Canadian Glassine Co LTD v. Minister of National Revenue, [1974] CTC 63, 74 DTC 6089

Heald, J:—This is an appeal from the income tax assessments of the appellant by the respondent for the taxation years ending in February of 1966, 1967, 1968 and 1969.

The sole issue in the appeal is a determination of the true nature of an expenditure by the appellant in the sum of $268,523.48 in 1953, which expenditure the appellant, in filing its income tax returns, amortized over a period of 25 years, thus deducting 1/25 of said total sum from income in respect of the above mentioned taxation years. The respondent denies that said deductions are proper and accordingly disallowed them in the assessment of the appellant’s tax returns for the years under review.

At the commencement of the trial, counsel for both parties filed an agreement as to facts to which is attached a number cf exhibits. The agreement of facts reads as follows:

With respect to the appeal from the assessments of tax fcr the Appellant’s 1966, 1967, 1968 and 1969 taxation years, the Appellant and the Respondent, for the purposes of this appeal only, admit the following facts:

1. The Appellant was incorporated in 1952 under the Canada Corporations Act.

2. By Agreement dated August 15, 1951 (Exhibit no 1), between Deerfield Glassine Company Inc and Anglo Canadian Pulp and Paper Mills Ltd, Deerfield Glassine Company Inc undertook, inter alia, to procure the incorporation of the Appellant, and Anglo Canadian Pulp and Paper Mills Ltd undertook to:

a) Supply to the Appellant 10% of the money from time te time required by the Appellant to complete the construction of its plant aid the acquisition of all the machinery and equipment needed for the manufacture of glassine grease-proof papers and other lightweight specialty parers;

b) Sell to the Appellant a certain parcel of land in the Ci:y of Quebec;

c) Enter into an agreement (hereinafter called the “Construction Agreement”) with the Appellant, whereby Anglo Canadian Pulp and Paper: Mills Ltd would agree to complete, at its own expense, the construction of two underground pipelines from the plant of the Appellant, one for the purpose of carrying the slush pulp to be deliverable from time to time by Anglo Canadian Pulp and Paper Mills Ltd to the Appellant, the other for the purpose of carrying to the plant of the Appellant the stean to be deliverable from time to time by Anglo Canadian Pulp and Pap:r Mills Ltd to the Appellant;

d) Enter into an agreement. (hereinafter called the “Pulp Contract”) with the Appellant for the supply of slush pulp for a period of 20 years under certain terms and conditions more fully described in the said agreement;

e) Enter into an agreement (hereinafter called the “Steam Contract”) with the Appellant for the supply of steam for an initial period of 5 years and subsequently for successive renewal periods of one year each.

4. On April 25, 1952 (Exhibit no 2), the Appellant entered into an agreement (Construction Agreement) with Anglo Canadian Pulp and Paper Mills Ltd under, inter alia, the following terms:

a) Anglo Canadian Pulp and Paper Mills Ltd was to complete, at its own expense, the construction of two underground pipelines from the plant of Anglo Canadian Pulp and Paper Mills Ltd to the plant of the Appellant, one for the purpose of carrying the slush pulp to be deliverable by Anglo Canadian Pulp and Paper Mills Ltd to the plant of the Appellant and the other one for the purpose of carrying the steam to be deliverable by Anglo Canadian Pulp and Paper Mills Ltd to the plant of the Appellant;

b) Anglo Canadian Pulp and Paper Mills Ltd was to have, free of cost, all necessary rights of access to the property of the Appellant for the construction, repair and maintenance of the two pipelines referred to in the preceding paragraph;

c) Title to the said pipelines was to remain vested in Anglo Canadian Pulp and Paper Mills Ltd;

d) The Appellant was not to reimburse Anglo Canadian Pulp and Paper Mills Ltd for the cost of the pulp pipeline and no charge for depreciation of the steam and pulp pipelines was to be charged to the Appellant;

5. On the same date, (Exhibit no 3) Anglo Canadian Pulp and Paper Mills Ltd agreed to sell and deliver to the Appellant sulphite pulp and slush to be required by it for a period of 20 years subject to automatic extension for successive periods of 5 years each. (Pulp Contract).

6. On April 25, 1952, (Exhibit no 4) Anglo Canadian Pulp and Paper Mills Ltd agreed to sell and deliver to the Appellant such steam to be required by it at a determinable price for a period of 5 years subject to automatic extension for successive periods of one year. (Steam Contract).

7. On June 22, 1952, (Exhibit no 5) Anglo Canadian Pulp and Paper Mills Ltd s ascribed (sic):

a) 100,000 fully paid and non-assessable Class B shares without nominal or par value of the capital stock of the Appellant at an aggregate price of $171,518.22: and,

b) 5% Notes of the Appellant in the aggregate principal amount of $281,250.00; the whole for and in consideration of the sum of $452,768.22 made up as follows: the sum of $150,922.74 representing each of the advances already made by Anglo Canadian Pulp and Paper Mills Ltd to the Appellant and the sum of $301,845.48, representing the value of

i) a land in the City of Quebec transferred by Anglo Canadian Pulp and Paper Mills Ltd to the Appellant;

ii) the agreement made by Anglo Canadian Pulp and Paper Mills Ltd to complete, at its own expense, the construction of a ‘‘steam pipeline” and a “pulp pipeline” subject to the condition that the cost of the steam pipeline be reimbursed to Anglo Canadian Pulp and Paper Mills Ltd by the Appellant, and

iii) the execution by Anglo Canadian Pulp and Paper Mills Ltd of the “Pulp Contract” and the “Steam Contract”.

8. On June 25, 1953, Class B shares of the Appellant and 5% notes of the Appellant, representing an aggregate value of $301,845.48, were issued to Anglo Canadian Pulp and Paper Mills Ltd.

9. The land referred to in sub-paragraph (i) was valued by the Appellant at $33,221.00, and the cost of the steam pipeline in the amount of $71,882.00 was reimbursed by the Appellant to Anglo Canadian Pulp and Paper Mills Ltd.

In addition, Mr John W Monaghan, the comptroller of the appellant gave evidence at the trial. He testified that construction on the appellant’s plant at Quebec City started in 1952 and was completed, with all machinery and equipment installed, in 1953 when the plant became operational. At said plant the appellant became engaged in the manufacture and sale of glassine paper, a glossy, translucent paper resistant to air, water or oil.

Mr Monaghan confirmed that the various contracts referred to in paragraph 2 of the agreement of facts were executed and were adhered to by the parties. He said that the pulp and steam contracts are still in full force and effect.

The pulp mill of Anglo-Canadian Pulp and Paper Mills Ltd (hereafter Anglo-Canadian) is situated about /4 mile to the south of appellant’s plant in Quebec City. The tunnel housing the steam pipeline and the pulp pipeline begins on Anglo-Canadian’s land, goes underneath a public boulevard, then enters appellant’s plant. The two lines run parallel with each other in the tunnel. The pipelines were completed by approximately the end of 1952. The pulp pipeline is connected to a washer in appellant’s plant. The slush pulp is pumped over to the appellant’s plant through the pulp pipeline at a consistency of about 2% of fibre to 98% of water where it is washed and the pulp fibre removed. The pulp pipeline is used every day that appellant’s plant is in operation. Situated near the beater room in appellant’s plant is a direct phone line to Anglo-Canadian by which the appellant informs Anglo- Canadian when to commence and when to cease pumping the slush pulp through the pipeline. These pumping operations will occur nine to ten times in a normal operating day. The pipeline is full of slush pulp at all times and is used only by the appellant. The amount of pulp being sold by Anglo-Canadian to the appellant is metered as it leaves the Anglo-Canadian mill.

The steam pipeline bringing steam from Anglo-Canadian’s mill to the appellant’s plant is turned on at the beginning of a week’s operation and remains on at all times. A steady supply of steam is necessary for the operation of appellant’s plant because the machinery therein is operated by steam turbines. While the pulp is metered at its point of exit from Anglo-Canadian’s mill, the steam is metered as it enters the appellant’s plant.

Appellant is billed monthly by Anglo-Canadian for both the pulp and the steam. Because the pulp is metered as it leaves Anglo-Canadian’s mill, the appellant is charged for all slush pulp in the pipeline at the end of the month. The appellant pays for the costs of maintenance, repairs and inspection of the pipelines which are inspected weekly. The actual work involved in maintenance, repairs and inspection is performed by Anglo-Canadian’s employees but Anglo-Canadian is reimbursed by the appellant for the full cost thereof.

The price paid by the appellant for the pulp has, at all times, been calculated in accordance with the provisions of paragraph 5 of the pulp agreement, ie, the announced price from time to time in effect on sales made east of the Mississippi River in the United States less a discount or reduction equal to 50% of the cost of freight from Quebec City to Monroe Bridge, Massachusetts, USA (the plant site of appellant’s parent company in the United States, hereafter described as Deerfield).

Mr Monaghan said that “the announced price from time to time” is the current price at which sulphite pulp is being sold in Eastern Canada and the Eastern United States. The invariable practice in the industry is for the vendor or pulp manufacturer to pay the full cost of freight to the destination, thus the freight is included in the “announced price”. Thus, in the pulp contract between Anglo-Canadian and appellant, Anglo-Canadian’s saving of freight, because of the existence of the pipeline, in the case of its sales to the appellant, as compared to its sales to other customers, is in effect shared equally with the appellant by the above described reduction. It seems clear from the agreement between the appellant, appellant’s parent and Anglo-Canadian, that one of the advantages accruing to all of the parties, by the construction of the appellant’s plant in Quebec City, was the savings effected in freight charges by removing the need to ship the raw pulp required in Deerfield’s manufacturing process to Deerfield’s plant in Massachusetts. The pulp contract provides that this saving in freight costs be shared equally between the appellant and Anglo-Canadian. Mr Monaghan produced a detailed tabulation of the savings accruing to the appellant under the pulp contract with Anglo-Canadian (Exhibit A-4).

Exhibit A-4 establishes that the appellant saved, during the period 1955 to 1972, some $802,000 by virtue of the reduced price it paid for slush pulp under the pulp contract with Anglo-Canadian (ie, the rebate of /2 the freight cost). This figure is arrived at by taking the total number of tons of slush pulp purchased from Anglo-Canadian; the current market price which appellant would have to pay for slush pulp from anyone other than Anglo-Canadian; and by deducting therefrom the actual cost of pulp under the pulp contract.

The pulp contract was for an original term of 20 years, renewable for further periods of 5 years by the consent of both parties. The steam contract was for an original term of 5 years, renewable for further periods of one year by the consent of both parties. Both contracts are still in full force and effect, having been renewed in accordance with the respective terms of each contract.

The expenditure of $268,623.48 being examined here is arrived at by taking the figure of $301,845.48 referred to in paragraph 7(b) of the agreement of facts and deducting therefrom the value of the land in the sum of $33,221 referred to in paragraph 7(b)(1) and paragraph 9 of said agreement.

Thus, according to the agreements, and as per the agreed facts, appellant paid to Anglo-Canadian the said sum of $268,623.48 for the following:

1. The agreement by Anglo-Canadian to construct, at its own expense, the steam and pulp pipelines subject to the condition that the cost of the steam pipeline be reimbursed to Anglo-Canadian (which reimbursement has in fact been made—see paragraph 9 of agreement of facts).

2. The execution by Anglo-Canadian of the pulp contract and the steam contract.

Both pipelines remain the property of Anglo-Canadian under the agreements.

The appellant makes three alternative submissions in respect of said expenditure of $268,623.48. Its first submission is that said expenditure constitutes the cost of the right of using the steam and slush pulp pipelines and is, therefore, a leasehold interest on which capital cost allowance could be claimed under paragraph 11(1)(a) of the Act and paragraph 1100(1 )(b) of the Regulations.

After a consideration of both the steam contract and the pulp contract, I have concluded that these agreements do not contain all of the essential characteristics of a lease so as to confer upon the appellant “a leasehold interest” within the usual meaning of that term.

The Living Webster Dictionary defines a lease as:

. . . A contract authorizing the use and possession of land and/or buildings for a fixed time and fee, usually payable in installments; . . .

(Italics mine.)

possesses property”. Furthermore, Article 1612(1) of the Quebec Civil Code makes delivery of possession of the thing leased an essential characteristic of a lease. On the facts of this case, Anglo-Canadian is required, under the pulp and steam contracts to deliver the pulp and the steam to appellant’s plant and for this purpose, continued possession of the pipeline in the hands of Anglo-Canadian is necessary in order to enable it to discharge said delivery obligations.

Accordingly, I am satisfied that Anglo-Canadian has retained possession of subject pipelines, and, since a delivery of possession to the lessee is an essential characteristic of a lease, there is no lease and consequently no leasehold interest accruing to the appellant. I therefore reject the appellant’s right to claim a capital cost allowance based on a leasehold interest.

The appellant’s second alternative submission is that said expenditure constitutes moneys expended for a franchise under the provisions of paragraph 11 (1 )(a) of the Act and paragraph 1100(1)(c) of the Regulations on which capital cost allowance could be claimed.

Paragraph 1100(1 )(c) reads as follows:

1100. (1) Under paragraph (a) of subsection (1) of section 11 of the Act, there is hereby alowed to the taxpayer, in computing his income from a business or property, as the case may be, deductions for each taxation year equal to

(c) such amount as he may claim in respect of property of class 14 in Schedule B not exceeding the lesser of

(i) the aggregate of the amounts for the year obtained by apportioning _. the capital cost to him of each property over the life of the property remaining at the time the cost was incurred, or

(ii) the undepreciated capital cost to him as of the end of the taxation year (before making any deduction under this subsection for the taxation year) of property of the class;

Then, Class 14 in Schedule B reads:

Property that is a patent, franchise, concession or licence for a limited period in respect of property . . .

I am of the opinion that, on the facts of this case, even assuming that the appellant has acquired a franchise, said franchise has not been acquired for “a limited period” as required by Class 14 of Schedule B. In the case at bar, the pulp contract was for 20 years, the steam contract for 5 years. Each contract provided for automatic renewals for further periods of 5 years and one year respectively unless and until such initial or extended term shall be terminated by either party by written notice to the other party. Thus, the period is unlimited, rather than limited.* [1] Accordingly, I have concluded that the appellant is not entitled to claim capital cost allowance on subject expenditure as a franchise.

The appellant’s third alternative submission is that subject expenditure constitutes an outlay or expense incurred by it for the purpose of earning income from its business and, as such, is deductible under paragraph 12(1 )(a) of the Act properly amortized over the lifetime of the pulp and steam contracts in accordance with proper accounting practice in a business of the kind with which the taxpayer is concerned. Respondent, on the other hand, submits that subject expenditure was made in consideration of the undertaking by Anglo-Canadian to construct underground steam and pulp pipelines, and to execute the “pulp contract” and the “steam contract”, and that such an undertaking constitutes an intangible capital asset in respect of which no capital cost allowance can be deducted because such an allowance is not permitted by any of the Income Tax Regulations. Respondent further submits that, even if said expenditure is determined to be a deductible expenditure, it should have been deducted from income in the taxation year in which it was incurred, namely 1953, and that the appellant is not entitled, for income tax purposes, to defer to subsequent years an expense incurred in 1953.

I will deal initially with the question of whether subject expenditure is an outlay or expense incurred by the appellant for the purpose of earning income from its business and, as such, is deductible from income.

It seems clear that subject payment made by the appellant to Anglo- Canadian is one which falls within the exception provided in paragraph

(a) of subsection 12(1)* in that it was in fact made for the purpose of gaining or producing income from the appellant’s business. The evidence establishes that said expenditure actually resulted in the appellant having some $802,000 more in net income over the period 1955- 1972 than it would have had but for the existence of the pulp contract. The only question for determination is whether said payment falls within paragraph (b) of subsection 12(1)* [2] as an outlay or payment on account of capital as is contended by respondent’s counsel.

The usual test applied to determine whether a payment is one made on account of capital in a case like the present is stated by Viscount Cave in British Insulated and Helsby Cables v Atherton, [1926] AC 205, 213, as follows:

But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.

Applying that test to the case at bar, I am of the view that subject expenditure cannot properly be said to have brought into existence an advantage for the “enduring benefit” of the appellant’s trade within the meaning of that expression as above quoted. The ordinary dictionary meaning of “enduring” is “permanent” or “lasting”.! The meaning of said expression is discussed in the case of Anglo-Persian Oil Co v Dale, [1932] 1 KB 124, by Lawrence, LJ at 142 where he equates the expression “enduring benefit” with a “permanent advantage”. The facts of that case were in many respects similar to those in the case at bar. In that case, the taxpayer company had entered into a 10-year agreement with an agent company, under which the agent company was to manage the taxpayer company’s oil business in Persia and the East. Since the remuneration payable to the agent company had proved to be larger and more onerous than had been anticipated by the taxpayer, the taxpayer decided to terminate the agency contract and thenceforth to do its own agency work in the East. Accordingly, after 8 years of the 10-year agreement, the taxpayer company and the agent company agreed to terminate the agency in return for the taxpayer paying to the agent company the sum of £300,000. Taxpayer company treated said payment as a revenue payment and charged same to revenue in instalments of £60,000 for 5 years. The English Court of Appeal held that said sums were admissible deductions. At page 139, Lord Hansworth, MR said:

The payment Is to put an end to an expensive method of carrying on the business which remains the same whether the distributive side is in the hands of the respondents themselves, or of their agents.

Then, Lawrence, LJ at pages 139 and 140 said:

It is not open to doubt that under ordinary circumstances where a trader in order to effect a saving in his working expenses dispenses with the services of a particular agent or servant, and makes a payment for the cancellation of the agency or service agreement, such a payment is properly chargeable to revenue; it does not involve any addition to or withdrawal from fixed capital; it is purely a working expense.

In the case at bar, subject expenditure was made for the purpose of and resulted in saving the appellant substantial amounts in raw material costs. Appellant’s business is the manufacture and sale of glassine paper. One of the raw materials used in said manufacture is raw pulp. But for the existence of subject pulp and steam contracts, appellant would have been required to pay a larger amount for its raw pulp. Thus, by entering into subject contracts, appellant was able to save some $802,000 in ‘‘working expenses” over the years. The appellant’s business remains the same, whether the pulp is obtained from Anglo- Canadian or some other source. Subject expenditure did not add anything to appellant’s fixed capital. In my view, the facts in this case come clearly within the principles enunciated in the Anglo-Persian case (supra).

It should also be observed that subject contracts were for fixed terms, and can be renewed on the agreement of both parties. Up to this point in time, they have been so renewed. However, Anglo-Canadian is able to terminate the steam contract any year and the pulp contract in 1977 or at the expiration of any further 5-year term thereafter. Such benefits can hardly be said to be enduring or permanent benefits as those terms are usually understood.

Associate Chief Justice Noël had occasion to consider a situation somewhat similar to the case at bar in The Queen v F H Jones Tobacco Sales Co Ltd, [1973] CTC 784; 73 DTC 5577. In that case, the defendant taxpayer sold processed tobacco to cigarette manufacturers. In 1963, one of the defendant’s largest customers was in financial difficulties. Arrangements were made for another cigarette manufacturing company to purchase the shares of the customer and the defendant undertook to guarantee the loan necessary to finance this purchase in exchange for the purchaser’s undertaking to buy tobacco from the defendant. The defendant’s new customer had considerable success in selling a new cigarette resulting in a substantial increase in defendant’s tobacco sales. However, the new customer failed to pay excise duties as required and federal government officials seized all the company’s property in 1966 at which time the defendant was called upon to pay about $115,000 under its guarantee. The Associate Chief Justice held that said loss was deductible as an operating loss and not on capital account. He held that the loan guarantee was an undertaking that was very much a part of the defendant’s normal operations and one which would enable it to increase its sales of tobacco. At page 790 [5581] of the judgment he said:

For some years, however, our courts. have: been inclined to accept certain expenses or losses as deductible, considering not so much the legal aspect of the transaction, but rather the practical and commercial aspects.

The facts here are similar to the Jones Tobacco case (supra) in that, here also, the pulp contract and the steam contract, involved as they were in the day by day delivery of raw products to appellant’s plant, were undertakings that were very much a part of the defendant’s normal operations.

Turning now to the final question for determination—whether the appellant is entitled, for income tax purposes, to defer subject expenditure to subsequent years since the expense was incurred in 1953. In support of this submission, the appellant called as an expert witness Mr Jacques Gunn, a chartered accountant and resident partner at Quebec City in the firm of Riddell, Stead & Co. Mr Gunn testified that, in his opinion, it was in accordance with proper accounting practices and principles to amortize or write off subject expenditure over a reasonable period of years. He said his opinion was based on the fact that revenues are normally matched with expenditures and that since subject expenditure has permitted the appellant to reduce its cost of production in each subsequent year, therefore the expenditure was properly amortized. He also gave as his opinion that in the circumstances here, a reasonable period for such amortization was 25 years inasmuch as the term of the contract was for 20 years, renewable for further 5-year periods. He explained that normal accounting practice called for amortization of leasehold improvements or franchise costs over the period of the lease or franchise plus one renewal and that with a contract such as the pulp contract a similar procedure should be followed.

The latest decision dealing with this matter is the decision of Mr Justice Collier in the case of MNR v Tower Investments Inc, [1972] CTC 182; 72 DTC 6161. In that case, Mr Justice Collier held that there was no prohibition in the Income Tax Act against the matching system. In that case, the taxpayer, in conjunction with its construction of several large apartment buildings, had launched an advertising campaign to secure tenants and sought to defer some portion of the amounts expended into subsequent years in accordance with ordinary commercial principles or well-accepted principles of business and accounting practice. Collier, J concluded that said system of deferring expenses more accurately set forth the taxpayer’s true income position because the advertising expenses were not current expenditures in the normal sense. They were laid out to bring in income not only for the year they were made but for future years. He thus held that said system was permissible.

The rationale of the Tower Investment case (supra) applies equally to the situation here. The expert witness, Mr Gunn, gave his opinion that, in the circumstances of this case, the matching system here used was in accordance with proper accounting practices and principles. No contrary evidence was adduced by the respondent. As in the Tower Investment case (supra), subject expenditure here was not a current expenditure in 1953 in the normal sense, said expenditure in 1953 had the effect of reducing appellant’s raw product cost for future years for the duration of the contract.

I have accordingly concluded that the appellant’s treatment of subject expenditure in this case was proper and not prohibited by the Income Tax Act.

The appeal will therefore be allowed with costs. The assessments of the appellant for the taxation years ending in February of 1966, 1967, 1968 and 1969 are referred back to the Minister for reassessment not inconsistent with these reasons.