Compensation Payments

The taxpayer (“Trac-World”) carried on its business through a warehouse, which was destroyed by fire. It sued the local municipality for providing inadequate water supply during the fire. The action was settled for a lump sum paid pursuant to a quit claim which stated that the sum was paid to compensate for the loss of Trac-World customers.

Trac-World reported the sum as being proceeds of disposition of goodwill, giving rise to an eligible capital amount. In finding that, under the surrogatum principle, the amount instead was fully taxable as compensation for lost profits, Bergeron JCQ noted that over 90% of Trac-World’s claim had been for lost profits and that its statement of claim had made no mention of loss of goodwill.

The taxpayer (“Les Sommets”), which had received $400,000 for granting an option to a third party to acquire various properties, later settled an action in damages against it by the current holder of the option (“Solstice”), for failure to honour the option, by agreeing that, in consideration for the $400,000 referred to above, it would transfer a particular property (not covered by the option) to Solstice. That property had been held in its inventory at a value of $400,000.

Gosselin JCQ found that this transaction should be treated the same as a sale of an inventory property for $400,000, giving rise to business income, given inter alia that the property was transferred in lieu of the transfer of property (under the original option) that would have occurred in the ordinary course of its business. She stated (at paras. 46, 48 and 57, TaxInterpretations translation):

The essence of the transaction in question is a dation in payment [in-kind damages payment, or “dation en paiement”]. In place of the land covered by the exercise of the option to acquire, for which $400,000 was paid to Les Sommets in 2004 and 2005, the latter transferred another piece of land with the agreement of Solstice. Les Sommets thus finds itself having transferred ownership of property, other than that provided for in the option to acquire land, in settlement of a dispute by transfer within the meaning of Article 1799 C.C.Q. As author Jacques Deslauriers writes: "Dation in payment has two effects: the extinction of an obligation and the transfer of ownership". …

There is no published case law dealing with the tax treatment of a dation in payment, but from the foregoing, the Court concludes that this transaction must receive the same tax treatment as a sale. …

The value of the consideration realized as a result of this transaction, i.e., the market value of the land transferred, established at $400,000, is taxable in the hands of Les Sommets as business income, since the transfer of the land it replaced was to occur as a sale in the ordinary course of business.

An integrated nickel-mining public company (“Falconbridge” – a predecessor of the taxpayer), entered into merger agreements with a more junior public company (“DFR”) which, through a 75%-owned subsidiary, held a valuable nickel-copper-cobalt deposit at Voisey’s Bay in Newfoundland. The merger agreement provided for the immediate payment by DFR of a “Commitment Fee” of $28.2 million, and for the payment of a break fee of $73.3 million (calculated to bring the total of the two fees to 2.5% of the transaction value) on a failure of DFR to complete the merger. In fact, another public company (“Inco” – the 25% minority shareholder) made a subsequent offer that was accepted by DFR, thereby triggering the payment by it of the break fee.

Favreau J stated (at para. 72):

Falconbridge primary objective was clearly to acquire a 75% interest in the Voisey’s Bay deposit but, in doing so, it made sure that all its takeover bid expenses would be covered by the Commitment Fee and that a substantial profit would be realized if the bid failed.

Before drawing an analogy (at para. 77) with the findings in Ikea that tenant inducement payments were received as “necessary incidents” of the conduct of a business in rented premises, Favreau J further stated (at paras. 76-77):

The potential acquisition of the Voisey’s Bay deposit was part of Falconbridge’s strategy for earning income from its business.

Falconbridge was carrying on its business when it negotiated the Merger … Agreement[s], both of which provided for the fees in dispute. … The … Fees were ancillary business income received by Falconbridge in the course of earning income from business.

Australian electricity distributors were entitled to require their customers to pay an amount equal to the estimated net economic burden to the distributors of hooking them up to electricity, i.e., where the the present value of the incremental cost exceeded the present value of the incremental revenue. Moshinsky J found that these “Customer Cash Contribution” amounts were ordinary income to the distributors as they were received “as an ordinary incident of their electricity distribution businesses” (para. 165).

The customer could instead choose to perform the work, in which case, on transferring the constructed assets to a distributor, the distributor would pay a rebate that did not represent the full cost of the work, so that again, the customer effectively bore the excess of the present value of the incremental cost over the present value of the incremental revenue (the “Customer Contribution”). In finding that a Customer Contribution was not ordinary income to the distributor, Moshinsky J stated: (para. 179):

[T]he Customer Contribution was not a payment or gain received by the Distributor; it was merely a component used in the calculation of the [rebate] amount to be paid [the other way] by the Distributor to the customer.

The taxpayer, a self-employed dental surgeon, received benefits totalling over $600,000 under three Great-West policies during a two-year period of illness. Two of the policies provided coverage for her monthly general professional expenses, and the third policy, styled as professional sickness insurance, provided monthly income replacement in the event of her illness. The taxpayer considered that there was no significant distinction between the third policy (replacing lost income) and the first two policies (covering business expenses). In affirming the Minister’s assessment, which treated the amounts paid out to the taxpayer under the first two policies as s. 9 income, Favreau J stated (at paras. 28-31, TaxIntepretations translation):

[T]he insurance benefits under dispute were paid for the purpose of reimbursing the appellant for part of the general expenses of her clinic during her period of illness and that were essential for the appellant’s clinic to continue being carried on … .

The source of the indemnification was a function of the business expenses incurred by the appellant for which there was a requirement to generate monthly statements for the general expenses incurred in the course of carrying on the clinic. Consequently, as the source of the insurance benefits was the business of the appellant, the insurance benefits paid to the appellant were required to be included in the computation of her business income.

… These benefits were not of a personal nature … .

The surrogatum principle … is applicable. By virtue of this principle, the tax treatment of sickness insurance benefits depends on what such benefits are intended to replace being, in this case, the general expenses of carrying on the dental clinic.

In 1980, Nortel had established a health and welfare trust (the “HWT”) for its employees. Following its insolvency and filing under the CCAA (with the related CCAA proceedings being court-supervised), it made lump sum payments in 2011 to the four taxpayers, pursuant to a court-approved settlement agreement, in satisfaction of their entitlement to funding of life insurance premiums or to survivor death benefits. In characterizing such payments, and after noting that the surrogatum principle had been commonly expressed in the context of someone carrying on a business or having an adventure in the nature of trade, Sommerfeldt J quoted with approval the statement in Dumas, 2000 DTC 2603 regarding the surrogatum principle that:

The real question is to determine why the compensatory amount was paid.

and then stated (at para. 102):

In determining why the distributions were paid in 2011 by the HWT to the Appellants, I have concluded that the distributions were paid to Ms. Ellis and Ms. Kennedy as partial compensation for the termination of the Group Life Plan, and the distributions were paid to Mr. Scott and Ms. McCann as partial compensation for the termination of the monthly payment of their respective death benefits.

Leases by the taxpayer ("GMAC") to GM dealership customers stipulated a "residual value" at which the customer could purchase the vehicle at lease termination. General Motors of Canada Limited ("GMC") would make "residual value support payments" to GMAC in consideration for GMAC increasing the residual values (thereby reducing lease payments).

Initially, GMAC was entitled to retain all the support payments. In a subsequent period, "true up" payments were made on the lease terminations based on the actual loss (if any) experienced by GMAC relative to the (inflated) residual value, so that if that loss were less than the support payment (or nil, if the customer purchased the vehicle for the residual value), GMAC refunded the support payment to GMC to that extent (and, conversely, received a further payment from GMC if the loss were greater.) Graham J found that, for both periods, the support payments were includable under s. 9, and thus excluded from s. 12(1)(x) per s. 12(1)(x)(v). They should be so treated, rather than as a contribution toward the purchase of the vehicles, as their purpose was to compensate GMAC for its lost income. The situation was more in line with Ikea than Woodward.

Graham J stated (at para. 30):

Had the contract residual value been set where it should have been, the customers' monthly lease payments would have been higher. The residual value support payments had the simple effect of replacing that lost income.

See summaries under s. 9 – timing, s. 12(1)(x), and s. 9 – computation of profit.

A subdivision property of the taxpayer, a developer, was blockaded by Six Nations protesters. To diffuse the conflict, the Ontario government passed a by-law prohibiting any use of the property (rendering it valueless), and then agreed to pay the taxpayer $15,800,000 in exchange for relinquishing its rights to the property and under a court order against the protesters, and for a release.

C Miller J found that although the taxpayer relinquished its claim to the property, it had not "received $15,800,000 for the sale of worthless land" (para. 163). The property also "lost its character as inventory by being made legally useless for development" (para. 168) so that, even if the payment were for the property, it would be taxable only as a capital gain (para. 169). He concluded (at para. 203):

Henco's business was destroyed. By the time it struck an arrangement with Ontario, Henco had no value as a business ... : there could not be and there was not a source of income. The capital receipt was non-taxable.

The taxpayer and four others formed a joint venture to acquire, lease and sell a golf course. The taxpayer attempted to have a corporation of which he and two other of the participants were directors ("Disctronics") acquire the property. The other two joint venture participants (the "non-directors"), rather than agreeing, secretly acquired the gold course for their own account and sold it at a profit.

The taxpayer and the other two directors obtained a damages award against the non-directors for breach of their fiduciary duties to the three directors qua joint venture participants.

The taxpayer was assessed to include his share of the award in his income notwithstanding that Disctronics had received that amount and included it in its income. The High Court first held that the taxpayer had not received the award by reason of his position of director (as Disctronics never was admitted to the joint venture) and that no conflict had arisen between his personal interests and those of Disctronics. Accordingly, he had not become entitled to the amount as constructive trustee for Disctronics, and it was income to him.

A pharmaceutical corporation ("Weyth") had collection agreements with the taxpayers for their on-going collection of pregnant mare urine ("PMU") and its supply to Wyeth. In exchange for the release from its purchasing obligations, Weyth agreed to make substantial payments to the taxpayers, 80% of which was identified in the agreements as "payments for feed and herd health expenses." The taxpayers treated the payments as capital receipts for the disposition of capital assets (the collection agreements). The Minister reassessed them on the basis that they were business income.

Hogan J agreed with the taxpayers that the "payments for feed and herd health expenses" were capital receipts, given that:

• the payments were not meaningfully tied to actual feed and herd health expenses - for example, the taxpayers were entitled to the payments even if they immediately sold their entire herds;
• the motivation behind labeling the payments as "feed and herd health expenses" in the agreements appeared to relate to Weyth's difficulties with animal rights groups "and to counter a potential negative public backlash as a result of the destruction of the PMU herds" (para. 61); and
• Weyth's cancellation of the contracts effectively drove the taxpayers out of the PMU business, and it was reasonable to conclude that the taxpayers were really being compensated for the destruction of their businesses.

Hogan J found that the parol evidence rule did not prevent him from considering the surrounding facts (set out above) in order to interpret the agreements. He cited (at para. 35) Ventas for the proposition that a commercial contract is to be interpreted, inter alia, "with regard to objective evidence of the factual matrix underlying the negotiation of the contract."

On the early termination of a power purchase agreement between the taxpayer and the Alberta government, the taxpayer received $59.7 million from the Alberta government and the Alberta government became the beneficial owner of a power generation plant of the taxpayer, although the taxpayer continued as legal title owner and continued to operate the plant under an operating agreement with the Alberta government. As the parties were clearly of the understanding that the payment received by the taxpayer was for the transfer of its capital investment in the plant rather than being a payment for future profits surrendered, under the surrogatum principle, the payment was a capital receipt.

A lump-sum payment received by the taxpayer in consideration for the cancellation of a non-compete covenant that had previously been given to it in connection with its acquisition of a business was a capital receipt given that the lump sum compensated it for a diminution in the market value of the goodwill that had been so acquired by it.

A judge of the Federal Court determined that a competitor of the taxpayer had infringed the taxpayer's patents, but did not deal with the taxpayer's claim for damages or for an accounting of profits as this was to be dealt with in a separate hearing. Pursuant to subsequent minutes of settlement, the taxpayer received a lump sum of $6 million dollars from the competitor. In that finding this sum was an income receipt Woods J. noted that the claim of the taxpayer (as evidenced by its brief and memorandum filed in connection with the infringement litigation) was for lost profits rather than damage to its goodwill, that the action of the competitor did not in fact damage the taxpayer's patents in the sense of any diminution in the taxpayer's statutory rights under the Patent Act and that the fact that the parties came to a compromise and settled for an amount that bore no relationship to the profits lost by the taxpayer did not change the nature of the interest of the taxpayer that was settled. Woods J. also noted that if, instead, the competitor's use of the patented technology had been consensual, the arrangement would have been in the nature of a licence, the taxpayer would have been entitled to royalties, and that a lump sum in lieu of royalties generally is income.

A lump sum payment received by the taxpayers, following negotiation, with the sole tenant of their building, was an income receipt given that the payment compensated them for the loss of rental income, and there was no direct link between the payment and loss in value of the property. Respecting an argument that the lease was a capital item to the taxpayers, Miller J. noted that the taxpayers themselves did not have a leasehold interest in the property: they were the owners of the property.

The taxpayer, which was a Canadian natural gas producer, received a lump sum as compensation for the losses it was considered to have suffered as a result of the cancellation of long-term natural gas supply contracts it had entered into with one purchaser ("A&S"), with the result that it thereafter was to sell its natural gas under short-term gas supply contracts and under a continuation of modified versions of existing sales arrangements.

These lump sums were found to be proceeds of disposition of capital assets, namely, the long-term supply contract. The contracts formed a significant part of the structure of the taxpayer's business (representing over 13% of its sales) and their capital nature was fortified by the dedication under some of the contracts of the lands containing the gas reserves to be sold under such contracts. Furthermore, even if the payments received by it were measured by the present value of the profits it might be reasonably be expected to earn under such contracts, which was not the case (as it instead received an arbitrarily negotiated lump sum) this would not have deprived the payments of their quality of capital.

General damages which the taxpayer received in an action against a corporation of which he had been an officer and shareholder were exempt capital receipts given that his purpose in litigating was to protect and preserve his reputation as a resource company promoter. Damages recovered for failure of the corporation to indemnify against, and maintain insurance for, his litigation expenses also were capital receipts. After noting (at p. 724) the "difference between prejudgment interest on a debt or other liquidated amount wrongfully withheld, and on an award of damages assessed", Bowie T.C.J. found that prejudgment interest awarded to the taxpayer was taxable as interest under s. 12(1)(c) based on a finding in the civil action that the right to indemnity on which the interest was awarded arose on the date the taxpayer was sued.

A lump sum received by the taxpayer (which owned an office tower) from its anchor tenant following the termination by the anchor tenant of the lease, was found to be an income receipt. Bonner TCJ. found that the effect of the payment was to compensate the taxpayer for the failure of the anchor tenant to discharge its obligation to pay rent under the lease.

On 23 November 1979, the trustee who owned shares of a private company ("Ballinamore") assigned to a UK company the right to any dividend payable by Ballinamore in 1979 for consideration that was equal to 99% of the dividend that in fact was declared and paid by four days later. Before going on to consider the effect of an anti-avoidance provision, Lord Browne-Wilkinson found (at p. 349) that prima facie, this lump sum received for the assignment of a right to receive future dividends, would be capital.

Damages received by Lloyd's names pursuant to their action against agents (who were member's agents) for their failure to exercise reasonable skill and care in conducting the business of underwriting on behalf of the names, were taxable as being received in respect of a trade carried on in the U.K.

Lease inducement payments received by the taxpayer were taxable to it given that they were found not to have been intended as reimbursements for the cost of tangible personal property but, rather, as consideration for the taxpayer becoming subject to an ongoing obligation to pay (deductible) rent, and given that the negotiation of leases was an important part of the taxpayer's business. (It had 120 separate lease premises in Canada and an employee negotiated leases on a full-time basis.)

A cash incentive of $400,000 which a company engaged in the wholesale auto glass business successfully obtained as an inducement for entering into a lease of premises to be used for its head office was received free of tax given that it was the only such inducement ever received by the company, it was not in the business of buying, selling, trading or otherwise engaging in dealing in leases, and the payment was not tied to the amount of the monthly rent.

The taxpayer had the right to receive $40,000 per annum for life (with certain survivor rights) from Col. Sanders Kentucky Fried Chicken Ltd. ("KFC") as a result of his previous agreement to terminate the arrangement under which he sold franchises in Canada for a fee of 1/2 of the resulting royalties. Later, when Pepsi Co. purchased KFC, it was agreed that the agreement to receive the annual amounts would be cancelled in consideration for the payment to him of two lump sums of $67,000 and $300,000. Although the cancellation agreement provided that he and his wife were to provide consulting services, it was found as a fact that he received the two lump sums in consideration for the cancellation of the existing contracts and relationships and that, accordingly, the sums were received by him on capital account as proceeds of disposition pursuant to s. 54(c)(ii)(B).

Lease inducement payments received by a holding company in connection with obtaining leases of office space which it, in turn, would provide to its operating subsidiaries, were found to have been received by it on income account based on a finding that it entered into the leases as part of its day-to-day business operations.

The taxpayer, which regularly franchised restaurants, was found to have received on income account fixturing allowances which it received in connection with leasing space which it intended to sub-lease to franchisees. The taxpayer's "business consisted of the creation of pre-packaged restaurants with a view to selling them to franchisees ... [and] it was in the course of acquiring and preparing the restaurant premises which were intended to form part of the package to be sold that the inducement payments were received" (p. 416).

£14,000 which the taxpayer received as damages from an agent for his negligence in failing to give a timely notice under a rent adjustment procedure (with the result that the rent payable by the company under the remaining five years of its lease increased substantially) was compensation for an increase in expenditure which reduced the taxpayer's trading profits, and therefore was income. A submission that the damages had been received as compensation for a fundamental change in the nature of the lease, was rejected.

Wage subsidies paid by the Department of Employment to a shoe manufacturer were taxable.

An arguably gratuitous payment received by a diamond merchant broker was compensation for past unremunerated work or for loss of anticipated future profits, and therefore was taxable as a trading profit.

The taxpayer, which operated an oil storage installation that was supplied by tankers, suffered damage to a jetty through the negligent handling of a tanker by a third party. Partial compensation was paid by the tanker owners for the cost of repairing the jetty, as well as for profits lost by the taxpayer during the time that the jetty was unavailable for use. (The balance of the cost of repairs was paid by the taxpayer's insurer, under a policy which did not cover compensation for lost profits.) As the recovery of "the whole cost of repair, …[was] without doubt, a capital receipt" (per Wilmer LJ, at p. 509), the only issue was as to whether the compensation relating to lost profits was an income receipt.

In rejecting a submission by the taxpayer that this compensation was part and parcel of the compensation received for physical damage to a capital asset, Diplock LJ noted (at p. 516) that

The cause of action was based upon the loss sustained by the Respondent trader by the negligent navigation of the tanker, and the loss sustained because the jetty could not be used for 380 days would have been recoverable even if there had been no physical harm to the jetty, as, for example, if the tanker had sunk alongside the jetty, so preventing its use.

As the compensation in issue instead was received for lost profits, it was an income receipt. Diplock LJ stated (at p. 515):

Where, pursuant to a legal right, a trader receives from another person compensation for the trader's failure to receive a sum of money which, if it had been received, would have been credited to the amount of profits (if any) arising in any year from the trade carried on by him at the time when the compensation is so received, the compensation is to be treated for income tax purposes in the same way as that sum of money would have been treated if it had been received instead of the compensation. The rule is applicable whatever the source of the legal right of the trader to recover the compensation. It may arise from a primary obligation under a contract, such as a contract of insurance; from a secondary obligation arising out of non-performance of a contract, such as a right to damages, either liquidated, as under the demurrage clause in a charterparty, or unliquidated; from an obligation to pay damages for tort, as in the present case; from a statutory obligation; or in any other way in which legal obligations arise. But the source of a legal right is relevant, however, to the first problem involved in the application of the rule to the particular case, viz., to identify for what the compensation was paid. If the solution to the first problem is that the compensation was paid for the failure of the trader to receive a sum of money, the second problem involved is to decide whether, if that sum of money has been received by the trade, it would have been credited to the amount of profits (if any) arising in any year from the trade carried on by him at the date of receipt, i.e., would have been what I shall call for brevity an income receipt of that trade.

The taxpayer, which was a publisher of The Canadian Law List, settled its copyright infringement action against another company ("Carswell's") on the basis of Carswell's agreement to pay it the lump sum of $7,000 plus a royalty of 30% of Carswell's gross revenues from a competing directory for years specified in the agreement. Because the $7,000 was not paid in respect of any loss of income of the taxpayer (in fact, sales of its directory had increased following the infringement) and instead was received as exemplary or punitive damages, it was not subject to tax.

The taxpayer, whose main activity was carrying on the trade of quarrymasters, sought to extend its business to civil engineering contracting by retaining a firm of consulting engineers to provide the services and reputation of one of their engineers. Insurance proceeds which the taxpayer received on the death of this individual represented compensation for loss of profits which it expected to make through utilizing his services and, accordingly, were taxable receipts.

The taxpayer received a lump sum from the tenant in consideration for releasing the tenant from its obligation to restore the leased premises (to which the tenant had made major alterations) to their original state, and from the obligation to pay rents for the unexpired term of the lease.

In finding that the sum was a capital receipt, Mr. Monet stated (at p. 130) that:

When, after the departure of the lessee, the landlord had to practically rebuild the inside of its building, I do not think that such an operation can be considered as purely incidental to the carrying on of its business.

The element of the rent for the unexpired term did not change the result given that such rent was less than 10% of the lump sum paid.

In finding that a company received insurance proceeds for the accidental death of a valuable employee on revenue account, Lord Greene, M.R. stated (p. 37):

"If when an employer finds it desirable to expend money in getting rid of an onerous contract of service, the expense incurred is a revenue expense, it does seem to me to follow that the money received in respect of the loss of a beneficial contract of service falls into the same category; and, apart from the fact that no actual contract existed, that appears to me to be the present case."

The taxpayer carrying on business as a theatrical agent and producer of plays, acquired the scenery, properties and costumes to a play for £1,000, and also obtained a five-year licence to perform the play in the United Kingdom outside London in consideration for a royalty. Damages which the taxpayer received for infringement of the licence were an income receipt:

"The acquisition of the licence to produce plays is an ordinary incident of their business and ... the acquisition of each licence to produce a particular play does not constitute that licence a capital asset, but is merely the acquisition of their stock-in-trade" (pp. 512-513).

The taxpayer, which already was entitled to receive annual subsidies in respect of every hundredweight of sugar or molasses manufactured during the 10-year period commencing 1 October 1924 from beets grown in Great Britain, received in 1931 further "advances" pursuant to the British Sugar Industry (Assistance) Act, 1931, which provided that such advances would be repayable by way of set-off against the annual subsidies in the event that the market price of sugar exceeded specified levels (which, in fact, did not occur). Lord Macmillan stated (p. 670) that "these payments were made to the Company in order that the money might be used in their business", and that the payments accordingly should be regarded as supplementary trade receipts.