Office Concepts Ltd. v. Minister of National Revenue, [1986] 2 CTC 2178

Goetz, T.C.J.:—The appellant is appealing the Minister's reassessments with respect to its 1979, 1980 and 1981 taxation years, whereby certain reserves sought to be claimed by the appellant were added back into income.

The appellant is an office-equipment dealer selling and servicing cash registers, typewriters, word processors and computers. In the course of its business it entered into maintenance plan agreements and maintenance agreement contracts. In that it anticipated that goods and services would have to be supplied after the end of its taxation year, it calculated a reserve for moneys received on account of these contracts and not used in the tax year. These reserves were entered into its balance sheets as "unearned income".

Customer cards were maintained whereby periodic inspections were made. These were for preventive maintenance. For instance, such inspections were necessary in keeping disks in alignment. Customers were visited twice yearly and if adjustments or repairs were required, they were made without charge. A large portion of the appellant’s business was done with the Department of Supply and Services of the Federal Government and their dealings with this Department required, according to documents filed:

Preventive maintenance will be carried out on an ongoing basis. In addition, at six month intervals a preventive maintenance inspection will be performed.

Other customers could enter into maintenance agreement contracts for a term of one year, which agreements were renewable each year thereafter. These agreements provided for "a Preventive Maintenance Program designed to maintain your OCL equipment at peak performance" and for service calls without charge. These contracts could be cancelled and the customer could claim a rebate for the balance of the term of the contract. To provide this service the appellant maintained a service staff at a cost of $1,500 a day. When inspections were made, or service calls received, the serviceman would make the necessary adjustments or repairs if needed and give the customer an invoice showing the work performed and the cost therefor and the amount ordinarily due was marked "N/C" (no charge). Servicing is an everyday operation and is essential and integral to the business. Service repairs and maintenance increased each year.

The relevant provisions of the Income Tax Act are paragraphs 12(1)(a), 12(1 )(e), 18(1 )(e), 20(1)(m) and 20(7)(a) which read as follows:

12. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:

(a) any amount received by the taxpayer in the year in the course of a business

(i) that is on account of services not rendered or goods not delivered before the end of the year or that, for any other reason, may be regarded as not having been earned in the year or a previous year, or

(ii) under an arrangement or understanding that it is repayable in whole or in part on the return or resale to the taxpayer of articles in or by means of which goods were delivered to a customer;

(e) any amount

(i) deducted under paragraph 20(1)(m) (including any amount substituted by virtue of subsection 20(6) for any amount deducted under that paragraph), paragraph 20(1)(m.1) or subsection 20(7), or

(ii) deducted under paragraph 20(1)(n),

in computing the taxpayer's income from a business for the immediately preceding year;

18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(e) an amount transferred or credited to a reserve, contingent account or sinking fund except as expressly permitted by this Part;

20. (1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(m) subject to subsection (6), where amounts described in paragraph 12(1)(a) have been included in computing the taxpayer's income from a business for the year or a previous year, a reasonable amount as a reserve in respect of

(i) goods that it is reasonably anticipated will have to be returned after the end of the year,

(ii) services that it is reasonably anticipated will have to be rendered after the end of the year,

20. (7) Paragraph 1(m) does not apply to allow a deduction

(a) as a reserve in respect of guarantees, indemnities or warranties,

The appellant contended that the provisions set forth above are, of course, interrelated and that if paragraph 18(1)(e) applies, namely, no deduction of reserves transferred to a contingent account, then the appellant can avail itself of the provisions of paragraph 20(1)(m) provided that subsection 20(7) does not apply. Further, it contends there are no elements of contingency in these reserves which were reasonable.

The Crown maintains that paragraph 18(1 )(e) precludes the deduction of reserves and that paragraph 20(1 )(m) does not assist the taxpayer because it is subject to the provisions of paragraph 20(7)(a) which provides that a deduction as a reserve in respect of guarantees, indemnities or warranties negates the application of paragraph 20(1)(m).

The maintenance contracts were not for the purpose of having to act on an unascertained or indefinite event. Rather, the preventive maintenance and service program was an existing obligation on the appellant requiring it to perform services at determined intervals. There is no indication of a contingency situation on the facts adduced in this appeal.

Crown counsel relied strongly on Paul Burden Ltd. v. M.N.R., [1981] C.T.C. 2847; 81 D.T.C. 651, a decision of Bonner, J. and approved by McNair, J. in Sears Canada Inc. v. The Queen, [1986] 2 C.T.C. 80; 86 D.T.C. 6304. In that case the taxpayer, a retailer of office machines, had prepaid contracts entitled “Extended Warranty Agreement”. The obligation on the dealer in that case was to maintain and repair office machines as called upon to do so by the customer. The facts of that case are clearly different. In the case before me there is a definite schedule of inspections with concomitant repairs if necessary. There is no connotation of contingency.

This Court must, therefore, determine if the provisions of paragraph 20(1 )(m) are nullified by the provisions of subsection 20(7). The decision in Mister Muffler Limited v. The Queen, [1974] C.T.C. 813; 74 D.T.C. 6615, was cited as being applicable to the facts of this appeal. At 823 and 6623 of the Mister Muffler Limited decision, supra, Walsh J. said:

The scheme of the Act does not permit deductions of reserves with respect to guarantees, indemnities or warranties and I am of the view that it is intended that these words should be comprehensive enough to include all types of guarantees, indemnities or warranties, which the Act intended to exclude from immediate deduction by way of reserves because of their contingent and uncertain nature.

Moneys extracted from the customers by way of warranties, indemnities and guarantees can possibly be excluded from income indefinitely. The provisions of subsection 20(7) are, I think, designed to prevent this. Warranty is not relevant to this case, nor does there exist any colour of indemnity or guarantee. Bonner, J. in the Burden case, supra, at 2851 and 654 respectively, found that the “elements of contingency and uncertainty are amply present here” and this because he found that preventive maintenance was not carried out according to a predetermined schedule but rather when a serviceman was on the scene as the result of a call for repairs by the customer. The preventive maintenance service in this case was provided on a determined schedule, was set and certain, and this service, under the circumstances, cannot be construed as an indemnity.

It was agreed by counsel at the outset of this trial that if the appeal was successful the amounts of $31,400, $62,414 and $14,239 should be added into income for the appellant’s 1979, 1980 and 1981 taxation years respectively.

The appeal is allowed and the matter is referred back to the respondent for reconsideration and reassessment. The appellant is entitled to party and party costs.

Appeal allowed.