Edgar Lantagne v. Minister of National Revenue, [1978] CTC 2233, 78 DTC 1212

Guy Tremblay [TRANSLATION]:—This case was heard at Quebec City on April 4, 1977.

1. Summary

The Board must decide whether the increase of $10,497.47, which was assessed by the respondent in accordance with the net worth method in respect of the appellant’s income for the 1971, 1972 and 1973 taxation years, is justified.

2. Burden of Proof

The appellant has the burden of showing that the respondent’s assessments are unjustified. This burden of proof derives not from one particular section of the Income Tax Act, but from a number of judicial decisions, one of which is the judgment delivered by the Supreme Court of Canada in R IV S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. Facts

3.1. The appellant, who has been a farmer since 1953, lives at Trottier Mills, in Quebec.

3.2. Since 1959 he has been a member of the Cooperative agricole de Granby, to which he sells the milk from his 16 cows. During the Summer he works for the roads department.

3.3. When he joined the co-operative, he purchased his share in the capital stock for $300. He paid $30 cash, and the balance was deducted by the co-operative from the money paid for milk.

3.4. It is sometimes decided, pursuant to a decision taken at a general meeting of the members of the co-operative, to distribute additional remittances to the members, depending on the volume of milk sold.

3.5. Each member is informed of the decision of the general meeting and the amount of the remittance by a counterfoil attached to the cheque in payment for the milk. The appellant stated that the remittance is not actually paid until 3 years later. The appellant has never received any certificates for Class A or B preferred shares.

3.6. Furthermore, the appellant and Mr Luc Jacques, who was also counsel for the appellant, said that meanwhile the additional remit- tance was converted into Class A and Class B non-interest-bearing preferred capital. Moreover, the beneficiary is never sure of actually receiving his capital. Everything depends,, in fact, on the financial position of the co-operative.

3./. In support of the above Mr Jacques produced, as Exhibit A-4, a letter dated April 5, 1976 and an appendix entitled “Role and source of the capital stock: ordinary and preferred A and B”.

The Board considers that the documents in question should be cited at length.

Mr Luc Jacques, Director

Taxation and Accounting Service

LA FEDERATION DE L’UPA DE NICOLET

PO Box 99

Nicolet, Quebec

JOG 1E0

Dear Sir:

Mr Jean-Louis Hains has brought your letter of March 16 last to my attention.

In answer to your first question, please find enclosed an explanation of the role and source of the capital stock held by members. This will allow you to appreciate how thousands of members finance their own business and are thus the real owners of it.

With respect to Class “A” preferred capital, the Co-operative is authorized to issue non-interest bearing shares without a fixed maturity date and with a par value of ten dollars ($10) each for an undetermined amount.

Class “B” preferred capital is non-interest bearing but is redeemed at the maturity date stipulated in the resigning members’ reimbursement by-law, a summary of which is appended hereto.

Each time there is an issue of Class “A” and/or “B” preferred capital, the shares are credited to each recipient member by an entry on his capital stock card, a copy of which is sent to him each year.

Furthermore, each time preferred capital is declared, the member may read the amount credited to him on the counterfoil of the cheque received in payment for the milk, once the Board has taken its decision.

I trust that this information will be of use to you.

Yours truly,

(Signed) André H. Gauthier, Econ

secretary.

ROLE AND SOURCE OF CLASS “A” and “B”

ORDINARY AND PREFERRED CAPITAL STOCK

Work of members to help their Co-operative to become self-financing.

The very nature of a co-operative requires that all members participate in financing their business.

ORDINARY CAPITAL: For this reason, anyone wishing to become a member must first subscribe to and pay for a share of the Co-operative ordinary capital. As a rule, this capital, which is non-interest bearing and must remain in the business so long as the person concerned remains a member, is used as a basis for constituting amounts needed for capital expenditure: constructing buildings, buying equipment and so on.

However, it is clear that the Co-operative also requires operating capital for day-to-day activities: paying for milk, purchasing supplies and so on. This operating capital must come, therefore, from other sources.

CLASS “A” PREFERRED CAPITAL: For several years members have decided at their general meetings to leave the additional remittances allotted for milk as Class “A” preferred capital in order to form the basis of the operating capital.

These additional remittances represent the overall reward for the personal, voluntary efforts of members, animators, directors and their associates to lower operating costs. They therefore constitute supplementary income, or a co-operative annuity, earned by all members and those working with them, which is added to the initial price paid for the milk. As the initial price is considered to be in accordance with the current market price for the milk, it is easy to understand why these members decided to lend these additional remittances to their co-operative in the form of Class “A” preferred capital, since they would see this as an excellent way of easily fulfilling the obligation to provide the operating Capital indispensable to the effective operation of their Co-operative and to help make it self-financing. The by-law also stipulates that no interest is paid on the Class “A” preferred capital.

Class “A” preferred capital is redeemed—starting with the oldest subscriptions—as soon as the Co-operative’s operating capital is deemed adequate.

Thus, it can be said that for over ten years Class “A” preferred capital has been redeemed two and a half or three years after it was issued.

These two ways of constituting capital stock have enabled members to maintain their Co-operative in an excellent financial position to date. However, as a result of rapidly occurring changes in agriculture, the ordinary capital has remained almost stable, since the number of new members has been just slightly higher than that of resignations caused by sale of farms, discontinuing of milk production and so on.

However, capital expenditure requirements remain constant as a consequence of the increase each year in the milk production of members’ farms and the registration of new members. In 1975, for example, the average increase in milk production on members’ farms was 26,000 pounds, which gives a total figure for all members of 200 million pounds; hence the need to develop the processing capacities of plants accordingly.

In these circumstances, it was to be expected that an excessively large gap would soon develop between the ordinary capital or equity and capital expenditure requirements.

CLASS “B” PREFERRED CAPITAL: In order to remedy this situation, the Board studied the question thoroughly, consulted animators on two occasions and then decided to issue a new class of preferred capital: Class “B”, payable by the application of a maximum amount of five cents ($0.05) per hundred (100) pounds of milk for five years, and one cent ($0.01) thereafter, each time an additional remittance is declared for milk. The terms for redemption (reimbursement) of this Class “B” preferred capital are the same as those provided for ordinary capital, namely, upon selling the farm, discontinuing milk production, at sixty- five years of age, at a member’s death and so on. This capital therefore becomes in turn the equivalent of the ordinary capital or equity, and can be used as a basis for constituting capital assets proportionate to the marketing requirements of the milk delivered by the members.

3.8. Mr Luc Jacques works for the Fédération de I’UPA de Nicolet and has prepared the appellant’s tax returns since 1966. He maintains that during 1971, 1972 and 1973 the appellant’s income was computed in accordance with the cash method and not the fiscal year method. 3.9. The document produced as Exhibit 1-1, a balance sheet prepared by the respondent, shows that the appellant’s preferred capital in the years in question was constituted as follows:

Moreover, these figures are confirmed by Exhibit 1-2, which includes inter alia a photocopy of the appellant’s capital stock card issued by the Coopérative agricole de Granby.

3.10. In his assessment using the net worth method for the period between December 31, 1970 and December 31, 1973, the respondent established the appellant’s cost of living, which the latter is challenging. When the Board adjourned after beginning an inquiry, the parties agreed that the cost of living was as follows:

3.11. The appellant pointed out during the inquiry that the respondent refused to include the appellant’s herd of cattle in the balance sheet under the heading “inventory”. The witness for the respondent stated that since the appellant computed his income in accordance with the cash method he should not include this item, just as he should not include accounts receivable or accounts payable.

Moreover, the appellant contended that he had never included the cost of his cattle as a current expense in computing his income.

3.12. Although the non-inclusion of this item in the balance sheet has no effect on the income of the years in question, the parties contend that it will have an effect when the herd is sold. The resulting profit will then have to be considered income and not a capital gain.

3.13. The notices of reassessment for 1971, 1972 and 1973 were issued on July 7, 1975.

3.14. A notice of objection was filed on September 17, 1975; the Minister gave his answer upholding the assessments on August 31, 1976.

3.15. On September 21, 1976 the appellant made an appeal to the Board.

4. Point at Issue

Apart from the agreement about the cost of living, the principal point now remaining at issue is to decide whether the additional remittances are taxable in the year in which the additional remittance is reported and converted into preferred capital, or in the year in which the preferred capital is paid to the member.

The question of whether the herd should appear on the financial statements is in fact irrelevant to the case at bar; however, the Board will give its opinion in an obiter dictum.

5. Comments, Act, Judicial Decisions

Subsections 75(6) of the old Act and 135(7) of the new Act are particularly relevant to the case at bar. They are almost identical. Only subsection 135(7) is cited:

135. (7) Payment to customer to be included in income.—Where a payment pursuant to an allocation in proportion to patronage (other than an allocation in respect of consumer goods or services) has been received by a taxpayer, the amount of the payment shall be included in computing the recipient’s income for the taxation year in which the payment was received and, without restricting the generality of the foregoing, where a certificate of indebtedness or a share was issued to a person pursuant to an allocation in proportion to patronage, the amount of the payment by virtue of the issue thereof shall be included in computing the recipient’s income for the taxation year in which the certificate or share was received and not in computing his income for the year in which the indebtedness was subsequently discharged or the share was redeemed.

In order to clearly understand the words “payment”, “allocation in proportion to patronage” and “allocation in respect of consumer goods or services”, we must refer to paragraphs 135(4)(a), (b) and (g) of the new Act:

135. (4) . . .

(a) “allocation in proportion to patronage” for a taxation year means an amount credited by a taxpayer to a customer of that year on terms that the customer is entitled to or will receive payment thereof, computed at a rate in relation to the quantity, quality or value of the goods or products acquired, marketed, handled, dealt in or sold, or services rendered by the taxpayer, from, on behalf of or to the customer, whether as principal or as agent of the customer or otherwise, with appropriate differences in the rate for different classes, grades or qualities thereof, if

(i) the amount was credited

(A) within the year or within twelve months thereafter, and

(B) at the same rate in relation to quantity, quality, or value aforesaid as the rate at which amounts were similarly credited to all other customers of that year who were members or to all other customers of that year, as the case may be, with appropriate differences aforesaid for different classes, grades or qualities, and

(ii) the prospect that amounts would be so credited was held forth by the taxpayer to his customers of that year who were members or non-member customers of that year, as the case may be;

(b) “consumer goods or services” means goods or services the cost of which was not deductible by the taxpayer in computing the income from a business or property;

(g) “payment” includes

(i) the issue of a certificate of indebtedness or shares of the taxpayer or of a corporation of which the taxpayer is a subsidiary wholly-owned corporation if the taxpayer or that corporation has in the year or within 12 months thereafter disbursed an amount of money equal to the aggregate face value of all certificates or shares so issued in the course of redeeming or purchasing certificates of indebtedness or shares of the taxpayer or that corporation previously issued,

(ii) the application by the taxpayer of an amount to a member’s liability to the taxpayer (including, without restricting the generality of the foregoing, an amount applied in fulfilment of an obligation of the member to make a loan to the taxpayer and an amount applied on account of payment for shares issued to a member) pursuant to a by-law of the taxpayer, pursuant to statutory authority or at the request of the member, or

(iii) the amount of a payment or transfer by the taxpayer that, under subsection 56(2), is required to be included in computing the income of a member.

The first observation that the Board would make is that the legal provision in question is a taxing section, that is, a section which imposes an obligation on the taxpayer—the appellant. Any doubt that may exist in the interpretation of such a section must be resolved in the taxpayer’s favour.

Certain fundamental principles of interpretation should be recalled here:

(1) as a tax law is public law, it must be interpreted restrictively;

(2) a taxing section shall be interpreted restrictively, in that if it is ambiguous it shall be interpreted in the taxpayer’s favour, so that the latter may be taxed as little as possible or not at all.

Was payment made?

In accordance with the foregoing and Exhibit A-4, the Board concludes first that a payment was made to the appellant.

Counsel for the appellant pointed out that this could not be a payment since, in fact, no shares were issued, and the Act clearly states that there is payment if a share is issued. The only notice the appellant received is what he was able to read on one of his cheques in payment for milk, notifying him that an amount had been credited to him. The appellant said that he never received a share certificate.

First, what is meant by an issue of shares? Does this necessarily mean giving the shareholder a document certifying that he owns a certain number of shares in the body in question (be it a company, co-operative or some other body)? It clearly seems that this is the ordinary meaning. Could the appellant be suffering from a lapse of memory when he states that he never received such a certificate? Could a co-operative issue shares without having to provide a certificate to that effect? In any event, the Coopérative agricole de Granby Stated in its letter dated April 5, 1976:

Each time there is an issue of Class “A” and/or “B” preferred capital, the shares are credited to each recipient member by an entry on his capital stock card, a copy of which is sent to him each year.

In fact, the appellant’s capital stock card, which was filed as Exhibit I-2, clearly shows the amounts credited.

The Board believes that the preponderance of the evidence shows that there was an issue of shares, and therefore payment. Moreover, even if there was not an issue of shares, would what the appellant could have read on the counterfoil of the cheque received in payment for the milk not constitute an issue of a “certificate of indebtedness” within the meaning of the aforementioned legal provisions? We shall cite the last paragraph of the letter from the Coopérative agricole de Granby:

Furthermore, each time preferred capital is declared, the member may read the amount credited to him on the counterfoil of the cheque received in payment for the milk, once the Board has taken its decision.

In view of this description of the content and the appendix to the letter of April 5, 1976, the Board is strongly inclined to the view that the counterfoil in itself constitutes a certificate of indebtedness. It is regrettable that the appellant did not produce the counterfoils of the cheques received in payment for the milk, notifying him of the amounts credited. If this evidence had been submitted, the Board might have ruled to the contrary. However, the lack of evidence is not to the appellant’s advantage since, as explained above, he had the burden of proof. Although an ambiguous taxing section shall be interpreted in the taxpayer’s favour, ambiguous evidence or a lack of evidence weighs against the party having the burden of proof.

Thus, even if there was no issue of shares, the Board considers that the content of the counterfoil of the cheque received in payment should be considered a certificate of indebtedness issued by the co-operative, and therefore payment to the appellant within the meaning of the aforementioned legal provisions.

“Cash” method

The appellant contends that as he is a farmer and keeps his accounts by the 4‘cash” method, he does not have to include his accounts receivable in his income until such time as the said payment has been received. Subsections 28(1) of ‘the new Act and 85F(1) of the old Act do in fact authorize farmers to compute their income in this way. The question is whether such authorization, which favours a person operating a farming business, rules out the inclusion in income of accounts receivable—if there are any—provided by subsections 75(6) of the old Act and 135(7) of the new Act.

The Board considers that the only way of solving this problem is to apply the interpretation principle which states that the particular rule takes precedence over the general. However, which is the general rule and which is the particular rule in the case at bar?

After studying the general structure of both the old Act and the new Act, the Board finds that subsections 85F(1) of the old Act and 28(1) of the new Act concerning the cash method are both part of so-called special divisions. Thus, subsection 85F(1) of the old Act is entitled “Special method of computing income” and is part of Division H, the title of which is “Exceptional Cases and Special Rules”. Subsection 28(1) of the new Act falls within the general category of Subdivision B entitled “Income or loss from a business or property”, but belongs more specifically to sections 26 to 37 entitled ‘‘Special Cases”. It seems at first sight, therefore, that the rule allowing the cash method is the particular rule and that the other, concerning the inclusion of patronage dividends—although not actually received—in one’s income, should give way to it.

However, the Board finds that subsection 75(6) of the old Act, which rules on patronage dividends, is also part of Division H entitled “Exceptional Cases and Special Rules”. It also notes that subsection 135(7) of the new Act is included in Division F of Part I and is entitled “Special Rules Applicable in Certain Circumstances”.

The Board must now ask which rule is the more special. Moreover, titles should not be considered part of the Act.

The Board considers that the description of the cash method provided in the aforementioned sections is, in practice, the description of a principle which is already generally recognized in accounting. As explained above, one of the results of this principle is that accounts receivable are included in income only when paid, However, in making his description the legislator wished to give a specific meaning to the term “amounts received”. He said in fact that “amounts received in the year, or . . . deemed by this Act to have been received in the year, in the course of carrying on the business” (paragraph 28(1)(a) new Act) are part of the taxpayer’s income. (emphasis added by the Board).

Indeed, when the legislator specified in sections 75 of the old Act and 135 of the new Act that the word “‘payment’ includes . . . the issue of a certificate of indebtedness or shares”, he thus presumes receipt of the patronage dividend even if it is not received. Subsection 135(7) of the new Act is, at the end, even clearer:

135. (7) . . . and, without restricting the generality of the foregoing, where a certificate of indebtedness or a share was issued to a person pursuant to an allocation in proportion to patronage, the amount of the payment by virtue of the issue thereof shall be included in computing the recipient’s income for the taxation year in which the certificate or share was received and not in computing his income for the year in which the indebtedness was subsequently discharged or the share was redeemed.

The Board must therefore conclude that the amounts received, by the appellant should be included in the appellant’s income in the year the shares were issued.

However, the Board believes that if it was not shares but clearly a certificate of indebtedness which was issued, it should still be included in the taxpayer’s income but the taxpayer should be entitled to reserves for doubtful debts and bad debts when applicable.

Herds in the inventories

This item is not relevant in the case at bar because the appellant’s herds were not sold during the years with which the appeal is concerned, namely 1971, 1972 and 1973. As an obiter dictum, however, in view of the evidence submitted concerning the herds (particularly the fact that the cost of purchasing the cattle was not treated as a current expense), the Board concludes that the subsequent profit on the sale of the cattle should be considered a capital gain.

6. Conclusion

The appeal is allowed in part and the whole is referred back to the respondent for reconsideration and reassessment.

Appeal allowed in part.