Transport Direct Systems Limitée (Formerly Called Direct Motor Express (Quebec) Limited), Direct Winters Transport Limited v. Minister of National Revenue, [1984] CTC 2845, 84 DTC 1773

Sarchuk, TC J:—The appeals were heard on common evidence by consent of all parties.

The appellants are in the motor transport business. Each seeks to exclude from its taxable income for the year ended January 1, 1977, the amounts referred to in paragraphs 14 of the respective statements of agreed facts. The full text of these statements (which are identical excepting paragraphs 12 and 14 follows:

1. At all material times the Appellant carried on the business of transporting goods by motor transport.

2. Goods would be transported by the Appellant in any one of the following circumstances:

(i) The Appellant would pick up the goods from the shipper and transport them to their ultimate destination.

(ii) A different carrier (often referred to as a connecting carrier) would pick up the goods and deliver them to the Appellant at some point in the journey to their ultimate destination and the Appellant would transport them to their ultimate destination.

(iii) The appellant would pick up the goods from the shipper and transport them to a connecting carrier.

(iv) The Appellant would pick up the goods from a connecting carrier and transport them to another connecting carrier.

3. In the course of the Appellant’s business, goods are lost, damaged or destroyed, in respect whereof the shipper, the consignee or a connecting carrier may make claims for damages upon the Appellant based upon the Appellant’s alleged liability therefor.

4. The Appellant’s liability in respect of goods which are lost, damaged or destroyed while in transit is based upon the law of the provincial jurisdiction or of the United States as the case may be, from which the shipment originates, whether or not the Appellant is the carrier which originally picked up the goods in such jurisdiction.

5. In each such jurisdiction, rules or statutes, are in force which deem certain conditions to be a part of every contract for the transport of goods for compensation. Such conditions are usually set forth on the Bill of Lading which is signed by the shipper and original carrier and which accompanies the goods to their final destination. The Appellant is not a party to any other written contract respecting the goods carried by it.

6. Shipments of goods which were transported by the Appellant in the year under appeal originated in every province of Canada and in the United States.

7. The conditions deemed to be included in every such contract of carriage which were in force in each province of Canada and in the United States at the relevant times and which may be relevant to this appeal have been extracted from the regulations under the relevant legislation and are set forth in the following schedules annexed to this Agreed Statement of Facts.

Schedule 1 — Ontario — Public Commercial Vehicles Act

Schedule 2 — British Columbia — Motor Carrier Act

Schedule 3 — Saskatchewan — Vehicles Act

Schedule 4 — Newfoundland — The Motor Carrier Act

Schedule 5 — New Brunswick — Motor Carrier Act

Schedule 6 — Nova Scotia — Motor Carrier Act

Schedule 7 — Manitoba — Highway Traffic Act

Schedule 8 — Alberta — Public Service Vehicles Act

Schedule 9 — Quebec — General Order No 4995 and Bill of Lading

Schedule 10 — United States of America — Rules of the Interstate Commerce Commission.

8. As may be seen from such schedules, in all provinces other than Quebec, such conditions provide that the entitlement of persons to make claims against the Appel- lant for damage to, loss or destruction of goods carried by the Appellant expires or cannot be pursued after a fixed period of time has elapsed.

9. In the normal course of the Appellant’s business, its liability in respect of such claims and the quantum of its liability is acknowledged only after the Appellant investigates the specific details of the alleged damage or loss.

10. The Appellant may disclaim liability in respect of a claim for damages from the damage to, loss or destruction of goods on the basis that, inter alia, the fault lay with the shipper, or with another person or corporation not employed by or associated with the Appellant who participated in the transport of the goods.

11. In any event, the Appellant is only liable for up to $5,000 from any claim, any excess being covered by insurance. The majority of claims are small being on average in the range of $200 to $300 each.

12. (Direct Winters Transport Limited) — In computing its income for the taxation year ended January 1, 1977, the Appellant deducted from income the sum of $135,000. Such sum represented the estimated ultimate liability of the Appellant with respect to goods lost, damaged or destroyed in transit prior to the end of such fiscal period as follows:

(i) $40,200 — where notice of the claim had been received by the Appellant prior to the end of such taxation year but the amount of the Appellant’s liability had not yet been settled either due to the fact that it had not been reviewed or due to a dispute as to the amount of the Appellant’s liability.

(ii) $94,800 — where notice of the claim had not been received by the Appellant prior to the end of such taxation year.

12. (Transport Direct System Limitée) — In computing its income for the taxation year ended January 1, 1977, the Appellant deducted from income the sum of $55,000. Such sum represented the estimated ultimate liability of the Appellant with respect to goods lost, damaged or destroyed in transit prior to the end of such fiscal year as follows:

(i) $16,800 — where notice of the claim had been received by the Appellant prior to the end of such taxation year but the amount of the Appellant’s liability had not yet been settled either due to the fact that it had not been reviewed or due to a dispute as to the amount of the Appellant’s liability.

(ii) $38,200 — where notice of the claim had not been received by the Appellant prior to the end of such taxation year.

13. The estimated amounts referred to in paragraph 12 of this Agreed Statement of Facts were based upon the volume of sales revenue in the year in question and upon historical data and experience as to the relationship between claims and sales revenue as well as taking into consideration any estimated reimbursements from third parties and insurance companies. The Minister of National Revenue does not dispute the reasonableness of the estimates of liability of the Appellant relating to deliveries which took place prior to the end of the said fiscal period. However, the Minister contends that, for purposes of the Income Tax Act (Canada), the amounts of such estimates were not deductible from income in the fiscal period of the Appellant ended January 1, 1977 whereas the Appellant contends that such amounts were deductible from income in such fiscal period.

14. (Direct Winters Transport Limited) — By the Re-assessment in dispute, the Minister of National Revenue disallowed as a deduction from income in the taxation year of the Appellant ended January 1, 1977, the amount of $94,800 referred to in subparagraph (ii) of paragraph 12 of this Agreed Statement of Facts.

14. (Transport Direct System Limitée) — By the Re-assessment in dispute, the Minister of National Revenue disallowed as a deduction from income in the taxation year of the Appellant ended January 1, 1977, the amount of $38,200 referred to in subparagraph (ii) of paragraph 12 of this Agreed Statement of Facts.

To complete their case the appellants called Robert George Coffey, the managing partner of Ernst and Whinney, Management Consultants, a division of Ernst and Whinney Chartered Accountants. Mr Coffey, a graduate of McGill University (B Comm) is a member of the Quebec and Ontario Institutes of Char- tered Accountants; the Institute of Management Consultants and of the Academic Accounting Association. He is an examiner in accounting for the province of Ontario and has taught and lectured at a number of schools and universities in Canada. His particular expertise is in the field of costing and management information systems. His qualifications are not in dispute.

As the clients’ service executive with overall responsibility for the appellants* accounts during the relevant taxation years Mr Coffey is familiar with the issue in dispute which was whether or not the Minister was correct in reassessing on the basis that the sums of $94,800 and $38,200 sought to be deducted as current business expenses by the appellants Direct Winters Transport Ltd and Transport Direct System Limitée respectively were in fact amounts credited to a reserve or contingent account within the meaning of paragraph 18(l)(e) of the Income Tax Act in consequence of which no deduction could be taken in respect thereof in the computation of the appellants’ incomes for the 1977 taxation year.

It was Mr Coffey’s opinion that the deductions taken by the appellants were in accordance with generally accepted accounting principles. According to him the basic fundamental accounting principle to be followed in determining the profit of a business enterprise for a particular fiscal period is the matching principle which involves the correlation of all costs in an accounting period and matching them with a corresponding amount of revenue in order to determine the net revenue for that period. The underlying reason for this is to ensure that one does not overstate net revenue which could result by overstating revenue or by understating cost. In the course of this matching process the deductibility of an expense has nothing to do with when that expense may be paid, but rather has to do with when the expense was incurred. According to Mr Coffey, in this matching process the expense is recognized as having been incurred when the event takes place. Therefore, if you determine that an amount should be included in revenue in a particular period the expenses that would be deducted are all the expenses that were incurred in the period of the earning of that revenue.

Applying this principle to the facts before the Court and assuming that certain goods were damaged, destroyed or lost and that the appellants incurred liabilities as a result of such incidents (for accounting purposes) it was Mr Coffey’s opinion that any expenses so incurred must be deducted in the period in which the events took place, in this instance in the appellants’ fiscal year which ended on January 1, 1977. He stated that in determining net revenue for accounting purposes it did not matter whether an actual claim was filed or not by the end of the fiscal period because the event had taken place. As well it would not make any difference whether or not one had knowledge at the end of the fiscal period of the specific amount of damages incurred. He stated:

The fact that the amount may be difficult to determine does not negate the fact that the amount must be determined. Otherwise, the net revenue will be overstated and the financial statements will be misleading.

Acting on that basis the appellants made a determination, by way of estimate, of their eventual potential liability. These estimates were reasonable and as Mr Coffey stated, from an accounting point of view were expenses incurred in the fiscal period ending January 1, 1977.

It was Mr Coffey’s opinion that these expenses could not be considered a reserve, this term being used strictly for the appropriation of a surplus account in setting aside something for some future event or reason. Similarly, in his view the expenses did not fall within meaning of “contingent account” as used in paragraph 18(l)(e) of the Income Tax Act nor were they a contingent liability. Mr Coffey referred to the definition of a contingent liability in the CICA handbook and stated that the mere fact that an estimate was involved did not by itself constitute the type of uncertainty which would prevent the deductibility of these expenses for accounting purposes. As well Mr Coffey did not consider the expenses in dispute to be “a sinking fund” within accounting terminology.

According to Mr Coffey if the appellants were prevented from deducting these expenses in the calculation of their net income, such net income or profit would not have been determined in accordance with generally accepted accounting principles. The position taken by his firm as the appellants’ accountants in deducting these expenses was logical and correct and ensured that the financial statements were meaningful.

He did concede in cross-examination that an accounting approach could have been taken that not all of the revenue (as presently shown to year end January 1, 1977) was earned because there would be doubt as to whether or not certain amounts were collectible in the normal course of business. He agreed that in such a case it was possible to eliminate a certain portion of revenue from the determination of net income by making additional provision for bad debts and in that manner to attempt to arrive at the same net income. This method was equally consistent with generally accepted accounting principles. However, this was not done by the appellants.

From his responses it was clear that when Mr Coffey spoke of deductibility of the amounts at issue deductibility had nothing to do with when the amount was paid but rather with when the expense was incurred. Since in his view the expense was incurred when the event giving rise to it took place, his opinion was that the obligation was certain and only the amount remained to be estimated. Accordingly, any amounts owing as a result thereof were not contingencies.

The Appellant's Position

In determining profit in accounting terms it is necessary to determine revenues and expenses in a particular accounting period. To ascertain the costs incurred it is necessary to utilize the matching principle, that is to determine the expenses incurred to generate revenue and to deduct these expenses from net revenue to provide a profit or loss figure. In the instant case the expenses associated with the earning of income from the transportation of goods were matched against the revenue received and it was proper to associate the expenses with those specific transactions. Since the expenses deducted were incurred as a result of damage or loss of goods occurring in the taxation year the expenses related thereto had to be claimed in the same year. This was true irrespective of whether a claim was received, or whether or not the amount could be determined with any degree of certainty or whether it was done by way of a reasonable estimate. This was in accordance with generally accepted accounting principles and was the method used throughout the industry.

The appellants’ position was simply that the expenses were deducted in accordance with a generally accepted accounting principle; were incurred within the meaning of paragraph 18( l)(a) and were not contingent within accepted meaning of that term. Furthermore, it was asserted that deduction of these expenses was not prohibited by paragraph 18(l)(e) of the Income Tax Act since they did not constitute a reserve, a sinking fund or a contingent account. I agree that they were not a reserve or a sinking fund.

Although counsel conceded that the expense could not be considered an outlay under paragraph 18(1)(a) because the appellants were not necessarily aware of the claim, it was submitted that the amounts were nonetheless an expense which was incurred in that fiscal year. The amounts were not obligations or liabilities contingent upon the happening of a future event. There was an obligation in these cases which was clearly that of the appellants. They estimated the amount of the liability and deducted only what the appellants were responsible for excluding: third party obligations, possible repayments from insurance and so-forth. It was the appellants’ position that the moment the loss occurred their customers had the right to claim against them and concurrently they had an offsetting obligation. There was no further outside event which could result in the cancellation of any such obligation. Appellants’ counsel submitted that the giving of notice was nothing but a formality and that the only event which might occur and thereby negate the appellants’ liability was the failure of the customer to claim damages.

Respondent's Position

Counsel submitted that Mr. Coffey’s opinion was based on the assumption that liability did not in fact exist. In utilizing the matching principle he did so on the basis that it was the event (the loss of the goods) that determined the time of occurrence of the expense and not the ascertainment of liability. This, counsel argued, ignored the fact that although the event causing the loss may have occurred within the taxation year liability vis-à-vis the appellants did not necessarily exist at that time. Counsel referred to paragraphs 9 and 10 of the statement of agreed facts as confirming the Minister’s position that contingencies existed and that liability was not yet determined. The fact that for one reason or another a potential claimant for damage to or loss or destruction of his goods fails to take the necessary steps within the time prescribed by statute was a further potential contingency.

The relevant legislation (schedules 1-10 — statement of agreed facts) details circumstances where carriers might properly deny liability. These statutory provisions are illustrative of the fact that there was no legal obligation to pay for damage immediately following the occurrence of the event. It was further submitted that the occurrence of the event could not be equated with a corresponding legal obligation to pay and that the appellants’ liability and its existence could only be determined following the making of a claim. Since a distinction was to be made between the occurrence of the event and the ascertainment of the liability and since in these appeals liability could not be ascertained until the following taxation year the estimated amounts could not be deducted as expenses from income in the fiscal year of the appellants ended January 1st, 1977.

Conclusion

The issue is whether or not the facts relied on by the appellants support a conclusion that there existed at year end a real as opposed to a contingent liability. Although the phrase “contingent liability” has been the subject of much discussion it appears safe to say that the decision of the House of Lords in Winter et al v Inland Revenue Commissioners, [1963] AC 235, provides the most useful definition of that term. Lord Reid stated at 248:

The third class is “contingent liabilities”, which must mean sums, payment of which depends on a contingency, that is, sums which will only become payable if certain things happen, and which otherwise will never become payable. [Emphasis added]

In the same judgment Lord Guest said at 262:

. . . Contingent liabilities must, therefore, be something different from future liabilities which are binding on the company, but are not payable until a future date. I should define a contingency as an event which may or may not occur and a contingent liability as a liability which depends for its existence upon an event which may or may not happen . . .

These comments have been accepted by various courts in Canada (see for example Jack L. Cummings v The Queen, [1981] CTC 285; 81 DTC 5207 at 293, [5213-14]; Harlequin Enterprises Limited v The Queen, [1974] CTC 838; 74 DTC 6634 at 848 [6641-42]; Lawrence H Mandel v The Queen, [1978] CTC 780; 78 DTC 6518 at 787 [6522]).

There is little dispute that the appellants can with some degree of accuracy predict what their potential liability resulting from loss or damage to customers’ goods might well be. Nonetheless, the fact remains that it is no more than a prediction and that clearly implies elements of uncertainty. Some examples are:

1. The entitlement of a claimant against the appellants for damage to, loss or destruction of goods carried by the appellant expires after a fixed period of time has elapsed. Such being the case the accident or event causing the damage or loss might have occurred within the year but no liability can exist unless the claim is made within the statutory period of time.

2. In some instances the appellants may properly disclaim liability on the basis that fault lay with some other person, for example, the shipper, or with another person or corporation not employed by the appellants who participated in the transport of goods.

3 . There are circumstances where a carrier of goods is relieved of liability for loss or by way of statutory exception, for example where loss is caused by riots, strikes or by a defect inherent in the goods.

Time Motors Ltd v MNR, [1969] CTC 190; 69 DTC 5149, a decision relied upon by the appellants, is distinguishable, as indeed it was in Harlequin Enterprises Limited, [1974] CTC 838; 74 DTC 6634 (FCTD) and [1977] CTC 208; 77 DTC 5164 (FCA) where Mr Justice Urie stated, at 215 [5168]:

I agree, too, with the learned Trial Judge that the decisions of the Supreme Court in Minister of National Revenue v Atlantic Engine Rebuilders Ltd [67 DTC 5155] and Time Motors Ltd v Minister of National Revenue [69 DTC 5149] are also distinguishable on their facts. In each of those cases there were existing, ascertained current liabilities in contra-distinction to the case at bar where not [sic] such ascertained liability existed unless and until the retailers exercised their right to return unsold books. [Emphasis added]

Although the appellants can be reasonably certain that they will become liable to some of their customers for damages arising out of delay or loss, liability to a customer in the strict sense does not occur unless and until a claim is presented. On balance the evidence fails to satisfy me that a real liability existed at the appellants’ fiscal year-end. The obligations which the appellants say they have to their customers in relation to the estimated amounts claimed are in my view contingent liabilities. The comments of the Trial Judge in Harlequin Enterprises Limited, (supra), apply here. I cite:

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 Plaintiffs 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 Plaintiffs obligation to the distributors in respect of credits for returns was a contingent liability. So was its obligation to rebate royalties to Simon & Shuster. An account set up to provide for those contingent liabilities whether by way of a provision for returns and allowances on its balance sheet or a deduction from earnings in the calculation of its taxable income was a contingent account within the meaning of section 12(l)(e). No deduction in respect of that ac- count, even to the extent that generally accepted accounting principles required it to be made, is permitted in the calculation of the Plaintiff's taxable income. [Emphasis added]

For the reasons I have expressed the appeals must be dismissed.

Appeals dismissed.