J F Burns, Sr, James F Burns, Jr, Clayton R Carroll, Burnco Industries Limited v. Minister of National Revenue, [1980] CTC 2817, 80 DTC 1705

John B Goetz:—These are appeals with respect to the appellants’ 1974 taxation year. In assessing the appellants, the Minister relied, inter alia, upon paragraphs 18(1)(a) and (e) of the Income Tax Act, SC 1970-71-72, c 63, as amended.

It was agreed between counsel at the outset of the hearing that there would be one set of evidence to apply to all of the appeals, namely: J F Burns, Sr, James F Burns, Jr, Clayton R Carroll and Burnco Industries Limited, and the decision would be binding on all the appellants. There is no disagreement between the parties as to the figures set forth in the various assessments.

Issue

The issue is simply whether the appellant Burnco Industries Limited (hereinafter referred to as “Burnco”) incurred certain expenses for backfilling a gravel pit which it excavated during its fiscal year ending October 31, 1974.

Facts

James F Burns, Jr, gave evidence as the first witness and he is the President of Burnco. Burnco is owned by Burns, Sr, and Burns, Jr, and there is another joint venture known as Carburn Aggregates in which Burns, Sr, Burns, Jr and Mr Carroll involved. Carburn Aggregates owned a few parcels of land for the purpose of mining gravel and selling the gravel to Burnco. Burnco was the operator of the gravel mining operations.

The appeals related to what is known as “the Ogden Gravel Pit” which is located on the Glenmore Trail from the east bank of the Bow River easterly to 24th Street East, in Calgary, and within the City limits. This land had been purchased by Carburn Aggregates in 1958-1959 but it was annexed to the City of Calgary in 1960.

The permit applied for in 1966 was received in 1968 and it was for a period of five years ending January 1, 1973. In 1969 the appellant Burnco applied for an extension of the area to be mined so that they would have a permit from 1973 onwards. The appellants did not get this permit immediately but they continued their operations pending the report of the engineer retained by the City, involving the whole large gravel deposit area which included the Ogden Pit. The question involved apparently was the impact on the environment and the ground water flow through the area because it was an old river channel and had the effect of developing lakes.

It was indicated by Mr Burns that the areas where they had been working and where they would be working, were below the ground water table and if they didn’t backfill the area then lakes would be created. When they moved into a new area, within ten days they were served with an injunction issued on behalf of the Department of Environment which enjoined them from continuing mining, pending the signing of an agreement with the City of Calgary, dated May 30, 1974, between the City of Calgary and the appellants. Under paragraph 4 of that agreement, the City undertook to grant a licence to mine and gravel and remove earth from the Ogden Gravel Pit and sets out specifications in Exhibit A thereto relating to the excavation, backfilling and ground water control and that they were to mine no other portion of the described land, other than the Ogden Pit. The mining gravel was to cease before December 31, 1978 and all gravel stock piles were to be removed and replacement of backfilling was to be completed on or before June 30, 1980. Burnco and the other individual appellants were required to file a bond in the amount of $250,000 which they did.

Attached to the agreement and schedule, were elevation maps and areas designated as the Ogden Pit Mining Schedule marking out what areas could be mined in what years. Gravel excavation consisted of:

A. GRAVEL EXCAVATION—(Reference Plan—Sheet 1 of 5

“Ogden Pit Mining Schedule”)

1. The prescribed schedule of excavation over a five-year period (1974 to 1978 inclusive) shall be as follows:

	Area Designation	Approximate Cubic Yards
Year	(Sheet 1 of 5)	(Loose Measure) to be Removed
1974	Areas A1, A2, A3, A4	580,000
1975	Area B	584,000
1976	Area C	620,000
1977	Area D	640,000
1978	Area E	660,000
TOTAL		3,084,000

The attachment to Schedule “A” was entitled “Outlines Specifications for Excavation, Backfilling and Groundwater Control”. Further, specifications were given with the type of backfill required and a schedule of backfilling was Set forth as follows:

SCHEDULE OF BACKFILLING TO INDUSTRIAL GRADES

(6 /2 Year Program—1974 to Mid 1980)

Year	Area Designation	Approximate Cubic Yards
1974	“A”	635,000
1975	“B1”, “B2”	635,000
1976	“C”	635,000
1977	“D”	635,000
1978	“E1”, “E2”	635,000
1979	“F”	635,000
1980	“G”	312,000
Total Material Required to Fill to
Industrial Grades		4,122,000 Cubic Yards

NOTE: Yield of borrow pit material for backfilling excavated areas to 95% compaction

calculated at a ratio of 1.1 to 1.0. That is, 11 bank cubic yards required to fill 10 cubic yards of excavation.

Section 4 also provided that if mining was accelerated, then backfilling would be accelerated accordingly.

When mining operations commenced in 1974 the depth of excavation was two feet below what was known as “the industrial grade’’. This in fact covered the water table by two feet. On the average they were at the water table elevation two feet below industrial grade. Mr Burns stated: “We had continued our operations and either the latter part of 1973 or early 1974 we started mining below the water table”, although the agreement with the City was dated May 30, 1974, which covered the period January 1, 1974 onwards.

It was during this period until May that the appellants continued their mining operations. As I said, it took five months to create the agreement.

By letter of agreement dated September 6, 1974, Carburn Aggregates agreed with Burnco to pay the cost of backfilling from the elevation of two feet below industrial grade and up to industrial grade, and secondly to pay 25% of the cost of the performance bond to the City of Calgary. That reaffirms the conditions in the agreement between Burnco and the appellants and the City of Calgary.

Mr Burns described the gravel pit operations, saying that it was necessary to create enough of an excavation to allow the excavating equipment to continue movement into the pit and create enough room for the reclamation to take place progressively behind the excavating equipment. In that all the work was below the water table, pumping water out of the pit was necessary in order to render it a dry operation. They were quite aware of this when they entered into the agreement with the City of Calgary in May. Mr Burns says that his lead time for excavating, because of the water problem, had to be much further ahead than the actual backfilling of the hole, although they were aware of the need and obligation to backfill prior to the entry into the formal agreement with the City.

Included in the equipment in the pit, were portable crushing plants that worked at the bottom of the pits and consequently, since the portable crushing plants were placed at the bottom of the pit rather than outside the pit, which could have been done, the excavation or hole had to be greater.

It was admitted that 1974 was a particularly busy year for contractors in the backfilling business and they indicated they had difficulty in obtaining a contractor to do the backfilling as required. They made a tender late in the year to Don Beddoes Construction Company Ltd (hereinafter referred to as ‘‘Don Beddoes”), which bid to do the work for a sum of $434,550. This agreement was entered into on November 15,1974, between Beddoes and Burnco subsequent to Burnco’s fiscal year ending October 31, 1974.

Mr Burns, in cross-examination, stated that mining operations had been ongoing since 1959 and the agreement of May 1974, entered into with the City of Calgary, referred to gravel mining which had commenced roughly five or six months before but under the sanction of a verbal agreement with the City Commissioners, which agreement was reached soon after the stopwork order was served on Burnco.

The fiscal period of Burnco in 1974 ended on October 31, 1974.

Although the appellants received four tenders from independent contractors to perform the backfilling by the end of October 1974, they had not accepted any of these tenders. Mr Burns indicated that commencing in 1969 and thereafter, he would contact a particular company which was doing backfilling work for them, for their estimates of backfilling cost, and this was done on an annual basis subsequent thereto.

After the Calgary agreement in May 1974 it was not until August of that year that the appellants sought to determine an estimate of the cost of

backfilling. Backfilling was always part of the job of mining aggregate from various pits. It should be noted that the Ogden pit had been mined on an Ongoing basis from January 1, 1974. Burns admitted that the mining operations in 1974 had accelerated to the degree that they mined 833,300 cubic yards of aggregate as opposed to that cited by the City in the said agreement.

The appellants asked the consulting firm of Reid Crowther to provide them with an estimate of the cost of backfilling, but not until August 1974. They were not presented with a formal report but merely a verbal one which indicated that the estimated cost of backfilling would be considerably higher than what they had paid the prior year, and in fact the cost was in excess of the actual old tender amount received in the latter part of October. The estimate was a cost of 50¢ a cubic yard for backfill whereas Don Beddoes’ bid came in at a figure of 47 /2$ a cubic yard.

When questioned why Burnco had not tendered earlier in 1974 for a bid for backfill contractors, or immediately after the agreement with the City of Calgary, Mr Burns, Jr admitted that they would have received a bid if they had tendered at that time but that it would probably have been too high because backfill contractors were busy at that time. His reason for not tendering was simply on the assumption that the bids coming in would be higher than what they had been paying from year to year in prior years, advice of which they only obtained from Reid Crowther in August 1974. Mr Burns, Jr, stated in cross-examination:

In any event, we knew that we had the obligation to fill the hole and in fact, when we first started mining the gravel prior to the May 30th date, we knew that once we went below the watertable,* it was a vested obligation.

(and that would be January 1, 1974).

The next witness called on behalf of the appellant was Alan Roderick Low. He was Administration Manager for Burnco Rock Products which is a wholly-owned subsidiary of Burnco Industries. Mr Low filed as Exhibit A-7, notes of calculations re gravel reserves, gravel removed and backfilling quantities. The notes were entitled “Calculation of Burnco’s backfilling liability at the Ogden pit—October 31, 1974’’ and the notes are dated November 15, 1974.

On September 28, 1973, Underwood McLellan & Associates Ltd wrote Carburn Aggregates, giving their engineering report on existing proposed developments of the Carburn Angus Pit which included the Ogden pit. This covered the type of aggregate to be expected, the volumes of water to be expected, the way of disposing of underground water, the levelling of certain wells, private wells in the area, the amount of aggregate estimated to be able to be excavated from the various pits, including the Ogden pit, and description of the type of backfill that was required throughout. This program extended for a period of seven years, from 1973.

The report indicated that 1,143,682 cubic yards was required to backfill the Ogden pit as of October 31, 1974. Further, this was based on removal of a lesser amount of gravel and aggregate as set out in the agreement with the City of Calgary. The appellant, knew that if a greater volume was removed from the pit, then they were to place a greater volume of backfill up to industrial grade.

Up to the date 1974 when the appellants ultimately contacted Don Beddoes, they calculated that 1,143,682 cubic yards of backfill was required. However, they (Don Beddoes) only tendered for 1,000,000 cubic yards at a fixed amount of $444,550. The backfill involved stripping, removing junk and installation of culverts as required by the City.

In cross-examination it was indicated that there were three main components to Burnco’s liability to the City. The first component was Beddoes’ contract (and this relates to mining that had taken place in 1974, or backfilling for the mining that had taken place in 1974). The second component was the preparation for that filling to take place in terms of clearing the site of junk, culverting and engineering fees. The third item, in addition to backfilling as required, was that there was 142,000 some yards of backfilling that also relates to the gravel that was removed in 1974 but the backfilling was not included in the Beddoes contract.

In cross-examination, Mr Low indicated that Don Beddoes continued to do the backfilling at Burnco’s mining excavations after November 1977 and the deduction sought in 1974 in respect of the Ogden pit backfilling claim by Burnco was $718,385. It was actually anticipated to cost $581,308, leaving a balance roughly of $137,000 to cover the additional backfill up to industrial grade.

The working papers filed by Mr Low enlighten the following questions and answers:

Q. Now, I believe in answer to questions from Mr Katchen, you said that you had in your possession certain working papers that were used to prepare the Burnco Industries income tax returns for the fiscal period ending October 31, 1974?

A. The paper I referred to which is now an exhibit was my working papers for journal entries which recorded the liability as at October the 31st.

Q. Now, as I understand it, you used the actual per cubic yard cost of the Beddoes contract?

A. In my calculations, yes.

Q. In your calculations. Even though the only contract that you had at that point was for the one million cubic yards?

A. Yes, that is correct.

Q. Now, when I say you had the contract at the end of October, 1974, you had not entered into that contract?

A. No, we had not.

In re-examination Mr Katchen elicited from his witness that accounts were invoiced on an accrual basis and included in their income for the fiscal year would be accounts receivable.

The last witness called by the appellants was one Murray Leon Davis, a professor at the University of Calgary. However, it would appear that he was a chartered accountant and had his PhD in Economics, with concentration in accounting from the London School of Economics. He stated in the following questions and answers:

Q. Would you say that the deductions by the appellants of the backfilling expenses in the gravel mining operation would qualify as a legitimate accounting expense of that gravel mining operation?

A. Yes. A legitimate expense within the context of the payment which either had been made or would ultimately have to be made in order to render the product saleable.

He stated further:

The determination of accounting income is essentially a two-stage process. It involves first of all the recognition on the accrual basis of revenues for a particular accounting period. The second stage in that process involves the determination of which costs were necessarily incurred in the generation of that revenue.

Those expenses incurred in the generation of that revenue would be deducted from that revenue in the computation of accounting income.

A failure to deduct the expenses incurred in the generation of 1974’s revenue would result, from a generally accepted accounting principle, would result in a failure to properly determine the income for the 1974 period.

The exercise of accounting income determination is to assign the revenues and expenses to their proper periods.

Mr Davis says that “the incurring of an expense in the determination of accounting income is a matter quite independent of the period in which those expenses might be paid for”. For instance, a payment might be made in a prior period to the period in which the expense is incurred, ie the acquisition of merchandise inventory for resale that is held in inventory and held over a year end, and then sold in a subsequent period. On the other hand, he says that payments are often made in the same accounting period as the expense incurred, ie rental premises. Further, in some situations payment would be made subsequent to the period in which the accounting expense is recognized as incurred.

An example of that would be the generalization of accrued expenses and accrued liabilities, payroll expenses for example.

In answer to questions, Mr Davis stated:

Q. And you have now talked about the expenses of the backfilling and matching those. Is there authority in general accepted accounting principles to require us to match this expense of backfilling against this accrued income, this income that is determined on the accrual method?

A. I can cite two sources in that context. One is Alvin S Hendrickson, Accounting Theory, 3rd Edition, published by Irwin, and he states on 198:

“The measurement of net income is assumed to represent the excess or revenues reported during the period over the expenses associated and reported during that same period. A proper matching is assumed to occur only when a reasonable association is found between the revenues and expenses. The timing of expenses therefore requires (1) association with revenue and (2) reporting in the same period as the related revenue is reported.”

There is a further citation in Accounting Principles Board, Opinion No 11, Paragraph 14(b):

‘‘Matching is one of the basic processes used in income determination. Essentially it is a process of determining relationships between costs and (1) specific revenues, or (2) specific accounting periods. Expenses of the current period consist of those costs which are identified with the revenues of the current period and those costs which are identified with the current period on some basis other than revenue. Costs identifiable with future revenues or otherwise identifiable with future periods should be deferred to those future periods. When a cost cannot be related to future revenue or to future periods on some basis other than revenues, or it cannot reasonably be expected to be recovered from future revenues, it becomes by necessity an expense of the current period.”

In further questioning, the following was stated:

Q. This backfilling expense, is that a reserve as the term is used in contemporary accounting?

A. No, it is not. Section 32.60 of the Handbook of the Canadian Institute of Chartered Accountants suggests that the use of the term reserve should be limited to an amount which has been appropriated from retained earnings or other surplus.

Q. And this is from expense?

A. This is from expense. It is not a reserve. (Emphasis in above mine).

Mr Davis stated that in the particular circumstances of the appeal, there was no reserve involved. In answer to a question by the Chairman as to whether there was a contingent account, Mr Davis stated:

A. The Handbook of the Canadian Institute of Chartered Accountants does not use the term contingent account per se. It refers to contingencies and to contingent liabilities but I might cite from those sources. Reading from Section 32.90 of the Handbook of the Canadian Institute of Chartered Accountants:

“A contingency is defined as an existing condition or situation involving uncertainty as to possible gain or loss to an enterprise that will utimately be resolved when one or more future events occur or fail to occur. The mere fact that an estimate is involved does not of itself constitute the type of uncertainty which characterizes a contingency.”

“Liability is a potential obligation the existence of which is conditional upon the happening of some future event.”

To my understanding of the circumstances, we do not have a contingency because there is no future event which must be resolved and which would lead to the existence of the item in question. The only future—to my understanding there are two future events: Future event No 1 would be the service, that is, the actual completion of the backfilling operation and circumstance No 2 the payment for that service when completed. In my previous testimony I suggested that the existence of an accounting expense was not conditional upon those factors. This is not in my opinion a contingency.

At 75 of the transcript, Mr Davis stated:

MR KATCHEN:

Q. . . . Would you say that in conformity with generally accepted accounting principles it is acceptable to make a determination of an expense after the year end based on information which is available at that time?

A. Yes, it is. The performance of audit work subsequent to the year end at least insofar as this situation is concerned, would essentially be threefold; first of all, that an expense was incurred during the fiscal period and should properly appear as a reduction from the revenues of that period in the computation of accounting income. Second of all, that an obligation existed with regards to that expense and third of all, the determination of the appropriate amount with respect to that liability or with respect to that expense which are really opposite sides of the same coin.

Mr Davis stated that a very significant part of the auditor’s requirements and procedures is to determine an appropriate cutoff, that is, make a determination of which sales applied to the previous period and which sales applied to the subsequent period. The same would be the situation with regard to expenses, liabilities and so forth and so on. In answer to a question by the Chairman as to the definition of a sinking fund, the witness answered:

A. A sinking fund is simply a transfer of cash from a general bank account, generally speaking, to an account which is restricted to its use for a specified purpose. These are often used within the context of bond refunding or bond retire- ment requirements where an organization had to insure the bonds on their due date. The trustee might then require them to place on deposit in a specified bank account sufficient funds to provide for that retirement. We are not dealing with a sinking fund in this situation. This has nothing to do with that at all.

Then in answer to further questions, the witness stated:

Q. So you are referring to this specific case. Let me put a hypothetical (question) to you. We have an ex-company that is in these circumstances, they had executed an agreement with the City of Calgary, they had the same year-end, October 31, 1974, it comes along and no backfilling work has been done, okay. If it is a matter of law, the City of Calgary could not sue that company either to get an injunction, a mandatory injunction to get them to go out and do the work or sue them for damages. Is therefore accounting purposes a liability?

A. There may or there may not be, depending on other factors. Upon those circumstances

one would look to what the particular accounting entity had done in the past with regards to items of this type; they would look to what is customary practice in industries and in other firms of that type; they would look to the intention of management but the statement evidence would not be so great as would be the case if there were a legally enforceable agreement. (Emphasis mine).

The subject property in these appeals was within the City limits of Calgary which, as a condition of giving a mining permit to the appellants, under the City’s agreement, with Burnco, imposed obligations to carry out backfilling.

Findings

The relevant section to be considered is paragraph 18(1)(a) and (e) of the Act. This is the section relied upon by counsel for the respondent in assessing the appellants. The said section reads as follows:

(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property.

(e) an amount transferred or credited to a reserve, contingent account or sinking fund except as expressly permitted by this Part;

Midway through his argument, counsel for the respondent abandoned his position under section 18(1 )(e) and in light of the evidence of Dr Davis, it appeared to be a prudent move on his part. He then concentrated on the question as to whether under paragraph 18(1)(a) the appellant had incurred an expense for backfilling in the 1974 fiscal year. Dr Davis gave a very clear picture of the meanings of the words “reserve”, “contingent account”, or “sinking fund”. The appellants calculated the cost of backfilling the Ogden pit up to October 31,1974, by calculations which they made in the month of November 1974 and which related back to the income earned by Burnco during its fiscal year ending October 31, 1974. This would appear to be the accounting basis upon which they prepared their financial statements in the past and is in accordance with ordinary accounting principles.

In the judgment of President Thorson of the Exchequer Court in the case of Publishers Guild of Canada Ltd v MNR, [1957] CTO 1; 57 DTC 1017, it was Stated:

If the law does not prohibit the use of a particular system of accounting then the opinion of accounting experts that it is an accepted system and is appropriate to the taxpayer’s business and most nearly accurately reflects his income position should prevail with the Court if the reasons for the opinion commend themselves to it.

In Pickle Crow Gold Mines Limited v MNR, [1954] CTC 390; 55 DTC 1001, Mr Justice Cameron stated:

In my opinion, the words “expense incurred by the taxpayer’’ have a natural and ordinary meaning of expenses either paid out by the taxpayer or which he had become liable to pay. (Emphasis mine).

The respondent’s position was simply that Burnco failed to establish, during his fiscal year ending October 31, 1974, that no expense had been incurred. He based his argument on the fact that up to October 31,1974, there was no present liability upon the appellant to perform the backfilling (notwithstanding the agreement of May 1974 with the City of Calgary).

It was the practice of the appellant, in the process of excavating gravel pits, to perform backfilling, and this, of course, it had done for many years. It had always recognized its constant obligation and liability to backfill any excavations made by it. Because the May agreement with the City of Calgary clearly delineated the specifications with respect to excavation and backfilling, the respondent argued that the calendar year was different from that of a fiscal year. That argument might be accepted excepting that the appellant had always backfilled its excavations and had always related back to the fiscal year the cost of backfilling of excavations performed by it during its fiscal year. The respondent further argued that the accounting evidence adduced by the appellant was only relevant in so far as it was consistent with the provisions of the Income Tax Act. There is no argument in this area. He argues that the word “incurred” means that expenses are not incurred unless there is some legal liability to pay for them. He argued that the provisions of paragraph 18(1)(a) constituted a departure from general accepted accounting principles.

In the facts of this case, I cannot see why the general accounting principles under the circumstances should not be applied as was done by the appellant in the preparation of its 1974 financial statement. There had been a continuing obligation and liability on the part of Burnco to backfill all excavations made by it during the preceding years which was again formalized in the agreement with the City of Calgary dated May 1974. it should be pointed out that the appellant had been continuously performing excavation and backfilling for several years except for a short period of time when an injunction was served upon it, which injunction was lifted very quickly and the appellant was given verbal approval to continue on with work of excavating and backfilling. It is clear from the evidence that the appellant was excavating the Ogden pit up to and after January 1, 1974.

The respondent argued that there was no liability on the part of the appellant to backfill during its 1974 fiscal year. I disagree with him and find, for the above reasons, that the expenses as calculated by Burnco for the cost of backfilling, although determined after the fiscal year, were properly related back to the income that accrued to it during its fiscal year. I therefore allow the appeals and refer the matter back to the respondent for reconsideration and reassessment accordingly.

Appeals allowed.