Mandel v. The Queen, 78 DTC 6518, [1978] CTC 780 (FCA), briefly aff'd 80 DTC 6148, [1980] CTC 130, [1980] 1 S.C.R. 318

Ryan, J:—This is an appeal from a judgment of the Trial Division dated August 9, 1976. The Trial judgment dismissed the appellant’s appeal from a reassessment of his income tax for the 1971 taxation year. This and eleven related appeals were disposed of at trial on common evidence, the points of law involved in all of the cases being identical. The eleven other appeals were, of course, also dismissed. They, too, are being appealed and, the issues being once again identical, all of the appeals will be disposed of on the basis of the submissions in the present appeal. Copies on these reasons will be filed on the appeal files of the other cases.

The appeal involves a capital cost allowance question. The appellant, along with eleven others, formed a partnership together wtih a corporation which they incorporated for the purpose, and the partnership bought a film in 1971, the film then being in an advanced state of production. The purchase price was the audited cost of production to the date of purchase, which was computed at $577,892, payable by way of a cash payment of $155,000, the baalnce to be paid out of earnings.

The question to be determined is whether the appellant was entitled to claim, as he did, by way of capital cost allowance for 1971, his share of the total stipulated price, or whether he was limited to his share of the cash payment, having in mind that the balance would be payable only if and when there were earnings, the position taken by the Minister. As became apparent from the expert accountancy testimony, the answer to the question depends on whether the liability to pay the balance of the price was a “real” or a contingent liability.

The applicable income tax legislation and regulations were those in effect for the 1971 taxation year.

There is really very little dispute over the facts. They are clearly set out in the appellant’s Memorandum of Fact and Law, and I will accordingly quote all of the paragraphs from 4 to 18 of the Memorandum, with the exception of paragraphs 13 and 16 which were questioned by the respondent. I have deleted paragraph numbers and the page references to the evidence, and I have made some minor consequent changes in punctuation.

As of September 14, 1971, an agreement was entered- into between Topaz Production Limited, Niagara Television Limited, Robert Lawrence Productions (Canada) Limited and John T Ross, for the production of a film known as “Mahoney’s Estate”, for a projected budget of $653,000. Production was scheduled to be completed by December 31, 1971.

Topaz sold 25% of its rights, title and interest in the film to Niagara, thus retaining a 75% interest. Under the Agreement, Topaz was to receive $20,000 deferred compensation and 25% of the profits. Robert Lawrence Productions were to receive $15,000 deferred compensation and 8% of the profits and was to arrange financing for the costs in excess of $375,000 exclusive of deferred costs. Niagara advanced $125,000 repayable out of revenues. Upon completion, Deloitte, Haskins & Sells, Chartered Accountants, were to audit and verify total production costs. The net profits in excess of expenses were to be divided as follows: 20% to the Canadian Film Development Corporation, 22% to Niagara, 8% to Robert Lawrence Productions, 25% to Topaz, 7% to Harvey Hart, 1.5% to Harvey Hart, 1.5% to Maud Adams, 1.5% to Sam Waterston, the remaining 15% to such persons jointly designated by Topaz and Robert Lawrence Productions and in default of designation, equally between these two corporations.

By additional Agreement dated September 14, 1971, the Canadian Film Development Corporation agreed with Topaz and Niagara as owners, Topaz as producer, and John T Ross as executive producer, to advance $250,000 and to receive 20% of the net profits in return for so doing.

By Agreement dated August 31, 1971 between Topaz and Niagara, as licensors, and International Film Distributors Limited, as distributors, arrangements were made for distribution of the film on a percentage basis of gross receipts.

On December 9, 1971 the Bank of Montreal loaned $100,000 in consideration of 2 /2% participation in profits at a rate of interest of 2 /2% above prime, repayment to start three months after production was complete.

As of 1971, the above named financial agreements formed part of what can be termed as standard financing arrangements in the industry.

On December 22, 1971, a letter agreement was reached between the law firm of Thomson, Rogers (of which eleven of the plaintiffs were then members) and Topaz and Niagara as owners of the film, confirming that they had assembled $150,000 in order to purchase on behalf of a limited partnership, the film on December 31, 1971, provided Niagara would advance the $125,000 bearing no interest and repayable by the same terms as the $250,000 advance by the Canadian Film Development Corporation. The balance of the purchase price was to be paid by the assumption of all the obligations of the producer for payment or repayment including the monies advanced by the Canadian Film Development Corporation and by Niagara, and the monies agreed to be paid by the producer under all agreements, contracts and arrangements in existence or made thereafter for the purchase of completing the film. The repayments were to be paid out of revenues.

For purposes of acquiring this film the individuals involved were to be formed, and were formed, into a limited partnership with a company to be incorporated as the general partner and the individuals to be limited partners. The company was incorporated as “One Flag Under Ontario Investments Limited” and the limited Partnership was known as “One Flag Under Ontario Investments Limited and Film Associates”. Each partner held an _. interest limited and proportionate to his contribution.

On December 30, 1971 the agreement was finalized between Topaz, Niagara, Canadian Film Development Corporation, Robert Lawrence Produc- tions, John T Ross, and One Flag, acting through its general partner. The 15% net profits previously to be designated by Topaz and Robert Lawrence were now to be distributed in the proportion of 12.5% to the purchasers, and 2.5% to the Bank, all percentages of the other parties remaining unchanged.

In addition, it was provided that the firm of Deloitte, Haskins & Sells would provide an audit determining the total cost of production at December 31, 1971. This was done, and production and acquisition costs were determined by audit to be $577,892 as of that date.

Final production costs were also to be determined by Deloitte, Haskins & Sells, but for purposes of the 1971 taxation year, and for the purchase price, the audit closed on December 31, 1971 and costs were certified as above.

Plaintiffs paid $150,000 against the figure of $577,892, the balance to be paid out of revenues pursuant to the agreement defined above.

As at the date of purchase, the filming was basically complete, with editing only remaining.

An Agreement dated February 1, 1973 between Canadian Film Development Corporation, Amaho Limited referred to as the assignee, Topaz Productions Limited, Niagara Television Limited, Robert Lawrence Productions Limited, John T Ross, and One Flag Under Ontario Investments Limited & Film Associates and Alexis Kanner sets out that Niagara provided financing of the film in the amount of $125,000 and paid a further sum of approximately $10,000 in connection with the completion of it. lt assigns all its rights save for the $10,000 to Amaho Limited, the assignee, and in consideration of $1 the Canadian Film Development Corporation assigns any interest which it had to recoupment of monies advanced by it out of a share of the profits the film made and the parties release the corporation from any demands or claims for the balance of its $250,000 commitment which it had not yet paid ($3,420).

On February 11, 1974, an agreement was entered into between Topaz Productions Limited and British Lion Films Limited which sets forth that principal photography in the motion picture film has been completed but that additional finance is required to complete production and deliver same ready for exhibition which Lion has agreed to provide in return for the acquisition of distribution rights in the film and media throughout the world.

The appellant claimed a capital cost allowance for 1971 based on his share of the stipulated price of the film, including the total amount of the balance to be paid when and if there were earnings. The Minister reassessed the appellant on the basis that the capital cost to the purchasers of the film in 1971 was limited to the cash payment of $150,000. The appellant appealed to the Federal Court. The Trial judge dismissed the appeal. He held that the capital cost of the film to the purchasers in 1971 was the cash payment and did not include the balance of the price because, in his view, the liability to pay it was contingent.

The appellant submitted that the learned trial judge erred in failing to find that the appellant’s capital cost allowance for 1971 was calculable on the basis of the total price, as determined by the auditors, of $577,892 and, in particular, in holding that the excess over the $150,000 cash payment was a contingent liability.

The appellant, at the trial, introduced evidence of an expert in accountancy, Robert Fraser. The respondent called Mr Bonham, also

an expert in accountancy. The trial judge said of these witnesses: “. . . both are highly qualified experts”.

In this case, expert accountancy evidence on the question whether, in the circumstances, the amount of the unpaid balance of the price was properly includable in the capital cost of the film in the year of its purchase was clearly pertinent. And there was nothing in the relevant legislation or regulations to limit its normal impact.

As I read this evidence, the experts were in agreement that the unpaid balance ought to have been included if it were a “real” liability, but not if it were a contingent liability. And it is clear that the trial judge also so read the evidence.

Mr Fraser was of opinion that the liability of the purchasers in respect of the balance was “real”, that it was not, for relevant purposes, contingent. Its payment was, it is true, contingent, but the contractual liability to pay the precisely ascertained sum was itself, in his view ,“real”.

Mr Bonham did not agree. It is true that when, before the trial, the respondent consulted him and asked for his opinion, he was asked to give it on certain assumptions, and his affidavit received in evidence was based on them. One of these assumptions was:

The obligations incurred by One Flag [the purchasing partnership] by which it acquired the said film were:

(a) Unconditional to the extent of paying $150,000, and

(b) Conditional or contingent with respect to the payment of any further amounts up to a maximum of $427,892, as established as of December 31, 1971 (for a total maximum consideration at that date of $577,892); the condition being that there must first be monies available from the exploitation of the film according to the terms of the relative agreements.

In both his direct examination and under cross-examination, Mr Bonham clearly expressed his opinion that such a condition would render the obligation to pay the balance of the price contingent for relevant accountancy purposes.* [1]

The trial judge, after careful analysis of the expert testimony, decided that the liability to pay the balance was contingent for relevant purposes, and I agree with him. The consequence, of course, was that the balance was not properly includable in the taxpayer’s capital cost for the taxation year. The amounts actually paid in the future from earnings, if any, would be taken into capital cost in the years of payment.

There is no doubt, as the trial judge indicated, that, in contracting to buy the film on the agreed terms, the purchasers incurred a lia- bility both in respect of the cash payment and the balance. It was not, however, as to the balance, a liability to pay merely on the expiration of a period of time or on the happening of an event that was certain, or even likely, to occur*. [2] It was a liability (from which the purchasers admittedly could not unilaterally withdraw) to become Subject to an obligation to pay the balance if, but only if, an event occurred which was by no means certain to occur. The obligation was thus contingent on the happening of the uncertain event.

In reaching this conclusion, I have derived assistance from the speech of Lord Reid in Winter and Others v Inland Revenue Commissioners, [1961] 3 All ER 855. That case involved deciding whether a possible liability of a corporation to pay tax on a capital cost recapture on a future disposition of an asset was a contingent liability for purposes of subsection 50(1) of the Finance Act, 1940. The case concerned estate duty. The deceased was controlling shareholder in a corporation which, before his death, had taken capital cost allowance on ships owned by it and in respect of which it would be bound to pay recapture if the ships were sold for more than the undepreciated capital cost. The value of the deceased’s shares for estate tax purposes would under the applicable legislation be determined by reference to the value of the assets of the corporation at the time of the shareholder’s death. In valuing the assets, the Commissioners were required to “. . . make an allowance from the principal value of those assets for all liabilities of the company (computed, as regards liabilities which have not matured at the date of death, by reference to the value thereof at that date, and, as regards contingent liabilities, by reference to such estimation as appears to the Commissioners to be reasonable) . . .”

The problem in the Winter case was whether the liability. in question was a contingent liability for purposes of the valuation or no liability at all. l venture to quote Lord Reid at length. The precise problem in that case was, of course, the meaning of ‘‘contingent liabilities” within the particular statute. His words, however, have in my view wider significance. He said at 247 to 249:

No doubt the words “liability” and “contingent liability” are more often used in connection with obligations airsing from contract than with statutory obligations. But I cannot doubt that if a statute says that a person who has done something must pay tax, that tax is a “liability” of that person. If the amount of tax has been ascertained and it is immediately payable it is clearly a liability; if it is only payable on a certain future date it must be a liability which has “not matured at the date of ‘death’ within the meaning of section 50(1). If it is not yet certain whether or when tax will be payable, or how much will be payable, why should it not be a contingent liability under the same section?

It is said that where there is a contract there is an existing obligation even if you must await events to see if anything ever becomes payable, but that there is no comparable obligation in a case like the present. But there appears to me to be a close similarity. To take the first stage, if I see a watch in a *shop window and think of buying it, I am not under a contingent liability to pay the price: similarly, if an Act says I must pay tax if I trade and make a profit, I am not before I begin trading under a contingent liability to pay tax in the event of my starting trading. In neither case have I committed myelf to anything. But if I agree by contract to accept allowances on the footing that / will pay a sum if I later sell something above a certain price I have committed myself and I come under a contingent liability to pay in that event. This company did precisely that, but its obligation to pay arose not from contract but from statute. I find it difficult to see why that should make all the difference.

It would seem that the phrase “contingent liability’’ may have no settled meaning in English law because, in this case, Danckwerts J thought it necessary to resort to a dictionary, and in In re Duffy (a case much relied on by the respondents) the Court of Appeal regarded its meaning as an open question. But the Finance Acts are United Kingdom Acts, and there is at least a strong presumption that they mean the same in Scotland as in. England. A case precisely similar to this case could have come from Scotland and your Lordships would then have considered the meaning of this phrase in Scots law. So I need make no apology for reminding your Lordships of its meaning there. Perhaps the clearest statement of the Law of Scotland is in Erskine’s Institute, 3rd ed, vol 2, Book Ill, Title I, section 6, p 586, when he says: “Obligations are either pure, or to a certain day, or conditional. . . . Obligations in diem . . . are those in which the performance is referred to a determinate day. In this kind . . . a debt becomes properly due from the very date of the obligation, because it is certain that the day will exist; but its effect or execution is suspended till the day be

elapsed. A conditional obligation, or an obligation granted under a condition, the. existence of which is uncertain, has no obligatory force till the condition be purified; because it is in that event only that the party declares his intention to be bound, and consequently no proper debt arises against him till it actually exists; so that the condition of an uncertain event suspends not only the execution of the obligation but the obligation itself. . . . Such obligation is there said in the Roman law to create only the hope of a debt. Yet the granter is so far obliged, that he hath no right to revoke or withdraw that hope from the creditor which he had once given him.”

So far as I am aware that statement has never been questioned during the two centuries since it was written, and later authorities make it clear that conditional obligation and contingent liability have no different significance. I would, therefore, find it impossible to hold that in Scots law a contingent liability is merely a species of existing liability. It is a liability which by reason of something done by the person bound, will necessarily arise or come into being if one or more of certain events occur or do not occur. If English law is different—as to which I express no opinion—the difference is probably more in terminology than in substance.

I must now turn back to the provisions of section 50(1) of the Finance Act, 1940. It directs the commissioners to make an allowance for (or deduction in respect of) all liabilities of the company, and it divides liabilities, as one might expect, into three classes. First, where the liability is a sum immediately payable there is no need for computation and the whole is deducted. Secondly, the liability may be one which has not matured: that would include a sum payable at a definite future date or a sum payable on an event which must occur some time, for example, the death of A. There the commissioners are to take the present value of the debt. The third class is “contingent liabilities,’’ which must mean sums, payment of which depends on a contingency, that is, sums which will only become payable if certain things happen, and which otherwise will never become payable. There calculation is impossible, so the commissioners are to make such estimation as appears to be reasonable.

The last class appears to me to cover exactly the conditional obligation dealt with by Erskine in the passage I have quoted. I agree with the respondents’ argument to this extent, that this class can only include. liabilities which in law must arise if one or more things happen, and cannot be extended to include everything that a prudent business man would think it proper to provide against. That is the distinction which I have already tried to explain. But I cannot agree with the respondents’ further argument that there must be an existing obligation because that would exclude at least all Scottish conditional obligations.

I have italicized the passages that I have found of particular assistance.

I have also found helpful the definition of “contingent liability’ appearing in the speech of Lord Guest in the same case at 262:

. . . Contingent liabilities must, therefore, be something different from future liabilities which are binding on the company, but are not payable until a further date. I should define a contingency as an event which may or may not occur and a contingent liability as a liability which depends for its existence upon an event which may or may not happen. . . .

It is of interest to note that Lord Guest also referred to the law of Scotland on conditional obligations, in particular to part of the passage quoted by Lord Reid from Erskine’s Institute of the Law of Scotland and to Gloag on Contract. He said of this law at 263: “. . . I see no reason why these principles should not be applicable to a United Kingdom statute and no authority was quoted to show that English law differed in any way.”

Before concluding, I would advert to a submission made by counsel for the appellant which was also made to the trial judge. The trial judge put the submission this way: the argument was

. . . that since the purchasers assumde all of Topaz’s obligations in addition to paying $150,000 cash they were in the place and stead of the vendors and . . . the capital cost of the film to them at the end of 1971 was the same as it would have been to the vendors.

The trial judge reviewed several cases, including Ottawa Valley Power Company v MNR, [1969] 2 Ex CR 64; [1969] CTC 242; 69 DTC 5166, relied on by counsel, and D’Auteuil Lumber Co Ltd, v MNR, [1970] Ex CR 414; [1970] CTC 122; 70 DTC 6096, in which President Jackett (as he then was) explained observations he had made in the Ottawa Valley Power Company case. The trial judge then said:

. . . In making the purchase they incurred an obligation to pay the balance but only out of the proceeds of the film so that both the time of payment and whether the payment would ever be made were contingent and these amounts should only be claimed when and if they are so paid. Certainly, to use the words of Chief Justice Jackett in the D’auteuil Lumber case “what was received can easily be valued and what was given is almost impossible to value”. He goes on to say however “Where the value of the thing given for the capital asset in question can be determined with the same kind of effort as is required to value the capital asset itself, I should have thought that the Court would not look kindly on attempts to lead evi- dence as to the value of the capital asset in lieu of, or in addition to, evidence as to the value of what was given for it”.

It appears to me in the present case that the value of the consideration can eventually be determined with complete accuracy when the net proceeds of the distribution of the film are finally received and there is no statutory or other requirement that an estimate be made of this as of the end of the 1971 taxation year, in which event these proceeds would have been impossible to value.

This, with respect, appears to me an adequate disposition of the submission, subject to a reservation I would make concerning the ease of valuing the film before sale. Quite clearly, the relevant capital cost figure is cost of the film to the taxpayers, not the expenditures made by the vendors in producing it, nor the obligations to which they may have become subject in raising the production funds. On the basis of the accountancy evidence properly accepted by the trial judge, the appropriate method of determining the capital cost to the taxpayers for the 1971 taxation year was to include the cash payment and to exclude the contingent liability. Future payments, if any, could be brought in when made. There was no real problem, once the accountancy evidence was accepted, in determining the capital cost of the film to the taxpayers, and thus no occasion to resort to any presumption based on costs to others or on any other circumstance. As a matter of fact, I would observe that, while it might have been easy to determine the costs to the vendors, the “value” of the film before the sale would not, as I see it, have been all that obvious.

In disposing of this appeal, it is not, of course, necessary to deal with submissions that were made to us on the assumption that the obligation to pay the balance of the price was real, not contingent.

There was no cross-appeal.

I would dismiss the appeal with costs. There should, however, be only one set of costs for all of the appeals, this and the appeals cited in footnote 1.