Auberge Des Quatre Vents, Inc v. Minister of National Revenue, [1985] 2 CTC 2156, 85 DTC 522

Taylor, TCJ [TRANSLATION]:—These appeals were heard on December 13, 1983, in the City of Montreal, Quebec, and were brought with respect to income tax assessments for 1978, 1979 and 1980.

In the notice of appeal dated November 29, 1982, Mallette, Benoît, Boulanger, Rondeau et Associés stated the following:

1. The Company is governed by the Act respecting health services and social services (chapter S-5) and entered into an agreement with the Minister pursuant to section 176. . ..

Section 177 of the said Act also provides that “the Minister may also, in all cases where an outright rate is not fixed by regulation in accordance with section 176, agree with a private establishment to repay to it all or part of the expenses incurred by it which are permissible under the regulations . . .

2. The contract concluded ... between DSA and the Company provides that DSA undertakes: “2.1 — To pay the following establishments the daily rate for each component set out in Appendix "A’ of this contract”.

In addition, the parties also agree that the content of Appendix "C” of the contract . . . forms an integral part of the overall contract . . .

Under the said Appendix "C”, it is provided that in addition to the lump sum granted for operating expenses (percentage of the scientific valuation of the land and building), any major repairs authorized by DSA and any equipment purchases approved by DSA will be subsidized over a certain number of years.

It is obvious that the purpose of clause 2.1 of the contract and of section 6.29 of the regulations under chapter S-5 is to reimburse an establishment for current expenses, while clause 4.1 of the contract, Appendix "C” of the said contract and section 6.2.10 of the regulations under chapter S-5 are designed to subsidize an establishment for capital outlays.

3. A reading of sections 6.2.9 and 6.2.10 of the regulations under chapter S-5 indicates clearly that there was meant to be a distinction between the operating expenses of an establishment, reimbursement of which is provided for in section 6.2.9, and expenses of an exceptional nature, most of which are capital outlays, provided for in section 6.2.10. In the case of the Company, all the expenses authorized under section 6.2.10, Appendix "C” of the contract and clause 4.1 of the contract were capital outlays:

— purchase of furniture and equipment

— purchase and installation of a septic tank and automatic sprinklers

— building improvements

— landscaping.

4. The Company did not use the sums received to pay for or reduce operating expenses. The sums would never have been paid by DSA if the expenses had not been capital expenditures approved by the Department There is therefore a direct causal link between payment of the sums and the capital outlays made. It was the fact of making certain capital outlays that entitled the Company to receive certain amounts, and not the fact of operating the centre.

5. The Exchequer Court’s decision in St John Dry Dock and Ship Building Company Limited v Minister of National Revenue, [1944] CTC 106, sets out the principal criteria to be used in determining how the amounts received are to be taxed, including Parliament's intention in paying a sum.

The means of calculation and the method of payment of an amount are not important criteria. The documents filed indicate clearly that the legislature’s aim was to subsidize certain of the Company’s capital outlays. The facts in the decision cited are fairly similar to the facts of the Company’s case.

The respondent, on the other hand, relied on the following presumptions of fact, inter alia, in his reply to the notice of appeal:

(a) During the taxation years in question, the appellant was a company that operated a reception and rehabilitation centre;

(b) The appellant is fully paid for its services by the Quebec Department of Social Affairs;

(c) During the years in question the appellant entered into contracts with the Department of Social Affairs governing the operations of the appellant's establishment and the consideration for which the appellant provided its services;

(d) The contracts between the appellant and the Quebec Department of Social Affairs were concluded under the Quebec Act respecting health services and social services, which provides, inter alia, that the Minister may enter into a contract with a private establishment for purposes of remunerating it for the health services and social services it provides pursuant to the contract, at an outright rate fixed by regulation for each category of establishment;

(e) The consideration provided for in the contracts concluded between the appellant and the Department of Social Affairs is based on formulae that take various factors into account, including those relating to the assets acquired by the appellant;

(f) During 1978, 1979 and 1980, as part of the total remuneration given to the appellant, the Department of Social Affairs paid the latter, inter alia, amounts of $41,306, $16,838 and $49,336 respectively;

(g) The method of calculating these payments was based on the depreciation and interest attributable to certain capital assets acquired by the appellant over the years to render the services it had undertaken to provide;

(h) The amounts in question were paid in the general context of a normal business relationship and they are part of the consideration the Department of Social Affairs undertook to pay the appellant pursuant to contracts the two parties had entered into for each of the years in question;

(i) The appellant’s total income for each of the taxation years in question came from the Quebec Department of Social Affairs pursuant to the contracts concluded between that Department and the appellant;

(j) The amounts referred to in paragraph (f) constitute income from the operation of the appellant’s business;

8. The respondent relies on sections 3, 9(1), 152(1.1), 152(1.2), 152(7), 165, 169 and 248(1) of the Income Tax Act (SC 1970-71-72, c 63, as amended), inter alia.

Both counsel provided the Court with various explanations concerning the assessments and the case in general. The present situation, as I understand it, is as follows.

During the three years covered by this appeal, the business corporation originally reported the sums in question as follows: in 1978, as "income", and in 1979, as a reduction in the cost of the capital outlays undertaken that year. In 1980, however, it did not use either of the above-mentioned methods but simply treated this amount as a "special" receipt having no effect on income or expenses. Since the appellant received a tax assessment on “nil” income for 1978, no appeal can be brought in this regard; whatever the outcome of this case, the appeal brought for that year will therefore be dismissed. The appellant would like the sum in question to be regarded as a "special" receipt for 1979 (as was the case in 1980). The Minister issued reassessments for 1979 and 1980, being of the view that the amounts in question constituted "income" for the business corporation (as in the case of the amount received for 1978). In the final analysis, there are two issues to be decided. Are the amounts in question on account of capital or of income? If they are on account of capital, are they covered by subsection 13(7.1) of the Income Tax Act .

With regard to the main issue, namely whether the amounts are on account of capital, there are two leading decisions to be considered: St John Dry Dock and Shipbuilding Co Ltd v MNR, [1944] CTC 106; 2 DTC 663, which seems at first sight to confirm the appellant’s theory, and Valley Camp Ltd v MNR, [1974] CTC 418;74 DTC 6337, which seems to confirm that of the respondent. Some 30 years separate these two judgments; not only did the learned judge in Valley Camp, supra, have the benefit of the judge's reasoning in St John Dry Dock and Shipbuilding Co Ltd, supra, but h e contrasted it with the facts before him in making his decision. The following is an extract illustrating this contract, taken from the decision rendered by Urie, J in Valley Camp, supra, at 424 (CTC) and 6341 (DTC):

At page 193 Thorson, P makes this observation:

The fact an amount is described as a Government subsidy does not of itself determine its character in the hands of the recipient for taxation purposes. In each case the true character of the subsidy must be ascertained anid in so doing the purpose for which it was granted may properly be considered.

Relying on the decision of the House of Lords in The Seaham Harbour Dock Co v Crook (HM Inspector of Taxes) (1931), 16 TC 333, as authority for the proposition that when a payment is made under the authority of an Act of Parliament, the statutory purpose for which such payment is authorized may be considered in determining whether the payment is to be regarded as an item of annual net profit or gain and taxable income in the hands of the recipient, he found the purpose of the subsidy payments could be found in the Act, the agreement and the Orders-in-Council made under its authority. He found at page 205 that “the whole Act shows the concern of Parliament for the construction of such a dock as would meet public requirements”. The payments were not made to supplement the operational income of the appellant. They were made to accomplish a special purpose, in the national interest, quite apart from the trade or business operations of the appellant and not connected with them.

In that, it differs from the case at bar. The payments here were not made apart from the trade or business operations of the appellant but were made as p»art of them as consideration for providing and operating the pellet facilities. This was not a payment or series of payments in the nature of a grant or subsidy paid by a public authority to encourage employment as in the Seaham case or to encourage the construction of a dry dock as in the St John Dry Dock (supra) case. If it: was, the appellant’s argument might have some validity.

At the risk of seeming simplistic, I suggest that there is a major distinction to be made between St John Dry Dock and Valley Camp, namely that at the time of “the Act, the contract and the orders” (cited above) pertaining to the construction of the dry dock, the appellant company “was not in the business of dry dock construction and was not yet engaged in the business of operating the dry dock” (St John Dry Dock, [1944] CTC 106 at 121; 2 DITC 663 at 669). In 1944 this distinction might have been sufficient for the judge to regard the sum in question as being on account of capital and not of income. Since at the time there was no section in the Act comparable to t he present subsection 13(7.1), the appeal would be allowed and no tax paid. The appellant is seeking basically the same result in the case at bar. It is not possible to make the same distinction now, on as narrow grounds, since the appellant corporation existed and was fully operational during the years in question. Apart from this major distinction, can it be said that the essential characteristics of the concept of “capital” set out by the judge in St John Dry Dock are present in the case at bar? In this regard I shall quote a comment made in St John Dry Dock, at 122 (CTC) and 669 (DTC): If the subsidy had been paid in a lump sum the amount of it certainly would not have been interest but a capital contribution and a capital receipt by the appellant rather than a receipt of income.

Several agreements concluded between the Auberge des quatre vents, the appellant, and the Quebec government were filed with the Court. The wording of these agreements is somewhat ambiguous and it is this ambiguity that is the basis for the present appeal. The parties stressed the divergent interpretations at the hearing. After reviewing the documents adduced in support, however, I find that there is a difference between the contributions made with respect to capital outlays pursuant to these agreements and the co ntributions made with respect to operating expenses, if only owing to the manner in which they are calculated and the restrictions placed on their use, According to my interpretation of the situation and the agreements in question, the amounts involved are directly related to obligations undertaken by the appellant to obtain a certain amount of capital and are therefore, by their very nature, payments on account of capital. In this regard the Court is in agreement with the appellant’s basic thesis.

However, the appellant pursued this reasoning so as to exempt the sums in question, as capital, from the accounting treatment whereby the amount of the capital “subsidies" received would be subtracted from the total capital cos t of the capital assets acquired.

I would like to cite two further extracts from St John Dry Dock, at 124 and 126 (CTC), 671 and 673 (DTC):

Parliament can, I think, so fix the character of a payment authorized by it that it cannot properly be regarded as taxable income in the hands of the recipient wit hin the meaning of the income War Tax Act.

. . .. 1 do not think that it was ever intended by Parliament that, after payment of the: subsidy had been authorized by the Government in aid of the construction of the* dry dock by the appellant, and after the dock had been completed by the appellant and the purpose of the Act accomplished, a substantial and increasingly large portion of the aid to construction should come back to the Government in the form of income tax.

It «can be said that the legislator (in this case the Quebec government) had determined the nature of these payments so that they could not be considered taxable in the sense that they constituted capital receipts and not income receipts; but there is nothing to indicate that the Quebec government treated the sums in question in such a way that they would not be covered by the provisions of the Income Tax Act at all. It is not possible to say that the application of subsection 13(7.1) of the Act directly imposes a tax on the sums themselves. If the sum involved in St John Dry Dock had been considered to be on account of income rather than on account of capital, the recipient might have remitted part of the subsidy received to the government in the form of income tax. In the case at bar I do not need to resolve this question since I have already concluded that these sums were in the nature of capital. If the analysis of this quotation (from St John Dry Dock) is taken further and if, in effect, the proposition is reversed, it could just as well be said that in the case at bar I do not think that it was ever intended by Parliament that, after the recipient had received the subsidy and had spent it as provided for capital purposes, an additional substantial portion should come back to the latter in the form of depreciation on the capital assets acquired, without the subsidy giving rise to any tax. I am of the view that the cases cited in Valley Camp confirm this opinion.

In my view the amounts in question are precisely those which Parliament had in mind in enacting subsection 13(7.1) of the Income Tax Act. I respect tHe arguments to the contrary made by counsel for the Minister, but the latter did not succeed in convincing me.

The purported appeal brought for 1978 is quashed. The appeals relating to 1979 and 1980 are allowed in part and the matter referred back to the respondent for reconsideration and reassessment so that the amounts in question may be deducted from the cost of the related depreciable property, pursuant to subsection 13(7.1) of the Income Tax Act. In all other aspects the appeals are dismissed.

Appeal allowed in part.