Date: 20020305
Docket: 1999-5040-IT-G
BETWEEN:
IPSCO INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasonsfor Judgment
Rowe, D.J.T.C.C.
[1] The appellant appealed from a reassessment of income tax for its 1994 taxation year. Counsel for the appellant filed - as Exhibit A-1 - an Agreed Statement of Facts (Agreed Facts) and a binder entitled Joint Book of Documents, tabbed 1-11, inclusive, as Exhibit A-2 and reference to a tab number indicates the relevant material or documents will be located within said Exhibit A-2. The Agreed Statement of Facts reads as follows:
For the purposes of this appeal, the parties, by their respective counsel, admit the following facts and agree that their admission of facts shall have the same effect as if the facts had formally been proved and accepted by the Court as true. The parties each reserve the right to adduce additional evidence which is relevant and probative of any issue before the Court and which is not inconsistent with the facts admitted herein. All statutory references are to the Income Tax Act (Canada) ("Act") as it read during the 1994 taxation year, unless noted otherwise. All references to the "Regulations" are to the Income Tax Regulations.
1. The Appellant is a public corporation and a taxable Canadian corporation for purpose of Act, the fiscal period of which ends on December 31.
2. The Appellant carries on a steel production and fabricating business including manufacturing of steel pipe.
3. The Appellant owns a pipe manufacturing plant in Calgary, Alberta ("Calgary Plant"),
4. The Appellant entered into a written agreement dated September 9, 1991 ("Contract") with ASEA Limited ("ASEA") for the design, engineering and supply by ASEA of a "quench and temper" pipe treatment system ("System") for a total price of $3,887,000.
5. The Appellant and ASEA at all times dealt at arm's length for purposes of the Act.
6. The System was built and installed by ASEA.
7. ASEA warranted and guaranteed that the System would perform as specified in the Contract.
8. In its 1983, 1984 and 1985 taxation years, the Appellant incurred total costs of $4,066,925 in respect of the construction of the System which, for purposes of the Act, were capitalized to classes 3 and 29 of depreciable property.
9. After installation of the System by ASEA, the Appellant incurred additional costs in an effort to make it perform as specified in the Contract.
10. The total additional costs incurred by the Appellant in the 1985 to 1988 taxation years amounted to $7,593,791, of which $6,117,023 was added to the undepreciated capital cost ("UCC") of classes 29 and 39 and $1,476,768 was charged to costs of sales.
11. The Appellant was the sole plaintiff in a civil action ("Action") against ASEA relating to the design, engineering and supply of the System.
12. The Appellant and ASEA ultimately agreed to a settlement of the Action. The terms of the settlement were set forth in Minutes of Settlement dated January 13, 1994. In accordance with the Minutes of Settlement, ASEA paid to the Appellant $4,800,000 ("Settlement Amount") in respect of the Appellant's claim for additional construction and installation costs relating to the System.
13. None of the System was transferred to ASEA under the terms of the settlement; the System was retained in its entirety by the Appellant.
14. The System continues to be used in the Appellant's pipe manufacturing operation.
15. In computing its income for its 1994 taxation year for purposes of the Act the Appellant treated the Settlement Amount as a non-taxable receipt. The Appellant did not reduce the capital cost of the System, or otherwise reduce the UCC of its class 29 or class 39 depreciable property by the Settlement Amount.
16. For accounting and financial statement purposes the Appellant reduced the historical cost of the System assets by the Settlement Amount.
17. The legal expenses incurred by the Appellant in connection with the Action were fully deducted on a current basis on income in the year incurred for both accounting and income tax purposes.
18. The Appellant's tax return for its 1994 taxation year was assessed as filed, by the Minister of National Revenue ("Minister") on August 28, 1995.
19. In a letter dated February 13, 1997 to the Department of National Revenue, the Appellant elected to transfer its class 29 depreciable property to class 39, pursuant to subsection 1103(2d) of the Regulations.
20. By Notice of Reassessment dated July 28, 1997 ("First Reassessment"), the Minister reassessed the Appellant's 1994 taxation year to, among other things, reduce the CCA claim in respect of class 39 depreciable property by $1,200,000 on the basis that the Settlement Amount reduced the capital cost of the System or otherwise reduced the UCC of the Appellant's class 39 depreciable property by $4,800,000.
21. The Appellant filed a Notice of Objection to the First Reassessment on October 22, 1997.
22. By Notice of Reassessment dated September 20, 1999, the Minister, among other things, confirmed for the Appellant's 1994 taxation year the $1,200,000 reduction in the CCA claimed in respect of class 39 depreciable property.
[2] As disclosed in paragraph 15 of the above stated facts, the appellant treated the Settlement Amount as a non-taxable receipt. The Minister of National Revenue (the "Minister") disagreed with this characterization and deducted the Settlement Amount from the capital cost of the system on the basis it constituted proceeds of disposition - generally - or in the alternative - as set forth in paragraph 13 of the Amended Reply to the Notice of Appeal - (Amended Reply) because it resulted from a disposition of property, being compensation for property injuriously affected. In either case, the Minister decided the effect of receiving the Settlement Amount was to reduce the undepreciated capital cost (UCC) of the assets in that class. The position of the appellant is that there was no requirement under the Income Tax Act (the "Act") to make any such deduction or otherwise to reduce the UCC of the appellant's class 29 or class 39 depreciable property in respect of the Settlement Amount.
[3] Charles Backman testified he is employed by Ipsco - in Regina, Saskatchewan - as a Senior Vice-President, and began working for the appellant in 1982. He graduated from the University of Manitoba with a Bachelor of Engineering (mechanical) degree. Originally, Ipsco owned and operated only pipe mills but it now owns three steel plants and pipe mills in Canada and the United States. The plant located in Calgary, Alberta was used to manufacture pipe. On September 9, 1981, a Canadian corporation - ASEA - entered into a contract (tab 1) with Ipsco to install a particular pipe treatment system described as a "quench and temper" system. Backman stated that, although he was a newcomer at Ipsco, he was assigned responsibility for oversight of this new construction project. The pipe produced in the plant - ranging in size from 4 inches to 10 inches in diameter - was utilized in the oil patch mainly for down-hole casings while other pipe was used as line pipe. The pipe production process commenced with rolled steel - known as skelp - in the width of the desired diameter of the pipe to be manufactured. The coiled steel was fed into a forming mechanism in order to make it round and it was then subjected to a method of longitudinal seam welding in order to create the finished pipe. Backman explained the "quench and temper" system takes normal steel, heats it sufficiently to change the grain structure from ferrite to ostenite, passes it through 4 induction coils and then quenches it with water jets in order to cool the material for the purpose of changing - again - the grain structure. Then, to temper the steel, the pipe is subjected to heat produced by another set of coils with a view to attaining a desired temperature for a specified period of time in order to reduce the stress created by the earlier quenching process. Backman stated the system was subjected to performance testing during which mechanical parts - including water jets and belts - were observed to ensure they worked properly. At that time, the system passed the test and seemed to be functioning adequately but later - when different grades and sizes of pipe were sent through the system - it did not create the required end product. Backman explained the problem occurred when the raw pipe entered the quench phase and the water application was insufficient to change the grain structure, and the subsequent tempering process did not provide sufficient, sustained heat for the requisite period needed to produce high-grade pipe. As a consequence, Ipsco conducted metallurgy tests which revealed the pipe - as produced - was not consistent with the specifications set forth in the contract. A supplier - Ajax - was contacted and it installed a new quench head. In order to rectify the heating problem, a gas-fired furnace was installed with the intent it would produce sufficient heat to temper the pipe. Backman stated that after these new installations were completed and the process of pipe production was restored, the desired specifications for the pipe were attained but the rate of production was less than 50% of the metric tons per hour specified in the contract with ASEA. Ipsco decided to continue utilizing the system even though it functioned properly only when operating at reduced capacity. Backman stated Ipsco spent a total of $7,593,791 (see para. 10 of Agreed Facts) in an attempt to make the system work, as intended. The appellant commenced a civil action against ASEA and its Swedish parent corporation - ASEA AB - relating to the design, engineering and supply of the system. Backman was referred to the Statement of Claim - tab 2 - filed in the registry of The Queen's Bench on May 23, 1986 at Regina, Saskatchewan. Details of special damages were set forth therein on pages 18-20, inclusive, including - at paragraph 28 (a)(iii) - the extra construction and installation costs - associated with attempts to remedy deficiencies in the system - in the amount of $4,257,117. In addition, extra costs relating to construction and installation incurred in planning and construction of normalizing the line in reliance on completion of the system were claimed in the sum of $1,721,000 - at paragraph 28(b) - on the basis the costs were wasted when the system was not completed. As stated in paragraph 10 of the Agreed Facts, the sum of $6,117,023 was added to the UCC of classes 29 and 39 and $1,476,768 was charged to costs of sales. Backman stated a settlement was reached on January 13, 1994 and in accordance with the Minutes of Settlement (Minutes), ASEA paid Ipsco the sum of $4,800,000, referred to in paragraph 12 of the Agreed Facts as the Settlement Amount. Backman explained that attempts to settle with ASEA had been undertaken prior to the commencement of litigation and recalled that he had been required to participate in a 21-day Examination for Discovery because he was a member of a group of officers of Ipsco involved in the decision-making process concerning the litigation. Backman identified a letter - tab 3 - dated January 5, 1994 from Larry LeBlanc at MacPherson Leslie & Tyerman - the law firm retained by Ipsco - concerning the prospects for - and categorization of - potential heads of damages in any recovery from ASEA. In said letter, LeBlanc expressed the opinion that the best head of damages was for extra construction and installation costs rather than claims for lost profit and interest which were considerably weaker and the least likely to succeed. Backman stated the settlement of $4,800,000 set forth in the Minutes - Tab 4 - resulted from hard negotiations assisted somewhat by ASEA's interest in providing its services to Ipsco in relation to new plants being constructed in the United States.
[4] In cross-examination, Charles Backman was referred to a letter - at tab 5 - dated April 12, 1996 from Kevin Harle to an official at Revenue Canada - in relation to an income tax audit - in which the breakdown of certain capitalized amounts was explained. He was also directed to a memorandum - at tab 10 - dated June 2, 1993, from John Comrie of the Ipsco legal department - to Kevin Harle - in which Comrie stated that the "combined case and contract in tort against the Canadian company, ASEA Inc. and its Swedish parent, ASEA, AB, totals approximately $33 million." Of that amount, Mr. Comrie attributed the sum of $12,000,000 to a claim for lost profit. A document - at tab 9 - set forth a precise and detailed breakdown of heads of damages in which the sum of $4,779,534 was categorized as the cost of construction and installation. Backman stated the Swedish company - ASEA AB - was well known to him during his previous employment and he regarded it as a competent corporation capable of fulfilling the terms of the contract with Ipsco. In expressing his level of confidence with the ASEA organization, he remarked "it was the last company I would check on."
[5] Robert Eisner testified he is Assistant Treasurer of Ipsco and Controller of Canadian Steel Works and Coil Processing. Until October, 2000, Eisner was the Treasurer of Ipsco and in that capacity was familiar with the manner in which the appellant treated the $4.8 million dollars received from ASEA in settlement of the litigation both for purposes of Ipsco financial statements and for reporting income. Counsel referred Eisner to paragraph 15 of the Agreed Facts and Eisner agreed it was an accurate description of the manner in which Ipsco treated the Settlement Amount for income tax purposes. He stated Ipsco sought outside tax advice and, based on that opinion, decided the proper treatment of those funds was not to reduce the capital cost allowance. Eisner also agreed with the statement contained in paragraph 16 of the Agreed Facts that, for accounting and financial statement purposes, Ipsco reduced the historical cost of the system assets by the amount of the settlement. He stated this procedure was undertaken in accordance with advice received from Ernst & Young, the appellant's external auditors.
[6] In cross-examination, Eisner was referred to the appellant's corporate tax return for the year ending December 31, 1994 - at tab 6 - and to the Non-Consolidated Statement of Financial Position (marked by a green tab) and to a yellow highlighted entry indicating capital assets (expressed in thousands of dollars) increased in 1993 from 229,310 to 232,195 in 1994. In the financial statement at note 4 - Capital Assets - a table indicated one of the components was the cost of capital assets which increased from 410,914 to 426,687. Eisner was referred to another green tabbed statement entitled "Non-consolidated Statement of Changes in Cash Position Years Ended December 31", and to a yellow highlighted entry including the figure 16,290 (again, expressed in thousands of dollars) with a reference to Note 10 indicating an addition to capital assets of 15,773 ($15,773,000). Eisner was referred to the last page of tab 7, a sheet with a handwritten notation at the top, "1994 Fixed Assets". Eisner explained the accounting entries contained therein included a reduction in the write down of assets regarding the ASEA construction project by the amount of $4.8 million, the sum received as a result of the litigation instituted by Ipsco against ASEA and an excerpt from journal entries (third page of tab 7) recorded receipt of that amount. Eisner agreed the legal expenses incurred by Ipsco in respect of the litigation were fully deducted on a current basis on income account in that taxation year both for accounting and income tax purposes. Eisner stated Ipsco followed the advice contained in an internal memorandum - tab 11 - concerning the ASEA settlement and - at page 2 thereof - the second last paragraph read:
Since the settlement relates to construction and installation of the equipment, the settlement would therefore be considered capital in nature and should be recorded as a reduction of fixed assets...
[7] Counsel for the appellant submitted there is no requirement under the Act that the appellant deduct the Settlement Amount from the UCC of any class of the appellant's depreciable property having regard to the circumstances in which the Settlement Amount was received and further contended said amount did not constitute proceeds of disposition, as defined by the relevant provisions of the Act. More specifically, counsel submitted the amount received in settlement of the litigation was not compensation for property injuriously affected within the meaning of that expression contained in the definition of "proceeds of disposition" in subsection 13(21) of the Act nor did it constitute "compensation for property damaged" within the meaning of that expression in the definition of "proceeds of disposition" in said subsection. The position of the appellant was that it was appropriate for it to have complied with the comprehensive legislative scheme of rules for entitlement of a taxpayer to deduct Capital Cost Allowance (CCA) in respect of capital costs incurred to acquire depreciable property. In that sense, any requirement for the appellant to reduce the UCC of class 29 or 39 property - in respect of the Settlement Amount - must be found within the wording of the Act and the appellant's treatment of said amount is based on the reasoning that no such provision exists, notwithstanding that Parliament has otherwise expressly determined certain other amounts should reduce the capital cost of depreciable property. In the face of this specificity, counsel submitted that if Parliament had intended to include damage awards or amounts received in settlement of litigation, then it would have expressly provided for that event in a manner like that contained in subsection 13(7.1) of the Act relating to amounts required to be deducted in respect of depreciable property if they were received as assistance from a government, municipality or other public authority in respect of certain grants, subsidies, loans and similar financial aid.
[8] Counsel for the respondent submitted the assessment issued by the Minister was in accordance with Interpretation Bulletin IT-365R2 regarding the tax consequences of damages and settlements. Further, counsel referred to the general scheme of reporting income pursuant to sections 3 and 9 of the Act, including the application of section 18 in limiting deductions from income, and the interplay of provisions governing CCA with respect to depreciable property - set forth in paragraph 20(1)(a) of the Act - and the effect of Regulation 1100 - referred to therein - together with the use of the formula for calculating UCC as set out in subsection 13(21). Under subsection 13(21), counsel submitted the statutory definitions of "disposition of property" and "proceeds of dispositions" do not require an actual transfer or giving up of property for there to be a disposition under the Act and, therefore, the Settlement Amount constituted proceeds of disposition - either generally - or specifically under paragraphs (e) or (f) of subsection 13(21) of the Act - which had the effect of reducing the UCC of the assets within that class. In counsel's view of the relevant jurisprudence, there is a requirement for the appellant to have reported the Settlement Amount in the manner assessed by the Minister because that would have presented the true picture of Ipsco's profit from business on the basis that the amount on which CCA is calculated must be representative of the actual cost of the system to the appellant. Counsel submitted that to ignore the Settlement Amount - in the sum of $4.8 million - is to grant a huge windfall to the appellant resulting in the cost of the asset being falsely inflated with the further effect that income is artificially deflated in that year and in the years that follow.
[9] The issue in the within appeal is essentially one of taxation of damages which usually depends on the nature of the legal right giving rise to the payment, whether following a victory in court or through settlement to end the litigation. The Statement of Claim - tab 2 - issued by Ipsco sought special damages - as detailed in paragraph 28 thereof - as well as general damages - in unspecified amounts - for incremental fixed and variable costs it incurred by reasons of the delay - on the part of ASEA - in performance under the contract as well as lost profits - both current and future - together with a claim for loss of market share and loss of reputation. The Minutes - tab 4 - provided that ASEA - and its parent ASEA AB - pay the sum of $4.8 million to the appellant "in respect of the Plaintiff's claim for additional construction and installation costs". Paragraph (b) of the said Minutes stated, "there shall be no payment in respect of any of the other claims and counterclaims in this action." The agreement further provided that each party would bear its own costs of, and incidental to, the action and the parties agreed to file Notices of Discontinuance relating to both the Statement of Claim and the Counterclaim. The parties also agreed as follows:
It is agreed that the terms of subparagraphs (a), (b), (c), and (d) above constitute a final and conclusive determination and settlement of all claims, rights and causes of action asserted in, or arising out of the matters referred to in, the pleadings in this action. For greater certainty, it is confirmed that all such claims, rights and causes of action are fully satisfied by, and merged in, these Minutes of Settlement.
[10] In my view, it is clear that none of the amount of $4.8 million is attributable to lost income and/or profit and - instead - was paid in respect of the appellant's claim for additional construction and installation costs resulting from the lack of performance in the system as designed and installed by ASEA pursuant to the contract between the parties. As a capital receipt, depending on its nature for purposes of analysis in the within appeal, it is either a capital gain or a non-taxable windfall.
[11] The policy of Canada Customs and Revenue Agency (CCRA) with respect to the characterization of capital amounts - relied on by the Minister in issuing the assessment to the appellant - is expressed in the relevant portion of paragraph 8 and paragraph 9 of IT-365R2 as follows:
8. An amount received by a taxpayer in lieu of the performance of the terms of a business contract by the other party to that contract may, depending on the facts, be either an income or capital receipt. If the receipt relates to the loss of an income-producing asset, it will be considered to be a capital receipt; on the other hand, if it is compensation for the loss of income, it will constitute business income...
9. Where an amount received by a taxpayer as compensation for a breach of a business contract is a capital amount according to the comments in 8 above, that amount would relate either to a particular asset of the taxpayer or to the whole structure of the taxpayer's profit-making apparatus. If, on the basis of the facts of the case, such as the terms of a contract, settlement or Judgment, the amount received relates to a particular asset (tangible or intangible) which is sold, destroyed or abandoned as a consequence of the breach of contract, it will be considered proceeds of disposition of that asset or a part thereof, as the case may be. Where the amount of compensation relates to a particular asset that was not disposed of, the amount will serve to reduce the cost of that asset to the taxpayer. On the other hand, where the amount of compensation is of a capital nature but it does not relate to a particular asset as indicated above, the amount will be considered as compensation for the destruction of, or as damages to, the whole profit-making apparatus of the taxpayer's business. Such compensation may result in an "eligible capital amount" for the purpose of subsection 14(1) and subparagraph 14(5)(a)(iv). [emphasis added]
[12] The appellant's position is that there is no express provision in the Act requiring the Settlement Amount to be deducted from UCC and that the Federal Court of Appeal has held - consistently - that where a taxpayer receives a reimbursement or compensation from a third party for capital costs of depreciable property, there is no requirement under the Act that the taxpayer reduce the original capital costs by the amount of the reimbursement or compensation. In the case of The Queen v. Canadian Pacific Limited [1977] C.T.C. 606, the Federal Court of Appeal considered the situation where Canadian Pacific (CP) - at the request of a third party - would make capital expenditures after the third party had agreed to reimburse CP for an amount not exceeding the costs incurred by it to improve or build facilities to serve the third party. In that case, CP calculated its CCA claim in respect of the assets it had acquired - as a result of the arrangement - on the basis that the amounts received by the third party were not to be deducted from the capital cost of those assets in computing the UCC of the relevant class. Pratte J.A. - writing for the Court - at page 611 stated:
The learned trial Judge, in my opinion, rightly rejected that contention which appears to me to be inconsistent with the decision of the House of Lords in Birmingham Corporation v. Barnes, [1935] A.C. 292, where it was held that "the actual cost to" a taxpayer of depreciable property is equal to the amount paid by the taxpayer. As Lord Atkin said in that case (at page 298):
What a man pays for construction or for the purchase of a work seems to me to be the cost to him: and that whether someone has given him the money to construct or purchase for himself; or, before the event, has promised to give him the money after he has paid for the work; or, after the event, has promised or given the money which recoups him what he has spent.
[13] Later, the Federal Court of Appeal heard the case of The Queen v. The Consumers' Gas Company Ltd., [1984] C.T.C. 83, wherein the issue concerned the reimbursement - by customers - to Consumers' Gas company for all or part of relocating portions of its gas lines at the request of those customers. In computing the CCA claims under the Act, Consumers' Gas took the position that it could add the gross cost of the line relocations to the UCC of the relevant class and then calculate CCA entitlements on that gross cost without taking into account the reimbursements received from the customers. The trial judge held the method followed by the taxpayer was correct. The Crown appealed and, although there was an issue concerning the sufficiency of pleadings by the Crown at trial, the Court did rule on the contention by counsel for the Minister that the decision in Canadian Pacific, supra, was not applicable. The judgment - dismissing the appeal - was delivered for the Court by Urie J. and at p. 86, he stated:
The learned trial judge, rightly, I think, found that he was bound by the principle expressed in the Canadian Pacific case in so far as the treatment of the reimbursements as an addition to undepreciated capital cost is concerned. However, he went further and, after reviewing considerable jurisprudence concluded that in the Canadian Pacific case contributions were not taken into revenue but were capitalized (page 18 of reasons) and, therefore, found as follows (page 21 of reasons):
I have concluded that Plaintiff in the present case was justified in considering that contributions received towards the relocation of its pipelines done, not for its benefit, but for the benefit of the parties making the contributions, can be carried to a contributed capital account without passing through income.
[14] The decision in Consumers' Gas, supra, was followed by the Federal Court of Appeal in Pacific Northern Gas Ltd. v. Her Majesty the Queen, [1991] 1 C.T.C. 469. In that case, Pacific Northern sold gas and delivered it to its customers by means of additional lines running off the main pipeline. The gas company received certain payments from its customers to pay for the connector lines to their premises and the trial judge held the payments to defray the cost of the connector lines were not income receipts but were to be applied to increase the UCC of the lines and in so doing relied - inter alia - on the decisions in Consumers' Gas and Canadian Pacific, both supra. The Federal Court of Appeal found the trial judge did not err in concluding there was no material difference between the receipts in question before him and those previously found to have constituted capital receipts in the cases referred to above.
[15] Prior to the case of Westcoast Energy Inc. v. Her Majesty The Queen, [1992] 1 C.T.C. 471, arriving at the Federal Court - Trial Division - in 1992, Parliament had enacted paragraph 12(1)(x) of the Act in an attempt to bar the door to what the Minister had considered to represent a glaring omission in tax legislation. In Westcoast, supra, the taxpayer - as plaintiff - had received a sum in excess of $20 million from Ipsco (demonstrating once more that what goes around comes around) in settlement for an action brought by Westcoast Energy against Ipsco and others in which it claimed damages for breach of contract and negligence. Westcoast took the position the settlement was a payment for damages for breach of contract and negligence while the Minister argued that the failure of the settlement to include an admission of liability could be considered as further support of the assessment in addition to the proposition that, in light of the new provision of the Act and the relationship of the payment to the replacement cost of the pipeline, the assessment was otherwise valid. Denault J. concluded that paragraph 12(1)(x) did not include damage awards even though he held that the legislative change had been made with the intent to plug the hole as exemplified in the case of Consumers' Gas, supra. Further, Denault J. found there was no evidence Parliament had intended the new paragraph to include damage awards under the word, "reimbursement" and - at p. 481 - went on to state:
I can appreciate the defendant's position that this situation creates a taxation inequity. The plaintiff in this case added the costs of rebuilding the failed pipeline to its undepreciated capital cost, sought recovery from IPSCO for breach of contract, recovered moneys for the reconstruction, and then did not reduce its undepreciated capital cost by the amount recovered, as well as not including its damage award in its corporate income. Howerver, I am not prepared to expand the legal meaning of the word reimbursement to capture this inequity. It is not the function of this Court to expand the meaning of a word to make the tax system fair. Parliament could have been more specific if the intention was to include commercial damage awards in paragraph 2(1)(x). If there is any ambiguity in legislative intent to tax, the taxpayer is entitled to the benefit of the doubt.
[16] The Federal Court of Appeal upheld the trial judge with regard to his interpretation (see Her Majesty The Queen v. Westcoast Energy Inc., [1992] 1 C.T.C. 261). An interesting feature of the trial before Denault J. was that the Crown - perhaps inspired by the sage choice of Robert the Bruce for respite rather than resumption of battle - decided to concentrate solely on the application of paragraph 12(1)(x)(iv) of the Act to the settlement amount and abandoned arguments that the $20,250,000 sum was either compensation for property injuriously affected or constituted compensation for property damages, pursuant to various relevant paragraphs in subsection 13(21) including (f).
[17] In the within appeal, the Minister did not advance the "reimbursement" argument probably because the law in that respect appears to be settled and there has been no amendment to the relevant paragraph - following the decision in Westcoast - to expand the provision in order to include damage awards and/or settlement amounts. To have done so, would probably have discouraged most taxpayers from further litigation over whether such payments were - after such amendment - still capable of being considered non-taxable receipts. While the failure of Parliament to do something does not assist in matters of statutory interpretation, it is still interesting to note that the analysis developed within the body of jurisprudence remains paramount to the resolution of the issue as opposed to the application of specific language embodied in statute.
[18] Counsel for the respondent relied on the decision of the Federal Court of Appeal in Her Majesty The Queen v. Mohawk Oil Co. Ltd., 92 DTC 6135 as support for the proposition that a settlement received from a corporation was not a windfall. In that case, the taxpayer had contracted with a U.S. corporation - Phillips - to supply and install a waste oil reprocessing plant. As in the within appeal, the plant failed to operate satisfactorily and, following certain negotiations, Phillips paid Mohawk Oil the sum of US $6 million in full settlement of its claims even though the original compensation sought had been in the sum of US $15 million. Initially, Mohawk Oil characterized the settlement proceeds as a loss of profits and as a reduction of the cost of assets. Later, it took the position that the entire amount received in the settlement was in respect of damages and, as such, constituted a non-taxable receipt. The Minister assessed on the basis that part of the settlement proceeds was income flowing from a claim for loss of profits and part was capital because it met the definition of proceeds of disposition as defined in subsection 13(21) of the Act with the result that said part was credited to the UCC pool. Hugessen J.A. - writing for the Court - after reviewing British and Canadian cases including The Queen v. Cranswick, 82 DTC 6073 (F.C.A.) concluded the facts did not meet the criteria of a "windfall" for various reasons including the fact there had been an exchange of mutual releases and the parties had also agreed to terminate a business relationship created by a specific agreement. Overall, the payment to Mohawk Oil - by Phillips - was seen by Hugessen J.A. as an amount paid in partial satisfaction of a claim for compensation sought by Mohawk Oil pursuant to an agreement within the context of a business transaction that had turned sour. At p. 6141, Hugessen J.A. stated:
I must now pass to consider the correctness of the reassessment itself. The first question here is whether the Minister was right in assessing the sum of $3,443,708 as compensation for lost profits and expenditures incurred. In my view, there was evidence which supported this assessment. I have already referred to the correspondence and documentation which indicate that the respondent did seek to be made whole including compensation for lost profits. Its treatment of the settlement amount in its accounting records is to the same effect. Moreover, the evidence reveals that in its fiscal years 1981 and 1982 the respondent suffered a loss of profits by virtue of operating expenses associated with the inoperable plant. The evidence further shows that in computing its income for these fiscal years the respondent deducted as "net expenses incurred" the amounts of $1,184,235 and $1,164,296, respectively. What is apparent in the present case is that Phillips agreed to take back the plant and, obviously, to recognize in the settlement a portion of the respondent's claim that was not represented by the expenditures for land, storage tanks and other auxiliary facilities which the respondent decided in the end to retain and, indeed, apparently put to use again after it acquired a new plant from another source.
We must also decide whether the reassessment was right in allocating a portion of the settlement amount to "proceeds of disposition of capital property" to the extent of $3,718,430. It seems to me that this too depends on whether the evidence supports that allocation as made by the Minister in the reassessment. In my respectful view, it does. To begin with, it is clear beyond doubt that the settlement amount did include compensation for the plant itself which, apart from the hydrotreater, was turned back to Phillips who then decided to have it dismantalled [sic] on site. This item alone had represented a capital outlay by the respondent of $3,942,000 Canadian ($2,850,000 U.S.) as the purchase consideration. Again, the respondent, in endeavouring to be made whole, sought to be compensated in respect of its capital investment. Moreover, its own accounting records, as approved by its board of directors, allocated a portion of the settlement amount as "proceeds of disposal of lubricant plant" and allocated a portion of the settlement amount to "deferred development costs".
[19] On the face of it, it would appear as though this decision is inconsistent with the one in Westcoast, supra. However, there are two significant differences. First, in Mohawk, supra, Phillips agreed to take back the plant and paid compensation for loss of profits associated with it. Phillips, after taking back the plant, dismantled it on site. That is an important distinction because - in the within appeal - payment by ASEA of the sum of $4.8 million - following the conduct of actual litigation past the Discovery stage - was not connected to any loss of profits nor did Ipsco abandon, transfer or otherwise provide ASEA with any property in return for accepting the payment. I also consider that Phillips decided to make the payment to Mohawk Oil prior to any legal requirement to do so and prior to the commencement of any civil action - by Mohawk Oil - to enforce payment. In that sense, it was a free and voluntary choice made by the board of directors. Further, it is apparent that Mohawk Oil clearly disposed of property to Phillips, thereby triggering a capital gain.
[20] Counsel for the respondent submitted that in order to obtain a true picture of the profit of the appellant in the taxation year under appeal, it is necessary to ensure that the amount on which CCA is calculated is representative of the actual cost of the system to Ipsco. In support of that proposition, counsel referred to the decision of the Supreme Court of Canada in Canderel Limited v. Her Majesty The Queen, 98 DTC 6100. In that case, the taxpayer - a corporate real estate developer - deducted all of the tenant inducement payments made by it during that year. The Minister disagreed with the method of computation utilized by the taxpayer and assessed accordingly. At p. 6110, Iacobucci J, set forth certain principles to be observed in relation to computation of income, as follows:
(1) The determination of profit is a question of law.
(2) The profit of a business for a taxation year is to be determined by setting against the revenues from the business for that year the expenses incurred in earning said income: M.N.R. v. Irwin, supra, Associated Investors, supra.
(3) In seeking to ascertain profit, the goal is to obtain an accurate picture of the taxpayer's profit for the given year.
(4) In ascertaining profit, the taxpayer is free to adopt any method which is not inconsistent with
(a) the provisions of the Income Tax Act;
(b) established case law principles or rules of law; and
(c) well-accepted business principles.
(5) Well-accepted business principles, which include but are not limited to the formal codification found in G.A.A.P., are not rules of law but interpretive aids. To the extent that they may influence the calculation of income, they will do so only on a case-by-case basis, depending on the facts of the taxpayer's financial situation.
(6) On reassessment, once the taxpayer has shown that he has provided an accurate picture of income for the year, which is consistent with the Act, the case law, and well-accepted business principles, the onus shifts to the Minister to show either that the figure provided does not represent an accurate picture, or that another method of computation would provide a more accurate picture.
[21] The issue in the within appeal does not, however, revolve around different philosophies concerning appropriate accounting methods and the rational choice of one over another, both of which are inherently valid. Instead, the Act provides an extremely precise and detailed method by which CCA is to be calculated and the provisions are utilized in a manner to override - in my opinion - any general concept of calculating what the Minister would like to have regarded as "true profit" for the year. In an admirable display of bootstrapping, the Minister assessed Ipsco on the basis of the administrative pronouncement promulgated in IT-365R2 on the basis that "where the amount of compensation relates to a particular asset that was not disposed of, the amount will serve to reduce the cost of that asset to the taxpayer". My reading of the relevant jurisprudence leads me to conclude that this ministerial proclamation is not otherwise supported by the case law in this field. There was no "disposition of property" - as defined in subsection 13(21) of the Act - because the transaction or event entitling the appellant to the sum of $4.8 million did not involve any disposition of property, even considering the term, "property" in a broad sense, in a manner consistent with the analysis performed by several courts in various cases over many years dealing with diverse subject matters. The particular definition referred to in subsection 13(21) of the Act reads:
"disposition of property" - "disposition of property" includes any transaction or event entitling a taxpayer to proceeds of disposition of property.
[22] In the within appeal, Ipsco incurred at least $10,183,948 of capital costs (see paragraphs 8 and 10 of Agreed Facts) to install the system and then to make it perform as contemplated in the contract with ASEA. The Settlement Amount received from ASEA represented compensation or reimbursement with respect to a part of those costs and ASEA received nothing in return except a Discontinuance of Action in respect to litigation rooted in breach of contract and negligence relating to the design and installation of the system. In my opinion, an exchange of releases by way of mutual discontinuances and minutes of settlement does not constitute property for the purposes of the subsection. The Minister noted the accounting treatment by Ipsco - with regard to the sum of $4.8 million obtained from ASEA - in which the shareholders were notified that the whopping amount of the additional expenditures in relation to the system were not as gloomy as they seemed because the bottom-line cost thereof had been reduced by the amount of the recovery from ASEA through the litigation process. For internal purposes concerning the financial state of the corporation, that just makes good sense. That does not, however, mean the same method must be utilized when reporting income pursuant to the Act. By reducing the amount of the historical cost of the system by deducting the sum of $4.8 million for its own accounting purposes, Ipsco obviously wanted to present an accurate picture of the situation. Ironically, that is exactly what counsel for the respondent submitted the appellant should have done when filing a return of income under the Act because the failure to do had the effect of distorting Ipsco's true profit picture in that taxation year and following years. However, the reporting of income in accordance with the Act - particularly when observing a rigid set of rules governing a particular aspect of income inclusion or deduction of expense - does not preclude different treatment of the same transaction for other legitimate business purposes unconnected with making a return of income.
[23] In the alternative, the position of the Minister is that the Settlement Amount constituted proceeds of disposition of property, being compensation for property injuriously affected. The definition of "proceeds of disposition" in subsection 13(21) of the Act is as follows:
"proceeds of disposition". - "proceeds of disposition" of property includes
(a) the sale price of property that has been sold,
(b) compensation for property unlawfully taken,
(c) compensation for property destroyed and any amount payable under a policy of insurance in respect of loss or destruction of property.
(d) compensation for property taken under statutory authority or the sale price of property sold to a person by whom notice of an intention to take it under statutory authority was given,
(e) compensation for property injuriously affected, whether lawfully or unlawfully or under statutory authority or otherwise,
(f) compensation for property damaged and any amount payable under a policy of insurance in respect of damage to property, except to the extent that the compensation or amount, as the case may be, has within a reasonable time after the damage been expended on repairing the damage,
(g) an amount by which the liability of a taxpayer to a mortgagee is reduced as a result of the sale of mortgaged property under a provision of the mortgage, plus any amount received by the taxpayer out of the proceeds of the sale, and
(h) any amount included in computing a taxpayer's proceeds of disposition of the property by virtue of paragraph 79(c);
[24] With respect to paragraph 13(21)(e), the respondent asserted the Settlement Amount constitutes "compensation for property injuriously affected". However, that concept is commonly associated with expropriation of property in the context of recognizing that payment must be made not only for the land taken but for consequential damage to other property. Counsel for the appellant referred to the phrase "injurious affection" as being present in the expropriation legislation of several provinces and submitted the expression at issue is equally entitled to have "an established and accepted legal meaning", in the words of Major J. - at paragraph 33 - of his decision in the case of Will-Kare Paving & Contracting Ltd. v. Her Majesty The Queen, 2000 SCC 36, as the word "sale" which was the subject of interpretation before the Supreme Court of Canada. In the within appeal, the action taken by the appellant against ASEA had nothing whatever to do with any allegation of injurious affection to land owned by it and it was clear the litigation was rooted in breach of contract and negligence pertaining to the inadequate performance of the system and the payment - by ASEA - was to compensate the appellant for the additional construction and installation costs as stated in the Minutes (tab 4).
[25] The next matter to be addressed - within the purview of subsection 13(21) of the Act - is the wording of paragraph (f). If - as asserted by counsel for the respondent - the payment by ASEA to the appellant can be characterized as "compensation for property damaged", then the sum of $4.8 million would have to be regarded as "proceeds of disposition" and the applicable rules for calculating CCA would require that amount be taken into account to reduce the UCC of assets in their class. Again, the Statement of Claim filed by the appellant and the resulting Minutes do not refer in any way to the damage - by ASEA - of Ipsco property. The litigation was based on the deficiencies in the construction of the "quench and temper" system and it was alleged that, in creating and installing this specialized process, ASEA did not live up to the specifications contained in the construction contract. The payment by ASEA was made because it had not been able to deliver the goods as promised and it recognized that the appellant had been forced to incur additional expenditures in the sum of $7,593,791 - in the 1985 to 1988 taxation years - in order to make the system work at substantially less capacity than originally intended according to specifications set forth in the contract between the parties. One can see from the wording of paragraph (f) that it is also intended to be utilized in instances where there has also been an amount payable under an insurance policy and there is reference to repairing damage. Had ASEA, in the process of building and installing the system, damaged other portions of the appellant's plant or otherwise interfered with separate and non-related income-producing activities, then there might be some validity to the argument that the payment - however categorized in any settlement documents - was actually attributable to that head of damage. That is not the case. The very thing that was created and integrated into an overall system was deficient and there was no damage in the usual and ordinary meaning of that term. Simply put, there was a flaw in the design, installation or - perhaps - the concept was over-ambitious at the outset but the work done by ASEA in constructing the system within the plant owned by Ipsco did not result in any property of Ipsco being damaged and no compensation was paid in that respect. The Supreme Court of Canada in St. Pierre v. Ontario (Minister of Transportation and Communications), [1987] 1 S.C.R. 906 considered the matter of the effect of highway construction on a certain strip of land owned by the plaintiffs. It is apparent from said decision that the entire thrust of the tort of injurious affection relates to damage caused to the subject property and not to any head of compensation such as personal injury or injury to business or trade. One must assume that Parliament was well aware of the specialized meaning of this term because there is reference to property injuriously affected, whether lawfully or unlawfully or "under statutory authority or otherwise". There is no ambiguity present in that phraseology and to extend it in the manner suggested by counsel for the respondent is to re-write the provision in order to embrace a concept never intended by the legislators.
[26] From time to time, the Minister seeks to tax amounts that do not fit neatly within the confines of any of the provisions of an Act now more than 2,200 pages - including Regulations - and attempts to assess on the basis that to ignore what appears to be a windfall is to violate the object and spirit of the taxing legislation. Legislation weighing more than a kilogram does not have much room in it for liberal, general interpretation, particularly when the road to the resolution of a specific issue is well-marked and the voyage is undertaken in accordance with a detailed map and a handy guidebook. The argument made on behalf of the Minister is that paragraphs 13(21)(a) through (h) are not necessarily exhaustive and the type of settlement in the within appeal could still be categorized as constituting proceeds of disposition. I do not agree. Parliament intended it to be exhaustive in the same manner as other precise legislation when it is crafted within the context of a specific purpose. Had it wanted to tax this type of settlement award, it would have amended the Act following the decisions in Consumers' Gas, and Westcoast Energy, supra.
[27] In the within appeal - unlike the situation in Mohawk Oil, supra - there was no transfer of property from the appellant to ASEA in return for payment of the Settlement Amount and this was admitted by the respondent at paragraph 9 (n) of the Amended Reply. In addition, there was no termination of an intended long-term business relationship and in the Mohawk Oil case the settlement included compensation for the plant itself which was turned back to the payor. In light of those previous decisions of the Federal Court of Appeal on similar fact situations, I conclude that the transfer of the plant - apart from one component known as the hydrotreater - to the payor of the settlement, was the governing factor in the decision of the Court in Mohawk Oil. At paragraph 9 (m) of the Amended Reply, the respondent asserted that, in computing its income for the taxation year, the appellant deducted all legal costs relating to the ASEA lawsuit. Generally, legal fees are deductible only when incurred for the purpose of earning income and legal costs expended in collecting damages on account of capital are not deductible. Notwithstanding the deduction of legal costs claimed by the appellant when filing its return of income, that does not make it correct nor does it transform the Settlement Amount into a receipt on account of income. In accepting the deduction for legal fees, it seems the Minister bobbled the ball. It may be that within the context of the facts in the within appeal, the term "win-win" is shorthand for "windfall-windfall" but strange things happen from time to time in the mysterious domain of taxation. Since the inception of a tax on income - as a temporary measure, in 1917 - the regime of tax collection is the result of constant accretion leading to a metamorphosis whereby the modern Income Tax Act became an instrument of social and economic policy designed to influence the behaviour of people together with the power to exert a profound effect on economic development of certain geographical regions within Canada. It also provides tax incentives for growth of certain industries and investments including the development of new technology within a rapidly-changing marketplace. The Act also differentiates among citizens, often based on age, occupation, residence, or type of investments held, without crossing the line into discrimination forbidden by the Charter of Rights and Freedoms. In the 1960's, there was a brief foray into uncharted territory when it was suggested by the author of the Carter Commission on Taxation (Canada, Report of the Royal Commission on Taxation (Ottawa: Queen's Printer, 1966)), commonly referred to as the Carter Commission, that a philosophy - worthy of adoption - was to afford equal treatment to all incoming revenue on the basis that "a buck is a buck is a buck." That proposal did not gain acceptance and, as a result, practitioners of various dark arts within the arcane world of taxation - and their loved ones - continue to be assured of a steady supply of jam with their tea.
[28] Having regard to the evidence - including the Agreed Facts - and the relevant jurisprudence, I find the appellant was justified in treating the Settlement Amount as a non-taxable receipt. Therefore, there are no proceeds of disposition and the assessment of the Minister is incorrect. I conclude there is no requirement in the Act - generally or specifically - that the appellant deduct the Settlement Amount of $4.8 million received from ASEA from the capital cost of the system and that said amount does not otherwise reduce the UCC of the appellant's class 29 or class 39 depreciable property. The appeal is allowed with costs and the assessment of September 21, 1999 is referred back to the Minister for reconsideration and reassessment in accordance with this conclusion.
Signed at Toronto, Ontario, this 5th day of March 2002.
« Rowe, T »
D.J.T.C.C.
COURT FILE NO.: 1999-5040(IT)G
STYLE OF CAUSE: IPSCO Inc. and Her Majesty the Queen
PLACE OF HEARING: Calgary, Alberta
DATE OF HEARING: November 20, 2001
REASONS FOR ORDER BY: the Honourable Deputy Judge D.W. Rowe
DATE OF JUDGMENT: February 5, 2002
APPEARANCES:
Counsel for the Appellant: Ken S. Skingle
Counsel for the Respondent: Margaret Irving
COUNSEL OF RECORD:
For the Appellant:
Name: Ken S. Skingle
Firm: Felesky Flynn
Calgary, Alberta
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
1999-5040(IT)G
BETWEEN:
IPSCO INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on November 20, 2001 at Calgary, Alberta, by
the Honourable Deputy Judge D.W. Rowe
Appearances
Counsel for the appellant: Ken S. Skingle
Counsel for the respondent: Margaret Irving
JUDGMENT
The appeal from the assessment made under the Income Tax Act 1994 taxation year is allowed, with costs, in accordance with the attached Reasons for Judgment.
Signed at Toronto, Ontario, this 5th day of March 2002.
|
"D.W. Rowe" |
D.J.T.C.C.