Minister of National Revenue v. Time Motors Limited, [1968] CTC 131, 68 DTC 5081

GIBSON, J.:—This appeal, from a judgment of the Tax Appeal Board dated December 23, 1966 (42 Tax A.B.C. 400), relates to re-assessments dated May 7, 1965 in respect of the taxation years of the respondent ended June 30, 1961, 1962, and 1963 whereby the appellant added to the respondent’s income respectively the sums of $4,413, $9,870 and $1,615.

These sums represented credit notes issued to customers of the respondent, from whom the former had purchased used cars and which had not been redeemed in these respective taxation years. In computing its income for these respective years, the respondent deducted as an expense in the years in which the credit notes were given, the total amount of the credit notes on the basis that such notes were a current liability. By the reassessments these deductions were disallowed on the basis that these deductions were considered a contingent liability.

The respondent at all relevant times was in the business of buying and selling used cars. These credit notes were issued to customers from whom cars were bought. In every such case, the customer was given part cash together with a credit. note. But these credit notes were issued in the course of the respondent’s business in the case of relatively few purchases of cars from customers, namely in about 200 purchases out of a total of 9,000 in a nine-year period.

Every such credit note had an expiry date, was non-transfer- able, could not be redeemed for cash but instead could be redeemed only on the purchase of another used car owned by the respondent and to a value of not less than an amount substantially in excess of the face value of the credit note, and were issued for the difference between what the purchased car was worth in the wholesale market and the cash paid to the customer.

The appellant submitted that these sums were not outlays or expenses incurred by the respondent within the respective taxation years and their deduction in computing income was prohibited by Section 12(1) (a) of the Income Tax Act; that these sums were transferred or credited to a ‘‘contingent account’’ and their respective deduction in computing the respondent’s income for the taxation years 1961, 1962, and 1963 respectively, was prohibited by Section 12(1) (e) of the Income Tax Act; and finally, that in any event the deduction of the amount of these credit notes in the said taxation years was prohibited by Section 137(1) of the Income Tax Act because such. deduction would be in respect of a disbursement or expense made or incurred in respect of an operation that if allowed, would unduly or artificially reduce the income of the respondent.

The respondent denies the submissions of the appellant and says that the credit notes issued by the respondent created an immediate binding legal obligation upon the respondent to give credit for the notes when presented, and that these credit notes represented existing trading obligations arising from trading transactions and that they were in no way contingent either in accordance with accepted accounting principles and practice or legal definition.

Two witnesses gave evidence, namely Mr. Paul Davidson Gardner, sales manager of the respondent, and Mr. Henry Richardson Lawrie, chartered accountant of the firm of chartered accountants who did the audit and prepared the financial statements of the respondent during these years.

Mr. Gardner explained the way the respondent’s business was carried on at the material times and the circumstances surrounding the issuance of these credit notes. He said that cars were bought at wholesale prices, and that the trade-in value allowances were also based on the wholesale market price of each car; that each car deal stood on its own—each was a “horse- trade’’ in that there was no fixed mark-up; that the listed selling price of every car was always subject to negotiation; that the repair cost to cars were bulked in the accounts and not allocated to each car; that the inventory value of the cars at each fiscal year end was based on the then wholesale market value of the cars without reference to their cost; that credit notes were issued only in the cases where the respondent bought cars by payment of cash plus the face value of the credit note; that in honouring a credit note, it was considered a second deal and that the respondent considered it was entitled to a profit on each of the two deals; that in honouring a credit note, the respondent always got full mark-up and a greater mark-up than if the buyer were paying all cash or equivalent financing; that the respondent expected and it happened that a substantial number of the credit notes expired; that the credit notes on expiration were eliminated from the liability account by debit entries, thereby changing the time period when the profit represented by them was taken into income.

Mr. Lawrie, who became a chartered accountant in 1960, was the chartered accountant supervising the audit of the respondent’s accounts during the years 1961 to 1968. Prior to 1960, when he was one of the persons doing the field work for the preparation of the year end financial statements of the respondent, he was told by the person then in charge of the field party that these credit notes were an immediate contractual obligation and therefore were an existing obligation and not a contingent liability. He stated that this was his reason for considering them not a contingent liability. During the years 1961, 1962, and 1963, he did none of the field work, did not check the accuracy of the entries in the respondent’s books, made none of the adjusting and closing entries, but instead only reviewed the working papers when they were turned in by the persons doing the field audit. He did not consider it relevant for the purpose of ascertaining whether or not these credit notes were contingent liabilities as opposed to current liabilities, to enquire as to the methods employed by the respondent in carrying on its business or the surrounding circumstances giving rise to the issuance and redemption of these credit notes, and as a consequence did not enquire.

In coming to a decision on the evidence as to the issues raised in this appeal, only the testimony of Mr. Gardner is of any assistance. The testimony of Mr. Lawrie has very little evidentiary weight because he has no knowledge of any facts that are relevant. His firm’s certificate on the financial statement, Exhibit R-11, is also of no help in deciding whether the balance sheet and statement of profit and loss are properly drawn up as the certificate says, ‘‘In accordance with generally accepted accounting principles’’, because among other things, Mr. Lawrie obtained no information and explanations from the respondent in relation to these credit notes which was of any value for such purpose. But, whether or not these financial statements were drawn up according to generally accepted accounting principles, can be disregarded in coming to a decision on the issues raised in this appeal.

In my view, this appeal may be decided by coming to a conclusion as to whether or not the said sums in the respective years were amounts transferred to a ‘‘contingent account’? within the meaning of those words as employed in Section 12 (1)(e) of the Income Tax Act.

The words ‘‘contingent account’’ are not defined in the Income Tax Act. They are not words of art. By dictionary definition there must be an element of uncertainty before an account qualifies as a contingent account, and the element of the uncertainty must be as to the obligation.

In my view, interpreting the evidence of Mr. Gardner in relation to this concept of ‘‘contingent account’’ gives the true meaning of these words in reference to the facts of this case. From Mr. Gardner’s evidence it is clear that there existed the uncertainty as to the obligations arising from these credit notes at all material times, in that the respondent knew that a substantial number of them would expire and not be redeemed; that in respect of those that were redeemed they would be redeemed only on the basis that a higher price would be paid for the same car by every buyer using such a credit note than by every other buyer paying by cash or equivalent financing; and that every credit note always bore a face value low enough in relation to the price of a car against which it could be applied, to permit this. The respondent, therefore, in its dealing, in my view, considered these credit notes, if anything, as a contingent liability within this meaning. The respondent knew it would have no liability for the amount of the majority of the credit notes, which would expire, and not be redeemed, and as to the rest of them the respondent knew that it would be liable for only a small fraction, if any, of the face amount of these credit notes, when redeemed, in view of the respondent’s said method of dealing with the purchasers of cars who presented these credit notes for redemption as part of the purchase prices.

In consequence, the said sums in the respective years were in reality amounts transferred or credited by the respondent to a “contingent account’’ and their deduction in computing the respondent’s income in these taxation years was prohibited by Section 12(1) (e) of the Income Tax Act.* [1]

The appeal is allowed and the re-assessments dated May 7, 1965 are restored.

The appellant is entitled to its costs.