Edgerton Fuels Limited v. Minister of National Revenue, [1970] CTC 202, 70 DTC 6158

CATTANACH, J. :—These are appeals from assessments made by the Minister under Part I of the Income Tax Act in respect of the appellant’s 1965 and 1966 taxation years.

The question for determination is whether sums of $20,000 received by the appellant in each of its 1965 and 1966 taxation years in respect, of the cancellation of a contract should have been included by the Minister in the assessable profits of the appellant for those respective years. The two sums of $20,000 were annual payments of a total amount of $75,000 for the cancellation of the contract and were payable to the appellant over a period of four years.

Wilfred Kaneb, a mechanical engineer, who had been engaged in the fuel oil business for a. number of years, in 1959 purchased the assets of a fuel oil business carried on by Art Edgerton under the firm name and style of Edgerton Fuels at Morrisburg, Ontario.

The assets so acquired consisted of two fuel oil tank trucks of 1,500. gallon capacity complete with meters, hose and like equipment, and two parcels of real estate. One such parcel was comprised of office premises located in a shopping centre at Morrisburg and the other was an industrial railroad siding, some one mile distant from the office premises, on which was a 25,000 gallon fuel oil storage tank and a garage building. and where sundry equipment such as a pump, rubber hoses, working equipment for the delivery trucks and sundry like equipment was stored and used to unload fuel oil from railroad tank cars into the storage tank and from the storage tank into fuel oil trucks.

Immediately following the acquisition of such assets, Mr. Kaneb caused the appellant company to be incorporated pursuant to the laws of the Province of Ontario under the name of Edgerton Fuels Limited by letters patent dated June 22, 1959 for the purpose of selling and supplying fuel and fuel. products and other products of a similar nature. All issued shares were held by Mr. Kaneb except qualifying shares one of which was held by Mr. Edgerton, who became an officer and employee of the company.

The appellant purchased from a supplier two grades of fuel oil, which were delivered in tank cars by rail. The appellant unloaded the fuel oil, stored it in tanks and then sold it to customers within a 15 mile radius of Morrisburg. The delivery to customers was by fuel oil tank trucks. The records of sales to customers were kept in the office at the shopping centre from where monthly statements were sent to the customers. There were four employees engaged in the sale of fuel oil, two drivers, a repairman and a bookkeeper.

In 1959 considerable highway construction was contemplated in the Morrisburg area. Shell Oil Company of Canada, Limited, a major manufacturer and supplier of petroleum products (hereinafter referred to as Shell”) had begun the manufacture of asphalt and was anxious to penetrate the market in this particular area. Accordingly, discussions took place between Shell and the appellant which resulted in a ‘‘Terminal Agreement’’ dated August 1, 1960 between the appellant and Shell whereby it was agreed that the appellant would construct, provide and maintain terminal facilities at Morrisburg solely for the unloading, storage handling and loading of asphalt manufactured by Shell. In the agreement dated August 1, 1960 Shell agreed to pay the appellant $1.50 per ton of the product loaded out of the terminal and Shell guaranteed a minimum annual ‘‘throughput’’ of 10,000 tons. This agreement was for a minimum of five years and five months with provision for termination on December 1 of any year after the expiry of the minimum period.

A subsequent agreement dated May 16, 1961 amended the initial agreement dated August 1, 1960 by increasing the amount to be paid by Shell from $1.50 to $2.00 per ton and the length of the agreement was changed to a period of ten years commencing on May 1, 1961, that is, to terminate on May 1, 1971. The appellant undertook to use the terminal facilities exclusively for Shell and also undertook not to enter into any similar throughput agreements with any other party without the prior consent of Shell.

The asphalt was shipped by Shell by rail from its plant in Montreal, Quebec, a comparatively short distance away, in railway tank cars. The product was loaded in a very hot state at Montreal and because of the shortness of the distance to Morrisburg remained sufficiently hot to be unloaded before it cooled and solidified. A preferential railroad rate was in effect for this product in this area. The fact that the appellant had a railroad siding at Morrisburg was undoubtedly a factor which influenced Shell to enter into this agreement with the appellant.

Mr. Wilfred Kaneb, who was a mechanical engineer, with the assistance of his brother, Mr. George Kaneb, who was a chemical engineer and had been in the fuel oil business for a number of years, designed the terminal facilities. Seven storage tanks were constructed, each fitted with serpentine coils through which hot oil was circulated to maintain the temperature of the asphalt to be stored therein at 400 degrees. The fuel oil storage tank already on the site was converted to an asphalt storage tank by the installation of coils. In the garage on the premises a scale and scale arm were installed and steel piping and like facilities were installed to unload the asphalt from the railway tank cars to the storage tanks and from those tanks into the tanks of customers of Shell. The railway siding was expanded by the purchase of adjoining land.

Unlike the fuel oil in which property passed to the appellant upon its delivery, the property in the asphalt remained in Shell and was sold by Shell to its customers who obtained delivery from the appellant upon written orders from Shell or who were designated customers.

The appellant prepared and furnished to Shell a monthly statement of all deliveries of asphalt to Shell customers. The delivery slips, showing the amounts, were sent from the terminal to the appellant’s office in the shopping centre where the compilation of the monthly statements to Shell was done by the appellant’s bookkeeper.

The construction of the asphalt terminal was completed by the appellant during the year 1960 and the cost thereof was approximately $85,000 which was financed by two loans from the appellant’s bank at Cornwall, Ontario.

Upon the conversion of the terminal facilities from the reception of fuel oil to the handling of asphalt, no fuel oil was handled at that site.

When the appellant entered into the terminal agreement with Shell, the former supplier of fuel oil refused to supply any further oil to the appellant. Therefore the appellant obtained fuel oil to supply its customers from Universal Fuels, a company owned and operated by George Kaneb, Wilfred Kaneb’s brother. The appellant’s fuel oil tank trucks picked up the fuel oil from Universal’s storage tanks. The fuel oil was no longer received at the railway siding in tank cars. The converted facilities on that site were devoted exclusively to the appellant’s handling of asphalt. There were two employees there who were specifically instructed as to safety precautions to be followed in handling the hot material. No other employees were engaged in these operations, nor were other employees allowed to do so.

There were two separate bank accounts maintained by the appellant. There was one account in which all receipts from sales of fuel oil were deposited and withdrawals from which were made respecting the appellant’s fuel oil operation. In the other, drawings against a loan which had been obtained from a Cornwall bank to finance the construction of the asphalt terminal, were deposited in the Morrisburg branch of that bank and all receipts or disbursements respecting the asphalt operation were deposited or withdrawn from this account by the appellant.

The appellant kept two sets of books of original entry, one for the fuel oil operation and the other for the terminal operation.

The appellant’s auditor was supplied with two separate sets of records. It was his practice to prepare separate financial statements which were supplied to the appellant, but he combined the two separate balance sheets into one consolidated balance sheet in the financial statement accompanying the appellant’s income tax return for June 30, 1962. There was also a combined statement of earned surplus but one statement of revenue and expenditures of the asphalt terminal and a separate statement of profit and loss for the fuel oil operation. There were separate statements of continuity of fixed assets and capital cost allowances with respect to the asphalt terminal and fuel oil operation, but these two statements were also combined into one schedule, as was done with the balance sheets.

In 1964 Shell decided that it should cancel the contract. The officer of Shell who had negotiated the contract was succeeded by another officer who concluded, with justification, that it was a bad deal for Shell. Shell had guaranteed the appellant a throughput of a minimum of 10,000 tons annually at $2.00 per ton, an annual sum of $20,000. At no time in 1961, 1962 or 1963 did the throughput exceed 5,800 tons. In 1964 a transcontinental highway through the Morrisburg area had been completed and the potential for asphalt sales in the area was considerably decreased. Any asphalt sales in the area could be readily supplied from Shell’s asphalt plant in Ottawa, Ontario. It was estimated by Shell that its asphalt sales in the Morrisburg area through the appellant’s terminal would not exceed 1,500 tons per year from 1964 onward. Since the contract then had approximately seven years to run until its expiry, it was estimated that its financial commitment for the unexpired period was $161,000. If only 1,500 tons of asphalt were put through the appellant’s terminal, that would result in $3,000 being paid by Shell for this service, but under its contract it was obliged to pay $20,000 or $17,000 in the nature of a penalty, for each of seven years. In addition there were throughput costs of $2.00 per ton, an estimated cost on 1,500 tons of $3,000 per year in addition to heating costs borne by Shell in the annual amount of $3,000. This would result in an annual cost of $23,000 the total for the seven years the contract had to run being $161,000. Obviously it was to Shell’s advantage to conclude the contract and negotiations were begun with Mr. Wilfred Kaneb to do so.

After considerable negotiation the appellant agreed to the cancellation of its contract upon payment to it by Shell of $90,000 being an approximation of the cost of construction of the terminal facilities less an amount of $15,000 being the estimated salvage value of those facilities which resulted in a cash payment of $75,000. Mr. Kaneb was anxious that the amount to be received would be sufficient to discharge the appellant’s obligation to its bank by reason of the loans to construct the terminal, which then stood at approximately $78,000.

Accordingly on April 15, 1964 the appellant released Shell from its obligations under the agreement in consideration of Shell paying to the appellant the sum of $75,000, with interest at 6% payable $20,000 annually.

It was explained by the Shell official who testified, that the arrangement to pay the appellant $20,000 annually was to facilitate the district office of Shell. By the contract the district office was committed and authorized by Shell headquarters to pay $20,000 annually. If, however, the entire $75,000 were to be paid forthwith that would be beyond the district office’s authority and would require approval and negotiation with Shell head office which was not the case if the payment were only $20,000 annually.

Each annual payment of $20,000 by Shell to the appellant was applied forthwith by the appellant to reduction of its obligation to its bank and bank statements were supplied to Shell in accordance with Shell’s insistence that the payments should be so applied, although I can see no logical reason for this on the part of the Shell officials other than that they wished to ensure that the appellant discharged its obligation to its bank.

As intimated at the outset, the Minister included the sum of $20,000 received by the appellant from Shell in the appellant’s income for the taxation years 1965 and 1966 to which inclusion the appellant objects.

As I understood the contentions on behalf of the appellant, they were :

(1) that the retail selling of fuel oil and the warehousing of asphalt under its terminal agreement were two separate and distinct businesses carried on by the appellant under one corporate structure, and

(2) that the cancellation of the contract with Shell destroyed the whole of the appellant’s business in asphalt and that the sum of $75,000 was paid by way of agreed compensation for the loss of that business; and alternatively

(3) that the sum of $75,000 was paid by way of compensation for the sterilization of a capital asset; and upon either view

(4) that the sum of of $75,000 was a capital receipt in the hands of the appellant and accordingly was not a profit of its trade.

On the other hand, it was contended on behalf of the Minister, as I understood these contentions:

(1) that the business of the appellant was that of dealing in petroleum products and that it, in fact, carried on but one business,

(2) that the contract in question was made in the ordinary course of the appellant’s business with a view to earning a profit,

(3) that the cancellation of the contract did not affect the appellant’s business as a whole;

(4) that the sum of $75,000 was in lieu of future profits which the appellant expected to earn under the contract and was, therefore, a profit from the appellant’s business ;

(5) that the sum of $75,000 was revenue and not capital and fell to be included in the assessable profits of the appellant accordingly.

In support of his contention that the appellant carried on only one business, counsel for the Minister pointed out that after the cancellation of the contract with Shell and the discontinuance of asphalt warehousing, the appellant still continued its fuel oil operation from which it followed that the cancellation of the contract did not affect the structure of the appellant’s business as a whole. He also pointed out that in the financial statements attached to the appellant’s income tax return, there was a schedule of continuity of fixed assets and capital cost allowance which included all such assets owned by the appellant without segregation as to the asphalt operation or the fuel oil operation. He directed attention to Section 1101(1) of the Income Tax Regulations which is to the effect that where more than one property of a taxpayer is in the same class and one of the properties was acquired for the purpose of producing income from a business and another of the properties was acquired for the purpose of producing income from another business, a separate class is thereby prescribed for the properties that were acquired to produce income from each business which would otherwise be included in the same class. From this circumstance he argued that the appellant considered its business as one, otherwise the properties would have been separated in accordance with Section 1101(1) of the Regulations.

In contradiction, counsel for the appellant submitted that the businesses were separate and distinct because of

(1) the different nature of the businesses, the fuel oil business was a retail sales operation and the asphalt business was warehousing ;

(2) the different technical nature of the businesses, particularly the special safety precautions required to handle hot asphalt ;

(3) the different equipment required in each operation ;

(4) separate bank accounts being kept for each business;

(5) different banking arrangements, the fuel oil business was financed by a line of credit extended to the appellant by its bank, whereas the asphalt business was financed by a loan;

(6) separate business records being kept for each business (there were books of original entry kept with respect to each operation) ;

(7) separate premises from which each business operated, except that the books were in the office premises and sales slips sent there;

(8) different employees operated each business without the possibility of interchange again excepting such general matters as the control by the same board of directors.

In Frankel Corporation Ltd. v. M.N.R., [1959] S.C.R. 715; [1959] C.T.C. 244, the Supreme Court had occasion to consider a related question. There the question was whether a sale by Frankel of its inventory in a non-ferrous smelting and refining operation was a part of a sale of a business and not a sale in the ordinary course of the company’s business so that the proceeds from such sale should not be considered part of the company’s income. In order to determine the matter the Court had to hold that the subject of the contract between Frankel and the purchaser was the sale of a business despite the fact that that business was not the subject of a separate incorporation.

Martland, J. speaking for the Court agreed with the conclusion of the trial judge that the business was a separate and distinct one.

In H. A. Roberts Limited v. M.N.R., [1969] S.C.R. 719 ; [1969] C.T.C. 369, an appeal from Sheppard, D.J., the Supreme Court considered the question of a company engaged in a real estate business and a mortgage business and held on the facts before it that the businesses were separate.

In my view the separation of the asphalt business conducted by the appellant herein from its fuel oil business was at least as distinct, if not more distinct, than the separation of the mortgage business from the real estate business in the Roberts case (supra) and the non-ferrous smelting and refining department in the Frankel case (supra).

To me the whole process by which the appellant earned profit from its asphalt business was quite distinct from that by which profit was earned in the fuel oil business, save in such general matters as control by the same board of directors and the ultimate preparation of the financial statements in a combined state.

The fact that the balance sheets were consolidated and that there was a single schedule of continuity of fixed assets and capital cost allowance is an indiciwm that the businesses were treated by the appellant as one, but which fact to me seems to be far outweighed by the preponderance of the indicia referred to by counsel for the appellant and which are outlined above to the effect that the businesses were separate and distinct. In the preliminary stages the auditor did complete separate accounts and even in the ultimate consolidation of those two sets of accounts into one, there still remained a degree of separation.

I therefore find, on the facts before me, that the asphalt warehousing and retail fuel oil sales carried on by the appellant were two separate and distinct branches or departments of the appellant’s business.

However this finding does not solve the matter. I must consider next whether the sum of $75,000 paid by Shell to the appellant was in lieu of the future profits which the appellant expected to earn under the contract and was, as such, a profit from the appellant’s business as contended by the Minister or the sum was paid by way of agreed compensation for the loss of that business or was paid for the sterilization of a capital asset as contended by the appellant.

Counsel for the appellant pointed to Mr. Kaneb’s testimony that the net annual profit to the appellant from its asphalt handling was between $8,000 and $10,000. He then pointed out that the sum of $75,000 approximates the total of the annual net profits for the seven years the contract had left to run.

The cancellation of the contract destroyed the appellant’s asphalt warehousing business. The appellant attempted to nego- tiate a like contract with other major suppliers of asphalt but without success, no doubt because a sufficiently large market did not exist in that area. The appellant investigated the possibility of adapting its asphalt storing and handling facilities to other uses but this proved to be impractical. The appellant’s contract with Shell was fortuitous and advantageous without which the appellant’s asphalt warehousing business came to a complete end. This contract was fundamental to the appellant’s asphalt business and constituted the whole structure of the appellant’s profit-making apparatus in this field. At the time of its termination the contract had seven years to run.

The test to be applied is, as I see it, what was the object of the payment. On the facts of this case I have come to the conclusion that the payment was for the termination of a separate business of the appellant, that the contract was a capital asset and accordingly the compensation therefor was likewise capital and cannot be assigned to the appellant’s income for its 1965 and 1966 taxation years under the authority of the well known cases of Van Den Berghs Ltd. v. Clark, 19 T.C. 390, and Barr, Crombie & Co., Ltd. v. C.I.R., 26 T.C. 406.

I do not attach any material significance that the payment of the sum of $75,000 was in three annual instalments of $20,000 and a fourth concluding instalment of $15,000 for the reason that it was explained by an officer of Shell that this was the most convenient way for the district office of Shell to make the payment of the amount.

I might add that the tanks and other equipment were later sold to Universal Fuels, owned and operated by George Kaneb, for $45,000, which were put to use by him in a manner not available to the appellant. There may be a question of the recovery of the excess of the proceeds over the undepreciated capital cost but I am not concerned with that question in these appeals.

The appeals are, therefore, allowed and the assessments are referred back to the Minister for re-assessment accordingly. The appellant is entitled to its costs in the amount of $1,100 which amount was agreed upon by the parties.