Leopold Lague Inc v. Minister of National Revenue, [1980] CTC 2451, 80 DTC 1384

Guy Tremblay [TRANSLATION]:—This case was heard at Sherbrooke, Quebec on January 25, 1979. The matter was taken under advisement on January 9, 1980 following written submissions.

1. Issue

The issue is whether the sale of three school bus routes constitutes an income profit for the appellant. The Department of Revenue maintained it did. The appellant argued it was a sale of eligible capital property.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessment is incorrect. This burden of proof derives not from one particular section of the Income Tax Act but from a number of judicial decisions, including the judgment rendered by the Supreme Court of Canada in R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. Facts

3.01 The appellant, whose principal object is to provide school bus service, was incorporated in 1966.

3.02 Before the appellant’s incorporation, however, Mr Léopold Lague had been operating a school bus service with his brother since 1956. Initially he served local rural schools, but subsequently extended his operations to a regional level. Having started with four buses, he had twelve in 1963. Before the incorporation Mr Lague also had a business involving the use of heavy equipment. This business was sold in 1963.

3.03 The appellant’s fiscal year in 1975 ran from September 1, 1974 to August 31, 1975.

3.04 Just as Mr Lague had done previously, the appellant carried out its business in the Farnham area.

3.05 It had contracts to transport school children with various school boards (Davignon, Honoré-Mercier, Missisquoi), local, regional and integrated.

3.06 Each of these school boards called for tenders for going to collect the children at their homes, driving them to school and vice versa, on well defined trips called “routes”. The routes were served by the same carriers from one year to the next and were the subject of transactions between carriers with the authorization of the school board and the Transport Commission. The appellant had 22 routes in September 1974.

3.07 On August 6, 1974 the appellant submitted its tender to the Davignon School Board for the routes called U-36, U-37 and U-38 (Exhibit A-1). Mr Lague had served these routes since 1963, three years before the appellant was incorporated.

3.08 Only owners of buses were allowed to tender. It was necessary to provide a list of vehicles, have experience in transporting school children, post bonds, and so on. Under the regulations under The Transport Act, a contract is awarded to the lowest tenderer. According to the appellant, however, there was an agreement among the carriers and in practice a carrier did not tender for another carrier’s route.

3.09 The said School Board accepted the appellant’s tender on August 6, 1974 as appears from the extract from the minutes of a meeting (Exhibit A-2).

3.10 The contract was signed between the appellant and the Davignon School Board (Exhibit A-3). It was for three years, renewable for a further three years.

3.11 Another carrier like the appellant, Mr Philippe Dorais, had offered to purchase all these routes from the appellant in May or June 1974. The latter had refused.

Since Mr Dorais served schools in the area known as Brigham and three of the appellant’s routes, U-36, U-37, and U-38, were located in that area, he was interested in acquiring at least these three routes. His centre of operations was one mile from the comprehensive school served. The appellant’s centre of operations, on the other hand, was six or seven miles from the said school. Following discussions it was agreed that the three routes in question would be the subject of a contract.

3.12 Mr Dorais said it was not clear whether he knew before the tender in August that he would become the owner of the three routes. Mr Lague Stated he was not aware when he tendered at the end of July 1974 that he would sell the routes a month and a half later.

3.13 Before purchasing the three routes Mr Dorais already had eleven. He acquired his fourteen routes by purchasing them from three different carriers.

3.14 According to Mr Philippe Dorais, witness for the respondent, a route with a one-year contract is not profitable. A route with a three-year contract renewable for a further three years, however, has a commercial value and can be bought and sold.

3.15 On September 10, 1974 the sale of the three routes plus a bus was signed between the appellant and Mr Dorais (Exhibit A-5). The routes were sold for $31,500 and the bus for $1,000. This bus had been purchased by the appellant in 1968 and was not in the best condition.

3.16 The price of $31,500 does not seem to have been the subject of a great deal of consideration. However, it seems obvious that the three-year term of the contract and its renewal for a further three years as well as the gross annual revenues were taken into account. The three routes U-36, U-37 and U-38 represented gross annual income of $36,898 (Exhibit A-3). The appellant’s other routes brought in gross revenues of $284,672 for 1975 according to the company’s financial statements. In 1974 the 22 routes had produced $241,599 in gross revenues.

3.17 In filing its 1975 tax return, the appellant treated the sale price of $31,500 as the sale of goodwill and included the sum of $7,750 in its income, pursuant to the sections governing the sale of goodwill.

3.18 In issuing the notice of reassessment on March 4, 1977, the respondent treated the sum of $31,500 as income from business, accordingly adding $23,750 ($31,500 - $7,750) to the income.

4. Act, Case Law and Comments

4.1 Act

The sections of the Income Tax Act concerned in this case are sections 3, 4, subsections 9(1), 14(1), paragraphs 14(5)(b) and 18(1)(a). These sections will be cited later, if necessary, in the course of the comments.

4.2 Case Law

The following cases were cited by the parties:

A. By the appellant’.

1. Services Farmico Inc v MNR, [1979] CTC 3012; 79 DTC 208;

2. Aliments Ca-Mo Foods Inc v MNR, [1979] CTC 2128; 79 DTC 152;

3. Schaefer Brothers Inc v MNR, [1979] CTC 2379; 79 DTC 288;

4. Herb Payne Transport Limited v MNR, [1963] CTC 116; 63 DTC 1075.

B. By the respondent:

5. Kelsall Parsons Inc v CIR, 21 TC 608;

6. Williams Brothers Canada Ltd v MNR, [1962] CTC 448; 62 DTC 1276;

7. British Insulated and Helsby Cables Ltd v Atherton, [1926] AC 205;

8. IRC v Fleming & Co Ltd, 33 TC 57;

9. Van den Berghs Ltd v Clark, [1935] AC 431;

10. Barr, Crombie & Co Ltd v IRC, [1945] SC 271;

11. Short Brothers Ltd v IRC, 12 TC 955;

12. Anglo-French Exploration Ltd v Clayson, 36 TC 545;

13. Fleming (Inspector of Taxes) v Bellow Machine Co Ltd, [1965] 1 WLR 1973;

14. Grégoire Dontigny Inc v MNR, [1967] Tax ABC 537; 67 DTC 382;

15. Courrier M H Inc v HMQ, [1976] CTC 567; 76 DTC 6331.

4.3 Comments

4.3.1 Respondent's contenton

In issuing the notice of assessment of March 4, 1977, the respondent relied inter alia on the presumption that the sale price for the three routes constitutes income from business and not a sum received as a result of the disposition of an eligible capital property (goodwill).

He based his contention on his interpretation of the provisions in subsection 14(1) and paragraph 14(5)(b).

These provisions read as follows:

14.(1) Where, as a result of a transaction occurring after 1971, an amount has become payable to a taxpayer in a taxation year in respect of a business carried on or formerly carried on by him and the consideration given by the taxpayer therefore was such that, if any payment had been made by the taxpayer after 1971 for that consideration, the payment would have been an eligible capital expen diture of the taxpayer in respect of the business, there shall be included in computing the taxpayer’s income for the year from the business the amount if any, by which half of the amount so payable (which half is hereafter in this section referred to as an “eligible capital amount” in respect of the business) exceeds the taxpayer’s cumulative eligible capital in respect of the business immediately before the amount so payable became payable to the taxpayer.

14.(5) In this section,

(b) “eligible capital expenditure” of a taxpayer in respect of a business means the portion of any outlay or expense made or incurred by him, as a result of a transaction occurring after 1971, on account of capital for the purpose of gaining or producing income from the business, other than any such outlay or expense

(i) in respect of which any amount is or would be, but for any provision of this Act limiting the quantum of any deduction, deductible (otherwise than under paragraph 20(1 )(b)) in computing his income from the business, or in respect of which any amount is, by virtue of any provision of this Act other than paragraph 18(1)(b), not deductible in computing such income,

(ii) made or incurred for the purpose of gaining or producing income that is exempt income, or

(iii) that is the cost of, or any part of the cost of,

(A) tangible property of the taxpayer,

(B) intangilble property that is depreciable property of the taxpayer,

(C) property in respect of which any deduction (otherwise than under paragraph 20(1 )(b)) is permitted in computing his income from the business or would be so permitted if his income from the business were sufficient for the purpose, or

(D) an interest in, or right to acquire, any property described in any of clauses (A) to (C),

but, for greater certainty and without restricting the generality of the foregoing, does not include any portion of

(iv) any amount paid or payable, as the case may be, to any creditor of the taxpayer as, on account or in lieu of payment of any debt or as or on account of the redemption, cancellation or purchase of any bond or debenture,

(v) where the taxpayer is a corporation, any amount paid or payable, as the

case may be, to a person as a shareholder of the corporation, or

(vi) any amount that is the cost of, or any part of the cost of,

(A) an interest in a trust,

(B) an interest in a partnership,

(C) a share, bond, debenture, mortgage, hypothec, note, bill or other Similar property, or

(D) an interest in, or right to acquire, any property described in any of clauses (A) to (C).

Thus in order to obtain the benefits of the Act with respect to dispositions of eligible capital property, it is necessary, under subsection 14(1), that the consideration (the contract on the three routes granted by the appellant for the sum of $31,500) be such that if any payment had been made by the appellant after 1971 to acquire that consideration, the payment would have been an eligible capital expenditure within the meaning of paragraph 14(5)(b). Under that section such an expenditure must be made “on account of capital”. The English translation “on account of capital” that is “a titre de capital” or “de nature capitale” gives a clearer understanding of the meaning.

Thus the expenditure made by the appellant to acquire the three routes (which it in fact sold in turn) must be a “capital” expenditure, that is, “on ac- count of capital” (and therefore deductible in part only), and not “for the purpose of gaining income” (and therefore deductible in full); the respondent maintained that for the purchaser this was an expense incurred for the purpose of gaining income which was deductible in full, and that consequently it was income from business taxable in full for the vendor receiving the amount.

4.3.2 In support of his thesis the respondent relied on the principles set out in the cases referred to above (para 4.2B).

The respondent also cited numerous English and Canadian cases establishing that monetary compensation received for the loss or sale of a contract can be capital in nature only where the contract in question is the very foundation of a business and its loss would ruin the business. It is obvious that on this basis, since the appellant did not sell all its routes, the appeal should prima facie be dismissed.

The basic principle underlying these cases seems to be somewhat unclear at first sight, however. The Board is of the view that what constitutes or creates permanence in a business is not necessarily in the business as a whole.

The respondent also cited the Williams Brothers Canada Ltd decision in this connection. In that case the appellant, a pipeline construction firm, purchased the contract awarded to another tenderer after tendering unsuccessfully in a call for tenders. The appellant paid $230,000 for the contract, and the learned Cattanach, J decided that this was a business expense on the basis that the work which was the subject of the contract was completed within the fiscal year of the purchaser Williams Brothers Canada Ltd. This could therefore not be the purchase of an asset that would have brought the purchaser long-term revenues, under the test put forward by Lord Cave in British Insulated and Helsby Cables Ltd v Atherton, cited above.

The principle underlying this decision is much more realistic and is closer to the ordinary principles of current expenses. Thus an expense incurred procures a benefit of a certain permanence (lasting at least one year) and is considered a capital expenditure. The same applies to an enterprise which disposes of an asset which gives it a benefit of some permanence.

The principle governing current or capital expenditures when assets are acquired and the principles governing the receipt of income or capital when assets are sold must coincide to be logical. This is essentially what section 14 provides.

In several cases cited by the respondent with a view to having the appeal dismissed because the appellant had not sold all its routes (constituting the appellant’s entire structure), reliance is placed on the principles of permanence and reference is made to the principle set out in Williams Brothers Canada Ltd.

In British Insulated and Helsby Cables Ltd it is stated: “In the present case the work covered by the agreement was completed within the fiscal year of the appellant . . Moreover, the cases which maintain that the entire structure must be sold for there to be a capital receipt are old. The Board is of the view that consideration must be given to the existence of section 14 of the new Act concerning intangible assets and in particular to the duration of the permanent benefit (over a year or two perhaps) of this intangible asset.

In the present case the routes sold have a duration of three years and are renewable automatically for a further three years. This is far from a contract carried out within a single year. Moreover, the payment received, $31,500, is less than the gross revenues for a year, namely $36,898 (para 3.15). The Board is of the view that from this point of view the appeal should be allowed.

4.3.3 We must now ask ourselves whether this is “an adventure or concern in the nature of trade’’ within the meaning of the definition of “business” in subsection 248(1) of the Act.

The principal factor in resolving this point is whether Mr Lague knew, before submitting a tender to the School Board at the end of July 1974 for the routes concerned, that he would sell them to Mr Dorais within a few months. Paragraph 3.12 of the facts gives a clear summary of the testimony given by Messrs Dorais and Lague in examination. Mr Dorais was not certain. Mr Lague was sure. The latter has an interest in the matter. However, there is nothing in his evidence as a whole that allows the Board to doubt his credibility. The Board is bound by this evidence. Moreover, if it takes into consideration the fact that the appellant had been serving the said routes since its incorporation in 1966, three years after Mr Lague himself acquired and served them (para 3.07) and if it takes into consideration the fact that each tenderer was in practice the only one to tender for its own routes (para 3.08), this strengthens the appellant’s position in this regard.

The Board concludes that this is not an adventure in the nature of trade.

5. Conclusion

The appeal is allowed and the matter referred back to the respondent for reassessment in accordance with the above reasons for judgment.

Appeal allowed.