Valley Camp LTD v. Minister of National Revenue, [1974] CTC 418

Urie, J:—This is an appeal from a judgment of the Tax Review Board dated June 8, 1972 wherein the Board dismissed the appellant’s appeal from the respondent’s assessment which included in the appellant’s taxable income for the year 1968 the sum of $520,655 received by the appellant from the Canadian National Railway Company (hereinafter called “CN”), pursuant to an agreement between those parties for the provision and operation of a facility to handle iron ore concentrate pellets delivered by CN trains to a dock operated by the appellant at Fort William, now Thunder Bay, Ontario.

The Valley Camp Coal Company of Canada, Limited, the name of which was changed to Valley Camp Limited (hereinafter sometimes referred to as “Valley Camp”) by Supplementary Letters Patent dated December 12, 1968, entered into an agreement with CN dated August 8, 1967 in which Valley Camp agreed to provide and operate on certain property owned by CN at Fort William, Ontario, complete facilities (hereinafter referred to as the “facilities”) for the unloading of railway cars containing iron ore concentrate pellets, the stockpiling of such pellets and the loading thereof into vessels for further carriage. The term of the agreement is 25 years and for such term CN has leased to Valley Camp, at a rental of $1.00 per year, the lands which are required by. Valley Camp to provide and operate the said facilities. During the term CN has agreed to pay all taxes, including local improvement taxes, assessed against the facilities or any addition, extension or modification thereof. Valley Camp covenanted that the facilities would be free and clear of all liens, claims or charges other than any charge created by: Valley Camp for borrowed moneys which, in any event, would be junior to the rights of CN.

The use of the facilities provided is exclusively for CN and if at any time any extension or modification of the facilities is required it is to be provided by Valley Camp on the terms set forth in the agreement.

During the term of the agreement CN is required by the provisions of paragraph 10 of the agreement to pay to Valley Camp a handling charge, in accordance with the rate schedule attached to the agreement, for each long ton of pellets which is handled through the facilities for CN. In addition, paragraph 9 of the agreement requires that during the term thereof CN shall pay to the appellant in each and every year during the term of the agreement an annual payment equal to 10%% of the final actual capital cost of the facilities without any right of CN to “cancel, reduce, abate, counterclaim against, delay the payment of, set off against, or withhold any amount from the said annual payment” and, in fact, if under the terms of the agreement, Valley Camp is in breach thereof and CN takes over the operation of the facilities, as it is permitted to do in such a circumstance, it will be required nevertheless to meet the balance of the annual payments so prescribed. The agreement also provides that the appellant may from time to time mortgage, transfer and assign its right to receive the annual instalments to any lending institution or any trustee appointed under a trust indenture or trust deed made by Valley Camp. In fact, Valley Camp did enter into a trust indenture dated as of April 1, 1968 wherein it issued debentures secured by such indenture in the aggregate sum of $4,500,000. Article III of the Trust Indenture specifically charges and assigns to the trustee under the indenture, with equal benefit to the holders of the debentures, all-its right, title, interest and benefit in respect of the annual payments to be made under the agreement by CN. As required by the terms of the agreement, CN acknowledged that it had received notice of the mortgage and assignment by the appellant to Montreal Trust Company as trustee of all rights of Valley Camp to the annual payments to be made by CN and agreed to make the said payments to the Montreal Trust Company as trustee.

The only witness called for the appellant was its president, Kenneth David Mooney, who testified that the annual payments to be made by CN pursuant to the agreement amortized the capital cost of the facilities at Thunder Bay over the term of the contract, viz, 25 years, at an interest rate of 9%. The agreement stipulates that each such annual payment is to be paid in 12 consecutive, equal monthly instalments, the first of which was to be made and was in fact made on January 31, 1968. At that date the final actual capital cost of the facilities had not yet been established because of the fact that the construction thereof had not then been completed. The payment on January 31st, and some subsequent payments, therefore, were based upon the estimated final actual capital cost of the facilities and any adjustments required in the monthly or annual payment were to be made when the final actual capital cost had been determined. There was no evidence adduced of the precise day upon which such determination was made but, in any event, the amount which was paid by CN to Valley Camp during the year 1968 was $520,655. Apparently the monthly instalments were taken into the revenue of the company because the appellant’s Statement of income for the year ending December 31, 1968 included under the heading “Revenue” the sum of $909,439 as revenue from its pellet handling facilities. Mr Mooney testified that this figure included the annual payment of $520,655 referred to above.

In its corporation income tax return for the taxation year 1968 both the appellant and respondent included as income the payment received from CN in the sum of $520,655. The Notice of Assessment in respect of this return showed no tax owing.

Subsequently an amended corporation income tax return for the 1968 taxation year was filed by the appellant and by Notice of Reassessment dated December 30, 1969 the respondent revised the Appellant’s taxable income for the year to the amount of $10,008.84 and claimed tax payable in the amount of $1,155.02 together with interest thereon of $47.64 or the sum of $1,202.66 in the aggregate. Both the appellant and respondent again included the annual payment in the calculation of the appellant’s taxable income for the year 1968. It is from this reassessment, which was confirmed by the Tax Review Board, that the appellant appeals.

After the time for the filing of a Notice of Objection to the reassessment had expired, the appellant filed a second amended return in which it did not include the annual payment of $520,655 as revenue with the result that it showed a loss of $114,221.86. This return would appear to have no status due to the failure of the appellant to file a Notice of Objection to the reassessment within the requisite time. However, it does serve the purpose of showing the position that the appellant now takes with respect to its taxable income for 1968.

I might point out that in the statement of income filed with each of the three returns the interest paid on the debentures above referred to, in the sum of $243,570, was deducted as an expense. In addition, in Schedule 2(a) to the original return and to the amended return the appellant claimed capital cost allowance on the above mentioned facilities. However, in the second amended return it was unnecessary for it to claim any capital cost allowance because the appellant already showed the loss for tax purposes referred to above.

The appellant alleges that the payment of $520,655 should not have been included in computing its taxable income for the year 1968 on the ground that it was a capital payment made to subsidize the construction of the pellet facility and so was not an income receipt. In its Notice of Appeal the appellant stated that it relied on paragraph 20(6)(h) of the Income Tax Act, inter alia, in support of its submission but in argument its Counsel did not stress this argument, conceding that he used this section only to buttress his submission by way of analogy, arguing that the word “subsidy” as used in that section meant the same as “capital contribution”. In his submission, CN had made in the year 1968 and would make in succeeding years thereafter, for the whole of the term of the agreement, capital contributions to the appellant, ie the 1968 payment was and succeeding payments have been and will continue to be capital payments to reimburse the appellant for the construction of the facilities above referred to.

On the other hand, counsel for the respondent argued with great force that the payment was not part of a subsidy either in the sense that that word is used in paragraph 20(6)(h) or in ordinary business parlance, nor was it, on the analysis of the agreement, a capital repayment or the repayment of what might be termed a construction loan and therefore capital in nature. The agreement, in his view, was an ordinary business contract negotiated by both parties to the contract for business reasons and, therefore, revenue derived therefrom was income to the recipient. It was not a subsidy, grant nor other assistance from a public authority within the meaning of paragraph 20(6)(h) nor was it a subsidy outside of that section. However, even if it was, that did not, in his view, automatically make it a capital payment. He argued that one must look at the purpose for which it was given to determine its true nature and to that extent he was in agreement with counsel for the appellant since both argued that the true nature of the business transaction must be determined to characterize the payment as capital or revenue as the case may be. They differed, therefore, only in the conclusions derived from their respective analyses.

Perhaps it should first be recalled that income tax liability does not depend on the manner in which the recipient enters an amount in its books of account or disposes of it after it has received it or, for that matter, whether the amount is assigned to a creditor prior to its receipt for the purpose of the repayment of the loan as the appellant did here. That being so, the fact that it appears that the appellant initially treated the 1968 annual payment as revenue does not in any way deprive it of the right to assert that the payment is in fact on account of capital in the determination of taxable income under the Income Tax Act. By the same token I do not think that because in the agreement between Valley Camp and CN reference is made to “the actual capital cost of the facilities” that the use of the word “capital” therein is necessarily determinative of the true character of the payments made to amortize such cost. The description adopted by the parties does not create the presumption that the designation is correct for tax purposes. The whole transaction must be analyzed before the character of the payment can be determined.

In this instance my analysis of the agreement and the subsidiary agreement with the engineering firm retained by the appellant to design and supervise the construction of the facilities does not lead me to the conclusion that CN either subsidized the construction or that, in effect, Valley Camp arranged for the borrowing of money for the construction of a capital asset on behalf of CN which was to be repaid by CN over the term of the agreement. In fact, the opposite conclusion is reached for a number of reasons, one of which is very compelling. That compelling reason is that at the end of the term of the agreement while CN will have fully paid for the facilities it will not be the owner thereof but, at that time, as set forth in paragraph 17 of the agreement, "‘shall at its sole option on 12 months’ prior notice given to Valley Camp have the right to purchase the facilities outright at a price, without crediting the said annual payments made under paragraph 9 hereof:— . . .” (the emphasis is mine). The price to be paid if the option is exercised is by agreement between the parties or by arbitration.

It is provided that in the event that arbitration is resorted to the price shall be “the value of the facilities (determined with reference to replacement cost, including site preparation and engineering, taking into account the condition of the buildings and equipment and of the site as at December 31, 1992)” plus any insurance proceeds held and receivable by CN as at that date. If CN does not exercise its option, Valley Camp has 12 months in which to remove the facilities failing which absolute title will vest in CN. In my view the fact that CN does not own the facilities at the end of the agreement but may purchase them at an adjusted replacement cost figure clearly contradicts the submissions of the appellant that the payments made under paragraph 9 are repayment of capital advanced by the appellant. This belief is reinforced by a consideration of the whole tenor of the agreement which throughout requires the appellant “to provide and operate” the facilities, to maintain, repair and keep the facilities in good repair and condition as well as to insure such facilities.

It is quite apparent that CN required the loading and unloading expertise of the appellant for which it was willing to pay charges not only for the actual handling of the pellets but also for the amount required to reimburse the appellant for the outlays it was required to make “to provide” the facilities for the services to be performed. Quite naturally each party wished to be protected in its particular liability in the complete recovery of such outlays. CN, for its part, had to be assured that it was paying only for the actual cost of the facilities and, therefore, strict conditions were imposed in the agreement for the determination of such cost. Valley Camp, on the other hand, had to be assured that the substantial outlays required would be wholly recovered even if, for some unforeseen reason, the agreement was terminated before the end of its term. The parties thus agreed on the stringent provisions relating to the calculation of cost and to the payment of such cost even if the agreement was terminated and the facilities taken over and operated by CN. It is obvious that it was for this reason that loss was payable to CN under the terms of the insurance policy, ie to protect it in the event of total or partial destruction of the facilities while it was still responsible for paying the outstanding balance of cost. The whole transaction was clearly a commercial one in which Valley Camp prudently ensured the recovery of its expenditures for this apparently single purpose facility whereas CN assured itself of facilities provided and operated by experts, in part at least at a predetermined annua! cost.

Therefore, the payments in both paragraphs 9 and 10 are, in my view, revenue in nature. As indicated before, the payment required to be made pursuant to paragraph 9 was assigned, with the concurrence of CN, to the trustee for the debenture holders as security for the appellant’s loan. It is quite probable that the monthly payments were divided under the terms of the agreement into two parts to ensure that this flat annual payment could be paid directly to the trustee. The fact that it was so assigned for the purpose of repayment of the loan made to finance construction of a capital asset does not make it any less revenue vis a vis the agreement between CN and Valley Camp. To regard the payments as being independent of one another is to disregard the fact that, without the inclusion of the payments made pursuant to paragraph 9 in appellant’s revenue accounts, its operations resulted in a loss of $114,228.86 in 1968.

In cross examination Mr Mooney admitted that this was so but he pointed out that at the beginning of the amortization, the interest portion of the payment was at its highest which portion would gradually reduce over the years. However, I think I am entitled to take notice that it will not be for many years that it will be reduced sufficiently to make any real impact on the profit picture unless the annual payment is included in whole as income. Moreover, it was conceded by counsel for the respondent that the appellant was entitled to deduct the interest portion of the payment as an expense and, of course, to claim capital cost allowance on the facilities. As previously noted, in its original and first amended tax returns for 1968 it not only included the annual payment as revenue but also deducted both the interest paid on the debentures as an expense and the capital cost allowance on the facilities in the calculation of its taxable income. It appears clear that the appellant cannot have it both ways; that is, it cannot fail to include the annual payment in its revenue receipts and yet deduct the interest payment as well as capital cost allowance in computing its taxable income. The gist of the transaction then must be that both payments, viz the handling charge and the flat annual payment are part of the same transaction and are income payments in the hands of the appellant.

Appellant’s counsel relied largely on St John Dry Dock & Shipbuilding Company Limited v MNR, [1944] Ex CR 186; [1944] CTC 106; 44 DTC 663, a decision of Thorson, P [as he then was]. That case arose out of an appeal from the decision of the respondent that certain subsidy payments received by the appellant in that case were income in nature and subject to tax under the Income Tax Act. The appellant in 1918 had entered into a subsidy agreement with His Majesty the King pursuant to the Dry Dock Subsidies Act, to build a dry dock after having satisfied the Governor-in-Council that the construction of such a dry dock was in the public interest. On its completion a subsidy was to be paid based on the cost of construction. The subsidy payable was described as a sum not exceeding 4 /2% of the cost of the work as fixed by the Governor-in-Council, half yearly during a period not exceeding thirty-five years. These payments were assigned to a trustee for bondholders. Originally it included in its corporation income tax returns, as revenue, the annual payments and claimed deduction of interest as well as capital cost allowance. However, later it objected to an assessment with the payment included thus resulting in this appeal to the Exchequer Court.

At page 193 Thorson, P makes this observation:

The fact that an amount is described as a Government subsidy does not of itself determine its character in the hands of the recipient for taxation purposes. In each case the true character of the subsidy must be ascertained and in so doing the purpose for which it was granted may properly be considered.

Relying on the decision of the House of Lords in The Seaham Harbour Dock Co v Crook (HM Inspector of Taxes) (1931), 16 TC 333, as authority for the proposition that when a payment is made under the authority of an Act of Parliament, the statutory purpose for which such payment is authorized may be considered in determining whether the payment is to be regarded as an item of annual net profit or gain and taxable income in the hands of the recipient, he found the purpose of the subsidy payments could be found in the Act, the agreement and the Orders-in-Council made under its authority. He found at page 205 that “the whole Act shows the concern of Parliament for the construction of such a dock as would meet public requirements.” The payments were not made to supplement the operational income of the appellant. They were made to accomplish a special purpose, in the national interest, quite apart from the trade or business operations of the appellant and not connected with them.

In that, it differs from the case at bar. The payments here were not made apart from the trade or business operations of the appellant but were made as part of them as consideration for providing and operating the pellet facilities. This was not a payment or series of payments in the nature of a grant or subsidy paid by a public authority to encourage employment as in the Seaham case or to encourage the construction of a dry dock as in the St John’s Dry Dock (supra) case. If it was, the appellant’s argument might have some validity. However, in my opinion the reasoning of Jackett, P (as he then was) in Ottawa Valley Power Company v MNR, [1969] Ex CR 64; [1969] CTC 242; 69 DTC 5166, is more appropriate in this case than that employed in the particular factual situation found in the St John’s case. He found at page 71 [249; 5171] in relation to the application of paragraph 20(6)(h) to the facts of that case:

What this rule appears to contemplate is the case where a taxpayer has acquired property at a capital cost to him and has also received a grant, subsidy or other assistance from a public authority “In respect of or for the acquisition of property” in which case the capital cost is: deemed to be “the capital cost thereof to the taxpayer minus . . the grant, subsidy or other assistance”. That rule would not seem to have any application to a case where a public authority actually granted to a taxpayer capital property to use in his business at no cost to him. Quite apart from the fact that the rule so understood would have no application here, I do not think that the rule can have any application to ordinary business arrangements between a public authority and a taxpayer in a situation where the public authority (I assume, for purposes of this discussion, that Ontario Hydro is a public authority within paragraph (h) without deciding that question.) carries on a business and has transactions with a member of the public of the same kind as the transactions that any other person engaged in such a business would have with such a member of the public. I do not think that the words in paragraph (h)—‘‘grant, subsidy or other assistance from a . . . public authority”—have any application to an ordinary business contract negotiated by both parties to the contract for business reasons. If Ontario Hydro were used by the legislature to carry out some legislative scheme of distributing grants to encourage those engaged in business to embark on certain classes of enterprise, then I would have no difficulty in applying the words of paragraph (h) to grants so made. Here, however, as it seems to me, the legislature merely authorized Ontario Hydro to do certain things deemed expedient to carry out successfully certain changes in its method of carrying on its business and the things that it was so authorized to do were of the same character as those that any other person carrying on such a business and faced with the necessity of making similar changes might find it expedient to do. I cannot regard what is done in such circumstances as being “assistance” given by a public authority as a public authority. In my view, section 20(6)(h) has no application to the circumstances of this case.

(Except in the second-last sentence, where the emphasis is that of Jackett, P, the emphasis is mine.)

Those words, I believe, are completely applicable to this case. Moreover, at page 77 in analyzing the nature of the transaction with which he was dealing he envisaged the following situation which is very similar to the factual situation in the case at bar:

It seems a little easier to analyze if one considers the somewhat simpler case of a supplier entering into a term contract with a purchaser under which the purchaser agrees to provide the supplier with his physical plant and to pay a fired (sic) price per unit for the commodity purchased instead of paying a larger price per unit without providing the supplier with his plant. In that case, my first impression is

(a) that what the purchaser is paying for what he is acquiring is the value of the plant supplied plus the price per unit paid and that the whole amount would have to go into the supplier’s revenue account; and

(b) that the supplier is not getting his plant for nothing, but is paying for it by entering into the low-priced supply contract and that, prima facie, what he pays for the plant is the value of the plant.

President Jackett was unable to make any findings on this set of facts because the issues were not raised in the Notice of Appeal. However, at page 78 he did express the view that if capital additions and improvements were received as consideration for agreeing to deliver the power the Appellant was required to provide at a price that was lower than would otherwise have been economic, it was probably received on revenue account in accordance with ordinary principles of commercial trading.

As I have earlier found the handling charge made for the services provided by the Appellant in this case was insufficient to permit a profitable operation. In fact it was so low that it resulted in a loss and it is clear to me, therefore, that the annual payments made pursuant to paragraph 9 duly assigned to the trustee for the debenture holders to retire a debt incurred in the construction of a capital asset, were received as consideration for the supply of services at a price that was lower than would have been otherwise economic. The two items of consideration received by the appellant were not as a result of separate and independent bargains but part of the same commercial transaction set up in the manner in which they were for the reasons to which I have previously alluded. The payments under paragraph 9 were just as much a part of the appellant’s revenue as the payments made pursuant to paragraph 10. They constituted revenue in the hands of the recipient and therefore must be taken into account in the calculation of the appellant’s taxable income under the Income Tax Act for the year 1968.

The appeal, therefore, will be dismissed with costs.