Fleur de Lys Warehousing Ltd. v. MNR, 91 DTC 1343, [1992] 2 CTC 2158 (TCC)

Garon, T.C.C.J.:—In this case, the appellant appeals a reassessment of income tax dated October 3, 1988 pursuant to which the amount of $103,640 was added to the appellant's income for its 1985 taxation year.

The essential facts could be easily summarized. As appears from paragraph I of the amended notice of appeal, the appellant entered into a five-year lease on July 3, 1974 with Aaron and Pearl Remer Investment Company Ltd. and Fendal Holdings Ltd. Pursuant to this lease, it was agreed, inter alia, that the appellant pay all of the real estate taxes in respect of the leased premises. In addition, the appellant was required to acquit the business taxes which are ordinarily levied on the person operating a business. The terms of the lease confirm this obligation by stipulating that real estate taxes include all municipal, school and business taxes.

Business and property taxes were paid by the appellant for the period 1977 through 1979 under protest. In computing its income for the 1977, 1978 and 1979 taxation years, deductions were taken by the appellant in respect of the full amount of such taxes in these years.

As a result of certain steps taken by the appellant with respect to the municipal, school and business taxes that had been levied against it for the years 1977, 1978 and 1979, the Bureau de révision de l'évaluation foncière du Québec, the "Tribunal", as set out in paragraph 4 of the amended notice of appeal, rendered on April 19, 1983 a decision by virtue of which:

a) it allowed in full the appellant’s appeal in respect of real estate taxes for the 1977 and 1979 taxation years, with the consequence that the appellant became entitled to a reimbursement of real estate taxes of $51,938.77, excluding interest detailed as follows:

1977:	$28,724.10
1979:	$23,214.67

b) it dismissed the appellant's appeal in respect of business taxes.

Paragraphs 5, 6, 7 and 8 of the amended notice of appeal gave an accurate account of the subsequent proceedings before the Quebec Provincial Court; these paragraphs read as follows:

5. The Communauté Urbaine de Montréal appealed the April 19, 1983 judgment of the Tribunal with respect to real estate taxes to the Québec Provincial Court, and the $51,938.77 reimbursement accordingly did not take place at that time.

6. The appellant appealed the April 19, 1983 judgment of the Tribunal with respect to business taxes to the Quebec Provincial Court.

7. On January 11, 1985, the Québec Provincial Court rendered the following two judgments:

a) it dismissed the Communauté Urbaine de Montréal’s appeal with respect to real estate taxes for the 1977 and 1979 taxation years, thereby confirming the Tribunal’s decision in respect to said taxes and the appellant's entitlement to a reimbursement of taxes in the amount of $51,938.77;

b) it allowed the appellant's appeal with respect to business taxes, thereby overturning the Tribunal's decision in respect of said taxes and establishing the appellant's entitlement to a reimbursement of taxes in the amount of $20,532.20.

8. On September 23, 1985, the Tribunal rendered a judgment by virtue of which it allowed in full the appellant's appeal in respect of real estate taxes for the 1978 taxation year, with the consequence that the appellant became entitled to a reimbursement of real estate taxes of $31,169.46, excluding interest.

It is common ground that the appellant received in the course of the year 1985 by way of three payments refunds of municipal, school and business taxes in the aggregate amount of $103,640.

It was further established by an expert witness by the name of Leon Krolik produced by the appellant that in accordance with generally accepted accounting principles a prior period adjustment represents the proper treatment of the refunds of the municipal, school and business taxes. More specifically, this witness testified that the appropriate portion of the refunds should be credited to retained earnings for the years 1977, 1978 and 1979. This accounting treatment was not disputed by the respondent. As a matter of fact, Helene De- shaies, CA, an employee of the Department of National Revenue, confirmed that the treatment proposed by Mr. Krolik was appropriate from an accounting standpoint.

It is of interest to note in the written report of accountant Krolik the following statements:

In the instance of FDL, the refund of business and property taxes was clearly a reduction of expenses initially recorded as a charge to income in the 1977, 1978 and 1979 taxation years. In order to comply with proper presentation of this refund for financial statement purposes, the refund must be reported in the period to which it relates, i.e., 1977 through 1979.

Section 3600 of the CICA Handbook deals with the specific item of Prior Period Adjustments. Examples of prior period adjustments are non-recurring income tax adjustments or settlements and claims settled as a result of litigation.

In order that an item qualify as a prior period adjustment, it must have all the following four characteristics:

(a) are specifically identified with and directly related to the business activities of particular periods;

(b) are not attributable to economic events occurring subsequent to the date of the Financial Statements for such prior periods;

(c) depend primarily on decisions or determinations by persons other than management or owners; and

(d) could not be reasonably estimated prior to such decisions or determinations.

(Paragraph 3600.03).

Paragraph 3600.6 states that “Prior period adjustments should be excluded from the determination of net income for the current period and applied retroactively to the income of the periods to which they relate".

Retained Earnings are the accumulated balances of revenues less expenses arising from business operations after taking into account dividends, refundable taxes and other amounts that may be properly charged or credited thereto (paragraph 3250.06).

The occurrence of prior period adjustments are few and its definition is narrow. In order to properly comply with generally accepted accounting principles and match the cost reduction of business and property taxes for the 1977 through 1979 years of FDL to the fiscal years to which they relate, DFL would be required to record the transaction as a prior period adjustment and a credit to retained earnings. The physical receipt of the refund in 1975 would cause FDL to reflect this transaction as a prior period adjustment.

In his oral argument, counsel for the appellant put forward as its main submission that a reimbursement of tax in the circumstances of this case does not constitute business income. This submission was virtually identical to the proposition formulated in paragraph 18 of the amended notice of appeal.

In support of this submission counsel pointed out that the reimbursement of a portion of an expense simply amounts to a reduction of an expense already made. He stressed that under the general accepted accounting principles such reimbursement will not in the particular circumstances of this case bring about a change to the income and expense statements for the years 1977, 1978 and 1979. The income for these years would not be altered or varied but the required adjustments will be made to the retained earnings account for the same years.

It was also urged on the Court that the refund of taxes cannot be related in any way to the efforts or activities of the appellant in carrying out its business and accordingly, so the submission goes, the refund cannot be viewed as income from the business.

I do not agree with the thrust of the appellant's submission which amounts to saying in effect that a refund of a current expense deducted in a prior year in computing income from a business has no bearing on the computation of business income for an appropriate future year when the entitlement of such refund comes into existence. In my view, it is clear that if the appellant had, for instance, as a result of the institution of appropriate proceedings obtained in the same year, say in 1977, a favourable judgment from the Tribunal, and if it had received in the same year as well the refund of taxes in question that refund would have reduced to that extent the expense in respect of taxes already deducted in that year and increased by the same amount the appellant's income for the 1977 taxation year.

This, in my view, is a true indication of the real nature of the reimbursement of an expense in the particular circumstances of this case. It has a direct bearing on the income of the recipient. I understood that counsel for the appellant agreed that under generally accepted accounting principles in the hypothetical case referred to earlier an adjustment to the taxpayer's income for that year would have been required if all of the relevant events, namely the assessment of municipal and other taxes and a favourable decision of the Tribunal (favourable from the taxpayer's standpoint) had occurred all in the same year. Counsel for the appellant did not in connection with that hypothesis refer to any provisions of the Income Tax Act or any tax principle that would have justified a departure from generally accepted accounting principles.

If the proper treatment of a refund of taxes made in the year in which the dispute arose would require an adjustment to the income for the same year I cannot see how the refund of taxes in a year subsequent to that in which the deduction of that expense was made would no longer require an adjustment to the income in respect of an appropriate year. I cannot see how the passage of time could change the character of the reduction of an income expenditure that is brought about by the refund of a portion of an expense although, from an accounting point of view, the technique of reporting the occurrence of the refund may not be precisely the same.

This conclusion that a reduction of a current expense resulting from a refund of an amount in relation thereto is not inconsistent with the accounting principle that such refund must be the subject matter of an adjustment to retained earnings of a prior year. In effect, retained earnings represent as mentioned by Mr. Krolik in his report "the accumulated balances of revenues less expenses arising from business operations after taking into account" certain other amounts that may be properly charged or credited thereto. Therefore, any adjustment to retained earnings to reflect the refund in a subsequent year of an expense deducted in a prior year would indicate that such adjustment has a direct bearing on the totality of income or losses accumulated over a given period of time. Such adjustment to retained earnings shows, in my view, the real impact of the refund of an expense on the totality of the income for a stated period of years.

There is the further point that the treatment of a refund of municipal, school and business taxes along the lines I have suggested above appears to be more consonant with the general scheme of the Income Tax Act and has the further advantage of not producing an anomaly or illogical result. In this connection, I have in mind the approach adopted by Estey, J. in the decision of the Supreme Court of Canada in the case of Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305 when speaking of the Income Tax Act he stated that" Courts to-day apply to this statute the plain meaning rule, but in a substantive sense so that if a taxpayer is within the spirit of the charge, he may be held liable”.

I do not see in the case law referred to by counsel for the appellant in support of this main submission, any authority that would point to the invalidity of the conclusion at which I have just arrived in dealing with the tax treatment that is to be accorded to the refund of taxes made many years after the related expenditure had been properly deducted.

The factual situation in the present case is totally different from that discussed by the Supreme Court of Canada in the case of Dominion Taxicab Association v. M.N.R., [1954] S.C.R. 82, [1954] C.T.C. 34, 54 D.T.C. 1020. In that case, the $500 paid by each taxicab owner as a deposit remained the property of the depositor unless he withdrew from the association without the parties agreeing upon a successor to replace him. The court decided that unless the latter condition was fulfilled the money deposited could not be properly regarded as a profit from the appellant's business. This decision was invoked by Counsel for the appellant mainly for the proposition that "the expression ‘profit’ is not defined in the Act. It has not a technical meaning and whether or not the sum in question constitutes profit must be determined on ordinary commercial principles unless the provisions of the Income Tax Act require a departure from such principles".

The decision of President Thorson of the Exchequer Court in the case of M.N.R. v. Publishers Guild of Canada Ltd., [1956-60] Ex. C.R. 32, [1957] C.T.C. 1, 57 D.T.C. 1017 would have been of special interest if there had been in the present case a dispute about the validity of any particular system of accounting. It became clear on the hearing of the appeal that the respondent was not disputing the correctness of the treatment of the municipal tax refund as a prior period adjustment under generally accepted accounting principles and practices.

I do not consider that the decisions of the Federal Court in the case of The Bank of Nova Scotia v. The Queen, [1980] C.T.C. 57, 80 D.T.C. 6009 and The Queen v. Metropolitan Properties Co. Ltd., [1985] 1 C.T.C. 169, 85 D.T.C. 5128 cast doubts on the correctness of the conclusion which I have reached to the effect that the reimbursement of tax refunds requires recalculation of business income for an appropriate year. Nor does the decision of the President Jackett, as he then was, in the Associated Investors of Canada v. M.N.R., [1967] 2 Ex. C.R. 96, [1967] C.T.C. 138, 67 D.T.C. 5096 suggest that I should come to a different conclusion.

I have also carefully considered the decision of the Federal Court-Trial Division in the case of Mohawk Oil Company Ltd. v. Canada, [1990] 2 C.T.C. 173, 90 D.T.C. 6434. It is true that the dictum of Teitelbaum, J. that he"accepted the submission of Counsel for Mohawk that the reimbursement of moneys previously deducted as an expense does not make the reimbursement taxable income” would appear to be helpful to the appellant in the present case. However, the point must not be overlooked that the learned Justice seems to have viewed, although in he did not say that in so many words, the settlement amount as a payment on account of capital when he concluded as follows at page 183 (D.T.C. 6442):

I am satisfied from all of the evidence it is not income to be counted for income tax purposes as the income is not income as contemplated in sections 3, 4 or 9 of the Income Tax Act.

Counsel for the appellant also relied on the decision of the Exchequer Court in the case of M.N.R. v. Eastern Abattoirs Ltd., [1963] Ex. C.R. 251, [1963] C.T.C. 19, 63 D.T.C. 1023. The payment received in that case was, in my view, in the nature of a windfall. Obviously we are not concerned here with such a situation but rather with the refund of an amount of tax legally owing to the appellant.

The preceding comments do not however, dispose of the matter of the appropriate year in which the required adjustment to the appellants income must be made to take into account the refund of the municipal, school and business taxes to which the appellant became entitled.

At this point, I shall now consider the appellants alternative submission formulated in paragraph 19 of the amended notice of appeal. This submission is couched in the following terms:

In the alternative, the appellant submits that, should the Court come to the conclusion that the appellants rights to be reimbursed taxes paid give rise to taxable income, then an amount of no less than $51,938.77 would be income in the appellants 1983 taxation year, as a result of the judgment of the Tribunal dated April 19, 1983, which established the appellants right to such amount.

In considering the matter of the appropriate year of assessment in respect of the refund of taxes I start with the premise laid down in the decision of the Supreme Court of Canada in the case of M.N.R. v. Benaby Realties Ltd., [1968] S.C.R. 12, [1967] C.T.C. 418, 67 D.T.C. 5275. This case had to do with the Question of the appropriate year in which the profit made by the taxpayer on the expropriation of some of its land must be included in its income.

The choice of years was between the year in which the company acquired the right to receive compensation in place of the land or, in other words, the year of expropriation or, alternatively, the year in which the agreement was reached fixing the amount of compensation. The following passages of the judgment of Judson, J. speaking for a unanimous Court are particularly instructive. At pages 419-20 (D.T.C. 5276), he said this:

The Crown’s argument is that the general rule under the Income Tax Act is that taxes are payable on income actually received by the taxpayer during the taxation period; that there is an exception in the case of trade receipts under section 85B(1)(b), which include not only actual receipts but amounts which have become receivable in the year; that the taxpayer's profit from this expropriation did not form part of its income for the year 1954 because it was not received in that year and because it did not become an amount receivable in that year.

In my opinion, the Minister’s submission is sound. It is true that at the moment of expropriation the taxpayer acquired a right to receive compensation in place of the land but in the absence of a binding agreement between the parties or of a judgment fixing the compensation, the owner had no more than a right to claim compensation and there is nothing which can be taken into account as an amount receivable due to the expropriation.

Later on the learned justice summarized his opinion in this way at page 421 (D.T.C. 5277):

My opinion is that the Canadian Income Tax Act requires that profits be taken into account or assessed in the year in which the amount is ascertained.

The next question must therefore centre on the year in which the amount of the refund became ascertained.

The applicable principles of the law for the determination of this question can be found in the decision of the Supreme Court in the case of Maple Leaf Mills Ltd. v. M.N.R., [1976] C.T.C. 324, 76 D.T.C. 6182 and in the decision of the Federal Court of Appeal in the case of Commonwealth Construction Company Ltd. v. The Queen, [1984] C.T.C. 338, 84 D.T.C. 6420.

In the latter case, Justice Urie speaking for the Federal Court of Appeal commented on the principles applicable to the determination of a proper year for the inclusion of amounts of income ascertained by a lower tribunal in the event of an appeal being taken from that decision to a higher tribunal. The learned justice had this to say:

The test for determining the proper year for the inclusion of receivables in taxable income enunciated by Kearney, J. received the approval of the Supreme Court of Canada in Maple Leaf Mills Ltd, v. M.N.R., [1976] C.T.C. 324, 76 D.T.C. 6182. At 330-31 (D.T.C. 6186) of the report de Grandpré, J., speaking for the Court, had this to say:

. . . I accept without question the test expressed by Kearney, J. in M.N.R. v. John Colford Contracting Co., [1960] Ex. C.R. 433, [1960] C.T.C. 178, 60 D.T.C. 1131 (1960), at pages 440 and 441. An appeal to this Court from this judgment was dismissed without written reasons, [1962] S.C.R. viii, [1962] C.T.C. 546, 62 D.T.C. 1338.

This test is the one this Court has applied in income tax cases resulting from expropriations; for an amount to become receivable in any taxation years, two conditions must coexist:

(1) a right to receive compensation;

(2) a binding agreement between the parties or a judgment fixing the amount.

The principle is to be found in M.N.R. v. Benaby Realties Ltd., [1968] S.C.R. 12, [1967] C.T.C. 418, 67 D.T.C. 5275, and in Vaughan Construction Company Ltd. v. M.N.R., [1971] S.C.R. 55, [1970] C.T.C. 350, 70 D.T.C. 6268.

There, thus, appears to be no doubt as to the applicable principle. However, the next question to be asked is — is that situation affected by the fact that the amounts held to be payable by the Judgments of Judge Ferg might have been varied if the appeals had been successful in whole or in part?

This question can be dealt with briefly. In Nouvion v. Freeman (1989), 15 A.C. 1, at pages 10 and 11 Lord Herschel I had this to say:

Although an appeal may be pending, a Court of competent jurisdiction has finally and conclusively determined the existence of a debt, and it has none the less done so because the right of appeal has been given whereby a superior Court may overrule that decision. There exists at the time of the suit a judgment which must be assumed to be valid until interfered with by a higher tribunal, and which conclusively establishes the existence of the debt which is sought to be recovered in this country.

The other law lords did not dissociate themselves from this view although, on the particular facts of the case, they chose somewhat different language. For example, Lord Bramwell at page 15 said this:

There is an essential difference, therefore, between the case where a Court of competent jurisdiction has entertained all the controversies between the parties which they could and chose to raise, and come to a conclusion, which is to be presumed to be accurate, and this case where there is no ground for saying that all possible controversies between the parties have been decided.

The Court of Appeal of British Columbia in Canadian Transport (UK) Ltd. v. Alsburg, (1953) 1 D.L.R. 385 at 406 said that an order of superior court has "full force until reversed on appeal". Other authorities cited to us from various courts are to the same effect and the principle of presumption of the validity of a judgment until reversed or varied on appeal seems to be well established.

It is true that in the Commonwealth Construction case the different amounts in issue held to be receivable were in fact paid in those years. However, it is clear from the analysis and reasoning of Justice Urie, speaking for a unanimous Court, that the matter of the payment of these amounts was not a critical element in the Court's decision.

The Tax Review Board in the case of The Cementation Company (Canada) Ltd. v. M.N.R., [1977] C.T.C. 2360, 77 D.T.C. 249 had applied the same principles to an award of money fixed by a Board of Arbitration.

Applying these principles to the fact of the present case, I am of the view that the amount of $51,938.77 became a receivable in 1983 as a result of a decision of the Tribunal on April 19, 1983. That decision established the value of the property for the 1977 and 1979 years and the rental value for the 1977, 1978 and 1979 taxation years.

Counsel for the respondent has argued that as a result of this decision the amount of tax payable by the appellant had not been determined and therefore the amount of the refund of taxes cannot be ascertained. The evidence indicates that in respect of the property, the valuation of which was in issue, there was no dispute as to the applicable tax rate. It becomes therefore a simple matter of multiplying the value of the property by the appropriate tax rate in the particular year. In a real sense, and for all practical purposes, the amount of tax payable by the appellant and the refund to which he became entitled in 1983 were ascertained and determined by the Tribunal.

I have not been referred to any provisions in the appropriate provincial legislation which would preclude the amount of that refund resulting from the Tribunal's decision from becoming a receivable in 1983.

In objecting to the contention that the amount of $51,938.77 became a receivable in 1983, as a result of the Tribunal's decision, counsel for the respondent invoked the law of estoppel against the appellant on account of the fact that the appellant's financial statements for the 1983 taxation year and the related tax return contain no note or information relating to the Tribunal's decision. Even if the law of estoppel could apply to the actions of the appellant, I see no merit in this objection. There was no clear requirement under generally accepted accounting principles that such information should appear in the financial statements. Nor I have been referred to any provisions of the law which would require the disclosure of such information. In this regard, an officer of the Department of National Revenue testified that he had full cooperation from the appellant's representatives when he had to deal with them some time later. It may well be that the reason why the appellant's officers and advisors did not disclose the information at the time the appellant's return of income was forwarded to the respondent was simply that there were unaware that in law the entitlement of the refund had created an amount receivable by reason of the Tribunal’s decision. The fact that an appeal from the decision of the Tribunal was instituted almost immediately coupled with the fact that there was no payment by the appropriate taxing authorities to the appellant may also explain the conduct of the appellant's officers and advisors. On that account, their reaction was similar to the attitude of the officer of the Department of National Revenue who candidly admitted that when he was informed of the Quebec Provincial Court's judgments it did not occur to him that the refund to which the appellant became entitled in 1983, as a result of the Tribunal's decision, could be taxable in 1983 although the information relating to the Tribunal's decision could be found right at the beginning of these two judgments of the Quebec Provincial Court delivered in 1985.

Because the refund of taxes resulting from the Tribunal’s decision could not be discovered by the respondent, as a practical matter, unless information had been given to him about the matter by the appellant it was suggested to me by Counsel for the respondent that I should not conclude that the amount of refund arising out of the Tribunal’s decisions should be included in the appellant's income for its 1983 taxation year. I cannot entertain this suggestion. The quality of “income” or" receivable” that may be attributable to the amount of the refund cannot in law be dependent on the knowledge of appellant's officers and advisors nor could it depend on the amount of difficulties that may be encountered by the respondent in finding out the necessary information.

I am therefore of the opinion that the amount of the refund to which the appellant became entitled by virtue of the Tribunal’s decision became a receivable in 1983 and was therefore income for the appellant in that year. Consequently, the amount in question cannot be included in the appellant's income for its 1985 taxation year.

For these reasons, the appeal is allowed in part, with costs, and the matter of the reassessment dated October 3, 1988 is referred back to the respondent for re-examination and reassessment on the basis that in computing the appellant's income for its 1985 taxation year the respondent should exclude therefrom the amount of the refund to which the appellant was entitled by reason of the decision dated April 19, 1983 of the Bureau de l'évaluation foncière du Québec.

Appeal allowed in part.