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.

Principal Issues:

1. Are clean-up costs deductible as expense for year incurred.

2. Is some clean-up cost expense and other costs capital.

3. Is the capital part of clean-up cost added to cost of land.

4. Will capital cost of depreciable property for water pollution qualify for Class 24.

5. Are costs to XXXXXXXXXX capital or expense.

6. Are clean-up costs incurred after the business was sold treated different from costs incurred while business was still operated.

Position TAKEN:

1. Expenditures to clean-up of pollution caused by business operations is expense.

2. Whether a cost is expense or capital is a question of fact and the answer depends on the purpose of the outlay.

3. Whether a capital cost is a cost of land is a question of fact.

4. Depreciable property must meet all requirements of Class 24.

5. XXXXXXXXXX may be a structure for the purposes of Class 1

6. Where there continues to be a responsibility or liability for a business or the results of a business, the business may continue.

Reasons FOR POSITION TAKEN:

According to Imperial Oil, 47 DTC 1090, Denison Mines Limited, 71 DTC 5375, Johns-Manville Canada Inc., 85 DTC 5373, Algoma Central Railway, 68 DTC 5096, Oxford Shopping Centres Ltd., 81 DTC 5065, Dominion Natural Gas Co. Ltd., 1 DTC 499-133

If a cost is directly related to or incidental to a business operation, it is an expense of the business.

									April 13, 1995

	 XXXXXXXXXX  District Office					Resource Industries
		    							Section
		Attention:XXXXXXXXXX 	 				 B. Rankin
		Large Business Audit	  				(613) 957-8974
		XXXXXXXXXX
				 					7-941337

XXXXXXXXXX . - Environmental Clean-up Costs

This is in reply to your memorandum of May 13, 1994 concerning XXXXXXXXXX and approximately $XXXXXXXXXX of environmental clean-up expenditures incurred in the period XXXXXXXXXX. We apologize for the delay in providing our response.

We understand from your memorandum and our telephone conversations that XXXXXXXXXX has been advised that a major portion of the $ XXXXXXXXXX costs have been treated as deductible expense and the remainder as capital expenditures to be amortized over three years as class 24 property. This settlement was reached to facilitate the completion of the XXXXXXXXXX audit.

Background

XXXXXXXXXX.

Questions

1) Should all clean-up costs be treated as deductible expense in the year incurred under section 9 and paragraph 18(1)(a) of the Act (with the exception of depreciable assets)?

2) Should some clean-up costs be treated as deductible expenses and others as capital expenditures?

3) Should the capital portion of the clean-up costs be added to the cost of the land?

4) Should capital expenditures relating to depreciable assets used for water pollution control purposes be included in class 24?

5) How should the costs associated with sealing and securing the "XXXXXXXXXX" be treated? Should they be treated differently than the costs of decontaminating the water?

6) Should the clean-up costs incurred prior to XXXXXXXXXX be treated differently than costs incurred after XXXXXXXXXX?

Our Comments

Question 1:

Should all clean-up costs be treated as deductible expenses in the year incurred under section 9 and paragraph 18(1)(a) of the Act?

Our comments on Question 1 are divided into two parts. The first part considers whether reclamation and clean-up expenditures are incurred for the purpose of earning income from business. The second part considers the time reclamation and clean-up costs may be deducted.

(A)Clean-up costs as expense in earning income.

For the purpose of this discussion, reclamation or clean-up includes removal, treatment or disposal of discarded materials and pollutants of soil and water, replacement of removed soil, site rehabilitation and maintenance costs to return the location to a natural habitat consistent with that found in other local undisturbed sites. Costs to plant vegetation and costs to maintain the site so that residue or pollutants that remain at the site do not escape and affect the neighbouring land, water or atmosphere are also included.

In order to determine whether a particular reclamation or clean-up expenditure is made or incurred for the purpose of gaining or producing income from a business or property the following factors (i to viii) are relevant. The factors are derived from those considered by the Supreme Court of Canada in Johns-Manville Canada Inc. v. Her Majesty The Queen, 85 DTC 5373, at page 5382.

(i) The purpose of the expenditure, viewed from a practical and business outlook, is to correct, treat, remove or modify pollutants, residue, discarded material and substances where the condition corrected or repaired is a direct result of activity for the purpose of gaining or producing income from business or property.

In Imperial Oil Limited v. Minister of National Revenue, 3 DTC 1090 (E.C.C. 1947) damages paid as a result of a collision between Imperial's oil tanker and another vessel were found to be a deductible operating cost for accounting and tax purposes as an operating expenditure incurred for the purpose of earning income. On page 1099 and 1100 Thorson, P. states that all expenses necessary and incidental to the business operations should be deducted in determining the profit from the operation that is subject to tax. For this purpose, expense includes all costs of the ordinary operations as well as all expenditures incurred to discharge the liabilities normally encountered in the operations. Thorson, P. also concluded that an expenditure that is intended to satisfy a legal liability which is directly related to the conduct of the business is a cost of that business. By analogy, costs incurred to clean-up pollution, residue and substances that were a direct result of the business operations will also be considered to be a cost of the business.

Consolidated Textiles Limited v. Minister of National Revenue, 3 DTC 958 (E.C.C. 1947) established that in order for an expenditure to be incurred for the purpose of earning income from business there is no requirement for income to be traced back to it.

Vallambrosa Rubber Co., Ltd. v. Farmer (Surveyor of Taxes) 5 T.C. 529, No.311 Court of Session (Scotland) First Division, 1924, considered the deductibility of costs of tending to rubber trees which were not expected to yield rubber for six years. This decision is often cited as supporting the view that income need not be traced back to an expenditure before the expense is deductible as having been made for the purpose of earning income. Similarly, Commissioners of Inland Revenue v. Carron Company, (C.S.) 1967 S.C. 204; 1967 S.L.T. 186; (H.L.) 1968 S.C. (H.L.) 47; S.L.T. 305 at the First Division of the Court of Session refers to British Insulated & Helsby Cables Ltd. v. Atherton (1926) A.C. 205, whereby it was said that a sum of money spent voluntarily to facilitate the conduct of the business may be considered to be wholly and exclusively for the purpose of the trade.

The unanimous Supreme Court of Canada decision Minister of National Revenue v. Dominion Natural Gas Co. Ltd., 1 DTC 499-133 (S.C.C. 1940) established that the test applied in Robert Addie and Sons' Collieries Limited v. The Commissioners of Inland Revenue (1924) 8 T.C. 671, Court of Session (Scotland) First Division by Lord Clyde and affirmed by the Privy Council in Tata Hydro-Electric Agencies Ltd., Bombay, v. Commissioner of Income Tax, Bombay Presidency and Aden, (1937) A.C. 685 was binding with respect to the question of Dominion's legal expenses incurred while defending its right to supply gas. The rule states that the principles of ordinary commercial trading apply to determine if an expenditure is part of the working expenses made in the process of earning profit from carrying on a business. In Dominion, the Supreme Court recognized that legal expenses can be a working expense incurred as part of the income earning process. However, Dominion's expenditures were not directly connected with the daily operations.

By analogy, many of the costs incurred by XXXXXXXXXX, which can be said to be made voluntarily or on account of a legal liability, are necessary and a direct result of the day-to-day business conducted at XXXXXXXXXX.

In Johns-Manville Canada Inc., the Supreme Court concluded that expenditures to acquire land adjoining the expanding pit were incurred for the purpose of earning income in the course of the regular day-to-day business operations. On page 5383 Estey, J. considerd a principle taken from B.P. Australia Ltd. v. Commissioner of Taxation of the Commonwealth of Australia, (1966) A.C. 224 at pages 264 and 265 that it is a commonsense appreciation of all the guiding features which must weighed. In determining the character of the advantage that Johns-Manville sought through acquiring the land around the pit Estey, J. commented that the expenditures were recurring and directly incorporated into the mining operations. As a result, it was concluded that the expenditures were incurred in the course of the regular day-to-day business operations.

The 1954 House of Lords decision Morgan (H.M. Inspector of Taxes) v. Tate & Lyle, Ltd., (1955) A.C., confirmed the deduction of costs incurred in respect of a propaganda campaign in opposition to the threatened nationalization of the sugar refining business. While we are not convinced that the same result would have been reached with respect to similar expenditures made in Canada, it is noted that the fact the costs were not incurred in the course of the daily operations and were made voluntarily was not critical to the Court's finding. The point is also present in British Insulated & Helsby Cables Ltd. v. Atherton (1926) A.C. 205 and Usher's Wiltshire Brewery, Limited v. Bruce, (1915) A.C. 433, and was also relied upon in Berman & Co. Ltd. v. Minister of National Revenue, 61 DTC 1150 (E.C.C.). By analogy, costs directly related to or incidental to the daily business operations are expense incurred for the purpose of gaining or producing income from the business.

The decisions for Her Majesty The Queen v. Burnco Industries Ltd., 84 DTC 6348 (FCA) and Her Majesty The Queen v. Nomad Sand and Gravel Limited, 91 DTC 5032 (FCA) are relevant to the requirement that reclamation and clean-up costs bear a direct relation to the business. In each decision the nature of the expense was not found to be capital and it appeared that the court was willing to consider the expense as directly related to the removal and sale of gravel.

In summary, expenditures made voluntarily or in compliance with a legal requirement, to clean-up or reclaim a site where the condition that is corrected or modified is a direct result of a business operation will be considered to be business expense. Please see our comments later in this memorandum regarding capital outlays. Expense incurred for the purposes described as XXXXXXXXXX would be business expense.

(ii) The expenditure is recurring or continuous as an integral part of the day-to-day operations.

In Johns-Manville, the fact that land purchases were recurring and a direct result of the business operations was significant to finding that the outlay was expense on account of income. Reclamation and clean-up costs are frequently incurred at one time and not ongoing, as a result, there is uncertainty about whether these expenditures are on account of income. Imperial Oil, Denison Mines Limited v. Minister of National Revenue, 71 DTC 5375 (FC-TD), and Dominion Natural Gas Co. Ltd. all considered expenditures to be on account of income if the amount was incurred for a purpose directly related to or incidental to the business operation. In considering whether a cost would be viewed as having been made as a result of a recurring or continuous need, we found relevant comments in Ounsworth (Surveyor of Taxes) v. Vickers, Limited, (1915) 3 K.B. 267. The question in Vickers, Limited involved costs incurred to dredge a shipping channel that had been neglected for a number of years. Speaking for the High Court of Justice (King's Bench Division) Rowlatt, J. agreed that continuous dredging on an ongoing basis would be expense in determining income. He went on to say that the dredging would continue to be on account of income even when it was not done for a number of years because it was not worth while to do so and was only done when matters became serious enough. In the opinion of Rowlatt, J. the dredging continued to be an expense of earning income because the channel was continuously filling with silt and it was not crucial that the expenditure to remove the silt was not made contemporaneously with the need to do so.

By analogy, the need to clean-up pollutants that result from the conduct of the business at XXXXXXXXXX is continuous and the character of that cost is not affected by virtue of the clean-up being done all at once instead of continuously while the business was conducted.

(iii) The expenditure is made necessary or the need for the expenditure arises as a result of a more or less constant element that is part of the day-to-day operations of the business.

As was the case with the expenditures considered in Vickers, Limited and Johns-Manville, the need to clean-up the XXXXXXXXXX was a constant element of the day-to-day business operations.

(iv) The expenditure produces a transitional benefit that is not of an enduring benefit because similar expenditures would be required to be made in the future if the business operation continued.

Similar to the silting in of the shipping channel or the continuing need to shape the walls of the open pit mine operated my Johns-Manville, the ongoing need to clean-up pollution and treat or dispose of residue and substances that are a result of the operation of the business would produce a transitional benefit that endures for only a temporary period because continuing operations create a repetitive need.

(v) The expenditure is not for the purpose of creating or acquiring a benefit of an enduring advantage to the business or another business or property of the person making the expenditure.

Denison Mines Limited v. Minister of National Revenue, 71 DTC 5375 (FC-TD) considered whether costs incurred to excavate and mine an underground ore body were capital in respect of the underground passage-ways that resulted from the mining. The alternate view was that the costs were incurred for the purpose of mining. Cattanach, J. stated on page 5386 that the passage-ways were incidental to the mining and costs were incurred for the purpose of mining the reserves. By analogy, XXXXXXXXXX need to clean-up the XXXXXXXXXX is a direct result of the business. Thus, costs to clean-up, treat and remove substances that are introduced to the site as a direct result of the business are not considered to be for the purpose of acquiring a benefit or enduring advantage. Generally, whether there is a benefit or enduring advantage as a result of the clean-up expenditures is a question of fact. According to Vickers, Limited one should carefully consider if the purpose of the expenditure is to clean-up or correct something directly related to the business or is the purpose to go beyond correcting or repairing damage introduced by the business operations.

(vi) The expenditure does not add to or enhance the value of existing property or land.

Where the clean-up and reclamation costs are incurred on account of income as a direct result of the operation of a business, we would measure the value of the property or land not from the value in its polluted state but the value it would have in a natural undisturbed state. We recognize that polluted land is worth significantly less than unpolluted land. However, since pollution was incidental to the business, correcting or modifying the polluted condition is not for the purpose of adding to or enhancing the land value. It will always be a question of fact whether the objective for the clean-up is more than to repair or modify pollution and return the site to a natural unpolluted state. Expenditures that are made to improve the site beyond its former natural state suggest that there is an intent to enhance the market value of the land or prepare it for a new use.

(vii) Depreciable property is not acquired or created as a result of the expenditure.

Please see our comments concerning depreciable property that follow.

(viii)The relative amount of the expenditure is not material in comparison with the relative cost of the business operations.

In Minister of National Revenue v. Vancouver Tug Boat Company Limited, 57 DTC 1126 (E.C.C.) and Canada Steamship Lines Ltd. v. Minister of National Revenue, 66 DTC 5205 (E.C.C.) the relative amount of an expenditure was a factor in determining whether a cost is considered to be a repair or alternatively the cost for a new asset. In Oxford Shopping Centres Ltd. v. Her Majesty the Queen, 79 DTC 5458 (FC-TD) there was no question that the expenditure in question was material in comparison with the relative cost of the business operations. At page 5466, Thurlow, A.C.J. comments that an expense on account of income should be considered in determining the income for the year it is incurred even if the deduction will distort the income for that particular year. By analogy, costs incurred to clean-up and reclaim land affected by the operation of a business will not be treated as capital when they are material when compared to the normal operating costs for that business. As in Vancouver Tug Boat Company Limited and Canada Steamship Lines Ltd. the materiality of the expenditure alone and by itself does not affect the income character of that cost.

(B) Time of Deduction

Her Majesty The Queen v. Burnco Industries Ltd., 84 DTC 6348 (FCA), considers the time a cost is incurred with respect to being deducted as expense in determining income. At page 6348 Pratte, J. said that an amount can not be considered to be a deductible expense unless it has been incurred and the taxpayer is obligated to pay money. Also, I.B. Pedersen Limited v. Her Majesty the Queen, 94 DTC 1085 (T.C.C.) concluded that a reserve for future reclamation and site maintenance costs was not deductible. An obligation to make an expenditure in the future does not qualify as an expense.

In Oxford Shopping Centres Ltd. v. Her Majesty The Queen, 79 DTC 5458 (FCTD) the amount in question had been paid to The City of Calgary. At page 5466 Thurlow, A.C.J. comments that while the "matching principle" applies to expenses related to particular items of income, the principle does not apply to business operating expense even though the deduction of a particularly large expense in the year it is paid will distort the income for that particular year. While GAAP called for Oxford's expenditure to be amortized, the Federal Court-Trial Division concluded that the amount was a business expense deductible in the year it was paid. In support of his conclusion, Thurlow, A.C.J. refers to the decisions Associated Investors of Canada Limited v. Minister of National Revenue (1967) 2 Ex. C.R. 96, Vallambrosa Rubber Co. Ltd. v. Farmer, (1910) 5 T.C. 529, Naval Colliery Co. Ltd. v. C.I.R., (1928) 12 T.C. 1017, Tower Investment Inc., 72 DTC 6161 and Minister of National Revenue v. Canadian Glassine Co. Ltd., 76 DTC 6083. In addition we would add a reference to Lawrence H. Mandel v. Her Majesty the Queen, 78 DTC 6518 (FCA) confirmed by the Supreme Court of Canada in Lawrence H. Mandel v. Her Majesty the Queen, 80 DTC 6148, where it was concluded that a contingent amount for the purchase of a motion picture film was not a cost of the film.

In summary, an expense for the purpose of gaining or producing income from a business is deductible in computing income for the period it is incurred or paid, whichever is earlier.

Question 2:

Should some clean-up costs be treated as deductible expenses and others as capital expenditures?

XXXXXXXXXX.

In Johns-Manville Canada Inc. v. Her Majesty The Queen, 85 DTC 5373 (S.C.C.) the court recognized that the expenditures were made to remove an obstacle to the operation of the mine. It was also noted that expenditures were incurred repeatedly over the years as an integral part of the day-to-day operations. The amounts were found to be a cost of the production.

Johns-Manville refers to B.P. Australia Ltd. v. Commissioner of Taxation of the Commonwealth of Australia (1966) A.C. 224, Hallstroms Pty. Ltd. V. Federal Commissioner of Taxation (1946) 72 C.I.R. 634, and Sun Newspapers Limited v. Federal Commissioner of Taxation (1938), 61 C.L.R. 337 in commenting that all relevant circumstances are to be weighed to reach a common sense appreciation of the features that when taken together indicate the character of the expenditure. Comments in Hallstroms at page 647 and Sun Newspapers at page 363 offered support in Johns-Manville and emphasize that to distinguish between expenditures of capital and expenditures on account of capital one should consider the difference between acquiring the means of production and using that means, establishing or extending the organization and carrying on the business, the advantage sought and if there are lasting qualities of that advantage.

B.P. Australia is also mentioned in Minister of National Revenue v. Algoma Central Railway, 68 DTC 5096 (S.C.C.) at page 5097 where Fauteux J. said:

Parliament did not define the expressions "outlay...of capital" or "payment on account of capital". There being no statutory criterion, the application or non-application of these expressions to any particular expenditures must depend upon the facts of the particular case. We do not think that any single test applies in making that determination and agree with the view expressed, in B.P. Australia Ltd. v. Commissioner of Taxation of the Commonwealth of Australia, (1966) A.C. 224, by Lord Pearce.

In Algoma Central Railway v. Minister of National Revenue, 67 DTC 5091 (E.C.C.) it was concluded that the amount Algoma paid to have a geological survey done was a deductible expense incurred to earn income from business. In finding that the expenditure was not incurred to bring into existence an advantage for the enduring benefit of the business, Jackett P., referred to the often cited test applied by Viscount Cave in British Insulated and Helsby Cables, Ltd. v. Atherton, (1926) A.C. 205:

But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.

Our opinion on the character of the XXXXXXXXXX clean-up expenditures was reached after weighing all the known factors with respect to the expenditures described in your submission. In weighing the reasons and purposes for making reclamation and clean-up expenditures, we recognize that in the majority of circumstances, some degree of capital element is present. In Johns-Manville on page 5377, Estey, J. highlights a comment Lord Pearce made at pages 264 and 265 in B.P. Australia:

The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in border line cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree.

On balance, expenditures that are a capital cost of equipment, facilities and structures for XXXXXXXXXX will be considered capital. We also note that the XXXXXXXXXX may involve the use of catalysts described in Class 26 of Schedule II of the Income Tax Regulations.

Question 3:

Should the capital portion of the clean-up costs be added to the cost of the land?

In our response to the question of whether clean-up costs are an expense of earning income, we concluded that a cost is on income account where the expenditure is made for the purpose of cleaning up, modifying or correcting a condition that arose as a direct result of a business operation. We would add a requirement that the business was conducted in whole or in part at the location by the person making the expenditure. This appears to be the case with the expenditures outlined earlier in this memorandum. However, reclamation and clean-up costs may be incurred for the purpose of correcting or modifying conditions of land that are not related to the person's business. While this does not appear to be the case with XXXXXXXXXX expenditures, in our view costs to clean-up a location would be considered to be a capital cost of the land when the damage or polluted condition existed at the time the land was acquired and/or the condition was not a result of a business conducted by the person making the expenditure.

An expenditure will also be considered a capital cost of land when the purpose is to do more than correct or modify a condition that resulted from the person's business. Examples include expenditures made to adapt the property to a new use or to enhance the value of the land such as modifications to facilitate improved access, improve drainage, alterations to grades or surface character of the land by introducing fill or levelling elevations, and vegetation that would not be considered native to the local or might not have been present at the time the business commenced. Such costs may be considered to be a capital cost of the land. In considering whether the value of the land has been increased or enhanced, costs to remove pollutants or refuse, correct, or modify a condition caused or directly attributed to the business carried on by the person incurring the expenditure alone and by itself would not contribute value to the land beyond what it would be in an undisturbed state.

Question 4:

Should capital expenditures relating to depreciable assets used for water pollution control purposes be included in Class 24?

In order to qualify for inclusion in Class 24 an expenditure must satisfy all the Class 24(a) and (b) requirements. Qualified property is new capital property, has not been included in another Schedule II class by the taxpayer, and is acquired for use primarily to prevent, reduce or eliminate water pollution caused by an operation at a site in Canada where the taxpayer has conducted operations since before 1974. Please see our comments later in this memorandum in respect of whether XXXXXXXXXX continues to be in the business after the XXXXXXXXXX sale of XXXXXXXXXX.

According to Class 24(b)(iv) the Minister of the Environment must accept the property as primarily for the purpose of preventing, reducing or eliminating pollution of water. Where the required certification has not been obtained, equipment for XXXXXXXXXX, and other water treatment will not qualify for inclusion in Class 24.

As a result of a February 22, 1994 Federal Budget proposal, accelerated CCA on qualifying class 24 and 27 pollution control equipment will not be available to equipment acquired after 1998.

Question 5:

How should the costs associated with XXXXXXXXXX be treated? Should they be treated differently than the costs of decontaminating the water?

Costs incurred to XXXXXXXXXX are appropriately considered to fit into two categories; costs to XXXXXXXXXX. In our view, costs related to the XXXXXXXXXX will be deductible expense or capital depending on the facts and circumstances specific to the particular expenditure.

In a memorandum dated February 6, 1989 Rulings confirmed to Appeals Branch the position that costs to XXXXXXXXXX on account of capital property that is a structure described in Class 10(g). In our view XXXXXXXXXX is a similar structure, the cost of which is subject to CCA under Class 1(q) or where the requirements are met Class 24. Repairs to the XXXXXXXXXX may be expense or capital (as above) depending on the nature of the repair and the particular expenditure. The ongoing maintenance XXXXXXXXXX may be expense, however, equipment that is acquired and used to XXXXXXXXXX may qualify to be included in Class 24 or another class in Schedule II for CCA purposes.

Question 6:

Should the clean-up costs incurred prior to XXXXXXXXXX be treated differently than costs incurred after XXXXXXXXXX?

The question appears to ask if clean-up costs specific to a business or facility should be treated differently when the costs are incurred after the business or facility has been sold (i.e. will paragraph 18(1)(a) of the Act apply to disallow the deduction of the expense because it does not relate to a source of income?).

In our view, the fact that the business or facility has been sold will not in and of itself cause the expense to be subject to paragraph 18(1)(a) of the Act. According to the decisions for Irving I. Selig v. Minister of National Revenue, 55 DTC 46 (Income Tax Appeal Board), and Jean-Camille Poulin v. Her Majesty the Queen, 94 DTC 1674 (Tax Court of Canada) the fact that the business was sold or the business ceased to operate did not mean that the taxpayer was not considered to be in the business. Selig addresses this issue where at page 48 W.S. Fisher, Q.C. said:

It is my opinion, therefore, that if, after the purchase and sale of this scrap copper in 1946, it had been found in that year that the material was stolen, and the action had been taken and completed to judgment and payment of the $ 7,000 in question made, all in the year 1946, no question could have arisen that this amount was anything but an allowable deduction in determining the appellant's taxable income. Is the situation altered, therefore, by reason of the fact that it was some time before the theft was discovered, action taken, judgment rendered, and payment made? Or by the fact that the appellant happens to be no longer actively engaged personally, as a sole proprietor, in the operation of the scrap dealing business in the year 1952? The liability was incurred personally by the appellant herein as sole proprietor of the business. It was not assumed by the limited company when it took over the business in 1947 for the simple reason that it was not even known to exist at that time. Nevertheless the court in 1952, has found that the appellant, personally, was liable to make the payment of the $ 7,000 as a result of his personal business transactions. To the extent that he was so liable, it would appear that he was still in business until his business liabilities had all been settled once and for all.

In Poulin, Garon, T.C.C.J. at page 1678 and 1679 said,

I shall now consider the respondent's main argument that the amount of $ 385,802 paid by the appellant in 1987 is not deductible given that it cannot be considered a payment made for the purpose of gaining income from a business or property since the appellant stopped operating the real estate brokerage business in May 1984.

This argument cannot be accepted. It is possible to proceed by analogy: if the appellant had received a payment in 1987, for example, for services rendered in 1987 in his capacity as a broker (taking for granted that the cash basis of accounting would apply in that case), there is no doubt that the payment would have had to be included as business income in computing the appellant's income, even if the appellant no longer actively carried on the business in question. In the above assumption, there is no doubt in my mind that the nature of that payment would not be altered merely by the passage of time. That payment would indisputably constitute business income. I do not see why it would be otherwise in the case of an expense which further would have been deductible if it had been made or incurred in a taxation year in which the taxpayer operated his business normally. Furthermore, it should not be forgotten that the event giving rise to the appellant's civil liability occurred in 1977 when the appellant was operating that real estate brokerage business. The courts merely sanctioned, recognized or observed several years later the appellant's civil liability for acts or omissions dating back to 1977... Furthermore, in my view, the aforementioned decision of the Tax Appeal Board in Selig clearly sets forth the applicable principles in a situation in which consideration had to be given to para. 12(1)(a) of the Income Tax Act of 1948, the text of which is to all intents and purposes, identical to para. 18(1)(a) of the present Act...

Although the normal activities of the appellant's brokerage business had been terminated when his broker's permit was surrendered, I believe it may be argued that the appellant was acting in the context of the operation of his brokerage business by taking a certain number of measures to ensure his defence against the action brought against him... Those actions were not common activities for a broker, but they undeniably concerned the operation of his business.

Other decisions, by analogy, support the view that a taxpayer that makes expenditures is still in the business despite having sold the business or ceased to carry on operations and include:

Imperial Oil Limited v. Minister of National Revenue, 47 DTC 1090, (Exchequer Court of Canada), where damages and costs with respect to a collision involving a ship owned and operated by Imperial were found to be expense wholly exclusively and necessarily laid out in earning income. Imperial's deduction was not affected by the fact that a legal liability was satisfied by the expenditure and the fact that there was no expectation of earning income by virtue of the expenditure being made.

Vallambrosa Rubber Co., Ltd. v. Farmer (Surveyor of Taxes) (1910 S.C. 519; 5 T.C. 529), where costs were held to be deductible in the year incurred despite there being no link to income in the year.

Ounsworth (Surveyor of Taxes) v. Vickers, Limited (1915) 3 K.B. 267, where the comment was made on page 675 that dredging is no less an income expenditure because it is not done continuously but only when it became absolutely necessary. Vickers, Limited expenditure failed to be characterized as being made on income account even though it was necessary to deliver a completed vessel.

If you have any questions or would like to discuss the above questions in more detail, please contact the writer.

Acting Chief
Resource Industries Section
Manufacturing Industries,
Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch

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