Commonwealth Construction Company Limited v. Her Majesty the Queen, [1984] CTC 338, 84 DTC 6420

Urie, J:—The sole issue in this appeal from a judgment of the Trial Division is whether the sum of $6,072,595 received by the appellant in its 1974 taxation year and the sum of $725,221 received in its 1975 taxation year ought to have been included in its taxable income for the 1974 and 1975 taxation years respectively, as assessed by the Minister of National Revenue, or in the year 1977 as the appellant contended.

The facts from which the problem arises are somewhat complex but I set out only hereafter those which are essential to its resolution.

In 1969, the appellant entered into six agreements for the construction of a pulp mill complex in northern Manitoba for Churchill Forest Industries (Manitoba) Limited (“Churchill”) and MP Industrial Mills Limited (“MP”). Partial financing was provided by Manitoba Development Corporation (“MDC”). In or about July 1970, default was made in the progress payments to which the appellant was entitled under its agreements. As a result, on March 1971, the appellant instituted a mechanic’s lien action in the County Court at Le Pas pursuant to the Manitoba Mechanic's Lien Act to recover moneys due it for services, labour and materials provided in the course of construction of the project. MDC appeared in the action as a mortgagee intervenant.

Later in the same year in an action in the Manitoba Court of Queen’s Bench, brought by the trustee in bankruptcy of, inter alia, Churchill and MP, it was held, in August 1972, that the interests of the lien holders took priority over those of MDC in respect of the assets of the bankrupt owners. An appeal was taken from this judgment and was heard by the Manitoba Court of Appeal, but, by agreement of the parties, judgment was never rendered.

Subsequently, after a very lengthy trial in the lien action, on November 20, 1974 before His Honour Judge Ferg, the appellant was awarded the sum of $4,573,601.55 plus interest together with costs to be fixed by the Court at a later date if the parties failed to agree on the amount thereof. The interest on the sum awarded brought the amount due on the judgment to $6,072,595.

In an exchange of letters dated December 13, 1974 from counsel for the appellant and December 19, 1974 by way of reply from counsel for MDC, the parties agreed that MDC would pay the full amount of the judgment and interest in the mechanic’s lien action provided, inter alia, that the appellant furnished releases and assignments in respect of the judgment in exchange for executed discharges of the mechanic’s lien claim and provided an appropriate guarantee in the maximum amount of $1,500,000 in respect of any potential reduction of the judgment made by a judgment of the Court of Appeal. The payment made by MDC in the letter from its counsel dated December 13, 1974 was directed to be held in trust by counsel for the appellant pending fulfillment of the various conditions which were imposed upon the appellant before it could be released.

On December 24, 1974, MDC filed a notice of appeal from the decision in the mechanic’s lien action. On December 29 or 30, 1974, having complied with the conditions of the trust, counsel for the appellant forwarded to his client the funds received from MDC without any restrictions as to their use other than the obligation to repay them in whole or in part should the Court of Appeal reverse or vary Judge Ferg’s judgment.

With respect to costs, since the parties could not agree on the quantum thereof, Judge Ferg fixed them at the sum of $725,221 on March 6, 1975. This sum was paid to and received by the appellant during the 1975 taxation year without any restrictions as to the use to which it might be put.

In February 1976, MDC filed an amended notice of appeal to include the costs awarded by Judge Ferg. The whole appeal was ultimately settled by agreement between the appellant and MDC whereby, in exchange for mutual releases, the appellant returned to MDC, in April, 1977, the sum of $455,000 from the moneys paid to it in satisfaction of the judgment and costs in 1974 and 1975 respectively by MDC.

The appellant did not report in its tax returns the amounts received in 1974 and 1975 until its 1977 taxation year. The Minister of National Revenue reas sessed the appellant’s 1974 and 1975 returns to include those amounts. He also reassessed its 1977 return to delete the amounts so reassessed for the 1974 and 1974 taxation years. The Trial Division upheld the various reassessments. It is from that decision that this appeal arises. The various amounts in the reassessments were not in issue at trial nor are they in issue in the appeal. I turn now to the attacks on the trial judgment.

Appellant’s counsel first asserted that the effect of including the sums in issue in the taxable income of the appellant in 1974 and 1975 was to remove the appellant from an accrual to a cash basis of accounting which is not permitted by the Income Tax Act. That is because, he said, the amounts in issue were not income for tax purposes in those years in that they were not “receivable” at the time they were “received” because neither the appellant’s entitlement to them nor their amount had been determined. They were not finally determined until the exact amount of the judgment was agreed upon in April, 1977. Thus they did not have, nor could they have had, the “quality of income” required to make them taxable in the years in which they were received. In counsel’s submission, unless the recipient had an unqualified right to retain the funds (which the appellant had not in this case because of the possibility that the appeal might be successful in whole or in part) they did not have the quality of income. That character was not acquired until 1977 when final settlement of the judgment was made.

There is no question that as a matter of law amounts become taxable as income in the year of receipt provided that the amounts received exhibit the nature and quality of income at that time. The facts adduced in evidence in this case disclose, inter alia, that:

(a) by virtue of the judgment of Judge Ferg the sum of $6,072,595 was ascertained and determined to be receivable by the appellant in the 1974 taxation year in respect of construction work performed by it prior to that year;

(b) that sum was paid to the appellant during its 1974 taxation year;

(c) for its own internal accounting purposes the sum received was recorded as income in the year of receipt.

With respect to the receipt of the sum of $725,221 for costs fixed by Judge Ferg in the lien action in the 1975 taxation year, they too were receivable, paid and taken into income for accounting purposes in 1975.

In each case there were no restrictions imposed by the payer, MDC, on the use and enjoyment of the funds by the payee, the appellant. It is this absolute use and enjoyment of the funds upon receipt which, according to counsel for the respondent, bestows upon them the quality of income. Thus, in his submission, they were properly included in the appellant’s income in the year of receipt since the amounts exhibited the nature and quality of income and were actually received in 1974 and 1975 respectively. He submitted, further, that the judgments of Judge Ferg created in the appellant clearly defined legal rights to receive amounts then determined and ascertained and that the appellant thus became entitled to accounts receivable which were properly included in the appellant’s income in the respective years 1974 and 1975 by virtue of paragraph 12(l)(b) of the Income Tax Act. That paragraph reads as follows:

12. (1)(b) any amount receivable by the taxpayer in respect of property sold or services rendered in the course of a business in the year, notwithstanding that the amount or any part thereof is not due until a subsequent year, unless the method adopted by the taxpayer for computing income from the business and accepted for the purpose of this Part does not require him to include any amount receivable in computing his income for a taxation year unless it has been received in the year.

Counsel for the appellant argued that this paragraph is inapplicable because, first, the amounts in issue were not receivable in the respective years of payment, 1974 and 1975, because, as earlier stated, there was not yet an unqualified right to retain them due to the outstanding appeal and, second, the moneys did not relate to “property sold or services rendered in the course of business in the year” but rather related to work performed in earlier years by the appellant.

The question as to the year in which sums received by a taxpayer are properly taken into income for tax purposes has been considered in a number of cases. In MNR v Benaby Realities Limited, [1967] CTC 18; 67 DTC 5275 the Supreme Court of Canada dealt with the question in the context of an expropriation case. In 1954 the Crown expropriated two parcels of land belonging to the respondent. An agreement fixing the compensation to be paid was reached in the 1955 taxation year and it was paid in that year. The taxpayer, operating on an accrual basis, contended that the profit from the expropriation was taxable in the year in which the expropriation took place, 1954, while the Minister took the position that the proper year for inclusion in taxable income was 1955, the year in which the compensation became receivable and was paid.

The taxpayer argued that, as a matter of law, from the moment of expropriation it no longer had its land but had instead the right to receive compenstion. The Crown argued that the general rule is that taxes are payable on income actually received by the taxpayer during a taxation year. However, by virtue of paragraph 85B(l)(b) of the Act then in force (which for all practical purposes, is identical to paragraph 12(l)(b) of the present Act) there is an exception in the case of trade receipts so that not only actual receipts but amounts which had become receivable during the year are included in income. Therefore, the taxpayer’s profit from the expropriation did not form part of its income in 1954 because it was neither received nor did it become receivable during that year.

At 420 [5276] of the report Judson, J for the Court said:

In my opinion, the Minister’s submission is sound. It is true that at the moment of expropriation the taxpayer acquired a right to receive compensation in place of the land but in the absence of a binding agreement between the parties or of a judgment fixing the compensation the owner had no more than a right to claim compensation and there is nothing which can be taken into account as an amount receivable due to the expropriation. (emphasis added)

At 421 [5277] he made these further findings:

My opinion is that the Canadian Income Tax Act requires that profits be taken into account or assessed in the year in which the amount is ascertained, (emphasis added)

Under the Canadian Expropriation Act, there is no doubt or uncertainty as to the right to compensation, but I do adopt the principle that there could be no amount receivable under s. 85B(1)(b) until the amount was fixed either by arbitration or agreement.

I can see no difference in the principle to be applied in an expropriation case as enunciated by Judson, J and that applicable in a case in which the amount payable is determined by a judgment of a court of competent jurisdiction. The amounts payable for services performed in prior years were ascertained by a judgment in 1974 and 1975 so that they became receivable in the hands of the judgment debtor in those years and were in fact paid in the same years. Thus, they were taxable in the hands of the taxpayer having acquired “‘the quality of income” in those years.

The phrase “quality of income” appears in a case relied on both by the appellant and the respondent, namely, Kenneth BS Robertson Limited^MNR, [1944] CTC 75; 2 DTC 655. At 90-91 [660] of the report Thorson, J (as he then was), after disposing of an argument that the appellant in that case was entitled to set up reserves in respect of certain types of commissions paid on insurance premiums received, made the following statement:

This does not, however dispose of this appeal, for the question remains whether all of the amounts received by the appellant during any year were received as income or became such during the year. Did such amounts have, at the time of their receipt, or acquire during the year of their receipt, the quality of income to use the phrase of Mr Justice Brandeis in Brown v Helvering (supra). In my judgment, the language used by him, to which I have already referred, lays down an important test as to whether an amount received by a taxpayer has the quality of income. Is his right to it absolute and under no restriction, contractual or otherwise, as to its disposition, use or enjoyment? To put it in another way, can an amount in a taxpayer’s hands be regarded as an item of profit or gain from his business, as long as he holds it subject to specific and unfulfilled conditions and his right to retain it and apply it to his own use has not yet accrued, and may never accrue?

To apply phrases from that quotation to the case at bar, the record discloses that the rights of the appellant to the amounts paid to it in 1974 and 1975 were “absolute and under no restriction, contractual or otherewise, as to its disposition, use or enjoyment”. They were not held subject to any specific and unfulfilled conditions. Once the conditions precedent imposed in the letter agreements between the parties, supra, had been fulfilled, as they were, the right to receive the moneys and to retain them had accrued and was absolute. True, it might be necessary to return the moneys in whole or in part if the appeal were successful. But, as I see it, that was a condition subsequent which did not affect the unrestricted right of the appellant to use them until such a requirement occurred. It did not, as I see it, affect their quality as income upon receipt.

As to the difference in effect of a condition precedent from a condition subsequent on the question of an accrual to income, the learned trial judge relied on a quotation from Meteor Homes Ltd v MNR, [1960] CTC 419; 61 DTC 1001 at 430-31; [1007-8] which substantiates the view which I expressed, supra’.

. . . Mertens, Law of Federal Income Taxation, Vol 2, c 12, p 127, considers “the problem of when items are . . . deductions to the taxpayer on the accrual basis”, and deals with it at p 132 in these terms:

Not every contingency prevents the accrual of income: the contingency must be real and substantial. A condition precedent to the creation of a legal right to demand payment effectively bars the accrual of income until the condition is fulfilled, but the possible occurrence of a condition subsequent to the creation of a liability is not grounds for postponing the accrual. (Emphasis mine.)

The possibility of a successful appeal does not, therefore, appear to derogate from the quality of income of the payments in issue at the time of receipt.

I am fortified in this view by the judgment of Kearney, J. in the Exchequer Court in the case of MNR V John Coif ord Contracting Company Limited, [1960] CTC 178; 60 DTC 1131. The sole issue in that case was not whether progress payments received by a mechanical contractor during the course of the execution of its contract and holdbacks in respect thereto which were not paid in a taxation year but to which it would ultimately become entitled, were taxable, but when they were taxable. According to the taxpayer, the progress payments could not be taken into income for tax purposes until, as required by the contract, a certificate of completion of the entire project to the satisfaction of the owner had been issued by the owner’s architect.

At 185 [1134] of the report Kearney, J had this to say:

. . . progress payments, whether made on demand or otherwise during the course of any year in connection with the contracts in question, must be reckoned with in the year in which they are received, and may not in effect be ignored by placing them in a suspension account as was done in the present case.

With respect to the question as to when the holdbacks should be taken into income, Mr Justice Kearney made the following comments at 186 [1134] ff.:

The second point in issue, namely, whether the holdbacks amounting in the aggregate to $67,728.24 should have been included as taxable income by the taxpayer in 1953, hinges on a narrow issue which is not easily resolved. It depends on the interpretation to be given to the word “receivable” found in s 75B(1)(b) of the Income Tax Act as amended, SC 1952-53, c 40, now s 85B(l)(b), RSC 1952, c 148, which reads as follows:

In computing the income of a taxpayer for a taxation year, every amount receivable in respect of property sold or services rendered in the course of the business in the year shall be included notwithstanding that the amount is not receivable until a subsequent year unless the method adopted by the taxpayer for computing income from the business and accepted for the purpose of this Part does not require him to include any amount receivable in computing his income for a taxation year unless it has been received in the year.

In the Wilson case (supra) Cameron J came to the conclusion that before s 85B became effective holdbacks were taxable only after the issuance of a final certificate by the architect or engineer appointed by the owner, but that, after the passage of s 85B(l)(b), this was no longer true because, in his opinion, as a result of it a holdback became “receivable” within the meaning of the said section. Although admittedly the section is drafted in broad terms, I am disposed to add to the above statement the proviso that the facts in each particular case are such as to give to the holdback the quality of a receivable.

In the absence of a statutory definition to the contrary, I think it is not enough that the so-called recipient have a precarious right to receive the amount in question, but he must have a clearly legal, though not necessarily immediate, right to receive it. A second meaning, as mentioned by Cameron J, is “to be received.” and Eric L Kohler, in A Dictionary for Accountants, 1957 edition, p 408, defines it as “‘collectible, whether or not due.” These two definitions, I think, connote entitlement.

In my opinion, a term or instalment account must be included in the taxation year in which it could be said that it had the quality that it shall be thus included “notwithstanding that the amount is not receivable until a subsequent year.”

Again I can see no difference in the principle to be applied on the facts of this case from that applied in the factual situation in Colford. The appellant here had the right to an ascertained amount in each of the years 1974 and 1975 by virtue of the judgments in its favour rendered in those years. The sums awarded became receivables which were turned into receipts by payments made during those years. If it were not for the appeals, then, it would seem that there could be no question that the amounts of the payments received were properly included by the Minister in the years of receipt.

The test for determining the proper year for the inclusion of receivables in taxable income enunciated by Kearnery, J received the approval of the Supreme Court of Canada in Maple Leaf Mills Limited v MNR, [1976] CTC 324; 76 DTC 6182. At 330-31 [6186] of the report de Grandpré, J, speaking for the Court, had this to say:

. . . I accept without question the test expressed by Kearney J in The Minister of National Revenue v John Colford Contracting Company Limited [60 DTC 1131] (1960) Ex. CR 433, at pages 440 and 441. An appeal to this Court from this judgment was dismissed without written reasons [62 DTC 1338] (1962) SCR viii.

This test is the one this Court has applied in income tax cases resulting from expropriations; for an amount to become receivable in any taxation years, two conditions must coexist:

(1) a right to receive compensation;

(2) a binding agreement between the parties or a judgment fixing the amount. [Emphasis mine.]

The principle is to be found in The Minister of National Revenue v Benaby Realties Limited [67 DTC 5275] (1968) SCR 12 and in Vaughan Construction Company Limited v The Minister of National Revenue [79 DTC 6268] (1971) SCR 55.

There, thus, appears to be no doubt as to the applicable principle. However, the next question to be asked is — is that situation affected by the fact that the amounts held to be payable by the judgments of Judge Ferg might have been varied if the appeals had been successful in whole or in part?

This question can be dealt with briefly. In Nouvion v Freeman (1889), 15 App Cas 1, at 10 and 11, Lord Herschell had this to say:

. . . Although an appeal may be pending, a Court of competent jurisdiction has finally and conclusively determined the existence of a debt, and it has none the less done so because the right of appeal has been given whereby a superior Court may overrule that decision. There exists at the time of the suit a judgment which must be assumed to be valid until interfered with by a higher tribunal, and which conclusively establishes the existence of the debt which is sought to be recovered in this country.

The other Law Lords did not dissociate themselves from this view although, on the particular facts of the case, they chose somewhat different language. For example, Lord Bramwell at 15 said this:

. . . There is an essential difference, therefore, between the case where a Court of competent jurisdiction has entertained all the controversies between the parties which they could and chose to raise, and come to a conclusion, which is to be presumed to be accurate, and this case where there is no ground for saying that all possible controversies between the parties have been decided.

The Court of Appeal of British Columbia in Canadian Transport (UK) Limited v Alsburg, et al, [1953] 1 DLR 385 at 406 said that an order of a superior court has “full force until reversed on appeal”. Other authorities cited to us from various courts are to the same effect and the principle of presumption of the validity of a judgment until reversed or varied on appeal seems to be well established.

Appellant’s counsel next took issue with what he deemed to be a finding of the trial judge that any treatment of the amounts received in 1974 and 1975 other than taking them into income would have the indirect effect of creating a reserve which is prohibited by paragraph 18(1)(e) of the Act. While he mentioned in his reasons that counsel for the Minister had advanced that contention, the trial judge neither commented nor made any finding with the respect thereto. In this Court counsel for the respondent merely pointed out that the paragraph prohibits such a reserve. Nothing further need be said about this argument since it does not appear to have any relevance to the issue in this case.

Finally, counsel for the appellant argued that the effect of the trial judgment was to require the appellant to leave its accounts open until the amount payable to the appellant by MDC has been finally determined which is contrary to the requirements of the Act. It is quite true that, as Judson, J pointed out in the Benaby case, supra, at 420 [5276], . . . “For income tax purposes, accounts cannot be left open until the profits have been finally determined”. But, by the same token, he also said that the Act requires that profits be taken into account or assessed in the year in which the amount is ascertained. Since, as has been earlier stated, I am of the opinion that the profit was ascertained when Judge Ferg’s judgments were rendered and must be taken into income in the years in which those judgments were rendered, the appellant’s accounts were not being kept open until final disposition of the appeals.

As it turned out, due to the settlement of the appeals in 1977, the sum of $455,000 had to be repaid from the moneys the appellant had received from MDC. That does not mean that the account had remained open during the intervening period or had to to be kept open to permit this payment.

As to the tax treatment of the latter sum, we need not be concerned with whether the trial judge was correct when he expressed the view that it was properly deductible as an expense item by the appellant in its 1977 tax year. The observation was neither necessary for his decision nor is it a matter requiring the opinion of this Court.

For all of the foregoing reasons I would dismiss the appeal with costs.