Supreme Court of Canada
Eli Lilly & Co. Ltd. v. Minister of National Revenue, [1955] S.C.R.
745
Date: 1955-10-04
Eli Lilly And Company (Canada) Limited Appellant;
and
Theminister of National Revenue
Respondent
1955: March 28, 29; 1955: October 4.
Present: Kerwin C.J. and
Estey, Locke, Cartwright and Fauteux JJ.
ON APPEAL FROM THE
EXCHEQUER COURT OF CANADA
Assessment―Taxation―Income
Tax―Whether sum reserved to pay Foreign exchange but not drawn on,
"income"―The Income War Tax Act, R.S.C. 1927, c. 97, s. 8.
The appellant, the
Canadian subsidiary of an American corporation, for the years 1940-1945
inclusive, purchased goods from the parent company totalling $640,978.29 in
American currency. During that time the United States dollar was at a premium and
the appellant, though it made no payments on account, set up in its books the
amount of its indebtedness in Canadian dollars (as if the two currencies were
at parity) plus the amount required each year to cover the premium on exchange
for the purchases made in that year. At the end of 1945 the amount of Canadian
dollars required to cover the premium totalled $67,302.77. In filing its income
tax returns in each of these years the appellant included the premium so
computed as an expense and it was allowed by the taxing authorities. In July
1946, the Canadian dollar attained a position of parity with the United States
dollar and the appellant in its 1946 profit and loss account included the said
sum of $67,302.77 as income under the heading of "Foreign Exchange Premium
Reduction" and, in filing its income tax return for that year, treated the
amount as a capital rather than an operating profit and deducted it in
determining its net income subject to tax. The deduction was disallowed by the
Minister. Appeals by the taxpayer to the Income Tax Appeal Board and to the
Exchequer Court were each dismissed. In its appeal to this Court the appellant
contended that as all the goods were purchased prior to 1946 it, in making
settlement of the indebtedness in that year (which it effected with $640,978.29
in Canadian dollars by the issue of additional shares to the parent company
without payment of any exchange) realized neither a profit, gain nor gratuity
within the meaning of s. 3 of the Income War Tax Act and therefore the
amount in question was not properly included in the word "income" as
defined in that section.
Held (Locke and Cartwright JJ. dissenting) : That the
amount set up by way of reserve to meet payments of foreign exchange when
unnecessary for that purpose was properly included as an item of profit in
computing income tax. In 1946, owing to the change in the rate of exchange, the
$67,302.77 held by the appellant as a reserve to provide for the contingency of
having to pay for the U.S. dollars required to discharge its indebtedness
ceased to be required for that purpose. It thereupon became available for the
general purposes of the appellant and was properly treated as income in the
year in which it became so available. Davies v. The Shell Co. of
China Ltd., 32 T.C. 133 at
[Page 746]
151, and H. Ford &
Co. Ltd. v. Commssr. of Inland Revenue, 12 T.C., 997 at 1004,
applied. The Texas Co. (Australasia) Ltd. v. Federal Commssr. of
Taxation, 63 C.L.R. 382, referred to. British Mexican Petroleum Co. v.
Jackson, 16 T.C., distinguished.
Per Locke J. (dissenting) : It was income and income
only, which was taxed by the Income War Tax Act as amended, which
applied to the taxation year 1946. As applied to corporations, taxable income
was determinable by calculating the amount received from the operation of the
company's business less operating expenses and other deductions permitted by
the Act in calculating such income. The appellant was benefited by the
restoration of the value of the Canadian dollar in terms of U.S. currency, an
event over which it had no control, but the advantage to it, as distinguished
from the extent to which its profits were increased by its occurence, was no
more a trading receipt than the advantage accruing to an export company by a
recovery in world trade, or the benefit accruing to all trading corporations by
a reduction in income or other taxation. British Mexican Petroleum Co. v.
Jackson 16 T.C. 570, applied.
Per Cartwright J. (dissenting) : The indebtedness of
the appellant to its parent company which accrued from 1940-1945 inclusive was
rightly calculated and allowed in those years at $708,281.06 in Canadian funds.
The fact that in 1946 owing to a change in the rate of exchange, the appellant
was able to discharge its indebtedness by payment of $640,978.29 in Canadian
funds did not render the difference between these amounts, income of the
appellant. In the year 1946 the appellant neither received the sum of $67,302.77
nor acquired any right to receive payment of it. The principle of the decision
in British Mexican Petroleum Co. v. Jackson, supra, applied.
Judgment of the Exchequer Court of Canada [1953] Ex. CR. 269, affirmed.
APPEAL from a judgment of the Exchequer Court, Thorson P.
dismissing
an appeal from the Income Tax Appeal Board.
R. B. Law, Q.C. and S. H. S. Hughes, Q.C. for
the appellant.
Joseph Singer, Q.C. and J. D. C. Boland for
the respondent.
The judgment of Kerwin C.J. and of Estey and Fauteux JJ. was
delivered by:¯
Estey
J.:¯The appellant, a Canadian
subsidiary of Eli Lilly and Company of Indianapolis, Indiana, purchased goods
from the latter during the period September 15, 1939, to December 31, 1945, at
invoice prices which totalled $640,978.29 to be paid in United States dollars.
While no part of this sum was paid prior to October, 1946, the appellant, as
the United States dollar throughout that period
[Page 747]
was at a
premium over the Canadian dollar, set up in its books an item equal to the
amount required in each year to pay the premium on the purchases in that year.
In filing its income tax returns in each of these years it included the premium
so computed as an expense which was allowed by the taxing authorities.
In July, 1946, the
Canadian dollar attained a position of par in relation to the United States
dollar. On October 22 of that year the appellant's directors allotted 7,450
shares of its common stock to the parent company in settlement of appellant's
indebtedness for goods purchased as already stated, computed at the sum of
$717,532.72, and a cash payment of $27,467.28. These two items total $745,000,
or an equavalent of 7,450 shares of common stock at a par value of $100.
The sum of $717,532.72
was made up of two items: (1) the sum of $640,978.29 and (2) the total of the
premiums for the respective years in the sum of $67,302.77, and other items not
material hereto. The appellant, in its factum, set the transaction up as
follows:
The said 7,450 shares,
having in the aggregate a par value of $745,000, were paid for as follows:
The above mentioned liability…………………………………….. $640,978.29
Cash paid by the parent
company to the appellant…………….. 27,467.28
In satisfaction of other amounts owing by
appellant to
parent company…………………………………………………….. 76,554.43
$745,000.00
In its 1946 profit and
loss account the appellant included the said sum of $67,302.77 as income under
the heading "Foreign Exchange Premium Reduction" and, in filing its
income tax return for that year, treated the amount as a capital rather than an
operating profit and deducted it in determining its net income subject to tax.
This deduction was disallowed by the Minister and by the Income Tax Appeal
Board, as well as in the Exchequer Court. In this appeal the appellant asks
that the judgment in the Exchequer Court be
reversed and the deduction allowed.
It is contended that as all of the goods were purchased
prior to 1946 the appellant, in making the settlement of that year, realized
neither a profit, gain nor gratuity within the
[Page 748]
meaning of s. 3 of The Income
War Tax Act (R.S.C. 1927, c. 97) and, therefore, the amount here in
question was not properly included within the word "income" as
defined in that section.
The agreement that the invoice price in the total sum of
$640,978.29 was payable in United States dollars introduced a contingency, or a
factor of uncertainty, in the purchase price that could only be settled or
determined by payment and, therefore, upon the date of payment. In reality the
amounts set up in each year totalling $67,302.77 were a reserve to
provide for this contingency. If, at the date of payment, no premium was
required, the reserve set, up would be unnecessary. If the premium was lower
than the rate at which it was computed, only a part of the reserve would be
necessary, but if, on the other hand, a higher premium was required, an
additional item of expense would be incurred. That such was the position would
seem to follow from the following evidence on behalf of the appellant :
Q. And you were not under any liability to them to pay the
additional accumulated items for foreign exchange which you show in this
statement totalling $67,302.77—that is correct, is it not? A. Yes.
* * *
Q. So we have our position then in 1946, that you paid all
your indebtedness to the American Company by the issue of shares in the
Canadian Company, and you did not have to resort or pay to anyone the sum of
$67,302.77, or any part of it—you did not have to resort to or pay any part of
the sum of $67,302.77, which is the accumulation of the various amounts set up
by you in this record, Exhibit 1, for exchange? A. Yes, that is right.
Payment was never made because the appellant was never in a
position to do so and it would appear that the parent company, in 1946, deemed
it desirable that a settlement should be made.
This case is, therefore, distinguishable from The British
Mexican Petroleum Co., Ltd. v. Jackson (H.M. Inspector of Taxes),
. There, because of
a slump in business conditions, the taxpayer was unable to pay its
indebtedness. Three of its larger creditors, apparently to assist the taxpayer,
entered into an agreement under date of November 25, 1921, whereby they reduced
their respective claims.
[Page 749]
One of the creditors, H. &
Co., reduced its claim by the sum of 945,232 pounds. The issue, as stated by
Lord Thankerton at p. 590:
The question in this appeal is whether this sum of £945,232
fails to be brought into account for the purpose of computing the profits and
gains of the Respondents under Schedule D of the Income Tax Act, 1918, either
by reducing by that amount the debit item in the trading account to 30th June,
1921, or by crediting it as a trading receipt in the trading account to 31st
December, 1922.
The total outstanding indebtedness of H. & Co. was the
sum of £1,073,281 and the Crown contended that, as that amount had been treated
as an expense in the accounts of June 30, 1921, part thereof, namely, £945,232,
was never expended and, therefore, the account of June 30, 1921, should be
reopened and this item of expense reduced by £945,232 in order to bring it into
conformity with the amount actually paid. In the House of Lords this contention
of the Crown was not accepted. Lord Thankerton, at p. 592, stated:
… the account to 30th June, 1921, cannot be reopened, as the
amount of the liability there stated was correctly stated as the finally agreed
amount of the liability and the subsequent release of the Respondents' proceeds
on the footing of the correctness of that statement.
In the case at bar there was no gift, nor had the item here
in question ever been settled. The parent company continued to claim the
invoice price of the goods in terms of United States dollars. The record
indicates that throughout the relevant period the appellant was never in a
position to pay cash and in 1946 it was apparently deemed, if not by the
appellant by the parent company, desirable that a settlement be effected. There
was, upon the day of the settlement, no premium and, therefore, the reserve
which had been provided for that contingency was unnecessary. The position
would appear, therefore, to be similar to that expressed by Rowlatt J. in H.
Ford & Co., Ltd. v. Commissioner of Inland Revenue , where, in
referring to the woolcombers and
Newcastle Brewery ,
cases at p. 1004, he stated that these cases
went quite far enough to
justify looking at the accounts and saying: "Nobody dreamt this was not a
loss at the time, but it turns out it was not. Re-open the accounts and find
out what really were the losses and the earnings in 1919."
[Page 750]
In the Ford
case the taxpayers engaged in the grain business were under a contractual
obligation to pay certain demurrage to the Royal Commission upon Wheat Supplies
in England. The Commission claimed the sum of £33,847 for the period April to
July, 1920. The taxpayer protested, but placed in its balance sheet an item of
expense of £33,847. Two years later the Commission abandoned their claim and it
was held by Rowlatt J., affirming the Commissioner, that this amount ought not
to be allowed as an expense.
The appellant states its alternative position in the
following language:
In the alternative if
there was a gain in 1946 it was due to the extinction fey the action of the
Government of Canada of a liability or reserve. This was entirely fortuitous in
its nature—not resulting from any action by the debtor or the creditor in the
way of trade or in any other way. It was a lucky windfall. And when the learned
President and incidentally Mr. Fisher, have classified it in the field of
trading they forget that it was not paid. The gain, if any, was not derived
from capital or the use of capital but was of the nature of a fortuitous
gain accruing to capital.
The cost of exchange arising out of fluctuations in foreign
currency is an ordinary expense in relation to foreign trade and has been so
recognized and treated in the computation of income tax. While the government,
in times of emergency, may have particular reasons for fixing the exchange
rate, it must be assumed. that the market rate remains a dominating factor in
the fixing of that rate. Moreover, while the rate of exchange, as fixed by
government action, eliminates the fluctuations arising out of the operation of
the market, it may itself be changed, as, indeed, it was in this case, from
time to time and, therefore, it does not entirely remove the possibility of
fluctuations. In other words, the fixing of the rate of exchange by government
action does not alter its nature or character in respect to foreign trade. The
language of Jenkins J. is appropriate:
… where a British company in the course of its
trade engages in a trading transaction such as the purchase of goods abroad,
which involves, as a necessary incident of the transaction itself, the purchase
of currency of the foreign country concerned, then any profit resulting from an
appreciation or loss resulting from a depreciation of the foreign currency
embarked in the transaction as compared with sterling will prima facie be
a trading profit or a trading loss for Income Tax purposes as an integral part
of the trading transaction. Davies (H. M. Inspector of Taxes) v. The
Shell Company of China, Ltd. .
[Page 751]
In Texas
Co. (Australia) Ltd. v. Federal Commissioner of Taxation , goods purchased were paid for in
subsequent years when the exchange rate for the purchase of United States
dollars had increased. It was contended that the delay in payment was permitted
by the American company in order that the Australian company might have
additional capital and that consequently the increase in exchange should be a
capital rather than a revenue charge. It was held that it was a revenue rather
than a capital charge.Latham C. J. stated at p. 428:
Such expenditure of
Australian pounds is an ordinary business expenditure, and the taxpayer is
entitled to claim as a deduction the actual outgoing which he makes in order to
discharge his normal business debts for stock-in-trade and the like.
Dixon J. stated at p.
465:
For where liabilities
are not fixed in their monetary expression, whether because of contingencies or
because they are payable in foreign currency, a difference between the estimate
and the actual payment must be borne as a business expense, and where the continuous
course of a business is divided for accounting purposes into closed periods it
is a reduction of the net profit, which otherwise would be calculated for the
period.
The appellant apparently
followed the usual practice of taking goods into account at the invoice price
and where an uncertain factor such as foreign exchange must be provided for
that was done by way of setting up a reserve. The position at bar is just the
opposite of that in Texas Co. (Australia) Ltd. v. Federal
Commissioner of Taxation, supra, where Dixon J. stated at p. 468:
… the true nature of the deduction claimed is for the
increase in the cost of discharging a past liability for which provision in the
accounts was made at a lower figure.
The appellant was in the
more fortunate position that the exchange discount had been eliminated. This,
however, does not alter the principle that should be applied and, in my view,
the established practice must here be followed that whether there be a loss or
a gain in respect to the item of foreign exchange it should be taken into
account as a trading loss or profit in the computation of income tax.
In my opinion the appeal
should be dismissed with costs.
Locke
J. (dissenting) :¯This is an appeal
from a judgment delivered in the Exchequer Court by which the appeal of the
present appellant from a decision of the Tax Appeal Board was dismissed with
costs.
[Page 752]
The
appellant is an incorporated company having its head office in Toronto, its
business being that of a manufacturer of drugs, and it is a wholly owned
subsidiary of Eli Lilly International Company, an American corporation carrying
on business in the United States.
During the years 1940 to
1945, both inclusive, the appellant purchased, from the American corporation,
materials the agreed purchase price of which was $640,978.29 payable in
American currency. In each of these years, in preparing the balance sheet of
the appellant for income tax purposes, the amount payable to the American
company for material supplied during the year was shown in Canadian funds,
which were at a discount in relation to American currency during the entire
period. It was upon this basis that the appellant was assessed for taxation
purposes under the Income War Tax Act during this six year period. On
December 31, 1945, the debt of the appellant to the American Company for goods
supplied during the period, expressed in Canadian funds, totalled $708,281.06.
During the period referred to, American funds were at a
premium of from 10 to 10½%. On July 1, 1946, this differential disappeared and
the Canadian dollar established at parity with that of the United States and,
as of that date, the appellant's debt to the parent company might have been
discharged by the outlay of $640,978.29 in Canadian funds. While the manner in
which it was accomplished does not, in my opinion, affect the question of
liability, this debt and a further indebtedness of the appellant to the
American company was extinguished by issuing to the creditor shares of the
common stock of the appellant company at their par value.
The question to be
determined is whether the benefit that accrued to the appellant company, by
reason of the recovery in the value of Canadian funds in relation to American
funds, became taxable as income for the taxation year 1946. No question arises
in regard to the earlier years where in preparing the profit and loss account
the indebtedness was, as stated, reckoned at the amount of the debt in American
currency plus the current rate of exchange and, since no impropriety is suggested
in regard to the tax returns made during those years, no question can now be
raised by the Crown in relation to any of them. It is to be noted, though the
fact does not affect the matter to be determined,
[Page 753]
that since
the liability to the American company was shown at the above mentioned amount
in the company's books at the commencement of the taxation year 1946, the fact
that the liability had been extinguished for the equivalent of $67,302.77 less
in Canadian funds necessitated a compensating entry for a like amount in the
company's books. The difference while shown in the profit and loss account as
"other income" was treated as a capital gain and shown as
"foreign exchange premium reduction."
The learned President
who delivered the judgment in the Exchequer Court rejected the contention of
the present appellant that the difference between the amount of the debt as
shown in the books and the amount of the consideration necessary to extinguish
it was a fortuitous or capital gain, saying that since the gain, if it must be
so called, was the result of the rise in value of the Canadian dollar and came
to the appellant in the course of its business and, since this had increased
the amount of its distributable profit for the year 1946, it had realized a
profit within the meaning of s. 3 of the Income War Tax Act.
It is income, and income only, which was taxed by the Income
War Tax Act (c. 97, R.S.C. 1927) as amended, which applied to the taxation
year 1946. By s. 3 of that Act, income was defined as follows:¯
3. For the purposes of
this Act, "income" means the annual net profit or gain or gratuity,
whether ascertained and capable of computation as being wages, salary, or other
fixed amount, or unascertained as being fees or emoluments, or as being profits
from a trade or commercial or financial or other business or calling, directly
or indirectly received by a person from any office or employment, or from any
profession or calling, or from any trade, manufacture or business, as the case
may be whether derived from sources within Canada or elsewhere; and shall
include the interest, dividends or profits directly or indirectly received from
money at interest upon any security or without security, or from stocks, or
from any other investment, and, whether such gains or profits are divided or
distributed or not, and also the annual profit or gain from any other source
including …
The enumeration which
follows does not affect the matter to be decided here.
As applied to
corporations, taxable income is determined by calculating the amount received
from the operation of the company's business, less operating expenses and other
deductions permitted by the Act in calculating such income. The argument
addressed to us on behalf of the Minister in the present matter amounts to
this, that the benefit
[Page 754]
which enured
to the present appellant, together, it may be said, with all other Canadian
nationals who were obligated to pay debts in American currency, was in itself a
receipt.
While the circumstances
were different, the decision of the House of Lords in British Mexican
Petroleum Co. v. Jackson , affords
an example of a somewhat similar attempt to impose income tax on a benefit
accruing to a company which, it was contended, must be taken into account in
computing its taxable income. The facts were that the company incorporated in
England for the purpose of dealing in oil imported large quantities of oil
purchased from Huasteca Petroleum Co., an American company operating in Mexico,
and incurred a large liability to Weir & Co., a shipping company operating
in England. In the year 1921 the company was in insolvent circumstances and, in
order to enable it to continue in operation, the two creditor companies who
owned all of its issued capital, and another creditor, released the Mexican
company of the greater part of the debt owing. To the extent that these debts
were released they were, for the purpose of the company's balance sheet,
carried to a reserve and the question in the appeal was as to whether the
amount so released was to be brought into account for the purpose of computing
the income of the company under Schedule D of the Income Tax Act 1918, either
by reducing the amount of the debit item in the trading account which showed
the debt at its full amount or by crediting the amount rebated as a trading
receipt for the year in which the debt was partially remitted. This contention
on behalf of the Crown was upheld by the Special Commissioners. The matter came
in the first instance by way of appeal before Rowlatt J. who reversed this
decision. An appeal from that judgment was dismissed by the Court of Appeal,
and a further appeal by the House of Lords.
In the British Mexican case the company benefited to
the extent that the debts were remitted by its creditors. In the present case,
the appellant was benefited by the restoration of the value of the Canadian
dollar in terms of American currency, an event over which it had no control and
which it had no part in bringing about. There is, in my opinion, no difference
in the principle to be applied in
[Page 755]
the present
case from that applied by the courts in England. The advantage to the company
which accrued from an event such as this, as distinguished from the extent to
which the profits of the company are increased by its occurrence, is no more a
trading receipt than the advantage accruing to an export company engaged in
international trade by a recovery in world trade or the benefit accruing to all
trading corporations by a reduction in income or other taxation.
I would allow this
appeal, with costs throughout, and set aside the assessment.
Cartwright
J. (dissenting):¯The relevant facts
are set out in the reasons of my brother Locke. I agree with his reasons and
conclusion and have little to add.
The only matter now in
dispute is whether the sum of $67,302.77 was properly included by the Minister
as an item of taxable profit in assessing the appellant for income and excess
profits tax for 1946. This sum is the difference between $708,281.06, the total
of the amounts charged in the appellant's annual tax returns for the years 1940
to 1945 as representing in Canadian dollars its indebtedness for raw materials
purchased during such years from its parent company in the United States and
for which it owed $640,978.29 in United States dollars, and the sum of
$640,978.29 in Canadian dollars with which it was able to discharge such
indebtedness in 1946, by reason of the Canadian dollar having reached parity
with the United States dollar.
There is no question but
that the Minister was right in allowing the appellant to charge the sums
totalling $708,281.06 in the years mentioned as the cost in Canadian dollars of
materials purchased. We are not concerned to inquire whether upon such
indebtedness being paid off in 1946 with $640,978.29 in Canadian funds the
Minister might have re-assessed the appellant for any or all of the years 1940
to 1945, as, no such re-assessment having been made and more than six years,
having elapsed since the latest assessment for the years in question and there
being no suggestion that the appellant made any misrepresentation or committed
any fraud in making its returns, it is conceded that the accounts for those
years can not now be re-opened.
[Page 756]
In these
circumstances this case seems to me to fall within the principles enunciated by
the House of Lords in British Mexican Petroleum Co. Ltd. v. Jackson . One of the questions calling for
decision in that case was whether the amount by which a debt, actually owing
and treated as an expense of the trade deductible from gross receipts in the
trading account of the taxpayer for the year ending June 30, 1921, was
subsequently reduced by the voluntary act of the creditor should be treated as
a trading receipt in the account for the year in which such reduction was
granted. I can find no significant difference between the statutory provisions
considered in that case and those of the Income War Tax Act which
applied to the taxation year 1946. The fact that in the case at bar the
reduction in the amount payable in satisfaction of the debt contracted and
allowed in earlier years resulted from a change in the rate of exchange and not
from the voluntary act of the creditor does not appear to me to render the
principle of the British Mexican case inapplicable. In each case a debt,
actually owing and properly deductible in one taxation period, was, in a later
taxation period, discharged for a lesser sum by reason of a circumstance beyond
the control of the taxpayer; and in each case it was sought to tax the
reduction in the amount required to discharge such debt as a profit received in
the taxation period in which the reduction occurred.
In the British Mexican case Lord Thankerton said at
page 592:¯
I am unable to see how
the release from a liability, which liability has been finally dealt with in
the preceding account, can form a trading receipt in the account for the year
in which it is granted.
and Lord MacMillan
said at page 593:―
If, then, the accounts
for the year to the 30th June, 1921, cannot now be gone back upon, still less
in my opinion can the Appellant Company be required to enter as a credit item
in its accounts for the eighteen months to 31st December, 1922, the sum of
£945,232 being the extent to which the Huasteca company agreed to release the
Appellant Company's debt, to it. I say so for the short and simple reason that
the Appellant Company did not, in those eighteen months, either receive payment
of that sum or acquire any right to receive payment of it. I cannot see how the
extent to which a debt is forgiven can become a credit item in the trading
account for the period within which the concession is made.
[Page 757]
In the case
at bar it seems equally clear that in the year 1946 the appellant neither
received the sum of $67,302.77 nor acquired any right to receive payment of it.
I would allow the appeal
with costs throughout, declare that the said sum of $67,302.77 should not have
been included in assessing the income of the appellant in the year 1946, and remit
the assessment to the Minister for amendment accordingly.
Appeal
dismissed with costs.
Solicitors
for the appellant: Raymond, Spencer, Law & Maclnnes.
Solicitor for the respondent: A. A. McGrory.
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