28 September 1990 External T.I. 74385 F - Requirements for Deductibility of Damages

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Subject:  24(1)                           

We are writing in reply to your request dated September 19, 1989, as amended, for our comments in relation to the income tax treatment 24(1)

Facts

Our understanding of the salient facts is as follows:

24(1)

Principal Issues

You have confirmed that the principal issues are: 

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Our Comments

24(1)

Paragraphs 4 and 5 of IT-467 set out the factors to consider in order to determine whether or not  24(1) would be deductible in computing income. Paragraph 5 thereof states that where damages are paid as the result of an event which is incidental to business operations, or where the potential liability to pay such damages is a risk normally inherent in those operations, the deduction of the expenditure will not be considered to be prohibited by paragraph 18(1)(a) of the Act. The case Imperial Oil limited v. M.N.R., 47 DTC 1090 (Ex. Ct.), is often quoted in support of this assertion.

In the Imperial case, the taxpayer paid damages of $526,995.35 in settlement (out of court) of a claim by another company for destruction of its ship resulting from a collision with the taxpayer's oil tanker.  The taxpayer's deduction of the payment was challenged under paragraph 6(a) of the former Act which is the forerunner to paragraph 18(1)(a) of the Act.  In finding that the payment was deductible by the taxpayer, Thorson P. had this to say at page 1096

     "The issue of fact is whether the payment made was in respect of a liability for a happening that was really incidental to the business.  In my view, there is no doubt that it was.  The undisputed evidence is that the transportation of petroleum and petroleum products by sea was part of the marine operations of the appellant and part of the business from which it earned its income, that the risk of collision between vessels is a normal and ordinary hazard of marine operations generally, and that, while the amount of the appellant's liability in the present case was unusually large there was nothing abnormal or unusual about the nature of the collision itself."

Thus, Thorson P. concluded that payments made with respect to liabilities for events that are incidental to a business or for risk that are normal and ordinary hazards of the business are deductible in computing income for tax purposes.

The hazards and risks associated with the mining and use of asbestos have been widely known for a long time.  An article entitled "Defender of Asbestos", The Ottawa Citizen, Saturday July 21, 1990 contained the following:

     "Scientists began documenting the links between cancer and  asbestos more than 50 years ago, but it wasn't until tile 1970's that countries began improving controls on asbestos dust in the workplace.

     But by then, health fears about the mineral had already sent the Canadian asbestos industries in Quebec, Newfoundland and British Columbia into a spiral.  The Quebec industry alone has seen its 6,500 workforce drop two-thirds in the past decade.

     The U.S. market has been shrinking since the U.S. health secretary labelled asbestos a cancer-causing agent and a strong contributor to lung disease...". 

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Paragraph 11, IT-467 also states that legal fees incurred in the payment of damages will be deductible provided that the damages are deductible under the Act. 

23

24(1)

In Custom Glass Ltd. v M.N.R., 67 DTC 5207 (Ex. Ct.), Shepard, D.J. considered whether insurance proceeds, which the taxpayer received for payments under warranties, were income for tax purposes. 24(1) In his analysis, Shepard, D.J. stated at page 5211 that

     "The fact that such monies are received under the policy of insurance is not material in that insurance monies are treated as income when paid to make good, the loss of income."

Shepard, D.J. also cited the Burmah Steamship and B.C. Fir cases, inter alia, in deriving his decision that the insurance proceeds received by Custom Glass were income for tax purposes; being amounts received for loss of income in carrying on business.  

24(1)

3.  Resource Profits

A.     Settlements Paid 

     24(1) 

     In Commissioners of Taxation v. Kirk (1990) A.C.588, a statutory provision under consideration provided for a tax on income arising  rom any trade carried on in New South Wales or derived from lands of the crown and stated that no tax shall be payable in respect of income earned outside the Colony. The taxpayer derived its income from the extraction of ore from the soil of New South Wales Colony and the conversion in the Colony of the crude ore into a merchantable product which was sold exclusively outside the Colony. The Supreme Court had held that the income was not earned in the Colony because the finished products were sold exclusively outside the Colony.  The Privy Council held that the real question was whether any part of the profits were earned or produced in the Colony. It stated that no special meaning was to be attached to the word "derived" which was treated as synonymous with arising or accruing and that there were four processes in the earning or production of the income, that is, the extraction of the ore, the conversion of the crude ore, the sale of the product and the receipt of the money.  It held that so far as it relates to the first two processes, the income was earned and arising and accruing in the Colony.

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B.     Reimbursements Received

     24(1)

     In M.N.R. v Bessemer Trust Company et al, 73 DTC 5045 (F.C.A.) end 72 DTC 6404 (F.C.T.D.), the F.C.A. reached a different decision than the F.C.T.D. in relation to the application of section 110 of the former Act (not section 216 of the Act). However, both courts shared the view that generally, the recapture provisions of the Act and Regulations are fundamentally adjustments to income of previous years and do not create, in the year of disposal of the asset, some new form or source of income. 

     24(1)

     In Cominco Ltd. v The Queen, 84 DTC 6535 (F.C.T.D.), leave to appeal was refused at the F.C.A. and Supreme Court levels, it was held that insurance proceeds received by the taxpayer for business interruption could not be characterized as "production profits" or resource profits because they simply did not arise out of the production of metal or industrial minerals or from the processing in Canada of ores from a mineral resource.  Reed, J. stated at page 6537

     "The question, then, is whether the insurance proceeds should be considered to be not only income in the hands of the taxpayer but also, more specifically, production  profits from his mineral processing operation. There is no doubt that had the plaintiff actually earned the income for which the insurance proceeds are replacements, they would have been considered production profits...".

     24(1)

     With respect, the taxpayer's eligibility for deduction under subsection 65(1), in and by itself, was not the major issue in the Cominco Case.  It is our view that the case was decided on the application of Part XII of the Regulations which provides, inter alia, for the computation of production profits. Reference page 6536 of the case where Reed, J. states "It is Part XII of the Income Tax Regulations which is relevant."

     Since Part XII of the Regulations, viz., the income from production of ore from mineral resources in Canada under clause 1204(1)(b)(ii)(A) of the Regulations, is also relevant to the computation of resource profits for purposes of the resource allowance deduction permitted under paragraph 20(1)(v.1) of the Act, it is clear that both subsection 65(1) and paragraph 20(1)(v.1) rely on Part XII of the regulations for computation of resource profits.

     24(1)

4.  Other

A.     Carrying on Business

     24(1)

B.     General and Administrative Expenses

     24(1)

     In Johns-Manville Canada Inc. v M.N.R., 85 DTC 5373 (S.C.C.), the court considered whether the taxpayer's cost of acquiring land in the course of asbestos mining was on account of capital or income. The court found that there was no tax relief of any kind with respect to these ongoing expenditures.  The court then stated at page 5282 

     "On the other hand, if the interpretation of the taxation statute is unclear, and one reasonable interpretation leads to a deduction to the credit of a taxpayer and the other leaves the taxpayer with no relief from clearly bona fide expenditures in the course of his business activities, the general rules of interpretation of taxing statues would direct the tribunal to the former interpretation."

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A/DirectorBilingual Services & Resource Industries DivisionRulings Directorate