Lakehead Newsprint Limited v. Minister of National Revenue, [1986] 1 CTC 2442, 86 DTC 1353

Sarchuk, T.C.J.:—The sole question in this appeal is the deductibility in the appellant’s 1980 taxation year of certain wage payments which were made by the appellant to its employees on March 26, 1981.

The facts are straightforward. Lakehead Newsprint Limited (Lakehead) Operates a newsprint processing factory. For over 20 years and at all relevant times its labour relations with its employees were governed by a collective bargaining agreement with the Canadian Paper Workers Union (the Union). Under the terms of this agreement applicable at the beginning of the 1980 year the wage rates of the employees were fixed at certain amounts for the period ending June 1, 1980. The agreement itself did not terminate on June 1, 1980, but pursuant to its provisions was continued in effect subject to amendment or revision as stipulated in Article 23.

On March 6, 1980, notice was given by the Union that it wished to "reopen the current labour agreement to negotiate terms of renewal thereof” (Ex. A-2). Concurrently the Union was involved in negotiating renewals of collective agreements with employers in the primary paper industry, that is with the manufacturers of pulp and paper. The practice, as described by the president of Lakehead, Mr. Jack Jones, was that when the Union concluded its negotiations with the primary industry and reached an agreement on the issue of wages with one or more of the large paper companies it would turn its attention to smaller companies such as the appellant. In most instances, it was customary for the smaller companies to accept the amount of the wage settlement agreed to by the major companies.

When negotiations between Lakehead and the Union commenced on November 4, 1980, both parties were aware that the Union had concluded a number of collective agreements with the primary industry providing for a general wage increase of $1.37 per hour to all classifications effective June 1, 1980. Negotiations continued and it appears that by November 20, 1980, the same general wage increase was accepted in principle by both parties. However, many other items remained unresolved. On November 28, 1980 a draft memorandum of settlement was prepared by Lakehead's solicitors for the purposes of presentation to the Union at the next bargaining session to be held on December 4, 1980 (Ex. A-5).

It should be noted that Lakehead's solicitors forwarded two memoranda to the appellant, stating in their covering letter:

P.S. I am also enclosing an alternate Memorandum of Settlement which differs from the other memorandum enclosed in that it does not included(sic) a proposal for LTD. The reason why I have drawn up an alternate Memorandum is that if Mr. Wirtz holds out no hope for accepting our settlement offer (including an LTD Plan), then there is no sense presenting the Memorandum (including the LTD Plan) at our next meeting since we should hold something back for purposes of Conciliation.

Wirtz was the representative of the Canadian Paper Workers Union.

It is not clear from the evidence which memorandum of settlement was presented to the Union on December 4, 1980. In any event the proposals made do not appear to have been accepted. A number of issues remained in dispute and at some point of time in late 1980 the Union invoked conciliation procedures. In January 1981 a conciliator filed his report with the parties. No evidence was adduced as to the specific items which were the subject of the conciliation proceedings. Following receipt of this report further negotiations took place and eventually all issues were resolved. On March 16, 1981, recommended terms of settlement were submitted to the appellant and to the Union for ratification. One of the terms was a general wage increase of $1.37 per hour. No evidence was adduced as to when the agreement was ratified by the employees however, it is a fact that on March 26, 1981, the wage increases for the period June 1, 1980 to December 31, 1980 were paid by the appellant to all of its employees entitled thereto. It is not disputed that the amount that was disallowed by the Minister represented payments made to the employees for work performed and completed by December 31, 1980. It should be noted that the appellant's fiscal year coincides with the calendar year and that the appellant computes its income, and is assessed by the Minister on an accrual basis.

It is the appellant’s position that by December 31, 1980, the amount of the wage increase payable to each of the employees concerned for the period June 1, 1980 to December 31, 1980 had legally accrued in favour of such employee and was payable to that employee without reference to any condition or contingency of any nature whatsoever. In counsel’s view the issue had been settled on or before November 24, 1980, even though the agreement was not ratified and executed until some time in 1981. The possibility that such payment would have to be made was so clear and obvious that it could not be considered a contingent liability as pleaded by the respondent but rather was, in the words of counsel for the appellant:

... à legal obligation that was an irrevocable legal obligation mutually binding on both parties, and that there is nothing really to argue about and an irrevocable point of the law, that is a factual matter I think even the Department, if those were the facts as they were to be established, would it not be that there is a clear liability and, on an accrual system, it is clearly deductible.

The amount had been recorded as a liability incurred in the taxation year in issue because, counsel submitted, it was not contingent upon the happening of an uncertain event which might or might not occur.

Counsel further contended that if the Court could not find that there was a clear cut liability for the salary increment of $1.37 per hour it still could find on the evidence that payment of this amount was so probable (although not absolutely certain) that it nonetheless was a liability which was not a contingent liability in respect of which no reserve is permitted under paragraph 18(1)(e) of the Act.

In support of these propositions counsel for the appellant relied upon Day & Ross Ltd. v. The Queen, [1976] C.T.C. 707; 76 D.T.C. 6433; The Queen v. V and R Enterprises Ltd., [1979] C.T.C. 465; 79 D.T.C. 5399; Time Motors Ltd. v. M.N.R., [1969] C.T.C. 190; 69 D.T.C. 5149; M.N.R. v. Ben Lechter, [1966] C.T.C. 434; 66 D.T.C. 5300 and on the expert evidence of B. W. Barrington, a professional accountant.

In Day & Ross, (supra) Dubé, J. allowed the deductibility of two items, insurance premiums and damage claims, on the basis that they could not be said to represent a mere contingent account or reserve prohibited by paragraph 12(1)(e) of the Act (now 18(1)(e)). The ratio of this decision lies in the Court's assessment of the nature of these items. In that respect Dubé, J. stated at 714 (D.T.C. 6437):

. . . A Standard yearly insurance premium would undoubtedly fit neatly under the generally accepted meaning of the term "expense”, and no one would think of describing it as a “contingency” or "reserve”: the exact amount of the premium is known, ascertainable, admitted and payable.

. . . The amounts booked as accident and cargo claims were so entered for that year because the specific events leading to the claims had occurred in that year. The accountants did not set aside approximate amounts as "reserve” against contingencies, these amounts were booked as definitely payable because the premiums had been earned, the accidents had occurred, the claims had been filed, the investigations had taken place, the quantum of damage assessed, and the amounts entered.

Dubé, J. considered the decision in J. L. Guay Limitée v. M.N.R., [1973] C.T.C. 506; 73 D.T.C. 5373 (F.C.A.) and distinguished that case on the basis that the amounts in issue in Guay were “conditional, contingent or uncertain” and “should not be used in calculating taxable profits” as contrasted to the insurance premiums and damages at issue before him. He stated:

Such is not the situation in the case at bar where the amounts entered as expense were definitely owing and payable and were in fact paid. [Emphasis added.]

It is clear from the foregoing that in Day & Ross (supra) the Court found that a legal obligation to pay the amounts in question in the taxation year existed and that accordingly they were properly entered in the appellant's books in that taxation year.

In Times Motors (supra) the Court dealt with credit notes given by a car dealer as partial payment for used cars acquired by it. These notes, although not transferable could be applied by the holder to purchase a car from the dealer within a specified time. Pigeon, J. speaking for the Court unequivocally rejected the argument urged by counsel for the Minister, that when the appellant issued each credit note there was not, in fact, created any contract or agreement which would give rise to any liability or obligation. At 191 (D.T.C. 5150) he said:

. . . This contention cannot be upheld. The credit note should not be considered apart from the transaction out of which it arises. It is part of the consideration for an executed contract, the purchase of a used car. Under that contract, appellant became obliged to pay a stated sum of money, a part only of that sum was paid in cash, the balance remaining due was stipulated payable in merchandise of a stated kind. While the contract is spelled out in two separate documents, the bill of sale and the credit note, the latter cannot be considered otherwise than as

evidence of the conditions of the obligation to pay the balance of the purchase price. That obligation must be considered as subsisting until satisfied or expired. . . . [Emphasis added.]

In V & R Enterprises on the facts before him Grant, D. J. found that certain senior employees rendered their services to the company on the understanding that their remuneration was to be established on the basis of a known formula or process. In Grant’s view the mechanism used created a binding legal obligation to pay that remuneration.

These decisions do not strictly apply in this appeal. In my opinion each was premised on a clear and unequivocal finding that a legal obligation existed. In the case at bar as at December 31, 1980 there was no such legal obligation. It may even be said that there was no certainty that any agreement would be reached in view of the fact that negotiations were at an impasse and a conciliator was involved. Given the nature of collective bargaining all items remained negotiable.

Counsel for the appellant further argued that the execution of the Minutes of Settlement and the Collective Agreement at some point of time in 1981 were steps that merely documented the existence on November 24, 1980 of a legally enforceable and binding agreement. He cited the Lechter Case (supra) in support of this proposition.

Lechter was an expropriation case and the issue to be determined therein was the point of time at which an amount of compensation became a receivable for the purposes of paragraph 85(B)(1)(b) of the Act. Notwithstanding the fact that under the Canadian Expropriation Act there is no doubt or uncertainty as to the right to compensation, the courts have consistently maintained the principle that there could be no amount receivable under paragraph 85(B)(1)(b) until the actual amount of compensation was fixed either by arbitration or agreement. In Lechter the expropriation was in the 1954 taxation year; the amount was fixed by agreement in the 1955 fiscal year and, according to its terms, payment should have been made within 60 days. For some reason the Treasury Board authorization for the payment was given seven months later and the actual payment made ten months later, both events occurring within the 1956 fiscal year. I do not find the situation in Lechter analogous to the case at bar. Two key factors were found to have co-existed in Lechter's 1955 taxation year: the absolute right to receive compensation, and a legally binding agreement between the parties which stipulated the quantum of such compensation. That was sufficient for that amount to become a receivable in that year.

The appellant also relied on the testimony of B. W. Barrington who gave evidence as an expert witness. His qualifications were not challenged. It was his opinion that if the payment of the amount in issue was the result of a “finalized signed agreement” then a clear liability existed and the appellant's treatment of it in the taxation year in question was correct.

In the alternative if the facts were that a settlement had been offered by the appellant and had been accepted by the union representative but had not been formally agreed to in the sense of a written contract; and, if a draft agreement had been prepared incorporating the agreed upon wage increase then, in his words, "the obligations were probable obligations, and, I am talking about the wage settlement only since it has the retroactivity, they would be considered a liability/

To judge whether or not such a liability was "probable” Barrington stated that he would consider these "known” facts in the context of the history of the company in the industry and in the context of its bargaining history with the Union. Once Barrington was satisfied that the facts disclosed a relatively stable pattern in its negotiations and settlements over a number of years then as an experienced accountant he would be prepared to accept that the concept of probability had been established within a reasonable range. In that event he would be satisfied that for accounting purposes a liability had been incurred by the appellant which liability could not be considered to be contingent. Barrington conceded that this would not necessarily be a liability for income tax purposes or a legally enforceable liability. Nonetheless he asserted that treating it in the manner that the appellant did was entirely consistent with generally accepted accounting principles and with guidelines established by the Canadian Institute of Chartered Accountants.

There seems to be little dispute that the manner in which the appellant treated the amount in issue probably conformed to generally accepted accounting principles. However, the fact of its acceptability in accounting terms does not of itself make it a proper deduction for income tax purposes. As stated by Noël, A.C.J. in J. L. Guay Ltée v. M.N.R., [1971] C.T.C. 686 at 692; 71 D.T.C. 5423 at 5427:

. . . Accountants are always inclined to set aside reserves for unliquidated liabilities, for, if they do not do so, the financial statement will not reflect the true position of the client’s affairs. The difficulty arises from the fact that making it possible to determine the taxpayer’s tax liability is not the main purpose of accounting. The accountant’s report is, in fact, intended to give the taxpayer a general picture of his affairs so as to enable him to carry on his business with full knowledge of the facts. To achieve this end, it is not necessary for the profit shown to be exact, but it must be reasonably close, while the Income Tax Act requires it to be exact, and it is thus necessarily arbitrary. . . .

The respondent's position is that as of the end of the 1980 taxation year Lakehead had not made or incurred any outlay or expense with respect to the amount in issue. Furthermore, there was no legal obligation to pay the amounts until at least March 16, 1981. It was submitted by counsel for the respondent that the assessment was proper because the proposed deduction was prohibited by paragraph 18(1)(e) of the Act in that it was “‘an amount transferred or credited to the contingent account.”

In support of this position counsel submitted a number of cases in which it was held that deductions sought to be made in similar circumstances were not allowed. These are M.N.R. v. John Coif ord Contracting Company Limited, [1960] C.T.C. 178; 60 D.T.C. 1131; Mister Muffler Limited v. The Queen, [1974] C.T.C. 813; 74 D.T.C. 6615; J. L. Guay Limitée v. M.N.R., [1975] C.T.C. 97; 75 D.T.C. 5094 (S.C.); [1973] C.T.C. 506; 73 D.T.C. 5373 (F.C.A.); [1971] C.T.C. 686; 71 D.T.C. 5423 (F.C.T.D.); Harlequin Enterprises Limited v. The Queen, [1977] C.T.C. 208; 77 D.T.C. 5164; The Queen v. Burnco Industries Ltd., [1981] C.T.C. 518; 82 D.T.C. 6001 (F.C.T.D.); [1984] C.T.C. 337; 84 D.T.C. 6348 (F.C.A.). As counsel for the appellant pointed out, some of these cases dealt with the provisions of subsection 85B(1) of the Act. Nonetheless the principles set out therein are of relevance in the case at bar.

It is also appropriate to refer to Northern and Central Gas Corporation Limited v. The Queen, [1985] 1 C.T.C. 192; 85 D.T.C. 5144. Dealing with a similar situation Reed, J. gives a useful review of the case law at 200-201 (D.T.C. 5149-50):

The problem the taxpayer has to meet is that while the amount it expected to pay was definitely ascertainable there was no existing legal obligation at the end of 1977 requiring payment. The decision in Meteor Homes Ltd. v. M.N.R., [1960] C.T.C. 419 at 429; 61 D.T.C. 1001 at 1007-8 (Ex. Ct.) quoted with approval the following:

All the above cases serve to illustrate the principle that, in the case of a taxpayer on an accrual basis, where an expense is incurred and the amount is definitely ascertainable and legally liable or payable in the year .. . such amount may be claimed as an expense of the year.

That decision continued:

. . . À Dictionary for Accountants, second edition, p. 290, defines a legal liability as —

A responsibility for some obligation, enforceable at law, as distinguished from a moral responsibility.

And quoting from Simon’s Income Tax, second edition, Vol. Il, pp. 203 and 204:

. . . A liability, the amount of which is deductible for income tax purposes, is one which is actually existing at the time of making the deduction, and is distinct from the type of liability accruing in Peter Merchant, Ltd. v. Stedeford (supra), which although allowable on accountancy principles, is not deductible for the purposes of income tax.

And from the Harlequin Enterprises decision (supra) at 849 [D.T.C. 6642]:

Certain as it was that the Plaintiff would, in due course, be obliged to give rebates on royalties or on returns of books, the fact is the Plaintiff's liability to do so, under the terms of the agreements. which were, in practice, observed, did not arise until the Plaintiff was presented with a demand for the credit. The Plaintiff’s obligation to the distributors in respect of credits for returns was a contingent liability. . . .

And from the recent Federal Court of Appeal decision in The Queen v. Burnco Industries Ltd.,(supra):

. . . An expense cannot be said to be incurred by a taxpayer who is under no obligation to pay money to anyone. . . .

Turning to the appeal of Lakehead I find that the appellant was under no legal obligation to pay money to anyone as at December 31, 1980. Furthermore, while it is not disputed that generally accepted accounting principles should normally be applied for taxation purposes it is equally clear that these principles need not and indeed cannot be followed where the contrary is required by the legislation. Such is the case here. I am satisfied that the amount in issue was not deductible as a result of the operation of para- raph 18(1)(e) of the Income Tax Act.

. The appeal is dismissed.

Appeal dismissed.