Newfoundland Light and Power Co. Limited v. Her Majesty the Queen, [1986] 2 CTC 235, 86 DTC 6373

Martin, J.:—This matter came on for hearing at St. John’s, Newfoundland, on June 17, 1986, by way of appeal from a reassessment by the defendant of the plaintiff’s taxable income for its 1977 taxable year in which the defendant disallowed deductions of $12,169 claimed by the plaintiff in respect of capital cost allowances and $1,029 claimed as current expenses.

The amount of $12,169 claimed as capital cost allowances results from the inclusion by the plaintiff in the calculation of the undepreciated capital cost of its property as of December 31, 1977 of the sum of $208,019.

The total amount of $209,048 (i.e. $208,019 undepreciated capital cost plus $1,029 current expenses) is the amount withheld by the plaintiff under the terms of several contracts and work orders with a number of contractors under the terms and conditions of which the plaintiff was entitled to withhold from amounts which were otherwise payable in 1977 a percentage of that amount pending approval or certification of the work by the plaintiff’s engineers. These amounts are collectively referred to as "holdbacks”.

The defendant disallowed the amounts claimed as deductions on the basis that, resulting from uncertified holdbacks they were not expenses made or incurred by the plaintiff in 1977 (i.e. that they were or resulted from contingent as opposed to actual liabilities in 1977).

The plaintiff claims that the holdbacks were not contingent but actual liabilities which were incurred in 1977 and were, though not payable or paid until 1978, properly used to give rise to the deductions claimed for its 1977 taxable income. It is upon the resolution of that issue this decision must rest.

The plaintiff is a privately-owned public utility incorporated and carrying on business in the province of Newfoundland and Labrador. In the course of its business it engages contractors to carry out works of both a capital and current or maintenance nature. The works undertaken by the contractors relevant to this matter were subject to written contracts or purchase orders both of which incorprated as a part of the agreement with the plaintiff, a standard form described as "Conditions of Contract”, document "H” in the Agreed Book of Documents filed at the commencement of the hearing.

The "Conditions of Contract” provide for progress payments, holdbacks ("Retention Money”) and completion of the contract to the satisfaction of the engineer in the following terms:

22. Payments and Retention Money

The Owner will make monthly payments to the Contractor against progress statements, approved by the Engineer, of the value of work done each month. In instances where the Contractor does not maintain a field office, the summary of units for each period will be compiled in duplicate in the field. Both copies will be signed by the Engineer and the Contractor's foreman, a copy of which will be forwarded to the office of the Contractor and the second copy to the office of the Owner. In each instance the progress statement will be paid on the basis of the quantities shown in the above mentioned summary. Such statements are to be submitted monthly by the Contractor and in the case of Force Account costs shall be substantiated by copies of payrolls, invoices, and other documents supporting all costs contained in the Force Account statements.

Ten (10%) per cent of all payments due to the Contractor other than payments for Force Account work will be retained by the Owner until the Contract has been substantially completed to the satisfaction of the Engineer and until the Contractor has settled all costs and claims by third parties with respect to the operations of the Contractor and any Sub-contractor, their employees and/or agents.

16. Work to be to the Satisfaction of the Engineer

The Contractor shall complete the Works in accordance with the Contract and to the satisfaction (and acceptance) of the Engineer and shall comply with the Engineer’s instructions on any matter relating thereto whether referred to in the Contract or not.

Document “E”’ in the Agreed Book of Documents is an agreed summary of the names of the contractors, the total contract price of the work to be done for the plaintiff, the description of work as capital or operating, and the amount of the holdback as of December 31, 1977. The discrepancy between the amount of $210,483.08 shown on document “E” and the amount of $209,048 referred to above (and shown on the defendant's reassessment of May 11, 1979 — document “B“ in the Agreed Book of Documents) is due to the fact that the defendant did not disallow the sum of approximately $1,400, presumably because it was either paid in 1977 or was certified (accepted) by the plaintiffs engineer.

The plaintiff’s vice-president and treasurer, Mr. Kevin Warr, gave evidence to the effect that all of the work done was done upon property owned by the plaintiff and was for improvements, additions or maintenance of its property. The holdbacks represented a percentage of work actually done, billed, accepted and used by the plaintiff, the value of which was, as of December 31, 1977, included in the plaintiff’s rate base for the purpose of earning its allowed rate of return under the provisions of the Public Utilities Act of the province.

The amount represented by the holdbacks is, and has been treated in the plaintiffs book of account as an actual liability as opposed to a contingent liability and, according to Warr is required under the Newfoundland public utility accounting system to be so characterized. He regards the amount as enforceable separate claims in the hands of the contractors waiting only reports from the plaintiffs engineer on each contract to ensure that the individual contract has been completed to the plaintiffs satisfaction.

The plaintiff also called C. William Hayward, F.C.A., ‘as an expert witness for the purpose of establishing the appropriate classification of contractual holdbacks under Generally Accepted Accounting Principles. Hayward is unquestionably well qualified academically and professionally to give such evidence. He was both articulate and convincing in the explanation of his written opinion which was taken as read. It was Hayward's view that the holdbacks should be treated as actual (recorded) rather than contingent (disclosed) liabilities as they represent amounts that will probably have to be paid in the future as a result of past events as opposed to their being potential liabilities, the probability of the payment of which is remote or, if not remote, is impossible to estimate with any degree of accuracy. Hayward observed that a certificate of completion does not affect what the plaintiff has already received from the contractor — it only defines when the amount will be paid. In his view the key factor is whether the contractor has performed services for 100 per cent of the progress billing and not when the obligation is paid.

Hayward has had experience with several other public utilities in Atlantic Canada and said all of them report holdbacks as liabilities at the point when the work is done rather than when the work is certified or accepted, and that this treatment of holdbacks is either required or accepted by the regulatory bodies governing the accounting practices of the utilities.

Hayward concluded with his formal opinion which was:

Holdbacks qualify as liabilities under generally accepted accounting principles on the basis that the total billings do not exceed value received by the company. The holdback on an asset purchase is reflected as a liability and the cost of the asset at that point in time includes the amount of holdback. The holdback on a service purchase is reflected as a liability and the expense for the period includes that amount.

Counsel for the defendant called no witness but relied instead upon the case law which he argued supported the defendant's position as disclosed in the reassessment and the pleadings.

Counsel for the plaintiff cited a number of cases dealing with the question of when an asset is acquired by a taxpayer for the purpose of claiming capital cost allowance and emphasized that as title, ownership, use and risk of the assets improved or maintained in this matter are all unquestionably owned by the plaintiff, it was entitled to the deductions claimed (M.N.R. v. Wardean Drilling Limited, [1969] C.T.C. 265; 69 D.T.C. 194, Henuset Bros. Ltd. (No. 2) v. M.N.R., [1976] C.T.C. 2039; 76 D,T,C, 1046, [1977] C.T.C. 228; 71 D.T.C. 5171, W.R. Schultz v. M.N.R., [1979] C.T.C. 2328; 79 D.T.C. 279 and Kirsch Construction Ltd. v. M.N.R., [1985] 2 C.T.C. 2387; 85 D.T.C. 675).

In my view these cases have no application to the matter at hand, in which the issue is the actual cost to the plaintiff, and not the ownership of the asset.

Hayward's evidence and expertise were impressive and, as already indicated, convincing. As a result of his observations and opinions I am left with no doubt that Generally Accepted Accounting Principles permit or allow the amounts, the characterization of which are in issue, to be treated as actual rather than contingent liabilities.

However the fact that holdbacks can, or even should, be so characterized under Generally Accepted Accounting Principles does not determine whether the holdbacks are deductible of the purposes of calculating taxable income under the provisions of the Income Tax Act.

If these principles run contrary to the provisions of the Income Tax Act the provisions of the Act must prevail. In my view it also follows that the phrase "the provisions of the Income Tax Act“ means the provisions of the Act as interpreted by court decisions which are binding on me.

In this respect I take the view that J.L. Guay Ltée v. M.N.R., [1971] C.T.C. 686; 71 D.T.C. 5423 and John Colford Contracting Co. Ltd v. M.N.R., [1960] C.T.C. 178; 60 D.T.C. 1131 are authorities for the proposition that uncertified holdbacks are to be treated as contingent liabilities rather than actual liabilities for the purpose of determining whether the plaintiff is entitled to deduct them from its taxable income in this matter. I note that in both cases appeals from the decisions to the Supreme Court of Canada were dismissed without reasons.

Counsel for the plaintiff sought to distinguish the Guay case by reference to the lack of evidence adduced by the taxpayer with respect to Generally Accepted Accounting Principles when the matter was heard before the Tax Appeal Board, [1969] Tax A.B.C. 691; 69 D.T.C. 490. While this may have been of significance to the decision at that level it did not appear relevant to the decision of Noel, A.C.J. of this Court, [1971] C.T.C. 686 at 691; 71 D.T.C. 5423 at 5426 who observed that the profit and loss statement prepared according to the rules of accounting practice:

. . . has always to be adjusted according to the statutory rules used in determining taxable profits. This is because a number of facts taken into consideration by accountants are excluded by certain provisions of the Income Tax Act in determining of taxpayers’ profits. The profit and loss statement, indeed, is really a statement of fact, and, consequently, a matter of evidence. It includes facts which cannot be questioned and statements of facts which may be called provisional. It is difficult to challenge the first category unless the figures used were taken, for instance, from improperly kept books. When, however, a statement of provisional facts is involved, the Minister is not obliged to accept what is submitted to him by the accountants. Such a situation occurs when, for instance, in a case such as this, a reserve is set-up, for accounting purposes, to provide for receipt of a benefit or payment of a demand which is contingent or conditional.

Counsel also sought to distinguish the Guay and Colford cases on the basis of the Federal Court of Appeal decision in Wilchar Construction Ltd. v. R., [1981] C.T.C. 415; 81 D.T.C. 5318 in which case the court considered the two earlier cases and found at 418 (D.T.C. 5320) that:

All that Colford (supra) is authority for, in my opinion, where the facts are as in this case, is that the Minister could not require the taxpayer to take subject amounts into income.

and at 419 (D.T.C. 5321):

The Guay decision referred to supra, simply reaffirms the principle set out in Colford (supra) and does not, in my view, add to or extend that principle in any way. Whereas Colford (supra) deals with amounts receivable, Guay (supra) deals with amounts payable but the principle set out in both cases is, in my view, the same.

Given those observations I was, at first, inclined to the view that I could ignore the findings in the two earlier decisions referred to and allow the plaintiffs appeal against the defendant's assesment. On a more careful review of the Wilchar decision however, I have concluded that it was not the intention of the court to overrule the earlier decisions in so far as they related to the characterization of uncertified holdbacks as contingent liabilities but instead the court's comments on those decisions were intended to relate to a case "where the facts are as in this case”.

In the Wilchar case the facts were unique. The taxpayer sought to change its method of reporting income for a given year from anticipating revenue to actual revenue without adjusting other years' revenues to reflect the change. Because the change was sought after the period allowed for the Minister to reassess the earlier year's income the result, had the court allowed the taxpayer's appeal, would have been that the taxpayer would have escaped taxation on revenue which was admittedly received and otherwise taxable.

The court found nothing in the Colford judgment or the provision of the Income Tax Act which would prohibit the taxpayer from adopting, and the Minister accepting, that method of reporting income i.e. reporting amounts contingently receivable as income, on the grounds that paragraph 85B(1)(b) did not prohibit such a method.

As I appreciate the Wilchar decision it found that amounts contingently receivable may, if the taxpayer so elects in circumstances similar to the facts in that case, be included in the taxpayer's taxable income. It does not, however, represent authority for a taxpayer deducting as an expense an amount which is contingently liable and which remains proscribed by paragraph 18(1)(e) of the Act.

Assuming that I am correct in my interpretation of the Wilchar decision there remains only to determine whether the holdbacks by the plaintiff are contingent liabilities within the meaning of the Colford and Guay decisions and not allowable as deductions for income or available for the purpose of calculating capital cost allowance for the relevant taxation year.

In this respect the contracts, written or purchase orders, between the plaintiff and its several contractors provide for a 10 per cent holdback or retention of amounts due and otherwise payable. Although due the amounts are not payable at the time the accounts are submitted but instead are deferred until the contract

. . . has been substantially completed to the satisfaction of the Engineer and until the Contractor has settled all costs and claims by third parties with respect to the operations of the Contractor and any Sub-contractor, their employees and/or agents.

Payment of the holdbacks is thus subject to these conditions which, until met, prevent the contractors from compelling the plaintiff to pay. Accordingly as of December 31, 1977 the contractors had no legal right to enforce payment of the holdbacks. Payment was contingent upon substantial completion of the respective contracts to the satisfaction of the engineer and the other conditions set out in paragraph 22 of the Conditions of Contract.

In my view these conditions precedent to payment of the holdbacks constitute then contingent liabilities within the meaning of paragraph 18(1)(e) of the Act and the earlier decisions of this court to which reference has already been made.

Accordingly the plaintiff’s claim will be dismissed.

Claim dismissed.