Oerlikon Aérospatiale Inc. v. R., [1998] 4 CTC 2821, 97 DTC 694

Archambault T.C.J.:

Oerlikon Aérospatiale Inc. (OA) is challenging an assessment made by the Minister of National Revenue (the Minister) under Part 1.3 of the Income Tax Act (the Act), namely the part dealing with tax on large corporations. In computing OA’s taxable capital, the Minister added an amount of $244,492,173 for the taxation year ending on December 31, 1989. The Minister contends that this amount represents advances within the meaning of paragraph 181.2(3)(c) of the Act. OA for its part claims that, as this amount was deducted in computing its income under Part I of the Act, it represents a reserve, which in computing its taxable capital is excluded under paragraph 181.2(3)(b) of the Act. Furthermore, the amount in question is neither a loan nor an advance within the meaning of paragraph 181.2(3)(c) of the Act.

Facts

There is really no dispute as to the relevant facts of this appeal. OA is a Canadian corporation all of whose issued and outstanding shares of its capital stock are held by Oerlikon-Büherle Holding Ltd. (OBH). In 1986, the Werkzeugmaschinenfabrik Oerlikon-Büherle A.G. (WO) company entered into a contract with the Minister of Supply and Services of Canada to supply the Canadian Department of National Defence with equipment that was to constitute a low-altitude air defence system (the Canadian contract). OBH holds all the issued and outstanding shares of WO’s capital stock.

For the performance of a portion of its Canadian contract, WO granted OA a subcontract for the assembly and delivery of one of the components of the low-altitude air defence system. A purchase order (comprehensive purchase order) dated September 8, 1988, lists all the individual purchase orders relating to this subcontract (Exhibit A-l). It succinctly describes the equipment and services that OA was to provide to WO. OA was to assembly 36 ADATS (air defence and anti-tank system) units at a cost of $304,166,920. OA was also to supply other pieces of equipment and related services for an additional total amount of $437,411,853. The comprehensive purchase order also sets out the invoicing procedure: “Invoices have to be accompanied by corresponding evidence of completion or deliveries (certificate of conformity signed by PMO or other acceptable evidence).” The terms of payment are described therein as follows:

Payments for these purchase orders have been carried out since 1986 in form of advance payments. Further payments will be made on financing concepts to be agreed upon between OBH, WO and OA. Normally, no single invoices will be paid but invoices will be netted against advanced payments.

[My emphasis.]

It would appear that the agreement between OBH, WO and OA on financing was entered into in June 1988. The terms are contained in a Ger- man-language document that was filed at the hearing (Exhibit A-4). Following are the relevant parts of the English version of this document prepared by OA’s controller:

2. Financing OA

21. Situation up to mid of 1988

The cash requirements to cover purchases for capital and fixed assets is provided by OBH. The total funds up to 30.6.1988 are: C$59,3 Million.

The total other cash requirements from OA were covered by WO in the form of advances. Total up to 30.6.1988 approx. C$ 170 Million calculated with the prevailing exchange rate of the month the moneys were transferred. As per this date, this amount is higher than the advances received from the Canada Customer for the OA portion of the contract (see Attachment 3).

The advances from WO were transacted mainly in C$, but partially also in US$ and in Sfr. (see Attachment 2). The last named position was also derived from converting accounts receivable from WO in advances. Accounts receivable WO were mainly a result of turret and laser deliveries to OA as well as a result of payment directly done by WO to third parties in the name of OA.

OA did not have a considerable local line of credit.

The payments from WO and OBH were evaluated monthly, based on a cash flow forecast done by OA. WO and OBH adapted themselves often on short note to changed circumstances at OA.

22. Financing principals from 1.7.1988 onwards

On a continuous basis, OBH will provide to OA funds in connection with acquisition of fixed assets for the purpose of conversion to share capital.

Furthermore, OBH will assure, through advances or issuance of shares, that OA ‘s net worth at year-end will always be between [C$ 40 - 50 Million].

To cover the NWC (Net Working Capital) OA will establish locally credit facilities with 3 to 4 banks for a max. amount of [C$ 100 Million]; one bank is to be of a Canadian nationality. A significant amount of these credit lines has to be reserved to encompass peak requirements.

With respect to the LLAD-contract WO will be transferring funds only in C$ and if following requirements are met:

-OA needs funds for the LLAD-contract

-WO disposes of C$ funds received from advance (Milestone) payments from LLAD.

All Invoices and Debit notes from WO to OA, no matter which currency and origin, will in principal be settled at value date through the OB-clearing. On the same basis, WO will pay to OA all invoices which are not LLAD related.

Should it be necessary, in exceptional circumstances, to convert accounts payable from OA to WO in to advances LLAD from WO to OA, these Sfr. amounts would have to be converted to C$ at the prevailing exchange rate of the day. (By the way, in March 1989 all US$ and SFr. advances from WO to OA were converted to C$ at an average exchange rate of 0,7492 respective 1,14475. On the other hand, all compensations for the OA portion of the LLAD-contract is newly done in C$).

Any eventually remaining funding requirements from OA has to be covered by OBH in the appropriate way.

23. Interest

OBH-KFF establishes an overview on a monthly basis where following elements are displayed (see Attachment 4):

-Payments from WO to OA in original currency and in C$

-C$-payments from the customer to WO

For statistical reasons and a complement to this overview, interest will be calculated based on the following sample:

total LLAD related payments from WO to OA total actual payments in C$ received from the customer related to the OA-portion of the contract.

The calculation of the interest is usually calculated by OBH-KFF based on the input from WO at the end of each month. Interest calculation: 30/360 days per year; LIBOR - 1 month.

3. LLAD invoicing from OA to WO

OA invoices WO in accordance with the purchase orders received from WO for the OA portion of the LLAD-contract, Annex A. The invoices have to contain all the information as shown on the enclosed sample invoice (Attachment 1).

If the invoice is accepted by WO, this invoice will be netted simultaneously by OA as well as by WO against LLAD-advances received from WO. A Special notice is not necessary (corresponding note exists on the invoice, see Attachment I).

[My emphasis.] ë

The cumulative amounts of the advances by WO to OA for the years 1986 to 1989 are as follows:

These amounts appear in accounting records of OA entitled “Advances from WO a/c no. 671”.

OA had invoiced WO for a total of $12,704,105 as at December 31, 1988. As at December 31, 1989, OA had invoiced for $44,545,685. These two amounts were therefore applied to the reduction of the amount of the advances.

In 1988, OA entered into a contract (the U.S. contract) with the Martin Marietta Corporation (MMC) for the manufacture of goods to be delivered to the U.S. government as part of a United States air defence program. As WO had done, MMC granted OA advances which, as at December 31, 1989, totalled $8,907,076. This amount appears in OA’s accounting records under the heading “Advances from MMC, account number 673”.

In its balance sheet for the fiscal year ending December 31, 1989, OA did not report the total amount of advances from its clients as a debt included in its liabilities, but rather deducted it from the value of its work in progress reported as an asset. The following explanation appears in note 4 to the financial which contains the breakdown of the amount of $16,431,000 appearing as an asset in OA’s balance sheet:

4 - Long Term Projects

	1989	1988
	$	$
Advances from customers	(244,492)	(255,029)
Work in progress	239,339	63,494
Less
Provision for loss on contract	(40,000)	(10,964)
Net work in progress	199,339	52,530
Advances to sub-contractors	46,952	127,796

Deferred cost attributable to	14,632	10,093
signed contracts
Net total contract expenditures	260,923	190,419
	16,431	(64,610)

As at December 31, 1989, net total contract expenditures exceeded advances from customers and accordingly, the difference is shown as Work in progress (in 1988, advances from customers exceeded net total contract expenditures and the difference was shown as a liability under the heading of Advances on contracts).

Advances from customers were made under contracts with an affiliated corporation and Martin Marietta Corporation (see Note 10a) for the production and support of low-level, air-defense systems. These advances include $235,584,000 ($231,355,000 in 1988) from an affiliated corporation. There are no advances to sub-contractors which are affiliated corporations as at December 31, 1989 ($21,227,000 in 1988).

The amount of the advances for 1989 appearing in this note was determined as follows:

In the balance sheet to December 31, 1989, paid-up share capital is $142,442,000, of which $87,400,000 was subscribed in 1989. The same balance sheet also shows bank debt of $40,119,000.

In computing its income for accounting purposes in 1989, OA did not include the balance — $244,492,173 — of its advances from clients. For tax purposes, it included that amount in income in accordance with paragraph 12(1)(a) of the Act as an amount received on account of goods not delivered and it deducted an equal amount as a reserve in respect of undelivered goods in accordance with paragraph 20(1 )(m) of the Act.

The chartered accounting firm of Raymond, Chabot, Martin, Paré signed an opinion to the effect that OA’s financial statements had been prepared in accordance with generally accepted accounting principles (GAAP). Note 2 to the financial statements indicates that the terms of OA’s contracts vary between three and five years from the date on which the contract is awarded. According to note 2-b, OA accounts for its revenue using the percentage of completion method, this percentage being determined on the ba- sis of the costs incurred. In actual fact, it would appear that the percentage of completion, at least with respect to the assembly of the equipment, was determined on the basis of the time of delivery of the units.[1]

At OA’s request, Réjean Blanchette, a chartered accountant with Samson, Bélair, Deloitte, Touche, testified in his capacity as an accountant. In his report,[2] he made the following comments on the description of this accounting method:

[TRANSLATION]

This note thus indicates that the revenue is recognized on the basis of the percentage of completion method. The percentage of completion is calculated according to the costs incurred. It is important to note here that, in my review of the financial statements and my discussions with OA representatives, I observed that the method for calculating the percentage of completion was based instead on equipment deliveries. This observation does not in any way change the results reported in the financial statements. The wording of note 2(b), however, is not entirely accurate. The part that says “Measured by cost incurred” should have read “calculated on the basis of units delivered”.

He concluded that this method of recognizing and accounting for revenue was consistent with the accounting principles applicable to this type of contract.

Mr. Blanchette’s main mandate was to provide an opinion on the nature of the advances granted by WO and MMC. At page 5 of his report, this expert acknowledged that there is a difference between an advance in the sense of a loan and an advance in the sense of a payment on account:

[TRANSLATION]

To establish an accounting distinction between a payment on account and a loan or an advance in the sense of a loan, the following elements may be considered:

- a payment on account is not usually repayable in cash, whereas a loan is;

- a payment on account does not generally bear interest, whereas a loan may or may not bear interest;

- the consideration for a payment on account is in the form of services rendered or goods delivered, whereas the loan is subject to repayment; -when the service is rendered or the goods delivered, the payment on account is entered as revenue, whereas a loan is not entered as revenue, except in rare instances where the lender agrees to waive the debt.

According to this expert, the amounts received by OA from WO and MMC represented payments on account. He writes as follows at page 4 of his report:

[TRANSLATION]

In OA’s case, based on the financial statements and my discussions with the company’s representatives, it is clear that the term “advance” means an amount that is to be applied against the contract price. Considering the fact that work had been performed by OA, it would have been more appropriate to speak of a “payment on account” or “instalment”. In note 4 to the financial statements of December 31, 1989, it would therefore have been more accurate, in my view, to use the term “payments on account from customers”.

Mr. Blanchette also described how these payments on account should be entered in the balance sheet, at page 3:

[TRANSLATION]

When amounts are paid before contracts are performed, they are entered in the balance sheet as a liability. In the course of the performance of the contract, these amounts are used to pay the costs incurred for the work. In accounting terms, however, even if the amounts have been used, they are entered in the financial statements as advances until they are brought into revenue.

[My emphasis.]

At page 4 of his report, Mr. Blanchette confirms that this was how things were done in OA’s balance sheet:

[TRANSLATION]

According to this information, all the amounts received by OA from WO and Martin Marietta Corporation were used for the work in progress and to cover the other expenses relating to the contracts. However, these amounts were always considered to be advances in accordance with the accounting principles stated above and entered as such in the financial statements.

[My emphasis.]

At the Minister’s request, Réal Labelle, a professor at the accounting department of the École des hautes études commerciales, gave his opinion, as a public accountant, on the treatment of the amounts received by OA from WO and MMC. He also confirmed that OA’s financial statements, in particular note 4 which forms a part thereof, were consistent with the GAAP in effect on December 31, 1989. In his remarks, he discussed the mode of presentation of entries in the income statement and the balance sheet. In support of his conclusion respecting the income statement, the ex- pert cited, at page 4 of his report (Exhibit 1-4), the CICA Handbook, Accounting Recommendations, paragraph 3400.08, October 1986, Toronto, Canadian Institute of Chartered Accountants, March 1996, p. 1802, which reads as follows:

In the case of rendering of services and long-term contracts, performance should be determined using either the percentage of completion method or the completed contract method, whichever relates the revenue to the work accomplished.

This rule describes when and to what extent a contractor must recognize revenue by including it in its income. As to the balance sheet, the expert stated at page 7 of his report that OA’s mode of presentation complied with international accounting standards, in particular paragraph 40 of the International Accounting Standard^[3]

Progress payments and advances received from customers in respect of construction contracts are disclosed in financial statements either shown as a deduction from the amount of contract work in progress or as a liability.

[My emphasis.]

In Mr. Labelle’s view, OA was allowed to rely on international standards in preparing its financial statements. OA’s entry of the amounts received from WO and MMC was correct from the standpoint of both Canadian and international standards. Lastly, OA’s entries in note 4 of its financial statements form an integral part of the company’s balance sheet for the fiscal year ending on December 31, 1989.

OA’s Position

In his written submission, counsel for OA summed up his client’s position as follows:

[TRANSLATION]

21. We submit that Revenue Canada’s position that the Amounts [totalling $244,492,173] should be included in computing the Appellant’s capital for the purposes of Part 1.3 of the I.T.A. is ill-founded in fact and in law. We submit that the Amounts do not have to be included in computing the appellant’s capital for the purposes of Part 1.3 of the I.T.A. for, inter alia, the following reasons:

-the Amounts are contemplated by the exception set out in paragraph 181.2(3)(b) of the I.T.A.; the definition of the word “reserve” for the purposes of the tax under Part I.3 of the I.T.A. includes the Amounts; the amounts contemplated in paragraph 20(1)(m) of the I.T.A. are “provisions” for the purposes of the I.T.A. and the definition of “reserves” in section 181 of the I.T.A. includes provisions and reserves claimed under the I.T.A.;

-we also submit that, since the Amounts are contemplated by paragraph 181.2(3)(b) of the I.T.A., under the rules of interpretation paragraph 181.2(3)(b) of the I.T.A. has primacy over all the other paragraphs of subsection 181.2(3), and more particularly over paragraph 181.2(3)(c) of the I.T.A.;

-the Amounts are in the nature of income and are treated as such for the purposes of Part I of the I.T.A.; the Amounts do not constitute advances for the purposes of Part 1.3 of the I.T.A.

Minister’s Position

In response to the position put forward by OA, counsel for the Minister argued that:

- although treated as a reserve under Part I of the Act, the amount of $244,492,173 does not represent a reserve for the purposes of paragraph 181.2(3)(b), which contemplates only reserves or provisions in the accounting sense;

- this amount of $244,492,173 received as a payment on account constitutes neither a reserve nor a provision in the accounting sense;

- this amount instead represents advances within the meaning of paragraph 181.2(3)(c) of the Act.

Analysis

Put succinctly, the question at issue is as follows: must the payments on account balance appearing in OA’s accounting records and balance sheet to December 31, 1989, be included in computing capital for the purposes of determining the tax on large corporations? To answer this question, we must first consider the relevant statutory provisions. The taxing provision appears in subsection 181.1(1) of the Act, which provides:

181.1 (1) Every corporation shall pay a tax under this Part for each taxation year equal to 0.175% of the amount, if any, by which

(a) its taxable capital employed in Canada for the year

exceeds

(b) its capital deduction for the year.

Section 181.2 defines “taxable capital employed in Canada” for the purposes of Part I.3 and reads as follows:

(1) The taxable capital employed in Canada of a corporation for a taxation year (other than a financial institution or a corporation that was throughout the year not resident in Canada) is the prescribed proportion of the corporation’s taxable capital for the year.

(2) The taxable capital of a corporation (other than a financial institution) for a taxation year is the amount, if any, by which its capital for the year exceeds its investment allowance for the year.

(3) The capital of a corporation (other than a financial institution) for a taxation year is the amount, if any, by which the aggregate of

(a) the amount of its capital stock (or, in the case of a corporation incorporated without share capital, the amount of its members’ contributions), retained earnings, contributed surplus and any other surpluses at the end of the year,

(b) the amount of its reserves for the year, except to the extent that they were deducted in computing its income for the year under Part I,

(c) the amount of all loans and advances to the corporation at the end of the year,

(d) the amount of all indebtedness of the corporation at the end of the year represented by bonds, debentures, notes, mortgages, hypothecs or similar obligations,

(e) the amount of any dividends declared but not paid by the corporation before the end of the year,

(f) the amount of all other indebtedness (other than any indebtedness in respect of a lease) of the corporation at the end of the year that has been outstanding for more than 365 days before the end of the year, and

(g) where it was a member of a partnership at the end of the year, that proportion of the aggregate of amounts (other than amounts owing to the member or to corporations that are other members of the partnership) that would be determined under paragraphs (b) to (f) and this paragraph in respect of the partnership at the end of its last fiscal period ending at or before the end of the year if the references in paragraphs (5) to (f) to “corporation” were read as references to “partnership” that the member’s share of the partnership’s income or loss for that period is of the partnership’s income or loss for that period,

exceeds the aggregate of

(h) the amount of its deferred tax debit balance at the end of the year, and

(i) the amount of any deficit deducted in computing its shareholders’ eq- uity at the end of the year

[My emphasis.]

Subsection 181(3) states the general rules governing the calculation of a company’s capital:

(3) For the purposes of determining the carrying value of a corporation’s assets or any other amount under this Part in respect of a corporation's capital, investment allowance, taxable capital or taxable capital employed in Canada for a taxation year or in respect of a partnership in which a corporation has an interest,

(a) the equity and consolidation methods of accounting shall not be used; and

(b) subject to paragraph (a) and except as otherwise provided in this Part, the amounts reflected in the balance sheet

(i) presented to the shareholders of the corporation (in the case of a corporation that is neither an insurance corporation to which subparagraph (ii) applies nor a bank) or the members of the partnership, as the case may be, or, where such balance sheet was not prepared in accordance with generally accepted accounting principles or no such balance sheet was prepared, the amounts that would be reflected if such a balance sheet had been prepared in accordance with generally accepted accounting principles, or

[My emphasis.]

Lastly, subsection 181(1) defines certain terms applicable to Part 1.3, including “reserves”:

« réserves » Montant à la fin d’une année d’imposition constitué de l’ensemble des réserves et provisions d’une corporation, y compris les réserves pour impôts reportés. En sont exclus F amortissement cumulé et les provisions pour épuisement.

“reserves”, in respect of a corporation for a taxation year, means the amount at the end of the year of all of the corporation’s reserves, provisions and allowances (other than allowances in respect of depreciation or depletion) and, for greater certainty, includes any provision in respect of deferred taxes.

[My emphasis.]

The first point for determination is whether the payments on account balance represents a reserve for the purposes of Part 1.3 of the Act. Paragraph 181.2(3)(b) includes in computing the capital of a corporation the “amount of its reserves for the year, except to the extent that they were deducted in computing its income for the year under Part P\ Counsel for OA argues that the payments on account balance constitutes a reserve deducted from OA’s income under paragraph 20(1)(m) of the Act and that it does not have to be included in computing OA’s capital because of the exception described in that paragraph.

Before deciding whether the exception applies, however, it must be determined whether the balance constituted a reserve contemplated by paragraph 181.2(3)(b) of the Act. If that paragraph does not apply to the payments on account balance, the exclusion need not be applied. In other words, the is no need to exclude an amount that would not have to be included.

It would be useful at this point to be reminded of the principle of interpretation adopted by Estey J. in Stubart Investments Ltd. v. R., [1984] 1 S.C.R. 536, 578, 84 D.T.C. 6305, [1984] C.T.C. 294 (S.C.C.):

Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

Part 1.3 of the Act levies a tax on large corporations computed on the basis of their “taxable capital”, one of the significant components of which is “capital”. Subsection 181.2(3) of the Act describes the component parts of capital. All the relevant information for computing capital is generally found in a corporation’s balance sheet. It is therefore not surprising to note that Parliament provides in subparagraph 18 1(3)(b)(i) of the Act that the amounts to be used to determine the carrying value of each of the components of a corporation’s capital are those reflected in the “balance sheet presented to the shareholders of the corporation ... in accordance with generally accepted accounting principles”. It therefore goes without saying that the terminology used in the Act to identify the component parts of capital is that used by accountants in preparing a balance sheet. I therefore find it entirely appropriate to use accounting dictionaries to define the scope of the components listed in subsection 181.2(3) of the Act for which the Act provides no definition.

As to the scope of the term “reserves”, it should be noted that the Act provides a definition of this term in section 181. However, that definition contains the very word that is to be defined, “reserves” being stated to mean “the amount ... of all of the corporation’s reserves ”. This definition specifically states however that the word “reserves”, as used in Part 1.3, includes “provisions” and “any provision in respect of deferred taxes”, but not allowances for depreciation or depletion.

The definition does not specify what a reserve is for the purposes of Part 1.3. We must therefore look to the ordinary meaning of this term as it is used in accounting. The Canadian Institute of Chartered Accountants, as well as the Ordre des experts comptables de France and the Institut des Réviseurs d’Entreprises de Belgique have collaborated in preparing the Dictionnaire de la comptabilité et de la gestion financière^[4] (Dictionnaire de la comptabilité), which gives, at page 631, three meanings for the English term “reserve”, two[5] of which are relevant here:

[TRANSLATION]

Reserve 1.

Réserve; Affectation

General accounting. (CAN. and U.S.) Amount appropriated for a general or specific purpose out of retained earnings or other surplus and which, unlike a provision, is not intended to acknowledge an actual obligation or potential liability or the depreciation of an asset at the balance sheet date. Note - There are two types of reserves: (1) legal, statutory or contractual reserves, such as a share redemption reserve and the sinking fund reserve for bond redemption, and (2) optional reserves set up at management’s discretion, such as a reserve for potential depreciation of inventory, the reserve for contingencies and the reserve for expansion. Reserves have practically disappeared from the balance sheets of North American commercial and industrial enterprises, which now prefer to use supplementary notes to report on retained earnings appropriations and on any restrictions that may be placed on the business as to the distribution of its resources.

>See also appropriated retained earnings; appropriation account 1.; legal reserve; reserve for contingencies 1.: sinking fund reserve.

Reserve 3.

Reserve; Provision

Taxation. Term to which tax legislation attributes various specific meanings.

[My emphasis.]

The first meaning of the word “reserve” corresponds to that appearing in chapter 3260 of the CICA Handbook, which provides:

.01 The use of the term “reserve” should be limited to an amount which, though not required to meet a liability or contingency known or admitted or a decline in value which has already occurred as at the balance sheet date, has been appropriated from retained earnings or other surplus...

.02 Reserves should be created or increased only by appropriations of retained earnings or other surplus. They should not be set up or increased by charges made in arriving at net income for the period.

It is also necessary to determine the scope of the word “provision”, which the Act does not define. The Dictionnaire de la comptabilité gives the following three meanings for this English term at page 590:

[TRANSLATION]

Provision 1.

Charge Estimative; Charge Calculée; Dotation aux Provisions

>See estimated expense 1.

Provision 2.

Provision (Pour Dépréciation)

General accounting; financial information. Amount deducted, in the balance sheet, from the value assigned to an asset, designating the portion of that value that has been expensed during the current or previous years; e.g. the allowance for doubtful accounts and provision for inventory depreciation. Note - In Belgium, the purpose of a provision cannot be to alter the value of an asset.

>Syn. allowance 7. See also allocation (to a provision); allowance 3.

Provision 3. (G.B.)

Provision; Dette Provisionnée; Charge A Payer

>See estimated liability.

[My emphasis.]

The definition of “estimated expense” is provided at page 280:

[TRANSLATION]

Estimated Expense 1.

Charge Estimative; Charge Calculée; Dotation Aux Provisions

General accounting. Charge or expense relating to an estimated deemed non- irreversible diminution in value of an asset (for example, the depreciation of investment) or to an estimated potential liability (for example, warranty costs).

>Syn. provision 1. See also warranty expense.

Estimated Expense 2.

Dépense Estimative

Public administration. Amount appearing in the budget and relating to the current fiscal year, whether or not there has been a disbursement in respect of the amount in question.

As the term “allowance” in the English definition of the word “reserves” in subsection 181(1) of the Act has no equivalent in the French version of that subsection, it is helpful, as regards that French version, to cite the definition provided at page 32 of the Dictionnaire de la comptabilité:

Allowance 3.

Réduction de Valeur; Dépréciation; Amoindrissement de Valeur; Moins-

Value; Décote

General accounting Reduction of the book value of an asset for the purpose of determining its approximate realizable value.

> Syn. writedown. See also amortization 1.; depreciation 2.; discount n. 6.; loss in value; provision 2.; valuation allowance; write down 1.

[My emphasis.]

I note that the Minister’s expert, Mr. Labelle, adopted in paragraphs 35 and 36 of his report the second meaning of the word “provision” provided by the Dictionnaire de la comptabilité:

[TRANSLATION]

35. According to the Dictionnaire de la comptabilité et de la gestion financière, a provision is an amount deducted, in the balance sheet, from the value assigned to an asset, designating the portion of that value that has been expensed during the current or previous years. For example, there is the allowance for doubtful accounts and the valuation allowance. Unlike an amount received in advance from a customer which constitutes an actual debt until the goods have been delivered or the service rendered, it constitutes a potential liability valued at the balance sheet date, which liability is rendered probable by events that have occurred or are taking place. This is the case, for example, with the estimated liability under warranties.

36. In accounting terms, a provision thus also arises from an accounting entry pursuant to an administrative decision affecting, for example, potential bad debts. While the nature of the potential liability is clearly specified, its amount and date of realization are uncertain. It cannot arise from an amount received in advance from a customer.

[My emphasis.]

Of the definitions given in the Dictionnaire de la comptabilité, I adopt the first meaning of the word “reserve”, that is an appropriation of retained earnings or of other surplus. As to the term “provision”, I adopt the second meaning provided by the Dictionnaire de la comptabilité, namely an amount deducted from the value assigned to an asset and expensed during the current or previous years. In both instances, the item in question is one which would appear in a balance sheet.

In paragraphs 26 and 27 of his written submission, counsel for OA argues that the “accounting meaning of the term ‘reserve’ cannot be used”. He claims that “accounting principles should at most serve only to deter

mine the amounts in issue and not the nature of the components used in computing capital”. In his view, the expression “reserves” in paragraph 181.2(3)(b) of the Act refers to tax reserves. He states his argument as follows:

[TRANSLATION]

29. The personal pronoun “they” in paragraph 181.2(3)(b) of the I.T.A., used for the purposes of excluding tax reserves in computing capital, confirms that the word “reserves” at the beginning of this paragraph necessarily includes tax reserves; the personal pronoun “they”, referring to tax reserves, clearly relates to the word “reserves” at the beginning of paragraph 181.2(3)(b) of the I.T.A.

30. To assert that the reserves contemplated by Part 1.3 of the I.T.A. are first of all “accounting” reserves and that only those reserves contemplated in Part I of the I.T.A. are excluded in computing capital would have the effect of adding words to the text of the statute.

I do not share this view of counsel for OA. Rather, I am of the opinion that the accounting sense of the terms “reserves” and “provisions” in subsection 181(1) of the Act should be adopted, and there are a number of reasons for this. First of all, as stated above, subparagraph 181(3)(b)(i) of the Act states that the carrying value of the various assets that constitute capital is that appearing in the balance sheet presented to the shareholders of the corporation. Unlike counsel for OA, I believe that accounting principles must be used to determine not only the value, but also the nature of the elements set out in subsection 181.2(3) of the Act. The value appearing in a balance sheet has meaning only when it is linked to a specific heading.[6]

Furthermore, why would Parliament have described in subsection 183.2(3) of the Act an item that does not appear in a balance sheet? It makes no sense. For example, under paragraph 20(1)(m) of the Act, a taxpayer may deduct from his income amounts received in a year in respect of goods not delivered or services not rendered before the end of the year and which he has included in his income under paragraph 12( 1 (a) of the Act. This provision thus has meaning only for the calculation of income for tax purposes, not for the purposes of drawing up an “accounting” balance sheet. The balance sheet contains no “reserve” or “provision” contemplated by paragraph 20(1 )(m) of the Act.

The balance sheet does however contain a corporation’s payments on account balance which is generally shown therein as a debt or, as is the case here, as a writedown of the value of work in progress. In either case, the amount involved would not have been expensed during the current or previous years. Indeed, the payments on account balance need not be expensed since, according to the GAAP, it is generally not necessary to include such amounts in revenue as long as the goods have not been delivered or the service rendered. Consequently, if the interpretation of counsel for OA were to adopted, we would have the absurd result of looking for a provision for “tax” that does not appear in the balance sheet.

On the contrary, if we adopt the accounting notion of provision, we obtain a reasonable result that is compatible with the objectives of the Act. To illustrate this result, we shall take the example of a taxpayer’s allowance for doubtful accounts. First of all, this is an item that appears in his balance sheet. This item is consistent with the accounting meaning of provision cited above, that is to say, it is an amount deducted from the value assigned to an asset and expensed. For tax purposes, this taxpayer may deduct a reserve for doubtful debts under paragraph 20(1 )(Z) of the Act, even though the amount may be different from that expensed for accounting purposes. This is where the exception in paragraph 181.2(3)(b) of the Act may apply. The amount of the provision for “accounting” purposes must be added to the corporation’s capital in accordance with paragraph 181.2(3)(b) of the Act, except to the extent that it has been deducted for tax purposes. Hence, the portion of the amount of the provision that has not been deducted in computing revenue for tax purposes will increase the corporation’s capital. Thus interpreted, paragraph 181.2(3)(b) yields a result that is consistent with both the spirit and the letter of the Act.

There is another reason for adopting the accounting meaning of the terms “reserves” and “provisions”. “Allowances in respect of depreciation or depletion” are excluded from the definition of “reserves” in subsection 181(1) of the Act. If the terms “reserves” and “provisions” were supposed to have a tax rather than an accounting sense, this exclusion provided for in subsection 181(1) would not have been necessary.[7] . The allowance in respect of depletion and the allowance in respect of depreciation (which is also a provision) would have been automatically excluded by paragraph 181.2(3)(b) since they are deducted under Part I. In other words, as counsel for the Minister stated in her written argument, it was the “accounting” provision for depreciation and depletion that Parliament wanted to exclude. This is logical since a provision for accounting purposes is often different from a provision for tax purposes. Counsel added at page 14 of her submission:

[TRANSLATION]

Furthermore, to be fair, it was important that Parliament exclude accounting depreciation and depletion from the computation of capital, and not the amounts deducted in respect of those items under Part I of the Act. If Parliament had not excluded accounting depreciation and depletion from the definition of reserve, only those corporations that took deductions for depreciation and depletion for tax purposes would have been able to reduce the amount to be included in computing capital, given the deduction allowed under paragraph 181.2(3)(b). Such a situation would have been unfair since companies in financial difficulty generally cannot take deductions for depreciation and depletion in computing their income and these companies would have had to pay more Part 1.3 tax than companies that were not in difficulty.

In conclusion, the meaning to be given to the words “reserves” and “provisions” in subsection 181(1) of the Act must be the accounting, not the tax meaning. The amount of the payments on account that OA deducted in computing the value of work in progress clearly does not represent a “reserve” in the accounting sense of that term. I concur in the following comments which Mr. Labelle makes, in paragraph 34 of his report, respecting the advances received by OA:

[TRANSLATION]

If the reserve arises from a decision to appropriate an existing surplus, it cannot come from an amount received in advance from a client. It is received for a specific purpose: the performance of a contract. It has not yet been earned. It therefore does not affect profits, much less retained earnings. The customer, WO in this instance, may claim repayment of it from OA if the contract is not executed.

Nor does the payments on account balance deducted by OA constitute a provision. Here, in OA’s balance sheet, the payments on account balance reduced the amount appearing under the work in progress item and, as already stated above, that amount was not expensed during the current or previous years. Furthermore, as the two public accountants admitted, this balance could simply have been shown as a liability.

Since the payments on account from clients balance constitutes neither an appropriation of retained earnings nor an amount that has been deducted from the value of an asset and been expensed, it does not represent a “reserve” as defined in subsection 181(1) and contemplated in paragraph 181.2(3)(b). This paragraph therefore does not apply to the payments on account balance. Since the payments on account from clients balance adds nothing in the way of a reserve to capital, it need not be considered to what extent that amount could have been deducted in computing OA’s income during the year under Part I and excluded from capital. In light of this conclusion, any further comment on the second argument put forward by counsel for OA is unnecessary.

It remains for the Court to consider the third argument by counsel for OA, namely that the payments on account from clients are in the nature of income, are treated as such under Part I and do not constitute advances for the purposes of Part 1.3.

In my view, the principles applied in determining the scope of the terms “reserves” and “provisions” also apply in determining that of the terms “loans” and “advances” in paragraph 181.2(3)(c) of the Act. The following definition of the term “loan” is given in the Dictionnaire de la comptabilité, at pages 438 and 439:

Loan 1.

Prêt

Law; finance. Onerous or gratuitous contract under which one person (the lender) provides a thing (generally money) to another person (the borrower) on condition that the latter return the thing (or the amount received) within a set time together with interest, where applicable, calculated at the agreed-upon rate.

This concept moreover coincides with the concept of loan contained in the Civil Code of Lower Canada and in the new Civil Code of Quebec. The following three meanings are given for the term “advance” at page 25 of the same dictionary:

Advance 1.

Avance (Sur Note de Frais)

Management. Amount paid to a person to enable him to make expenditures for which he will have to account at a later date.

>Syn. expense advance. See also out-of-pocket costs.

Advance 2.

Avance; Acompte; Arrhes

Commerce. Amount to be applied against the price of a contract, services or goods, paid before the contract is performed, the services rendered or the goods delivered. Note - The term advance is more appropriate in cases where the amount in question is paid before any order is filled. However, the term payment on account is used where the amount is paid by reason of the partial filling of the order. In the case of deposits, the amount paid is not returned if there is a breach of contract, whereas it may be in the case of an advance.

>See also deposit 3; downpayment; earnest money.

Advance 3.

Prêt; Avance

Finance. Amount lent by one person to another or by one entity to another; e.g., the amount advanced by a parent company to its subsidiary.

[My emphasis.]

As may be seen and as OA’s accountant admitted, the word “advance” may mean “advance in the sense of a loan” or “advance in the sense of a payment on account”.[8] Since Parliament took pains to speak of loans and advances in paragraph 181.2(3)(c) of the Act, it must be concluded that the intent was to include both loans and instalments. If Parliament had wished to limit the application of paragraph 181.2(3)(c) of the Act solely to loans, it would have used only the term “loan”. It would have been redundant to use a synonym for the word “loan”. Rather, there is reason to believe that Parliament wished to broaden the scope of the word “loan” so as to include payments on account with respect to a contract.

In Transcanada Pipelines Ltd. v. Ontario (Minister of Revenue), (1992), [1993] 1 C.T.C. 277 (Ont. C.A.), the court relied on the notion of “advance in the sense of a payment on account” in defining the scope of the word “advance” used in the Corporations Tax Act, R.S.O. 1980, c. 97. That act levies a tax on capital similar to the large corporations tax. The question at issue was whether payments described as “take or pay payments” were “investments ... in ... [loand and] advances to other corporations”. The Court of Appeal held that those payments came within the definition of “‘advance’ as a ‘payment [made] beforehand or in anticipation’ and a ‘payment made before ... the completion of an obligation for which it is to be paid’: Dictionary of Business and Finance, (1957) p. 9”.[9]

In my view, the payments on account from clients received by OA constitute advances within the meaning of paragraph 181.2(3)(c) of the Act. They are amounts paid before the contract was executed, the services rendered or the goods delivered. The fact that the payments on account from clients balance was deducted from income for tax purposes because the Act requires that this balance be included in computing income for tax purposes does not change the nature of the payments on account. They represent “advances” which appear in a corporation’s balance sheet.

It should be noted that the balance sheet prepared by OA treats the payments on account from clients as “advances” (see in particular note 4 to the financial statements). Furthermore, even though OA’s accountant indicated in his report that it would have been more appropriate to use the expression “payments on accounts from customers”, this expression is essentially a synonym for “advance”. This expert moreover stated himself that the payments on account received by OA had to be shown in the balance sheet as “advances”. He wrote as follows at page 3 of his report:

[TRANSLATION]

When amounts are paid before contracts are performed, they are reported in the balance sheet as a liability. In the course of performance of the contract, these amounts are used to pay the costs incurred for the work. In accounting terms, however, even though the amounts have been used, they are reported in the financial statements as advances until they are brought into revenue.

[My emphasis.]

As both experts confirmed that OA’s financial statements were prepared in accordance with generally accepted accounting principles and since the balance sheet shows an advance balance of $244,492,173 at the end of the 1989 fiscal year, that amount must be included in computing OA’s capital for 1989.

For these reasons, OA’s appeal is dismissed, with costs.

Appeal dismissed.