Ellis Construction LTD v. Minister of National Revenue, [1982] CTC 2604, 82 DTC 1625

Guy Tremblay:—This case was heard in Edmonton, Alberta, on March 1, 1982.

1. The Point at Issue

The point at issue is whether the appellant company, a general contractor engaged in building construction, is correct in the computation of its income for its 1977 taxation year in claiming an amount of $95,003.08 as accounts payable.

The respondent disallowed the deduction on the basis that the said amount was in respect of 15% holdback amounts deducted from payments to subcontractors conditional upon the issuance of an engineer’s or architect’s certificate of completion.

2. The Burden of Proof

2.01 The burden is on the appellant to show that the respondent’s assessment is incorrect. This burden of proof results particularly by from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

2.02 In the same judgment, the Court decided that the assumed facts on which the respondent based the assessment or reassessment are also deemed to be correct. In the present case, the assumed facts are described in the Reply to Notice of Appeal as follows:

6. In so reassessing the Appellant’s 1977 taxation year, the Minister of National Revenue assumed, inter alia:

(a) that the Appellant regularly withheld 15% of invoice amounts from payments made to subcontractors and the total of such holdback amounts payable at the end of the 1977 fiscal period was $95,003.08;

(b) that payment of each holdback amount was conditional on the Appellant receiving the related holdback receivable from the developer upon the issuance of an engineer’s or architect’s certificate of completion;

(c) that in computing its 1977 income for tax purposes, the Appellant included holdback payable amounts of $95,003.08 in expenses but excluded the related holdback receivable amounts from income; and

(d) that the costs in the amount of $95,003.08 were not properly deductible in computing the Appellant’s income as of December 31, 1977.

3. The Facts

3.01 The appellant corporation is a general contractor engaged in building construction. It is located in the City of Lacombe, Alberta.

3.02 Mr Jack Ellis, president of the appellant company, was the only witness in this case. During the chief examination he testified that (SN pp 4 to 7):

(a) he had been personally involved in the construction business for over 20 years;

(b) during the 1977 taxation year the appellant worked for a developer;

(c) he admitted subparagraph (a) of the assumed facts;

(d) the holdback amounts were to purchase material and services;

(e) the appellant company, according to normal business practice, paid the subcontractors when it received the money from the developer. This practice was based on a lack of funds;

(f) the term of the invoice of the subcontractors was for a thirty-day period; and,

(g) the payment was not dependent on the issuance of an architect’s or engineer’s certificate (SN p 5).

3.03 Mr Ellis, during cross-examination, testified as follows on the following points (SN pp 7 to 11):

(a) the appellant company had been incorporated for about 40 years;

(b) he recognized his signature on three purchase orders given by the appellant to suppliers (Exhibit R-1, nos 1332, 1395 and 1396). On those three purchase orders, one can read the following details:

No 1332 No 1395 No 1396

Date: October 4, 1976 September 30/76 September 30, 1976

Supplier’s name: Border Paving Ltd Bonnybrooke Steel C Beckett Company

Ltd Limited

Reference to Lacombe Sr Citizens Lacombe Senior Cit- Ext to Senior

building contract: Home		izens Apartments	Citizens Apts
Reference to the
Estimate of the
Supplier:	August 31, 1976	September 2/76	Sept 3/76
Material Service:	Asphalt paving of	Supply and fabrica- Labour and material
	the parking lot	tion of structural	to complete
		steel	stucco
Amount:	$3,718	$6,700	$9,643

Terms and conditions: “Invoice within 30 Days of Receipt of Goods or Services All Invoices in Duplicate”

(c) despite the fact that those purchase orders were dated in 1976, they were representative of those issued and they are similar to the year involved;

(d) he explained his understanding of the purpose for the holdbacks:

Well, as I explained before the main reason is just strictly cash flow and probably the prime reason is to ensure that the sub-contractor gets the work done. When you pay somebody and it’s not done, well then it’s tough to get the work cleaned up. Even when the work is completed you can’t get paid for it until you get that final certificate. It is strictly a case of economics why you don’t pay them, and you never get any problem with it so I assume it is common practice in the construction industry but you don’t go around asking the other contractors this type of question. (SN p 10)

(e) during the 1977 taxation year, he had to complete three jobs for developers.

3.04 In re-examination, Mr Ellis testified on the following points:

(a) “If the work was completed within 30 days, yes, they (the subcontractors) would have been paid”;

(b) the 15% was withheld “until such time as we received our holdback payment from the owner” (SN p 12); and,

(c) according to him he “had no legal right to withhold the money from them”. “There is nothing in writing that says we are allowed to do that’, but he explained that there is a verbal agreement which applies to all construction.

4. Law — Case at Law — Analysis

4.01 Law

The main provisions of the Income Tax Act involved in the present case are paragraphs 18(1 )(a) and (e) and 20(1 )(n). They shall be quoted if necessary during the Analysis.

The agents for both parties also referred to the Alberta Builders’ Lien Act (1970), c 14) as amended by “The Builders’ Lien Amendment Act, 1972’’ (chapter 102) and to the Alberta Public Works Act. The appropriate provisions shall be quoted if necessary during the Analysis.

4.02 Case at Law

The respondent referred to:

J L Guay Ltée v MNR [1969] Tax ABC 691; 69 DTC 490, (Tax Appeal Board); [1971] CTC 686; 71 DTC 5423, (Federal Court-Trial Division); [1973] CTC 506; 73 DTC 5373, (Federal Court of Appeal); and, [1975] CTC 97; 75 DTC 5094, (Supreme Court of Canada).

The company appealed unsuccessfully to all the above tribunals. The facts and the decision are well described in 71 DTC 5423:

The appellant company was a building contractor with several outstanding contracts with subcontractors. The terms of the standard contract provided, inter alia, that the company could withhold 10% of the amount due under the contract until the work was completed. This amount then became payable at the end of 35 days after a certificate of acceptance was issued by the architects and engineers to the effect that the work was completed in accordance with the contract. For its 1965 taxation year, the appellant (which computed its income on the accrual basis) deducted over $277,000 as holdbacks on contracts awarded to subcontractors. The Minister refused to allow the deduction on the basis that the amounts were neither due nor payable during the company’s 1965 year.

Held: The appeal was dismissed. The deduction was properly disallowed by the Minister. It was far from certain that the amounts of the holdbacks would be paid in full to the subcontractors. It should not be forgotten that the purpose of the provision permitting withholding a percentage of the subcontract price was to ensure the payment of any damages the owner or the prime contractor might incur from the subcontractor’s failure to perform the work or his faulty performance of it. Thus, the amounts withheld were not only uncertain as to quantum if partial damages resulted but would no longer be even due or payable if damages exceeded the amounts withheld. While the holdbacks could be set up as a reserve, for the appellant’s own accounting purposes, to provide for payment of a demand which was contingent or conditional, the deduction of such a reserve was prohibited by section 12(1)(e) of the Act. Moreover, there was another reason for dismissing the appeal. The Court stated that the deduction of the holdbacks by the appellant in 1965 was contrary to the rule that an expenditure may only be deducted from income for the period in which it was made.

4.02 Analysis

4.03.1 The crux of the matter is whether the $95,003.08 (the quantum of which is not in dispute) is an account payable or not.

If it is an account payable it is deductible. Indeed, it was “incurred by the taxpayer for the purpose of gaining or producing income from the business” (paragraph 18(1 )(a) of the Income Tax Act), and it is clear from the evidence and not in dispute, that the expense was incurred for the purpose of gaining income from business (paras 3.02(b) and (c) and 3.03(a), (b) and (c)).

4.03.2 The deciding criterion is whether an account is payable when the involved amount is legally due and payable, and therefore the debtor might be sued and condemned to pay.

This principle was explained in J L Guay Ltée (supra) and in John Colford Contracting Co Ltd v MNR, [1960] CTC 178; 60 DTC 1131, a case which is referred to in J L Guay Ltée.

4.03.3 Pursuant to the evidence there is no written agreement concerning the obligation to withhold the 15% (para 3.04(c)). Therefore, the taxpayer did not have to retain it until the issuance of an engineer’s or architect’s certificate of completion. Consequently, it seems that the account was payable and that the appeal should be allowed.

However, Mr Ellis said that there was a “verbal agreement which applies to all construction” (para 3.04(c)) . . you never get any problem with it so I assume it is common practice in the construction industry but you don’t go around asking the other contractors this type of question”.

4.03.4 Is a verbal agreement sufficient in the present circumstances to bind the parties?

Moreover, it is important to check whether there is a legal obligation to the same effect as a written agreement coming from an Act of the Government of the Province of Alberta.

4.03.5 Builders’ Lien Act

There is no statutory requirement to withhold the 15% from a subcontractor in the Builders’ Lien Act of the Province of Alberta. The Builders’ Lien Act simply sets out the directions to follow and to protect somebody against improper claims as an owner or contractor.

4.03.6 Public Works Act

The Public Works Act of the Province of Alberta applies only when the work is done at the expense of the Crown. There is no evidence before the Board that the construction done by the appellant was at the expense of the Crown and therefore was “public works”.

Any practice based on a section of the said Act and applying to public works is therefore not pertinent to the instant case. The appellant, in his written submissions, tried to prove a practice based on a section of the Public Works Act. in fact, such evidence out of Court could not be accepted. Even if it were accepted it could not be applied in the present case as explained above.

4.03.7 Verbal Agreement

The disadvantage of a verbal agreement ordinarily comes from the difficulty In proving the said verbal agreement. Once it is proven, however, the parties involved are bound as if it had been a written agreement.

In the instant case, the evidence given by the appellant himself concerning the verbal agreement is more than clear, the 15% holdback is even a practice, a custom.

The Board could not see why, before a civil court, such evidence would not be admitted if the appellant had been sued by a subcontractor with a view to collecting the 15% holdback. The legal action would be dismissed and the amount claimed indeed would not be payable.

4.03.8 As the deciding criterion explained above (para 4.03.2) cannot apply in the instant case because the appellant would not be condemned to pay, therefore the amount of $95,003.08 was not accounts payable. The reassessment must be maintained.

5. Conclusion

The appeal is dismissed in accordance with the above reasons for judgment.

Appeal dismissed.