been accepted by the plaintiff, in these circumstances, as compensation for the loss of its civil engineering division, a division which generated 90 per cent of its gross revenues, or 90 per cent of some $20 million in 1978.

Finally, the plaintiff made a great issue of the fact that KBR was required to negotiate and to agree to a bonus payment as compensation for accelerated work. Furthermore, it was to this obligation that it referred in its above- mentioned letter of January 24, 1978 to KBR when it wrote:

An acceptable bonus-penalty arrangement was to have been finalized two months after commencement of works. No agreement was ever reached on this matter and, consequently, we are not prepared to enter into any such arrangement for 1978.

In referring to this bonus during the proceedings, the plaintiff wished to establish what it failed to establish: that the inducement of an even higher bonus, linked to the acceleration of the works and payable by the Société d'énergie de la Baie James, was what prompted KBR to terminate its subcontract.

In this respect, the plaintiff's representatives stated that they had attempted prior to January 24, 1978 to negotiate for a bonus of $600,000 with KBR, without success. Subsequently, prior to the signing of the transaction, the plaintiff would have negotiated the compensation on the basis of this $600,000 figure. This, from my point of view, only makes more likely the fact that the sum of $227,000 had been agreed as compensation primarily for real losses sustained by the plaintiff in its partial execution of the works, rather than for the eventual sterilization of an important portion of its business.

The cases of Parsons-Steiner Limited v. M.N.R. ([1962] C.T.C. 231; 62 D.T.C. 1148) and of M.N.R. v. Import Motors Limited ([1973] C.T.C. 719; 73 D.T.C. 5530) to which the plaintiff referred are quite different from the present case. Indeed, in each of these two other cases, it was clear and evident for both parties that the termination of the contract would result in the sterilization of a major portion of the business of the company receiving compensation. As a matter of fact, in the Parsons-Steiner Limited case, the case involved the termination of one of the two principal sales agencies of the taxpayer, where these two agencies represented some 80 per cent of its income. The Import Motors Limited case involved an alteration of a Volkswagen distributor's franchise and the termination of the taxpayer's role as a wholesaler, with the latter becoming merely a retailer. As may be easily observed, the contracts that were cancelled were not contracts made in the ordinary course of business, but rather contracts affecting the very structure of the taxpayer's business. Moreover, in Parsons-Steiner Limited, the Chief Justice of that Court expressed the following very well, at page 243 (D.T.C. 1154):

One may, I think, usefully examine the payment from another angle as well. In my view it was clearly not a payment for arrears of earned commission or in lieu of earned commission for the appellant received the commissions earned to the end of 1955 and though the Doulton letter of April 29, 1954 referred to commissions on goods ordered before but invoiced after December 31st, 1955, the business was so arranged that there were no commissions or practically none to which this provision could apply. To the extent that there were any such commissions, I think, the payment would represent taxable income. Nor was it a payment in lieu of commissions that might have been earned to a normal termination of the agency contract and which were lost because of a premature termination of it. So far from there being a premature termination the effect of the arrangement was to defer termination far beyond the time when it might lawfully have been brought about. Nor is the sum of payment in lieu of notice or a payment made to obtain an early termination of the agency or a bonus for services rendered, for no claim for it was put forward by the appellant on any such basis and no such basis is suggested in the correspondence or in the other evidence. Nor is the payment merely one referable to an alteration of the terms of a contract made in the course of the appellant's business. Such an explanation in my opinion does not account satisfactorily for a payment of such size and particularly so where the alteration of the contract was at the appellant's request and to its advantage.

[Emphasis mine.]

Furthermore, this kind of case essentially involves a question of facts. In H.A. Roberts Ltd. v. M.N.R. ([1969] C.T.C. 369; 69 D.T.C. 5249), Spence, J., of the Supreme Court of Canada, gave the following opinion, at page 376 (D.T.C. 5253):

As was said by Lord Evershed in Wiseburgh v. Domville, [1956] 1 All E.R. 754 at 757, when referring to the distinction between the case where such payments are to be considered as capital receipts or, on the other hand, as income:

But, the matter being largely one of degree and so of fact, as Lord Normand said, I think the question is one of fact for the commissioners to find.

The same view was expressed by Lord Normand (the Lord President) in Kelsall Parsons & Co. v. Inland Revenue (1938), 21 T.C. 608 at 619:

. . no infallible criterion emerges from a consideration of the case law. Each case depends upon its own facts . . .

For these reasons, in consideration of the special circumstances of the case at bar, I conclude that the plaintiff failed to prove that the sum of $227,000 paid by KBR would have been to compensate the sterilization of a major portion of its business. On the contrary, the weight of the evidence suggests that this amount was primarily intended to compensate the real loss sustained by the plaintiff in the partial execution of a contract that it concluded in the normal course of its operations and which was prematurely terminated because of disagreements concerning the rate of progress of the works. This would thus be business earnings as defined in subsection 9(1) of the Income Tax Act, and is thus taxable income as defined by section 3 of this same Act.

Consequently, I dismiss this action with costs.

Action dismissed.