Fortin & Moreau Inc. v. The Queen, 90 DTC 1450, [1990] 1 CTC 2583 (TCC)

Couture, C.J.T.C.:—This is an appeal from an assessment issued by the respondent for the 1982 taxation year.

In its income tax return, the appellant, in computing its income for the taxation year involved in the appeal, deducted the amount of $84,219 as depreciation of the capital cost of eight trucks and two bins that it claimed to have acquired under agreements in the nature of a capital lease at a cost of $583,184. As a result, it argued that these assets constituted depreciable property Within the meaning of paragraph 13(21)(b) of the Income Tax Act ('Act"). In addition, it deducted the amount of $48,931 as interest paid on the balance of the purchase price of these assets.

It also deducted the amount of $21,729 with respect to six of the trucks and the two bins, on the basis that these assets constituted qualified transportation equipment entitling the taxpayer to an investment tax credit, under subsection 127(5) of the Act. Two of the trucks were used when the appellant took possession and, as a result, it admits that they were ineligible for the credit.

In its assessment, the respondent disallowed all the deductions claimed by the appellant, relying on the fact that the agreements in question represented for the appellant not an acquisition of the trucks and bins within the meaning of the Act but rather a lease with an option to purchase the property, and allowed the amount of $65,109 paid as rent as a deduction in computing its income.

According to the evidence, the appellant was incorporated in 1971, when it began operating a construction business, specializing in roads, sewers, aqueducts, sidewalks and also, beginning in 1973, snow removal for a number of Quebec municipalities.

In 1982, the appellant obtained a contract from the City of St-Hubert to collect household waste and a similar contract from the municipality of St- Mathias, located about seven kilometres from St-Hubert. According to estimates by its management, the company would have to acquire six side-loading and two rear-loading trucks to perform the contracts.

A supplier named Equipement Labrie Ltée ("Labrie") confirmed to the appellant's representative that it had six side-loading trucks in stock.

In his testimony, appellant's president, Mr. Victor Fortin, explained that the management intended to purchase this equipment but unfortunately did not have the necessary cash. A number of financial institutions were approached for financing, which was eventually obtained subsequent to negotiations with the Société Financière Canadian Acceptance Limitée, through a division operating under the name Compagnie de Location C.A.C. ("C.A.C.").

The documentation produced by the witness as evidence included several documents concerning one of the trucks and, according to counsel for the appellant, identical documents were signed for each of the others. The following documents were involved:

1. An agreement between C.A.C., referred to as the lessor, and Fortin & Moreau Inc. ("Fortin"), referred to as the lessee, dated April 23, 1982. The name Labrie also appears on the agreement as the supplier. This agreement was signed by the regional credit manager for C.A.C. and the president of the appellant but no signature appears on the form opposite the supplier's name. The document is entitled [Translation] “Original term and payment of rent", with the words [Translation] "Terms and conditions of lease" underneath. At the foot of the first page are the words: [Translation] “Part 3 — Lease (lessee's copy)". The agreement was for a period of 65 months and provided for a downpayment of $10,950 and 64 rental payments of $1,533.73 commencing 30 days from April 26, 1982.

Clause 20 reads as follows:

[Translation]

ACQUISITION OF RIGHT OF OWNERSHIP.

Subject to payment of any rental and any other amount due and payable at the time, Lessee shall have the option to purchase the leased equipment at the location and in the condition in which it is found, upon expiry of the 60th month of the term of the lease for $7,300.00, or upon expiry of the original term of the lease "at the fair market value” of the equipment, provided that it gives Lessor written notice of its intention to exercise either purchase option at least 90 days prior to the aforesaid month of the term or 90 days prior to expiry of the original term.

Should Lessee exercise one of the aforesaid purchase options, it shall receive title to and right of ownership of the leased equipment only upon payment in cash to Lessor of the price of the purchase option and shall maintain the leased equipment in its possession, subject to all conditions set out in the present lease. Lessor and Lessee may settle on terms of payment acceptable to Lessee, without any other written agreement to this effect being required, and on the amount of additional charges to be paid to Lessor by Lessee, if the period for payment in full of the price of the purchase option is extended. Lessee authorizes Lessor to show the leased equipment while in operation, at any reasonable time during the last 89 days of the term of the lease, to potential purchasers or lessees or to establish its “fair market value”.

This agreement was accompanied by a letter from C.A.C. to the appellant, in which the relevant sections read as follows:

[Translation]

We are pleased to have the opportunity to lease you the equipment detailed in the lease hereinafter. If the dates and amounts in the lease relating to this equipment differ from those in your books, please be good enough to advise us accordingly.

Please send all lease payment directly to us. You will receive a reminder letter before each due date.

2. A purchase agreement between Labrie, referred to as the vendor, and C.A.C. , referred to as the purchaser, for a truck, International make, dated April 23, 1982 and containing the description of the truck and a waste compactor at a cost of $73,000.

3. An agreement entitled [Translation] "Acknowledgement and Agreement" dated April 23, 1982 between C.A.C. referred to as the lessor, Fortin referred to as the lessee, and Labrie referred to as the supplier. The document was signed by C.A.C.'s general credit manager and by the respective presidents of the two other parties. The agreement provides as follows:

1. Lessee acknowledges that it has selected the aforesaid leased equipment and required Lessor to acquire it from the supplier for the purpose of leasing it to Lessee, for the latter's commercial, industrial, occupational or artisanal purposes;

2. Lessor, by these presents, transfers to Lessee the warranty covering the leased equipment, resulting from the sale between Lessor and the supplier;

3. The supplier unconditionally accepts the transfer from Lessor to Lessee of the aforesaid warranty resulting from the sale by the supplier to Lessor of the leased equipment.

5. A registration certificate issued by the “Régie de l'assurance automobile" to Fortin for the truck in question.

6. Another document entitled [Translation] "Lease" between RoyLease Limitée as lessor and Fortin as lessee dated June 29, 1982, concerning the two used trucks and two bins for which the [Translation] "terms and conditions” are nearly identical to those contained in the agreement referred to in paragraph 1.

According to the witness, the trucks weighed approximately 36,000 pounds. Two landfill sites were accessible to the appellant. The first, identified as Miron, was located in the City of Montreal, approximately 37 kilometres from St-Hubert and the second was located at Mont St-Grégoire, approximately 42 kilometres away. He explained that 65 per cent of the waste was dumped at Miron.

In 1982, Société financière C.A.C. was acquired by RoyLease Limitée and, while the evidence is not clear on this point, it appears that Roylease Limitée was substituted for C.A.C. with respect to its rights under the agreement with the appellant.

According to documents produced in the hearing entitled [Translation] "Deed of Sale”, on April 29, 1983 RoyLease Limitée "sold" all the trucks and bins to the appellant. The wording in these documents follows:

[Translation]

For the amount of $64,251.04, we hereby sell the equipment described over, on an “as seen and accepted” basis without any guarantee, explicit or implicit, other than those mentioned hereinafter, to:

Name: Fortin & Moreau Inc.

Address: 4 Chemin du Tremblay

Boucherville, Quebec J4B 5E4

We guarantee and certify that we are the absolute owners of this equipment.

Roy Lease Limitée

Corporation created from the merger of RoyLease Limitée and La Société Financière Canadian Acceptance Limitée

Per (signed)

E. Lemay

Credit Officer

Purchase price	$59,088.01
Sales tax	$ 5,163.03
TOTAL	$64.251.04

Another document introduced by the witness attests that a payment of $51,140 was made to the appellant by Allstate of Canada, an insurance company, following the destruction of one of the trucks in a fire in 1985.

The second witness called by counsel for the appellant, Mr. Claude Boivin, president of Labrie, stated that he himself had negotiated with Mr. Fortin for the purchase of the six trucks. He also confirmed that one truck with a loaded bin weighed 62,000 pounds and that its market value in 1987 was between $38,000 and $45,000. He produced copies of sales contracts relating to similar trucks attesting to this value.

A third witness, Mr. Michel Gagné, a chartered accountant who had audited the appellant's books since 1971, explained that he had been commissioned by Mr. Fortin to obtain financing to acquire the trucks in question and that, at the time, C.A.C. offered the best terms. He mentioned that under a financing arrangement such as that negotiated by the appellant, three elements had to be considered: the interest rate, the [Translation] "repayment" period and the warranty. The formula negotiated for the [Translation] “acquisition” of each new truck included a downpayment of $10,950 and 65 monthly payments of $1,573, although after the 59th payment the appellant had the option of paying $7,300 as a final payment rather than making six more monthly payments. The monthly payments, according to the witness, had been based on an interest rate of 18.5 per cent.

The witness also explained that the appellant, in its financial statements for the fiscal year ending September 30, 1982, had included under “fixed assets" the amount of $1,194,983 and a note explaining that $583,184 of that amount was allocated to an item identified as [Translation] “leased heavy trucks". In its liabilities, there is a note under [Translation] "long-term debt" that an amount of $671,263 has been entered, and it is explained in another note that an amount of $503,467 represents the portion of the amount applicable to [Translation] “capital lease contracts".

Counsel for the appellant, referring to sections 20(1)(a), 20(1)(c), 127(5), 127(10) and 127(11) of the Act as well as section 4601 of the Regulations, offered the following grounds for appeal in paragraphs 10 and 11 of its notice of appeal :

[Translation]

10. The appellant alleges that it acquired the trucks from the above-mentioned companies and that it is therefore entitled to deduct the capital cost allowance as well as interest paid to the purchasers on the acquisition price of the said trucks.

11. In addition, as a result of the aforesaid acquisition, in computing its income tax payable, the appellant is entitled to deduct the investment tax credit, as the trucks in question are qualified transportation equipment.

For his part, counsel for the respondent made the following argument in paragraphs 7 and 8 of his reply to the notice of appeal:

[Translation]

7. . . . the appellant did not acquire the aforesaid trucks during 1982, with the result that:

(a) It can deduct rent paid to lease the trucks, under section 18(1) (c) of the Income Tax Act; but,

(b) It can deduct neither the capital cost allowance of the aforesaid property, which it did not own, nor the amounts that it claims as interest paid to obtain the loan for its acquisition; and,

(c) It is not entitled to the investment tax credit.

8. In the alternative, even if the appellant did acquire the aforesaid trucks, a fact which is not admitted but denied, it would not be entitled to the investment tax credit, as the trucks were not acquired principally for the purpose of carrying or hauling freight on highways outside of any metropolitan area, as stipulated in section 4601(c)(i)(C) of the Income Tax Regulations.

There is no argument between the parties as to the class of property involved for the purpose of the depreciation deduction or the tax credit deduction.

The questions that the Court must answer may be expressed as follows:

(a) Is the property that is the subject of the agreement dated April 23, 1982 between C.A.C. and the appellant depreciable property within the meaning of paragraph 13(21)(b) and hence eligible for a capital cost allowance?

(b) Can the appellant deduct the interest on the balance of the purchase price of this property, in accordance with paragraph 20(1)(c)?

(c) Does this property constitute eligible transportation equipment for the purpose of the investment tax credit, under subsection 127(5)?

The answer to the three questions may be found in the interpretation of the agreements between the appellant and C.A.C. (RoyLease for the two used trucks) in terms of whether they are in the nature of a capital lease, as the appellant claims, or a simple lease or rental, as the respondent claims, and whether, if they are in the nature of a capital lease, such an agreement satisfies the requirements of paragraph 13(21)(b) and 20(1)(c) and subsection 127(5). Paragraph 13(21)(b) defines “depreciable property" as follows:

“depreciable property". — "depreciable property" of a taxpayer as of any time in a taxation year means property acquired by the taxpayer in respect of which he has been allowed, or, if he owned the property at the end of the year, would be entitled to, a deduction under regulations made under paragraph 20(1)(a) in computing income for that year or a previous taxation year;

[Emphasis added.]

Paragraph 20(1)(c) reads:

20(1)(c) Interest. — an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) n/a,

(ii) an amount payable for property acquired for the purpose of gaining or producing income therefrom or for the purpose of gaining or producing income from a business (other than property the income from which would be exempt or property that is an interest in a life insurance policy),

(iii) n/a.

The expression “qualified transportation equipment" is defined in paragraph 127(10.1)(d):

“qualified transportation equipment” of a taxpayer means prescribed equipment acquired by him after November 16, 1978 that has not been used, or acquired for use or lease, for any purpose whatever before it was acquired by the taxpayer and that is

(i) to be used by him principally for the purpose of transporting passengers, property or passengers and property, in Canada or to and from Canada, in the ordinary course of carrying on a business in Canada other than a business

(A) the income from which is exempt from income tax by virtue of any provision of this Act, or

(B) the income from which is not included in his income or, in the case of a non-resident person, his taxable income earned in Canada.

(ii) n/a.

Note that in drafting the three sections Parliament used the word "acquired" as a condition for their application.

Section 4601 of the Regulations reads:

4601. For the purposes of paragraph 127(10.1)(d) of the Act, the following depreciable property of a taxpayer (other than property prescribed pursuant to section 4600) is prescribed equipment:

(c) property that is

(i) a truck, tractor or trailer that

(A) is included in Class 10 in Schedule ll by virtue of paragraph (a) or (e) of that Class,

(B) is designed for the purpose of carrying freight, or hauling a trailer that carries freight, on highways, and

(C) was acquired principally for the purpose of carrying or hauling freight on highways outside of any metropolitan area, city, town, village, municipality or other similar community or area, and

(D) in the case of a truck or tractor, has a "gross vehicle weight rating” (within the meaning assigned that expression by the Motor Vehicle Safety Regulations) of 26,001 pounds or more, and in the case of a trailer, is of a type designed to be hauled under normal operating conditions by a truck or tractor described in this subparagraph, but for greater certainty,

(E) was not acquired principally for the purpose of carrying or hauling

freight locally or making local pickups or deliveries, or

(ii) machinery or equipment included in Class 8 or 10 in Schedule II that is ancillary to and used as part of any property described in subparagraph (i) that is qualified transportation equipment within the meaning of paragraph 127(10.1)(d) of the Act.

Counsel for the appellant referred in his arguments to generally accepted accounting principles in support of his viewpoint, while recognizing that such principles could not prevail over a specific provision of the Act. He referred the Court to the chapter entitled "Leases" in the handbook published by the Canadian Institute of Chartered Accountants ("CICA") and the section entitled "Classification", which reads as follows:

This Section classifies leases as follows:

(i) from the point of view of the lessee — capital and operating leases; and

(ii) from the point of view of the lessor — sales-type, direct financing and operating leases.

In the opinion of the Accounting Research Committee, a lease that transfers substantially all of the benefits and risks of ownership to the lessee is in substance an acquisition of an asset and an incurrence of an obligation by the lessee and a sale or financing by the lessor.

From the point of view of a lessee, a lease would normally transfer substantially all of the benefits and risks of ownership to the lessee when, at the inception of the lease, one or more of the following conditions are present:

(a) There is reasonable assurance that the lessee will obtain ownership of the leased property by the end of the lease term. Reasonable assurance that the lessee will obtain ownership of the leased property would be present when the terms of the lease would result in ownership being transferred to the lessee by the end of the lease term or when the lease provides for a bargain purchase option.

(b) The lease term is of such a duration that the lessee will receive substantially all of the economic benefits expected to be derived from the use of the leased property over its life span. Although the lease term may not be equal to the economic life of the leased property in terms of years, the lessee would normally be expected to receive substantially all of the economic benefits to be derived from the leased property when the lease term is equal to a major portion (usually 75% or more) of the economic life of the leased property.

(c) The lessor would be assured of recovering the investment in the leased property and of earning a return on the investment as a result of the lease agreement. This condition would exist if the present value, at the beginning of the lease term, of the minimum lease payments, excluding any portion thereof relating to executory costs, is equal to substantially all (usually 90% or more) of the fair value of the leased property, at the inception of the lease.

It is clear that the application of these principles is restricted to the accounting profession, that is, to the rules governing the preparation and submission of the financial statements of a business. It is clear from the wording that the CICA does not purport to establish the legal status of a lease, as the text reads: "(the) lease . . . is in substance an acquisition of an asset . . . by the lessee”. On the other hand, we must bear in mind that the Act does not define the word “acquisition”.

Relying on this concept of a capital lease, counsel for the appellant went on to examine the various provisions of the agreements to show that they contained all the elements of a capital lease as described in the CICA Handbook. While the agreements with C.A.C. and RoyLease may have been worded differently, they were essentially the same.

Among the clauses of the agreement with C.A.C. referred to and cited by counsel, the following provide the clearest illustration of his claim:

[Translation]

4. Lessor, being neither the manufacturer of the leased equipment, nor the manufacturer's agent, makes no representations; nor does it make any warranties, express or implied, as to the accuracy, plans or condition, or as to the quality or effectiveness of the material used in the equipment or of the work in the leased equipment; nor does it make any warranty that the leased equipment will be in compliance with any law, regulation, specification or contract regulating the machinery or its operators or special procedures, with the understanding that all these or other risks concerning Lessor-Lessee relations must be borne by Lessee at its own risk and expense. No agreement, guarantee, promise, contract, representation or verbal authorization shall be binding on the parties; any preliminary conversations, agreements or representations concerning the present lease and/or the leased equipment are an integral part of the present contract and no amendment to the contract shall be binding on the parties, unless it is in writing and signed by Lessor. Lessee consents, using its own funds and at its own expense, (a) to pay all shipping and other expenses incidental to shipment by the vendor of the leased equipment to Lessee; (b) to pay all costs or expenses relating to the operation of each item of leased equipment; (c) to comply with all government laws, orders, regulations, requirements and rules concerning the use, maintenance and operation of the leased equipment; (d) to maintain at all times insurance covering public liability, property damage, fire and theft and combined protection in Lessor's name for an amount acceptable to Lessor, in order to protect Lessor's interest such as it may exist, and to deliver to Lessor evidence of the coverage required herein; (e) to make all repairs and replacements required in order to maintain the leased equipment in good repair, subject to normal wear and tear.

5. In case of the total destruction of any leased equipment, Lessee shall be released from its obligation to pay rent by paying Lessor any rent payable to date plus the amount of future rent less the net amount, if any, recovered by Lessor from insurance or other sources for loss or damage. However, Lessor shall not be obliged to initiate any proceeding or other collection method against any party to recover such loss or damage to the leased equipment. Except where expressly stipulated in this paragraph, neither the total or partial destruction nor the total or partial loss of use or possession of any leased equipment shall release Lessee from its obligation to pay the rent provided under the present contract.

6. Lessee consents that over the full term of this lease, in addition to its obligation to pay the rent provided under the present contract, it shall promptly pay all taxes, assessments and other government charges imposed on Lessee's interest in the leased equipment or on the use or operation of the leased equipment, or on the profits derived therefrom, and as additional rent it shall promptly pay or reimburse Lessor for all taxes (except for sales tax paid by Lessor to purchase the leased equipment) assessments and other government charges (including title and registration fees for the leased equipment, as required) assessed against and paid by Lessor by reason of its ownership of the leased equipment in whole or in part or by reason of the use, operation or lease of the aforesaid equipment to Lessee, or by reason of the rent or benefit derived therefrom, with the exception of taxes based on Lessor's net income.

12. Lessee shall protect and indemnify Lessor against any liability, loss, damage, expense, cause of action, suit, claim or judgment arising from bodily injury or damage to the person or property, where such injury or damage in fact results, or is alleged to result, from the use, operation, delivery or transportation of all or part of the leased equipment, or from its situation or condition, and Lessee shall further contest, at its own expense, each and every legal action brought against Lessor alone or jointly with others as a result of such liability or allegation, and it shall pay, discharge and satisfy all judgments and fines recoverable from Lessor in such actions, on condition, however, that Lessor gives Lessee notice in writing of the aforesaid demands or claims.

To summarize this part of his argument, he asserted that all the normal incidents of title, apart from legal title, were vested in the lessee. It had assumed all the risks and expenses pertaining to the property in question, such as insurance, repairs, defence against any legal action initiated against the lessor, payment of taxes and other government charges. In the case of the lessor, he argued, it would have received full repayment of the $73,000 price of the truck, and then some, by the end of the lease term, as the payments stipulated in the lease totalled over $100,000. He added that, from the time the agreement was signed, it seemed clear that the $7,300 option in favour of the appellant would be exercised, as it represented for the latter a lesser cost than the balance of the monthly payments.

According to the argument by counsel, all these elements forming the basis of the agreement are the same ones considered by the CICA in determining whether a lease is a capital lease, that is in substance an acquisition of an asset by the lessee.

On the issue of whether a capital lease agreement satisfies paragraphs 13(21)(b) and 20(1)(c) and subsection 127(5) of the Act and Regulations thereunder, counsel referred the Court to a number of decisions in which the word "acquired" was examined to determine its application under legislation in force at the time.

It should also be noted that even though the capital lease agreement for the truck in question came under paragraphs 13(21)(b) and 20(1)(c), it does not necessarily follow that the acquisition of these assets by the appellant meets the requirements of subsection 127(5) of the Act and section 4601 of the Regulations.

The first decision deferred to by counsel for the appellant was by the Exchequer Court, as it then was, in M.N.R. v. Wardean Drilling Limited, [1969] 2 Ex. C.R. 166; [1969] C.T.C. 265; 69 D.T.C. 5194. In this appeal the Court was asked to interpret the word “acquired” used in paragraph 20(5)(e) of the former Act, that is, R.S.C. 1952, c. 148, as amended.

The section read :

[Translation]

(e) "undepreciated capital cost” to a taxpayer of depreciable property of a prescribed class as of any time means the capital cost to the taxpayer of depreciable property of that class acquired before that time minus the aggregate of

(i) not applicable

(ii) not applicable

(iii) not applicable

[Emphasis added.]

Cattanach, J. (as he then was) noted at pages 270-71 (D.T.C. 5197):

[Translation]

The decision in this appeal turns on the question as to when the rig and substructure were “acquired” by the respondent. The submission on behalf of the re- spondent was, as I understand it, that goods are acquired by a purchaser thereof when the vendor and the purchaser have entered into a binding and enforceable contract of sale and purchase. The test and concept of a contract was adapted by the Tax Appeal Board in the decision now under appeal.

With all deference I cannot accede to that view.

In my opinion the proper test as to when property is acquired must relate to the title to the property in question or to the normal incidents of title, either actual or constructive, such as possession, use and risk.

He continued later on page 271 (D.T.C. 5198):

[Translation]

As I indicated above, it is my opinion that a purchaser has acquired assets of a class in Schedule B when title has passed, assuming that the assets exist at that time, or when the purchaser has all the incidents of title, such as possession, use and risk, although legal title may remain in the vendor as security for the purchase price as is the commercial practice under conditional sales agreements.

This statement by the learned judge derives its validity from the legal doctrine that an agreement must be interpreted by looking to its substance for the reality or factual situation on which the parties have agreed, rather than by giving probative value to what they have simulated, either by the name they have given it or through the use of certain terms or expressions in drafting it.

This doctrine was the basis for the decision by the Federal Court of Canada in Olympia and York Developments Ltd. v. The Queen, [1981] 1 F.C. 691; [1980] C.T.C. 265; 80 D.T.C. 6184. The comments by Addy, J. at page 277 (D.T.C. 6193; F.C. 709) are helpful for our purposes:

Paragraph 20(5)(c), [1] states that "disposition" includes sale and several other types of payment such as compensation for damage, amounts payable under a policy of insurance, etc., but does not purport to be exhaustive of the definition of "disposition" contained in paragraph 20(5)(b) which I have quoted. In fact, paragraph 20(5)(b) itself, which uses the word “includes” is not itself an exhaustive or restrictive definition. In this respect, in delivering judgment on behalf of the Supreme Court of Canada, Pratte, J in The Queen v. Compagnie Immobilière BCN Limitée, [1979] 1 SCR 865; [1979] CTC 71; 79 DTC 5068 stated [at page 876]:

The substantive definitions of “disposition of property" and "proceeds of disposition” in paragraphs 20(5)(b) and (c) are a clear indication that the words "disposed of” should be given their broadest possible meaning.

The word “acquired” used in paragraph 20(5)(e) is obviously the direct opposite of "disposed" (or disposition) as used in the same section and must contain substantially the same elements viewed from the side of the person acquiring the asset as opposed to the person disposing of it. . . in M.N.R. v. Wardean Drilling Limited, [1969]. . . .

Counsel also referred the Court to a decision by the Federal Court of Canada in The Queen v. Lagueux & Frères Inc. (now Marker Industries Inc.), [1974] C.T.C. 687; 74 D.T.C. 6569; in which Décary, J. ruled that an agreement between parties was in the nature of a sale rather than a lease, as claimed by the appellant (the Minister of National Revenue), and accordingly represented a disposition for the respondent and an acquisition for the other party.

At page 688-89 (D.T.C. 6570-71) Décary, J. comments:

[Translation]

On April 30, 1967 Corporate Plan Leasing Limited gave defendant a purchase option at a price equivalent to five per cent of the balance owed at the end of the contract period, that is prior to renewal of the contract.

Defendant was to obtain “all permits, licences and registration required for use of the equipment"; to pay all "fees, expenses, charges and taxes"; obtain policies of insurance on the equipment, and not sell the equipment without the prior consent of Corporate Plan Leasing Limited.

It was established that the total cost of the alleged rental, if interest and administrative costs are deducted, was equivalent to the market price, and that when the option was exercised the market value of the equipment was greater than the nominal amount paid by defendant.

At page 692-93 (D.T.C. 6573) he adds:

Taking into consideration the facts established, the precedents and legal commentary cited, the Court concludes that the payments as a whole were made in order to purchase the equipment; indeed, the total amount of the payments made during the period of alleged rental are wholly deductible from the purchase price, and correspond exactly to the purchase price of the equipment plus interest payable, during the period of alleged rental, on the balance of the purchase price. I therefore conclude that these were conditional sales on a suspensive condition, and not leases.

Counsel concluded his submission concerning the tax treatment of the property in question by referring the Court to Interpretation Bulletin IT-233 and, specifically, paragraph 3 entitled "Lease-Option Agreements", which spells out the respondent's administrative policy with respect to the application of the legislation to this type of agreement. The paragraph reads:

Lease-Option Agreements

3. The Department's principle [sic] interest in lease-option agreements is to see that significant sums paid for the purchase of property are not being charged against income as rent, of which no recapture can be made from a lessee who exercises his option and sells the property at a price which reimburses him for all or part of the "rent". Therefore it is necessary to determine whether or not the object of the transaction at its inception is to transfer the equity in the property to the lessee. Under conditions similar to those that follow a transaction is considered to be a sale rather than a lease:

(a) the lessee acquires title to the property after payment of a specified amount in the form of rentals,

(b) the lessee is required to buy the property from the lessor during or at the termination of the lease or is required to guarantee that the lessor will receive the full option price from the lessee or a third party (except where such guarantee is given only in respect of excessive wear and tear inflicted by the lessee),

(c) the lessee has the right during or at the expiration of the lease to acquire the property at a price which at the inception of the lease is substantially less than the probable fair market value of the property at the time or times of permitted acquisition by the lessee. An option to purchase of this nature might arise where it is exercisable within a period which is materially less than the useful life of the property with the rental payments in that period amounting to a substantial portion of the fair market value of the property at the date of inception of the lease, or

(d) the lessee has the right during or at the expiration of the lease to acquire the property at a price or under terms or conditions which at the inception of the lease is/are such that no reasonable person would fail to exercise the said option.

As the agreement was executed in the Province of Quebec and is therefore governed by provincial civil law, counsel for the appellant attempted in his arguments to show that the provisions of the Civil Code and related cases were in agreement with the principles laid down for the application of the provisions of the Act with respect to the nature of a lease with option to purchase, whether it be called a capital lease or by any other name chosen by the parties.

He referred to a number of authorities, including article 1013 of the Civil Code of the Province of Québec ("Code") which provides:

Article 1013. When the meaning of the parties in a contract is doubtful, their common intention must be determined by interpretation rather than by an adherence to the literal meaning of the words of the contract.

For guidance on the application of this article, he referred the Court to Thibault v. Auger, Paré et Société Colbert Ltée mise en cause, [1950] Q.S.C. 343. At page 345 the president states:

[Translation]

In interpreting a contract, one must look for the intention of the parties, whatever the name they may give it. They may well claim to sell or rent a thing, but it is not in their power to change the meaning of the contract itself and, if this contract that they call a lease offers all the characteristics of a sale, it will be subject not to the principles governing leases but to the principles governing sales. [2]

These arguments relate to the application of paragraph 13(21)(b), that is, whether under the circumstances the appellant could claim a deduction for capital cost allowance in computing its income and also whether it could deduct the amounts claimed as interest under paragraph 20(1)(c).

On the question of whether these assets are qualified transportation equipment within the meaning of paragraph 127(10.1)(d), counsel for the appellant referred to the evidence and argued that, in his opinion, these assets satisfied all the conditions set in paragraph 4601(c) of the Regulations, that is, their classification for depreciation purposes, their weight established by witnesses at approximately 62,000 pounds, the fact that they were designed for the purpose of carrying freight and, specifically, since the trip between St-Hubert and the Miron dump represented 65 per cent of the total distance covered by the appellant's trucks, the fact that they had therefore been acquired principally for the purpose of carrying freight on highways outside of any metropolitan area or municipality, as stipulated under paragraph (c).

Counsel for the respondent, for his part, developed a theory based on three major arguments. He argued first that the appellant was not the owner of the assets under its agreements with C.A.C. as required under paragraph 13(21)(b) and therefore could not claim the deductions in question. Second, the terms and expressions contained in the agreements were clear and precise and article 1013 of the Civil Code could not be used in an attempt to discover in them any intention other than that expressed by the words used. Third, not only had the trucks not been acquired by the appellant under the agreements, but also they were not transportation equipment within the meaning of paragraph 127(10.1)(d) and the Regulations thereunder.

In support of his first argument, counsel relied on paragraph 13(21)(b), which defines “depreciable property", supra, claiming that since the section stipulates that the expression means property in respect of which the taxpayer would be entitled to a deduction if he owned it at the end of the year, it is self- evident that a rental contract or lease does not satisfy this requirement. His comments as reported in the stenographer's notes at page 160 are reproduced below:

[Translation]

This is tantamount to saying that in order to be entitled to a deduction for depreciation, the taxpayer must own the property; otherwise, Parliament would not have felt the need to add the concept in respect of which the taxpayer, if he owned the property, would be entitled.

From the foregoing, it follows that the word "acquired" is not decisive in determining whether paragraph 13(21)(b) is applicable; the taxpayer must have title to the property, a quality that flows exclusively from a sale under the circumstances, if I have followed his argument.

He continued by suggesting that the terms and conditions used and contained in the agreements make it clear that the intention of the parties was to sign a rental agreement or lease and not for the appellant to acquire property. Therefore, article 1013 of the Code is not applicable. Counsel drew the Court's attention to a number of clauses in the agreement, insisting that from the terms used, such as the name of the agreement, the designation of the parties as "lessor" and “lessee”, the reference to "rent", there could be no question that the agreement was anything other than a lease.

In the matter of the investment tax credit deduction, counsel argued that the appellant did not satisfy the requirements of section 4601 of the Regulations, mainly because household waste was not "freight" within the meaning given to the word in the Regulations, that the appellant's trucks had been designed not for the purpose of carrying freight, or hauling a trailer that carries freight on highways, but to collect household waste. In addition, they had not been acquired for the purpose of carrying or hauling freight on highways outside of any metropolitan area, since St-Hubert was part of the Montreal metropolitan area.

Despite the well-articulated presentation by counsel for the respondent, I have difficulty granting his interpretation of the nature of the agreement between the appellant and C.A.C. for the purpose of applying the various provisions of the Act.

The outcome of this appeal hinges on the substance of this agreement. Case law concerning the meaning of the word “acquired” of [sic] the purpose of applying the Act seems reasonably clear to me. A distinction has been established between the owner who holds legal title and the beneficial owner. When Cattanach, J., supra, states:

[Translation]

As I indicated above, it is my opinion that a purchaser has acquired assets of a class in schedule B when title has passed, assuming that the assets exist at that time, or when the purchaser has all the incidents of title, such as possession, use and risk, although legal title may remain in the vendor as security for the purchase price as is the commercial practice under conditional sales agreements.

he is merely confirming the distinction between the owner who holds legal title and the beneficial owner of the property, that is, the one to whom ownership belongs subsequent to a transaction, but who will receive title to the property at a later date.

Incidentally, the Code does not recognize this type of dismemberment of ownership rights. This right is absolute by definition.

Ownership is defined in article 406 as follows:

Ownership is the right of enjoying and of disposing of things in the most absolute manner, provided that no use be made of them which is prohibited by law or by regulation.

In light of this definition, it is clear that this right is indivisible, since it is impossible for more than one person to possess such authority over a thing. A thing may be the property of two or more persons, but these persons hold between them, as co-owners, all the rights associated with the right of ownership of the thing. The dismemberment of the right of ownership is allowed to the extent provided in the Code and is governed by specific provisions. A typical example is that of servitude, which grants the enjoyment of a thing or a part of that thing to someone who is not the owner.

Although contracts of sale are given a separate chapter in the Code, they are subject not only to those provisions exclusive to them but also to the provi- sions covering obligations in general. The Code recognizes a number of types of obligations, such as the conditional obligation, for example, the one signed between the appellant and C.A.C. The conditional obligation may be suspensive or resolutory. According to the relevant facts in this appeal, it is clear that the agreement between the parties created a conditional obligation on a suspensive condition in favour of the appellant, that is, it provided for transfer of ownership if the option was exercised by the appellant on a specified date.

Writers are of the opinion that the suspensive obligation does not transfer the right of ownership on the date of execution of the agreement. Ownership is only transferred to the purchaser when the condition is fulfilled, with retroactive effect to the date of the agreement.

In volume 2 of “Traité de Droit Civil du Quebec", Faribault notes at page 60:

[Translation]

A sale is amenable to all terms and conditions appropriate to contracts. As a result, it may be conditional. If it contains a suspensive condition, the formation of the contract will remain in abeyance until the condition is fulfilled. Until that time, ownership of the thing sold will remain in the vendor, who must, on the other hand, assume all the risks relating thereto.

In volume 5 of the same work, which deals with obligations, Mignault expresses the same opinion. At page 442 he states:

[Translation]

The suspensive condition, until it is fulfilled, holds all the effects of the contract in abeyance.

The obligation does not yet exist; there is only a hope that it will exist. The conditional debtor who mistakenly pays before the condition is fulfilled is therefore paying what he does not owe and accordingly has the right to claim back what he paid.

Ownership, when the purpose of conditional agreement is its transfer, has not yet been shifted; there is only the hope that it will be shifted.

Case law to the effect that a taxpayer who has possession and the use of a thing and has assumed all the risks relating thereto has acquired the thing for the purposes of the Act was founded on provisions of the Act whose wording was quite different from that applicable in this instance, although the word to which the Court had to give a legal meaning was "acquired".

In M.N.R. v. Wardean Drilling Ltd., supra, the Court had to define the word “acquisition” in the context of paragraph 20(5)(e) of the Act in force at the time, that is, in 1963, which read as follows:

(e) "undepreciated capital cost" to a taxpayer of depreciable property of a prescribed class as of any time means the capital cost to the taxpayer of depreciable property of that class acquired before that time minus the aggregate of. . .

[Emphasis added.]

In Olympia and York Development Ltd. v. The Queen, supra, the Court was called on to give a legal interpretation, again for the purposes of the Act, of the definition of the expression “disposition of property" found in paragraph 20(5)(c) of the Act in force at the time, that is, in 1969. The section read:

(c) “disposition of property" includes any transaction or event entitling a taxpayer to proceeds of disposition of property;

In both situations the Court found that an acquisition of property, on the one hand, and a disposition of property, on the other, had occurred when the purchaser enjoyed the possession and use of the property and had assumed all risks relating thereto.

In the present appeal, we must define the word “acquired” in the context of paragraphs 13(21)(b), 20(1)(c) and 127(9)(a).

With regard to the deduction claimed by the appellant as a capital cost allowance, the Court must determine what constitutes depreciable property within the meaning of paragraph 13(21)(b), supra. Prior to the 1979 taxation year, the Act referred essentially to property acquired by a taxpayer during a fiscal year, but under chapter 48, subsection 5(5) of the 1981 Statutes of Canada, an amendment was made to the paragraph applicable to property acquired since December 11, 1979, requiring the taxpayer, from that date, to own such property, at the end of the year, that is, his taxation year. In view of this amendment, which adds a special dimension to the section, although in terms of the cases to which I referred earlier it appears from the evidence that the appellant acquired the trucks and bins, it did not own them at the end of its taxation year, according to the provisions of the Code.

I must also add that, despite the fact that writers are of the opinion that, in the case of a conditional obligation on a suspensive condition, all risks pertaining to the thing sold remain with the vendor, the fact that these risks were assumed by the appellant, the lessor in the present case, does not in any way change my opinion that the case involves a conditional obligation on a suspensive condition. The fact that, under the agreement, the appellant assumed all the risks flows from the contractual obligations between the parties, which are valid because they do not infringe on the Act or public order. I therefore conclude that it was not eligible for a capital cost allowance deduction for the 1982 taxation year.

This finding with respect to the application of paragraph 13(21)(b) does not settle the problem of the application of paragraph 20(1)(c) and subsection 127(5) of the Act and the relevant Regulations. For the purposes of this legislation, the solution must be considered on the basis of the nature of the agreement between the parties.

Counsel for the respondent suggested that the agreement was in the nature of a lease and supported his claim with the argument that the expression used in the agreement between the appellant and C.A.C. clearly reflected the intention of the parties that this should be a lease and not a contract for the acquisition of property. On this point, I refer back to clause 5, which, in my opinion, particularly demonstrates that this intention is not as clear as counsel would have us believe.

Clause 5 reads:

[Translation]

5. In case of total destruction of any leased equipment, Lessee shall be released from its obligation to pay rent by paying Lessor any rent payable to date plus the amount of future rent less the net amount, if any, recovered by Lessor from insurance or other sources for loss or damage. However, Lessor shall not be obliged to initiate any proceeding or other collection method against any party to recover such loss or damage to the leased equipment. Except where expressly stipulated in this paragraph, neither the total or partial destruction nor the total or partial loss of use or possession of any leased equipment shall release Lessee from its obligation to pay the rent provided under the present contract.

Article 1600 of the Code defines a lease as follows:

1600. The lease of things is a contract by which the lessor binds himself towards the lessee to grant him the enjoyment of a thing during a certain time, for a consideration, the rent.

According to this definition, it appears from the substance of the lease that the lessee receives the enjoyment of the thing in return for rent. If the latter loses this enjoyment through the destruction or loss of the thing or for any other reason, it is clear that such an event terminates the contract.

In volume 2 of "Traité de Droit civil du Québec”, Faribault comments on article 1601 of the Code, since replaced by Article 1600, which essentially reproduced the substance of Article 1601. At page 19 he states:

[Translation]

In point of fact, article 1601 provides a definition that is not entirely accurate. When it states that the lessor grants the lessee the enjoyment of a thing, it does not express the exact nature of the lease of things. The lessor must do more than grant the lessee this enjoyment. Specifically, he must bind himself to grant him this enjoyment and maintain it for the duration of the lease.

[Emphasis added.]

Article 1604 of the Civil Code reads:

1604. The lessor must:

1. deliver the thing in a good state of repair in all respects;

2. maintain the thing in a condition fit for the use for which it has been leased;

3. give peaceable enjoyment of the thing during the term of the lease.

At page 312 of her work "Précis du droit de la vente et de louage", Thérèse Rousseau-Houle comments:

[Translation]

Article 1604 C.C. provides for delivery of the thing “in a good state of repair in all respects". Although a distinction is drawn between types of repairs during the term of the lease, none exists at the moment of delivery. The lessor is accordingly responsible for all faults and defects in the thing leased and must, if there are repairs to be made in this regard, perform them at his own expense prior to delivery.

Donna Corp. v. Daoust, J.E. 82-1006 (C.S.).

This obligation extends to incidents; they must be in a good state of repair and capable of being used for their intended purpose.

Skyline Holdings Inc. v. Favorite Sportswear Inc., [1975] C.S. 1247.

The lessor's position is thus less flexible than that of the vendor, who is required only to deliver the thing “in the condition in which it is found at the time of sale" (article 1498 C.C.).

The lessor's obligation may, however, be amended by the parties. If the lease contains a clause to the effect that the lessor shall take the premises in the condition in which they are found, the lessor may be excused from making any kind of repair. Such a clause is valid only to the extent that the property leased may be used for its intended purpose. It is of the essence of the lease that the lessee have enjoyment of the thing. If the property is unusable, the obligation of the lessor has not been fulfilled. On this point, Snow states: [3]

[Translation]

Even where the lease stipulates that the landlord shall not be required to make any repairs, not even those which the law imposes on him, this does not absolve the landlord from his obligation where the premises become totally uninhabitable owing to their unsanitary condition.

In case of doubt or ambiguity, a clause absolving the lessor of responsibility for making repairs will be interpreted against the latter.

[Emphasis added.]

As a result, since clause 5 of the agreement requires the lessee continue to pay rent even if the property is destroyed or the lessee no longer has the use of it, it seems quite persuasive to me that the parties signed an agreement that went far beyond the framework of a simple lease.

For all these reasons, I accept the arguments of counsel for the appellant that the agreement between the parties resulted, for the purposes of the Act, in the acquisition of the property by the appellant. It had possession and use of the aforesaid property and had assumed all the risks; furthermore, it was almost certain that the appellant would exercise the option to purchase when the agreement expired. With this in mind, can the appellant deduct interest paid for the acquisition of this property within the meaning of paragraph 20(1)(c)? Note that the wording in this section is quite different from that in paragraph 13(21)(b), in that the latter does not require the taxpayer to be owner of the property at the end of his taxation year but merely to have acquired the property. The section reads as follows:

20(1)(c) Interest. —an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) n/a,

(ii) an amount payable for property acquired for the purpose of gaining or producing income therefor or for the purpose of gaining or producing income from a business (other than property the income from which would be exempt or property that is an interest in a life insurance policy),

(iii) n/a.

Having found that the agreement between the parties resulted in the acquisition of property by the appellant, I must now conclude that the latter is eligible for the deduction in the amount of $48,931 claimed as interest paid on the balance of the purchase price of the property.

Subsection 127(10), which defines “eligible property" for the purposes of the investment tax credit, is worded in the same way as paragraph 20(1)(c), that is, it does not require the taxpayer to be owner of the property but merely to have acquired it. The same holds true for section 4601 of the Regulations.

On the question of the tax credit, counsel made the following argument in his reply to a notice of appeal:

[Translation]

8. In the alternative, even if the appellant did acquire the aforesaid trucks, a fact which is not admitted but denied, it would not be entitled to the investment tax credit, as the trucks were not acquired principally for the purpose of carrying or hauling freight on highways outside of any metropolitan area, as stipulated in paragraph 4601 (c)(i)(C) of the Income Tax Regulations.

9. The assessment has merit in fact and in law.

Apart from this submission, which clearly reflects the basis of the respondent's assessment, counsel also argued that the appellant was ineligible for this deduction for a number of reasons other than those offered in his reply.

Although counsel for the appellant did not object to this submission by counsel for the respondent, I cannot disregard the comments of Urie, J. of the Federal Court of Appeal of Canada in The Queen v. Consumer's Gas Ltd., [1984] 1 F.C. 779; [1984] C.T.C. 83; 84 D.T.C. 6058. At pages 89-90 (D.T.C. 6063; F.C. 782) he states:

Quite aside from any rules of court in respect of pleadings and the necessity for pleading particular defences, it is trite to say that one of the purposes of a statement of defence is to raise all grounds of defence which, if not raised, would be likely to take the opposite party by surprise. A fortiori where, as here, a particular statutory provision is to be relied upon it must be pleaded together with the facts disclosing why the provision is applicable. Jackett CJ in The Queen v. Edmund Littler Sr. [4] put the principle in this way:

In my view, when a cause of action is to be supported on the basis of a statutory provision, it is elementary that the facts necessary to make the provision

applicable be pleaded (preferably with a direct reference to the provision) so that the opposing party may decide what position to take with regard thereto, have discovery with regard thereto and prepare for trial with regard thereto.

Urie, J. also referred to another comment by Jackett, C.J. in The Queen v. Transworld Shipping Ltd. [5] :

In my view, justice requires that any defence based on special statutory provisions must be pleaded, particularly if it is based on specific facts, so that the opposite party may have discovery with regard to such facts and prepare to adduce evidence with regard thereto.

[Emphasis added.]

Counsel for the respondent argued that waste was not freight within the meaning of the Regulation, that St-Hubert was part of the Montreal metropolitan area and that the manufacturer of the trucks provided no evidence as to their weight.

Notwithstanding the comments in the preceding paragraphs, I believe that the conditions set out in subparagraph 4601(c)(i)(C) should be reviewed briefly for an understanding of its application. First, I have difficulty with the argument that the trucks in question were not designed for the purpose of carrying freight or hauling a trailer that carries freight on any highway. The word "designed" in the context of the Regulation must, in my opinion, be given the meaning of [Translation] "manufactured for the purposes of”. A vehicle whose loaded weight is 62,000 pounds must surely have been manufactured for the purpose of carrying freight on provincial highways rather than for the purpose of travelling on roads or avenues within a municipality. The Regulation requires not that it travel on the highways but that it be designed for such use.

Second, on the question of household waste and specifically whether this constitutes freight or "marchandises" in the French, I refer to the definition of "marchandise" in the Grand Robert de la Langue Française: [Translation] “Movable object that may be traded or sold. . ."

Note also that “freight”, used in the English, is defined in The Random House Dictionary of the English Language as follows: “U.S. and Canada, cargo or lading carried for pay either by water, land or air". In view of these definitions, I have no hesitation finding that household waste, notwithstanding its special nature, constitutes freight within the meaning of the Regulation.

Subparagraph C of the Regulation reads:

[Translation]

acquired principally for the purpose of carrying or hauling freight on highways outside of any metropolitan area, city, town, village, municipality or other similar community or area, and

In order to give a logical meaning to this provision, bearing in mind the word “principally” and still within the context of the Regulation, I suggest that we first consider the type of business carried on by the appellant. It consisted of two distinct operations, the collection of waste and its delivery to a dump located outside municipal limits. The two operations, in fact, constitute a single activity, that is, the activity carried on by the appellant in performing its contract with the municipalities it served.

In order to perform its job for the municipalities, the appellant had to collect and dispose of waste by delivering it to designated locations outside the municipality of St-Hubert, so that under the circumstances the trucks were, in my opinion, acquired principally for the purpose of performing the appellant's contract, which included carrying or hauling freight outside a municipality, as required under the Regulation.

On the question of whether the city of St-Hubert, located outside Montreal Island, is part of a metropolitan area, I note that Parliament did not define “metropolitan area”, in terms of either size or boundaries and, consequently, it is not for the Court to define or otherwise limit the term. The expression "metropolitan area” is too vague in itself to provide a legal meaning. Furthermore, in the situation with which we are concerned, the freight was carried outside a municipality and this is sufficient, in my view, to comply with the Regulation. In Alger F. Walls v. The Queen, [1976] C.T.C. 501; 76 D.T.C. 6309, the Federal Court ruled that in the case of Detroit and Windsor, the city of Detroit was not part of the Windsor metropolitan area, as the respondent appears to have argued.

Finally, subsection D, which sets the minimum truck weight for classification as transportation equipment, instructs us to consider "the gross vehicle weight rating" as defined in the "Motor Vehicle Safety Regulations". The expression is defined in section 2 of the Regulations and reads: [Translation] '"gross vehicle weight rating’ or ‘GVWR’. . . ” means the value specified by the manufacturer as the weight of a single loaded vehicle".

The manufacturer's representative did not testify to establish the weight of the trucks in question. However, the president of Labrie, distributor for the trucks, testified that a truck with a loaded bin weighed 62,000 pounds, considerably more than the 26,001 pounds stipulated in paragraph D. In light of the provisions of subsection 14(2) [6] of the Tax Court of Canada Act of the Statutes of Canada, 29-30-31-32 Eliz. Il, c. 158, I am convinced that the distributor's representative was fully qualified to provide this information on behalf of the manufacturer. It seems to me that a person responsible for the sale of a product must at least be familiar with those features essential for its use. On the basis of the foregoing, I am also of opinion that the appellant is eligible for the investment tax credit deduction in the amount of $21,729, as claimed.

For all these reasons, the appeal is allowed and the assessment referred back to the respondent for reassessment, allowing the appellant the deductions claimed in the amount of $48,931 as interest paid on the balance of the purchase price of the property and in the amount of $21,729 as the investment tax credit. The appellant is entitled to party-and-party costs.

Appeal allowed in part.