22 June 1989 Internal T.I. 8-0289 F - Deductibility of Fines and Penalties

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)

This is in reply to your memorandum of April 24, 1989, wherein you requested our comments with respect to your proposal to vacate the reassessments of 24(1) based upon the case of TNT Canada Inc. [1988] 2 CTC 91.

It is our understanding that the facts of the case, positions of the parties and your opinion are as follows:

I. Facts

24(1)

II. Taxpayer's Position

1. The taxpayer asserts that the circumstances under which the penalties were levied do not indicate that it committed any offence or has knowingly or under circumstances amounting to gross negligence failed to pay any federal sales tax as required.

2. Genuine efforts were initially made to comply with the Excise Tax Act, a fact situation purported to be similar to the Day & Ross Limited case (76 DTC 6433) in which penalties were found to be deductible. The Day & Ross case was relied upon in the TNT decision which the 24(1) claims is identical to its situation.

3. The method of calculating the penalty under subsection 50(4) of the Excise Tax Act is basically an interest calculation and interest on sales tax is deductible.

4. Given that the federal sales tax penalty is calculated similarly to interest, it is not the type of penalty envisaged by Interpretation Bulletin IT-104R.

III. Toronto District Office Appeals Division's Opinion

1. The jurisprudence on the topic of the deductibility of sales tax penalties supports the position reflected in Interpretation Bulletin IT-104R paragraphs 3 and 7, (see Horton Steel Works Ltd.v. MNR 72 DTC 1123).

2. The issue, as they see it, is whether the facts would allow the Department to modify the normal view of penalties as being non-deductible by reference to the criteria noted in paragraphs 4a and b of the above-noted Bulletin. They acknowledge that 24(1) efforts to have its tentative calculation reviewed by the Department's Customs and Excise Division and external auditor is evidence that the test of paragraph 4b may have been met however, the imposition of such fines cannot be said to be "... inevitable and beyond the control of the taxpayer and his employees" as required by paragraph 4a.

3. In order to illuminate the underlying meaning of paragraph 4a of Interpretation Bulletin IT-104R they cite the English Court of Appeal in the Commissioners of Inland Revenue vs. Alexander Von Glehn & Co. Ltd, 12 T.C. 232 in which the Court disallowed the deduction of a compromise penalty paid by the respondent in respect of alleged infringements. Lord Sterndale, M.R., ruled in that case that:

"the business could perfectly well be carried on without any infraction of the law at all."

"...there seems to me to be a difference between a commercial loss in trading and a penalty imposed upon the person or a company for a breach of the law which they have committed in that trading."

4. Based on the reasoning noted above they are of the opinion that the taxpayer could have carried on the business without any infraction of the law. Although 24(1) took reasonable steps to preclude a sales tax reassessment, the measures do not absolve it of the ultimate responsibility for adherence to the Excise Tax Act.

5. Furthermore, none of the substantive impediments to complying with the provincial statutes, found in the Day & Ross case, can be said to be present in the matter under review. On these grounds,it is their opinion that the disallowance of sales tax penalties should be confirmed.

IV. Your Comments

Although you disagree with the taxpayer that the facts of its case are "identical" to those of TNT, you believe that the TNT case still applies for the following reasons:

1. Paragraph 7 of IT-104R was based on the Horton Steel case. It can be argued that the hard line taken in this case was somewhat softened by the Day & Ross judgement which is subsequent to it and at a higher court level. This reasoning is supported by Justice Cullen's comments at page 99 of TNT, " the cases prior to Day & Ross, supra, tended to adhere to the view that fines imposed as a result of an infraction of the law would not be regarded as a proper deduction. The basis for this view is found in CIR v. Alex Von Glehn & Co. Ltd., 12 T.C. 232. In Day & Ross, Dube, J. seemed to take a more liberal view of the deductibility of fines under paragraph 18(1)(a) of the Act. " and at p.101 "... we have seen a more liberal approach to the subject in Day & Ross and more likely will follow."

2. Using the wording of paragraph 4(b) of IT-104R, it is your opinion that the penalty "... does not result from negligence, ignorance or deliberate disobedience of the law, (the infraction) does not endanger public safety and the offence is not one of moral turpitude ...". The examples given in parentheses after "moral turpitude" appear to be incongruous with the preceding words.

You believe your reasoning would be approved by the Courts as Justice Cullen states, again on page 99 of TNT, that "...Dube,J. concluded that the fines were not precluded from deductibility (on) the basis of a "broader principle" known as public policy." It is your view that allowing the penalty in the present case would not contravene public policy. The penalty arose as a result of an honest error made by a company employee.

3. In the Canadian Motor Sales Corporation Limited (CMSCL) case [1977] CTC 2037, it was held that a penalty similar to 24(1) was not deductible. However, Justice Cullen seems to disagree with the decision as he states at page 99 of TNT that CMSCL's lawyer erred in conceding that the penalty was not deductible.

V. Our Comments

1. In reviewing the Day & Ross decision, it seems to us that the overload penalties were allowed because the taxpayer's trucks were loaded by their customers and the taxpayer had relied on their declared shipping weights. The taxpayer treated the amounts recovered from customers in respect of fines incurred as revenue. In a competitive business like theirs it was impractical, if not impossible, to exercise control regarding the overloading of their vehicles. As a result, the overload penalties were considered, by the Court, to be "unintentional violations" and as such were not "outrageous transgressions of public policy".

2. In the TNT decision, the Department's counsel conceded that pursuant to Dube, J., in Day & Ross, the penalty imposed for having repair work done in the United States and purchasing parts there without paying the necessary sales and excise tax was deductible. We feel the better view is that the penalties allowed in the Day & Ross case are summed up by Dube, J. at p.6640.

"In the absence of constant control by the plaintiff over the exact cargo weight carried in its trailers, and the uncontradicted evidence would suggest that such a tight control would be impractical if not impossible in a very highly competitive road transport industry, then unintentional violations of weights restrictions would seem to be inevitable."

3. While we would agree with your view that the penalty "...does not result from negligence, ignorance or deliberate disobedience of the law, (the infraction) does not endanger public safety and the offense is not one of moral turpitude ...", we feel that the penalty cannot be said to be "...inevitable and beyond the control of the taxpayer and his employees" as noted by the Toronto District Office Appeals Division and as required in the Day & Ross case.

4. Based upon the above, we feel the non-deductibility of the penalties imposed in 24(1) should be confirmed on the basis that the penalties were avoidable and within the control of the taxpayer and as a result the decision in Day & Ross is not applicable.

We are enclosing your file submitted with your memorandum.

for Director General Specialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch

c.c. Publications Division