Les Entreprises De Pipe-Line Universel Ltee v. Minister of National Revenue, [1988] 2 CTC 2002, [1992] DTC 1319

Couture, C.J.T.C. [Translation]:—The appellant is appealing an assessment dated May 17, 1985 for the 1979 taxation year. In this assessment the respondent added $502,133 to its income as business income from the sale of assets in the circumstances described below.

The relevant facts can be summarized as follows.

In 1977 the appellant and Dominion Bridge Ltd. (Bridge) had formed a joint venture under the name of Dominion Universal Joint Venture (DUJV), for purposes of bidding on a project to build an atomic power plant at Pointe Lepreau in New Brunswick for the New Brunswick Electric Power Commission (the Commission).

DUJV's tender was accepted in principle on August 17, 1977. The project involved the construction of the nuclear reactor for this atomic plant. A contract had previously been awarded to a group of contractors for the construction of a concrete building to house the mechanical facilities DUJV was to install. The appellant specialized in piping, while Bridge specialized in the installation of structures and heavy equipment.

DUJV's original tender had been filed on July 15, 1977, and following a meeting with representatives of the Commission, a revised tender was drafted on July 28, 1977 and finally accepted in principle by telex on August 17, 1977, as mentioned earlier, followed by a letter dated August 23 contain- ing certain additional clarifications. It was not until October 25, 1977 that DUJV, after numerous negotiations, agreed to perform the work provided for in the contract. The contract itself still had to be incorporated into a formal document in order to finalize the agreement between the parties.

The general terms of this agreement provided for two forms of payment by the Commission to DUJV for performance of the work. There was first a lump sum covering the personnel on the site, namely the engineering personnel and part of the quality control personnel, as well as all equipment belonging to DUJV to perform the work, such as welding machines, cranes and trucks. The sum of $15 million had been agreed upon as a lump-sum price for this part of the tender.

There was also a reimbursable part which had been defined as the part for site installation and welding and which essentially represented wages for the locally hired and trained personnel. One million hours had been allocated for performing this part of the work for a total of $14,180,000. The agreement also provided for an adjustment mechanism in the event these projections turned out to be unrealistic. The details of this adjustment mechanism are not relevant.

On the basis of the acceptance of DUJV's tender, the work began on October 25, 1977, even though the formalities for signing a specific contract had not been completed.

As the work progressed, the parties, at least DUJV, realized that the costs set out in the tender were not realistic, and following lengthy negotiations a new agreement was concluded with respect to the terms of payment. Several reasons were given by one witness concerning as to what had caused this situation, but they do not add anything to the nature of the problem we are concerned with, except to say that the project had turned out to be much more complex than had been originally estimated. What had been seen as a project assessed at $29,959,000 was completed at a cost of some $100 million.

Alain Boisset was called as a witness by counsel fo the appellant. He explained that he had been the president of A Janin et Cie Ltée since July 1, 1985, but that before that, beginning in 1975, he was employed by the appellant as executive vice-president. He said that the appellant operated three divisions, one called the mechanical and industrial piping division, which essentially worked in petrochemical plants and refineries and on the construction of piping and mechanical installations. A second division, the civil and pipeline division, was also responsible for underground piping, while a third division made piping parts needed by the company or its customers. In the latter case it was not actually a case of making pipes but of assembling them, in other words, cutting, welding and joining them in accordance with plans and specifications supplied by the customer.

This joint venture contract with the Commission was the first contract of this nature awarded in Canada to a private undertaking for the construction of a nuclear plant. For the performance of this contract each party to the joint venture operated in its own well-defined area of specialty. The appellant took care specifically of installing extremely complex piping, which was supplied by the Commission. Bridge for its part took care of installing the turbine, boiler, etc. The witness explained the terms of payment referred to earlier, the details of which were stipulated in the tender between the parties. A copy thereof was filed.

In the document entitled "Terms of Payment”, which is part of the contract signed on May 29, 1979, in clause 1.0 entitled “General”, we read the following:

The work performed under this contract shall be paid for on a part lump sum and part cost reimbursable basis. The lump sum in general will cover all the Contractor's charges except for the Direct Labour which will be paid on a reimbursable basis. Adjustments to both the lump sum and amount reimbursable will be made as per the conditions contained herein.* [1]

The costs that were to have been included in "Contractor's Charges" and “Direct Labour” are specifically set up in the contract. The former had been estimated at $15,779,336 while the latter amounted to $14,180,000, for a total of $29,959,336.

According to the witness, shortly after the work began as mentioned earlier, the parties to the joint venture realized that the project was much more complex than anticipated in their tender and that it would be impossible for the appellant to carry it out and complete it according to the terms and conditions provided.

According to the witness, negotiations were undertaken between the parties in about October 1978 to rectify the situation.

At an initial meeting held on December 1, 1978, following which minutes were prepared, it was agreed by the Commission that the lump-sum portion of the contract would be amended and that part would become reimbursable.

These negotiations continued at the same time as other negotiations intended to finalize the drafting of a basic contract, if we can call it that, which would incorporate all the terms and conditions contained in the tender.

This meeting on December 1, 1978, had been preceded by a proposal submitted by the joint venture to the Commission in the form of a telex containing a new method of payment.

It provided for a rental for the use of the equipment on the site, and suggested the following formula:

For owned equipment and facilities, cost shall be rental based upon either the Canadian Construction Association rates who [sic] are applicable or trade practice. For equipment and facilities rented from third parties invoices shall be reimbursed at cost.

The negotiations continued and a new proposal containing new terms of payment dated January 25, 1979, a copy of which was filed at the hearing, was studied by the parties. This proposal contained the following provision respecting the equipment used on the site:

All items whose new replacement value per unit, including taxes, is in excess of $700 shall be considered as equipment. Rental rates for these items shall be determined using as a guide the 1977 edition of Rental Rates on Construction Equipment as published by the Canadian Construction Association. In the event of a conflict between the Equipment Rental Agreement contained in the above document and the other provisions in this Contract, the other provisions shall take precedence.

Equipment rented from third parties including fuel, maintenance, repairs and operation, if applicable, shall be reimbursed at actual cost.

For Contractor owned equipment and facilities, supplied as requested by the Engineer, the cost shall be based on local trade practice or Canadian Construction Association rates, whichever is lower.

In other words this proposal contained a provision almost identical to the one contained in the telex of November 15, 1978.

The witness went on to say that on January 31, 1979, at a meeting with representatives of the Commission, the latter advised them that they could not accept the proposal of January 25,1979 concerning rental of the equipment. According to the explanation given by the witness, the representatives had come to the conclusion that for a rental for a long period of time, the rent or the cost of the rental would exceed the replacement value of the equipment in question. It appears that these representatives were afraid that the Commission's auditors would raise objections to such terms of payment.

To avoid the difficulty, the Commission's representatives proposed that the equipment in question be purchased with an option in favour of the joint venture to buy it back when the work had been completed.

Minutes of a meeting on January 31, 1979 were drawn up and a copy thereof was filed. We read the following with respect to "Equipment":

NB Power advised that they could not accept the DUJV (Dominion Universal Joint Venture) proposal for reimbursing equipment used on the site for long periods of time based on Canadian Construction Association (CCA) rates. Under these rates the rental cost of much of the equipment would exceed the new replacement cost. Also, these rates include profit for the contractor which is not compatible with our present objective of a cost reimbursable type of contract. NB Power stated that they might be prepared to purchase this equipment and sell it back to the Contractor as [sic] a reasonable price at the completion of the job, but this creates severe bookkeeping problems with DUJV and they would have to review the situation. Both parties, now having a better understanding of the other's situation, agreed to study this problem further.

At subsequent meetings held on February 13 and 14, 1979, the Commission's representatives informed the representatives of the joint venture that they were prepared to adopt this proposal, in other words, to purchase the equipment which had been used or would be used on the site. In the minutes of these meetings we read the following:

DUJV proposed that except for short term rentals, i.e., equipment required on site not longer than 6 months, and for all equipment except trailers, DUJV be reimbursed for equipment supplied up to the date of signing the proposed revised contract at a monthly rate of 2 percent of the new replacement cost of the equipment on the date it arrived on the site.”

The 2 percent is considered to be 1 percent for shipping to the site and maintenance and 1 percent for the cost of money. For trailers, the 1 percent for maintenance shall not apply. The replacement cost of trailers that DUJV purchased from N.B. Power shall be the actual purchase price of the trailers from N.B. Power.

As of the date of signing the proposed new agreement, N.B. Power will purchase all DUJV equipment on site now or which may come on site except equipment which may be considered to be short term rental equipment, with the cost to N.B. Power to be the replacement cost of the equipment on the day the equipment arrived on the site.

[Emphasis added.]

For short term rental equipment, the monthly rental rate shall be the rate as determined by the Canadian Construction Association (CCA) formula except that for rental for a 3 month duration the CCA monthly rate shall be reduced by 10 percent and for rental for a 6 month duration the CCA monthly rate shall be reduced by 20 percent.

The percent reduction for the intervening months shall be interpolated from the above figures. N.B. Power agreed to accept this proposal.

DUJV will prepare a list of the equipment covered by this agreement together with its new replacement value on the day it arrived on the site. Equipment rented from third parties shall be at cost.

According to the witness, once the principle of purchase of the equipment by the Commission had been accepted by the parties, it was necessary to determine first on what date this purchase would be made and second, how the joint venture would be reimbursed for use of the equipment on the site between the commencement of operations and the date of its acquisition. The formula chosen is the one contained in the minutes, namely payment of two per cent per month of the replacement value of the equipment with the modifications mentioned.

The witness said that no studies had been made at the time to determine whether or not it was advantageous for the members of the joint venture to sell the equipment in question. According to him, this was a major obstacle which had to be circumvented and this was the only way of doing so. The witness added that the Commission proceeded to purchase the equipment in question on May 29, 1979, the date on which the original contract was also signed and the new terms of payment were regarded as being an amendment to this basic contract. The evidence also revealed that although the joint venture had an option to buy the equipment back from the Commission, this equipment remained the property of the latter when the work was completed in 1982.

The evidence also revealed the following facts.

The book value of the equipment in question, or of the portion which was owned by the appellant, was $72,386, and it received $734,124 as proceeds of disposition of these assets, thus realizing a gain of $661,738 on the book value.

The appellant took the position that the proceeds of the sale of this equipment constituted a capital gain and reported this gain for the 1981 taxation year. The respondent for his part assessed the appellant on the basis that the proceeds of the sale were in fact business income from the carrying out of the contract with the Commission, and also that this income was taxable for the 1979, not the 1981, taxation year. In court, the appellant maintained its position concerning the capital gain but admitted that this gain was taxable in 1979.

Counsel for the appellant submitted as a basic thesis first that the appellant was not operating an equipment sales business; that this was an entirely exceptional transaction completed in very special circumstances for the sole purpose of circumventing or eliminating a major obstacle to performance of the nuclear plant construction project; he added as well that in the tender DUJV had prepared, there was no question of the joint venture realizing a gain from the use of the equipment in carying out the project, since the gain came from another source entirely separate from use of the equipment. Finally, he said that the equipment had always constituted capital property for the appellant on which capital cost allowance had been claimed and allowed in computing its income.

The respondent's position is set out clearly in paragraphs 5(g) and (h) of the reply to the notice of appeal, which read as follows:

[Translation]

(g) The amounts paid for purchase of the equipment were paid in the general context of a normal business relationship and represent part of the consideration which NBEPC (the Commission) had undertaken to pay the appellant pursuant to the contract between the parties.

(h) The sum of $502,133 represents income from the operation of the appellant's business for its 1979 taxation year.

These two theses are obviously irreconcilable. Which of them is consistent with the legislation and the principles established in the case law concerning the latter's application? Is this a disposition of capital property completed according to normal commercial principles in this type of transaction?

The evidence revealed a fairly unique situation resulting from a commercial agreement between parties dealing at arm's length. This unique situation does not mean, however, that the fundamental legal principles should be ignored in favour of considerations relating exclusively to the uniqueness of the transaction.

DUJV, of which the appellant was a member, bid on a project to build a nuclear plant. This was an entirely new experience for DUJV since this was the first time private industry had been called upon to take part in this type of construction. Obviously DUJV planned to make a profit on this project and in Exhibit A-4 it is stipulated that this profit was estimated at $1,860,000. This amount would thus be shared between the two parties to the joint venture, namely Bridge and the appellant.

It turned out, however, that DUJV's projections regarding the costs of carrying out this project had been greatly underestimated. A $29 million project was completed for approximately $100 million. Given this discrepancy it is clear that construction of this nuclear plant would have resulted in a financial catastrophe if DUJV had been forced to complete the project in accordance with the estimates given in the tender as accepted.

In the face of this situation the parties agreed to amend the tender, and, whatever the reasons for this decision, the fact remains that such an amendment was negotiated and accepted and made it possible to overcome the impasse between them. This impasse was shown in the Commission's refusal to rent DUJV's equipment for the rates established by the Canadian Construction Association because over a long period the cost of such rental would exceed the replacement cost of the equipment. Furthermore, according to the Commission, the Association’s rates included a profit element, and this was incompatible with the objective of the Commission.

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 respected 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-à-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. The following information is entered in relation to each piece of equipment sold, and a few examples will be sufficient to explain the essence of the transaction.

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.

Walsh, J. of the Exchequer Court, as it then was, made the following comments in Minister of National Revenue v. Ouellette and Brett, [1971] C.T.C. 121 at 136; 71 D.T.C. 5094 at 5103:

The jurisprudence is very clear that it is not what parties call a payment in a contract which determines the nature of it but the real character of the transaction. Simon's Income Tax 1964-65, Vol. 1, has this to say at page 59 in connection with the case of C./.R. v. Duke of Westminster, (1936) A.C. 1, quoting from the judgment of Lord Russell of Killowen on the contrast between the form and the substance of an arrangement:

If all that is meant by the doctrine is that having once ascertained the legal rights of the parties you may disregard mere nomenclature and decide the question of taxability or non-taxability in accordance with the legal rights, well and good . . . If, on the other hand, the doctrine means that you may brush aside deeds, disregard the legal rights and liabilities arising under a contract between parties and decide the question of taxability or non-taxibility upon the footing of the rights and liabilities of the parties being different from what in law they are, then I entirely dissent from such a doctrine.

He also quotes from the judgment of Viscount Simon in the case of C./.R. v. Wesleyan and General Assurance Society, [1948] 1 All E.R. 555 at 557 as follows:

It may be well to repeat two propositions which are well established in the application of the law relating to income tax. First, the name given to a transaction by the parties concerned does not necessarily decide the nature of the transaction. To call a payment a loan if it is really an annuity does not assist the taxpayer, any more than to call an item a capital payment would prevent it from being regarded as an income payment if that is its true nature. The question always is what is the real character of the payment, not what the parties call it. Secondly, a transaction which, on its true construction, is of a kind that would escape tax is not taxable on the ground that the same result could be brought about by a transaction in another form which would attract tax.

On the basis of the evidence presented, I am satisfied that it is clear that the transaction between the parties was not in the nature of a sale as the appellant maintains but of an exercise to permit the appellant to increase its revenues.

In the circumstances, the arguments of counsel for the respondent set out in his reply to the notice of appeal to the effect that the amounts paid for the equipment purchase were paid in the general context of a normal business relationship and represent a portion of the consideration which NBEPC had undertaken to pay the appellant are correct and consistent with reality in view of the evidence.

He submits in support of this thesis the Privy Council's decision in Californian Copper Syndicate (Limited and Reduced) v. Harris (surveyor of taxes), 5 T.C. 159, in particular the comments of Lord Justice Clerk 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 assessable to Income Tax. But it is equally well established that enhanced values obtained from realisation or conversion 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. The simplest case is that of a person or association of persons buying and selling lands or securities speculatively, in order to make gain, dealing in such investments as a business, and thereby seeking to make profits. There are many companies which in their very inception are formed for such a purpose, and in these cases it is not doubtful that, where they make a gain by a realisation, the gain they make is liable to be assessed for Income Tax.

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?

I think that it is amply clear from the evidence that the profit made by the appellant on the sale of its equipment to the Commission was made “in an operation of business in carrying out a scheme for profit-making” as the learned judge says in his judgment, and a payment received in such circumstances constitutes income for the recipient, according to him.

Counsel for the respondent also referred the Court to another decision, Valley Camp Ltd. v. M.N.R., [1974] C.T.C. 418; 74 D.T.C. 6337. The facts are summarized as follows:

Under a 25-year agreement with the CN, the appellant undertook the construction and operation, on CN property, of facilities for the unloading and loading of iron ore pellets. In addition to a handling charge, based on actual tonnage handled, the appellant received, under the agreement, a fixed annual charge equal to 10 /4% of the capital cost of the facilities. The appellant sought to characterize the latter as a capital receipt, on the ground that it was calculated to amortize its cost, at 9%, over the 25 years and was in the nature of a subsidy or other assistance towards the cost of construction. A term of the agreement, however, gave the CN the right to purchase the facilities from the appellant at the end of the term at fair market value. The Minister treated the amounts as business income.

At page 422 (D.T.C. 6340), Urie, J., of the Federal Court, Trial Division, says the following concerning the agreement between CN and Valley Camp Ltd.:

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. Quite naturally each party wished to be protected in its particular liability in the complete recovery of such outlays. CN, for its. part, had to be assured that it was paying only for the actual cost of the facilities and, therefore, strict conditions were imposed in the agreement for the determination of such cost. Valley Camp, on the other hand, had to be assured that the substantial outlays required would be wholly recovered even if, for some unforeseen reason, the agreement was terminated before the end of its term. The parties thus agreed on the stringent provisions relating to the calculation of cost and to the payment of such cost even if the agreement was terminated and the facilities taken over and operated by CN. It is obvious that it was for this reason that loss was payable to CN under the terms of the insurance policy, ie to protect it in the event of total or partial destruction of the facilities while it was still responsible for paying the outstanding balance of cost. The whole transaction was clearly a commercial one in which Valley Camp prudently ensured the recovery of its expenditues 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.

In that transaction Valley Camp Ltd made sure it would recover the cost of its outlays incurred in constructing the facilities provided for in the contract, whereas in the case we are concerned with the appellant made sure of an increase in revenues by means of an amendment to the terms of payment.

At page 423 (D.T.C. 6341) the honourable judge added:

The gist of the transaction then must be that both payments, viz handling charge and the flat annual payment are part of the same transaction and are income payments in the hands of the appellant.

Another decision to which the Court was referred by counsel for the respondent is the decision of Thorson, J. of the Exchequer Court of Canada as it then was in Canadian Kodak Sales Limited v. M.N.R., [1954] C.T.C. 375; 54 D.T.C. 1194. The facts are summarized as follows:

The appellant, a Canadian company incorporated in 1938, was formed to take charge of the sales in Canada of all the products of the Canadian Kodak Company Limited. It sells a large range of cameras and related photographic equipment and supplies as well as other products. In 1940, the appellant also took over the business and assets, of Recordak Limited, a company which had rented recordak machines equipped with cameras and used for taking reduced photographs and microfilms of documents. Until 1951, the appellant only rented recordaks and treated them as capital assets in respect of which it claimed and was granted capital cost allowances. In 1951, it changed its business policy regarding recordaks and decided to sell them. The decision was one of management and was made known to all its customers by letter. By the end of 1952, almost half of the recordaks which users had previously rented, were purchased by them. The appellant continued to lease the recordaks which it did not sell and is still acquiring recordaks and selling or leasing them. Those which it leases, it carries as capital assets subject to capital cost allowances. The Minister has assessed the appellant for the years 1951 and 1952 in respect of the profits realized from the recordaks sold. The appellant appealed the assessment on the ground that since the recordaks had been subject to capital cost allowances and had not been purchased for resale, they were capital assets and the profit from their sale was a capital profit not subject to income tax.

At page 379 (D.T.C. 1196) the learned judge stated:

The issue in this case is whether the profit made by the appellant on the sale of the recordaks which it had previously leased was taxable income within the meaning of the Income Tax Act, S.C. 1948, c. 52. By Section 2(3) of the Act the taxable income of a taxpayer for a taxation year is said to be his income for the year minus the deductions permitted by Division C. Then Section 3 provides, inter alia, that such income includes income for the year from all businesses and Section 4 goes on to say:

4. Subject to the other provisions of this Part, income for a taxation year from a business or property is the profit therefrom for the year.

It was contended for the appellant that the profit made by it was not a profit from its business. It was admitted that its recordaks had always been regarded by it as capital assets and accepted as such by taxing authority, that they had never acquired the characteristics of inventory or property held for sale but had always been held exclusively as revenue producing property from which income was received, that when they were sold the sale was not made with a view to making a profit but for the purpose of freeing capital and obtaining a wider distribution of machines, that they always retained their characteristics as capital assets and that when they were sold they were sold as capital assets with a resulting capital gain.

I cannot accept these submissions. On the contrary, I agree with the argument put forward by counsel for the respondent. He contended that. the appellant was organized to be the selling instrument in Canada of the products of the Eastman Kodak Company, that its recordaks were not fundamentally different in principle from the wide range of cameras and photographic equipment and supplies sold by it, that the decision to sell the recordaks was a business decision made for business reasons to increase the appellant’s sales and to increase its profits, that from the time of this decision the appellant was in the business of selling recordaks and that its profit therefrom was a profit from its business and taxable income within the meaning of the Act.

Admittedly, there is a distinction between the appellant's situation and that of Canadian Kodak Sales Ltd in that the latter was already operating a sales business as well as renting "recordaks", but the fact remains that the only reason the appellant had for disposing of its equipment was to increase its revenues from the operation of its business in carrying out the nuclear plant project at Pointe Lepreau in New Brunswick.

For these reasons the appeal is dismissed.

Appeal dismissed.