Rowland J Purdy v. Minister of National Revenue, [1985] 1 CTC 2294, 85 DTC 254

Christie, ACJTC:—The appellant is a farm equipment dealer from Fremont, Ohio, and carries on business under the name of Purdy Rental and Sales Company. The issue is whether in 1979 he became liable to income tax under subparagraph 212( l)(d)(i) of the Income Tax Act (“the Act”) which requires that every non-resident person shall pay income tax on 25 per cent* [1] of every amount that a person resident in Canada pays to him on account of rent for the use of or the right to use any property in Canada.

The appellant was requested by H J Heinz Company of Canada Ltd to endeavour to sell mechanical tomato harvesters to its tomato suppliers in the Leamington-Blenheim area in Ontario and to train them in their use. The H J Heinz Company has a plant at Leamington.

Thirty or more harvesters were imported after sale and purchase and the necessary training was supplied. The appellant testified that the operation was very successful. In 1979, however, a problem developed with one customer. Mr Henry Renders had purchased a harvester in 1974, but by 1979 he had decided he wanted another which was larger, more sophisticated and consequently more expensive. A purchase order regarding the second harvester signed by Renders and the appellant’s representative, Mr R J Kleinschmit, is dated February 8, 1979. From the proceeds of the sale of the first machine, $25,000 was paid to the appellant on March 1, 1979, for the purchase of the second, the selling price of which was $91,000, leaving a balance of $66,000.

At the time of delivery of the harvester to Renders in July 1979, he disclosed that he did not have the funds to pay the balance. The upshot was that he offered, and the appellant accepted, a cheque which was postdated to October 5, 1979, for $66,000. Renders gave assurances that by then his tomato crop would be harvested and sold to the H J Heinz Company. He added that if necessary the company was prepared to assist him to make payment so that there would be funds to honour the cheque. On October 5 the appellant deposited the cheque with his banker in Fremont. It was returned because of insufficient funds. Precisely when the appellant knew or had good reason to believe that the cheque was bad is not altogether clear. Initially his recollection was that it was after the cheque was returned to Fremont, which was about one month after he had deposited it. On being cross-examined on this point he said that he “found out very shortly thereafter (ie, after October 5, 1979) that there was a possibility that the money was not going to be raised”. In the light of the appellant’s experience with Renders in July when the harvester was delivered and the magnitude of the cheque, I believe that it was soon after October 5 that he had good reason to suppose that the cheque was bad. The appellant had no security agreement pertaining to the harvester. When he realized that the $66,000 debt was in jeopardy his agent Kleinschmit got together with Renders and they added this to the purchase order of February 8, 1979:

Balance due no later than October 15, 1979. If balance is not paid by October 15, 1979 the $25,000 deposit will apply towards a rental of harvester with a balance rental due after season prorated on total acres harvested and tonnage.

It was initialled by Renders and Kleinschmit, but was undated. The harvester was returned, removed from Renders’ farm and stored in Leamington. The appellant was concerned about Renders’ financial condition, a concern which, as it turned out, was well founded. Renders subsequently became a bankrupt. A year after the harvester was taken from Renders’ possession it was sold to another farmer near Blenheim who made final payment for it a year later. The evidence indicates that the harvester was not used by Renders after the addendum was added. The appellant testified that he never rented harvesters in Canada and was not engaged in that aspect of the business here. It was established in cross- examination that after Renders made an assignment in bankruptcy the appellant received a communication from the trustee regarding whether he had a claim against the estate. The appellant admitted that he filed a claim for $12,000 for rent for the harvester, but he also said that he filed a claim “when the assumption would be that we would be in line in case any additional moneys were available that we would be compensated for our problems.”

By notice of assessment which was mailed on May 13, 1983, the appellant was assessed income tax under subparagraph 212(l)(d)(i) in the sum of $4,393.80 on income of $29,292 ($25,000 US) plus interest thereon in the sum of $1,779.

It must be borne in mind that in deciding questions pertaining to liability for income tax the manner in which parties to transactions choose to label them does not necessarily govern. What must be done is to determine what on the evidence is the substance or true character of the transaction and render judgment accordingly. In MNR v Saskatchewan Co-operative Wheat Producers Ltd, [1928-34] CTC 47; (1930) 1 DTC 186, Lamont, J in delivering the judgment of the Supreme Court of Canada said at 54 (DTC 189):

In revenue cases it is a well recognized principle that “regard must be had to the substance of the transactions relied on to bring the subject within the charge to a duty and the form may be disregarded.” Pollock MR, in Inland Revenue Commissioners v Eccentric Club, Ltd, [1924] 1 KB, 390, at p 414.

Viscount Simon in delivering the judgment of the House of Lords in Commissioners of Inland Revenue v Wesleyan and General Assurance Society (1948), 30 TC 11, said at 25:

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.

In Front & Simcoe Limited v MNR, [1960] CTC 123; 60 DTC 1081, Cameron, J said at (DTC 1085):

In Simon’s Income Tax, Second Ed, Vol 1, p 50, the author, after referring to a number of decisions, states:

The true principle, then is that the taxing Acts are to be applied in accordance with the legal rights of the parties to a transaction. It is those rights which determine what is the “substance” of the transaction in the correct usage of that term. Reading “substance” in that way, it is still true to say that the substance of a transaction prevails over mere nomenclature.

The foregoing was reiterated in MNR v Ouellette and Brett, [1971] CTC 121; 71 DTC 5094 by Walsh, J at 136 (DTC 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.

The contention of the respondent is that while the original transaction between the appellant and Renders was unquestionably one of sale and purchase of the harvester, the addendum had the effect of changing the character of the $25,000 payment to that of rent even though it was made months prior to the addendum. I cannot appreciate how, for the purposes of the Act, the addendum can be properly construed as changing the legal nature of the $25,000 payment to create liability for tax any more than a similar ploy could erase liability for income tax. The assertion made on behalf of the respondent that it did was not buttressed in any way. While I understand that the law of contract acknowledges that acceptance may be retrospective under certain circumstances (Trollope & Colls, Ltd v Atomic Power Constructions Ltd, [1962] 3 All E.R. 1035 at 1040) this has no application to the contention of the respondent on this appeal. Furthermore, my assessment of the evidence is that in truth and substance a rental agreement never existed between R and the appellant regarding the harvester. I believe that the appellant thought that the addendum would in some way protect his interest in the harvester against looming action on claims by other creditors of Renders, and Renders went along with it. The addendum did not reflect the reality of the legal relationship between the appellant and Renders. As for the claim for $12,000 in rent lodged with the Trustee in Bankruptcy, this was simply perpetuating the fiction created by the addendum. What the appellant was seeking under the rubric of rent was in substance damages which he regarded as having been inflicted on him by Renders’ breach of contract.

The appeal is allowed and the matter referred back to the respondent for reconsideration and reassessment on the basis that the appellant is not liable for income tax in 1979 in the sum of $4,393.80 or interest thereon in the sum of $1,779 as previously assessed. The appellant is entitled to his party and party costs.

Appeal allowed.