The Elias Rogers Company Limited (Appellant)
v.
Minister of National Revenue (Respondent)
Trial Division, Kerr J.—Montreal, P.Q., Febru-
ary 29; Ottawa, April 25, 1972.
Income tax—Business income, computation of—Current
or capital expense—Cost of installing rented heaters by fuel
oil sales company—Income Tax Act, section 12(1)(b).
Appellant company was in the business of selling fuel oil
and also sold and installed furnaces and heating equipment.
In order to increase its sales of fuel oil and meet competi
tion it also went into the business of leasing water heaters to
fuel oil customers and sought to deduct the cost of installing
the water heaters in 1966 ($14,450) and 1967 ($27,200) as
current expenses in computing its income for those years.
Held, the cost of installing the water heaters was an
outlay or payment on account of capital within the meaning
of section 12(1)(b) of the Income Tax Act and accordingly
not deductible from income.
INCOME tax appeal.
Bruce Verchere and R. W. Pound for
appellant.
L. R. Olsson and R. Thomas for respondent.
KERR J.—This is an appeal against re-assess
ments of income tax under the Income Tax Act
on the appellant company for its 1966 and 1967
taxation years.
The company sells fuel oil to consumers and
also sells and instals furnaces and heating
equipment. It leases oil fired water heaters to
certain of its fuel oil customers and instals the
heaters in the customer's premises. During its
1966 and 1967 taxation years it made outlays of
$14,450 and $27,200 respectively on account of
various costs relating to installations of such
leased heaters and in computing its income for
those years deducted the said amounts. The
respondent disallowed the deductions.
The company says that the amounts were
current outlays or expenses made or incurred
for the purpose of gaining or producing income
for ,its business and accordingly were deduct-
ible. The respondent says that the amounts con
stituted an outlay or payment on account of
capital within the meaning of section 12(1)(b) of
the Income Tax Act and accordingly were not
deductible as expenses; and that they formed
part of the capital cost to the company of
property within the meaning of section 11(1)(a)
of the Act in respect of which capital cost
allowance may be claimed.
There is no dispute that the water heaters
themselves are capital assets. The issue relates
to the costs of their installation.
Four witnesses were called on behalf of the
company, namely, Mr. Leo J. Hanley, Vice-
President of the company and Manager of Fuel
Oil Sales of Texaco Canada, of which the appel
lant company is a subsidiary; Mr. Calvin
Wattie, General Manager of Sales of Texaco
Canada; Mr. H. David Spielman, General
Manager of the Oil Heating Association of
Canada; and Mr. David Tarr, a Chartered
Accountant with Arthur Andersen & Co., the
auditors of Texaco Canada and its subsidiaries.
Mr. Hanley and Mr. Wattie testified to the
effect that the appellant company operates in
the Toronto area, its business being wholesale
and retail distribution of fuel oil and heating
equipment. It sells fuel oil to householders,
commercial users and jobbers; and also sells
furnaces and heating equipment and instals
them, and leases and instals the water heaters
whose installation costs are here in issue. It has
a fleet of trucks and a service department. In
the 1960's the company found itself faced with
severe competition from natural gas and among
plans conceived by it to retard the encroach
ments of such gas was a plan to lease water
heaters to householders. The heaters are for
domestic use and consist of a hot water tank
and a heating unit powered by fuel oil instead of
by gas or electricity. An initial plan involved
sale, rather than rental, of the heaters, but it
was not successful and leasing was resorted to.
The intention was to retain the company's cus
tomers, increase the number of its residential
accounts, and sell about 300 additional gallons
of fuel oil yearly to each customer having a
leased heater. A brochure, Exhibit A-2, pictur
ing the heater and setting forth its advantages
vis-à-vis gas or electric water heaters, was
published.
The number of heaters installed in 1966 and
1967 was 175 and 268, respectively, of which
101 and 197 still remained as at December 31,
1971, as shown in Exhibit A-8. In 1969 and
1970 the company had 578 and 693 accounts
with water heaters, as compared with 40,412
and 39,334 without heaters, and the cancella
tions of accounts with heaters was 1.7% and
2.2%, as compared with 6.49% and 6.28% for
accounts without heaters, as shown in Exhibit
A-l. I gathered from the testimony of the com-
pany's officers that they considered that the
program helped to keep the company in busi
ness and that the revenue derived was worth
the effort, although looked at by itself the leas
ing of the heaters was not profitable.
Exhibit A-5 shows a typical heater installa
tion, which involves, inter cilia, plumbing, elec
trical work, venting of a flue pipe, and connect
ing the heater to the oil tank. The average
installation costs per heater were $85 in 1966,
and $100 in 1967. Details are shown in Exhibits
A-6 and A-7. The costs were borne by the
company, not charged to the customer. The cost
to the company of a water heater, with its
controls, not installed, was $197. The selling
price of fuel oil in 1966-67 was about 20 cents
per gallon. The expected additional 300 gallons
sold to a customer using a water heater would
yield about $60 gross to the company. There
was also a monthly rental charge for some or all
of the term as set forth next. When heaters are
removed they go through reconditioning pro
cesses and some are used again. The costs of
removal are written off'. When heaters are
removed, some of the installed parts, including
the flue pipe and water line, are left in the
premises, as the cost of their removal and trans
portation would exceed their value to the
company.
Exhibits A-3 and A-4 are typical lease agree
ments for the company's water heaters. The
lease is for a minimum term of 2 years, thereaf
ter from year to year terminable by prior writ
ten notice of 2 months. In cases where the
customer moved from the premises or other
wise terminated the lease, the company did not
in fact collect any penalty and it absorbed the
installation expenses. The rent, payable month
ly, is $2.50, plus provincial sales tax. In the A-3
lease, which was the form used in 1966, there
was a provision that no rental charge was pay
able during the first 6 months. The company
retains ownership of the heater and maintains it
while leased. The customer agrees to purchase
exclusively from the company during the term
of the lease all furnace fuel oil required to heat
the residence and to operate the heater. There is
a separate fuel oil contract, such as Exhibit A-9.
As I recall the evidence, the average length of
time during which fuel oil customers were hold
ing their oil contracts with the company in the
1960's was about 6.8 years, and the average for
those having water heaters was somewhat
longer; and the heaters had a useful life of
about 8 years.
The company's officers, Mr. Hanley and Mr.
Wattie, said that the installations costs were
charged to current expenditures. They were
considered to be expenses incurred in the com-
pany's efforts to meet and attack the competi
tion from natural gas and to promote sales of
fuel oil, and the company felt that it was proper
to charge them to current account in the same
way as advertising expenses would be so
charged. Mr. Tarr, the auditor, also treated the
costs as promotional expenses, based on con
siderations that there was uncertainty as to how
long the customer would retain the heater and
purchase the necessary fuel for its operation
and uncertainty as to whether the expenses of
installation would be recovered, for the
expenses were sunk and would be lost if the
contract were not continued for a sufficient
period; the company gambled that it would
retain the customer long enough to cover the
expenses; and the expenses were related to the
company's promotional program to retain cus
tomers, combat the competition of natural gas
and increase the number of its fuel oil accounts
and sale of oil. Mr. Tarr agreed, as I understood
his testimony, that the installation expenses
were incurred with the hope of earning revenue
over a period of years, that the heaters them
selves were fixed capital assets, and that their
installation in the customer's premises was a
condition precedent to their use and capacity to
earn income; but he considered that in the case
of the appellant it was right to charge the instal
lation costs as current expenses in the year in
which they were incurred, and inappropriate to
charge them to capital, and this was the view of
his firm, Arthur Andersen & Company. He
agreed with a statement on page 431 of Princi
ples of Accounting, 4th ed., 1951, by Finney
and Miller, that "the cost of machinery includes
the purchase price, freight, duty and installation
costs", but he seemed not to regard the heaters
as being "machinery".
Mr. Spielman, General Manager of the Oil
Heating Association of Canada, spoke of the
competition between natural gas, electricity and
fuel oil, and to competition between members
within the industry. He said that all major oil
companies have programs for supplying water
heaters to their customers, and that the majority
of such companies, more than 70% of them,
charge the installation expenses to current
account, while some charge them to capital
account.
In argument counsel for the appellant made a
general submission that the answer to the ques
tion whether an outlay is a capital or business
expenditure has to be derived from many
aspects of a whole set of circumstances and a
common-sense appreciation of all the guiding
features 2 and that it depends on what the
expenditure is calculated to effect from a prac-
tical and business point of view rather than the
juristic classification of the legal rights, if any,
secured, employed or exhausted in the process';
that from a "common-sense" appreciation of
the facts in this case the expenditures on
account of installation of the heaters were part
of the total costs relating to the marketing of
fuel oil and "from a practical and business point
of view" these costs were incurred to create (a)
an increase in the volume of fuel oil sold by the
appellant and (b) protection against a reduction
of its business caused by a loss of a portion of
the heating market to competitors, and as such
the installation costs were "an expenditure in
the process of operation of a profit-making enti
ty" and properly deductible as expenses in the
year in which they were incurred.
As to the facts in the present case counsel
submitted that the appellant's business was sell
ing fuel oil; due to competition from natural gas
its sales were suffering and it conceived a pro
gram initially of selling and later of leasing
water heaters to increase its volume of oil sales
and to retain its customers; the rental program
was profitable not per se but only when consid
ered with the result of the increased volume of
oil sales; the duration of the term of leases was
uncertain; the recovery of the installation costs
was also uncertain and they were not in fact
recovered in the cases of early cancellations;
the costs were promotional, like advertising
costs; the company knows best how to run its
business, and its officers and auditors thought it
proper to charge the installation costs to current
account rather than to capital in the face of
drastic and continuing competition and a con
stant need to compete and to promote sales of
fuel oil; the company was forced by circum
stances to engage in the leasing program in
order to hold cutomers and stay in business; the
great majority of other fuel oil companies treat
similar installation costs as current expenses in
their business practice; and the appellant's audi
tor and Arthur Andersen & Company thought
that it was in accordance with generally accept
ed business and accounting principles to charge
the costs to current expenses rather than to
capital account.
Counsel for the respondent contended that
the installation costs were outlays on account of
capital. He submitted that the heaters can earn
income only after they are installed, that the
cost of readying a fixed capital asset for use has
been generally held to be on capital account,
and that in the present case the installation
costs were part of the cost of providing fixed
capital assets for the purpose of earning income
over a period of years, the intention being to
retain customers as long as possible; the appel
lant is seeking to offset the costs against rental
revenue and profits from additional fuel oil
sales in years subsequent to the year in which
the heaters were installed; the heaters were
expected to stay in place on the average for a
number of years and had a useful life expectan
cy of some years, which is not controverted by
the fact that a relatively small percentage were
removed within 2 years (8.6% of those installed
in 1966 and 4.9% of those installed in 1967 as
per Exhibit A-8); the installed heater is a new
income earning capital asset that earns income
as from its installation, and it is different from a
crated heater that has no capacity in that condi
tion to earn income; installation and its costs
are not recurrent each year in the case of the
individual customer; installation of a fixed asset
is what results from the outlay, it is intended to
be and normally is of enduring benefit over a
period of years; the principal, immediate and
direct result is rental revenue and additional oil
sales, plus perhaps some goodwill, and any pro
motional element is secondary; the rental reve
nue and profit from additional oil sales appear
to be sufficiently large to lead to an inference
that the leasing of heaters is not per se unprofit
able; also that the practice of the appellant and
of numerous other, but not all, oil companies of
charging heater installation costs to current
account is not conclusive as to the propriety of
so doing, the appellant did not cite any account
ing book as authority for that practice, and the
company's auditor agreed that in the case of the
appellant the crux was the uncertainty as to the
outcome of the expenditures in view of the
uncertainty as to how long heaters would be
retained by customers.
Counsel for the respondent cited the follow
ing cases:
B. C. Electric Rly. v. M.N.R. [1958] S.C.R. 133; Thom-
son Construction (Chemong) Ltd. v. M.N.R. [1957]
Ex.C.R. 97 at pp. 104-106; Law Shipping Co. v.
12 T.C. 621; Glenco Investments Corp. v. M.N.R.
[1968] Ex.C.R. 98; M.N.R. v. Lumor Interests Ltd.
[ 1960] Ex.C.R. 161; M.N.R. v. Vancouver Tugboat Co.
[1957] Ex.C.R. 160; M.N.R. v. Haddon Hall Realty
Inc. [1962] S.C.R. 109; C.LR. v. Granite City Steam
ship Co. (1927) 13 T.C. 1; Sherritt Gordon Mines Ltd.
v. M.N.R. [1968] Ex.C.R. 459; British Insulated and
Helsby Cables Ltd. v. Atherton [1926] A.C. 205; Val-
lambrosa Rubber Co. v. Farmer, 5 T.C. 529; Montship
Lines Ltd. v. M.N.R. [1954] Ex.C.R. 376; Regent Oil
Co. v. Strick [1965] 3 W.L.R. 636.
Sections 11(1)(a) and 12(1)(a) and (b) of the
Income Tax Act in the taxation years concerned
read as follows:
11. (1) Notwithstanding paragraphs (a), (b) and (h) of
subsection (1) of section 12, the following amounts may be
deducted in computing the income of a taxpayer for a
taxation year:
(a) such part of the capital cost to the taxpayer of
property, or such amount in respect of the capital cost to
the taxpayer of property, if any, as is allowed by
regulation;
12. (1) In computing income, no deduction shall be made
in respect of
(a) an outlay or expense except to the extent that it was
made or incurred by the taxpayer for the purpose of
gaining or producing income from property or a business
of the taxpayer,
(b) an outlay, loss or replacement of capital, a payment on
account of capital or an allowance in respect of deprecia
tion, obsolescence or depletion except as expressly per
mitted by this Part,
It is sometimes difficult to determine whether
an outlay can be set against income or must be
regarded as a capital outlay. Several criteria
have been used in the cases cited in argument.
In Regent Oil Co. v. Strick [1965] 3 W.L.R. 636,
Lord Reid said at pages 645-46:
Whether a particular outlay by a trader can be set against
income or must be regarded as a capital outlay has proved
to be a difficult question....
One must, I think, always keep in mind the essential
nature of the question. The Income Tax Act requires the
balance of profits and gains to be found. So a profit and loss
account must be prepared setting on one side income
receipts and on the other expenses properly chargeable
against them. In so far as the Act prohibits a particular kind
of deduction it must receive effect. But beyond that no one
has to my knowledge questioned the opinion of Lord Presi
dent Clyde in Whimster & Co. v. Inland Revenue Commis
sioners, (1926 S.C. 20; 12 T.C. 813) where, after stating
that profit is the difference between receipts and expendi
ture, he said: "the account of profit and loss to be made up
for the purpose of ascertaining that difference must be
framed consistently with the ordinary principles of commer
cial accounting so far as applicable ..." So it is not surpris
ing that no one test or principle or rule of thumb is para
mount. The question is ultimately a question of law for the
court, but it is a question which must be answered in light of
all the circumstances which it is reasonable to take into
account, and the weight which must be given to a particular
circumstance in a particular case must depend rather on
common sense than on a strict application of any single
legal principle.
In Bowater Power Co. v. M.N.R. [1971]
C.T.C. 818, Noël A.C.J., of this Court said at
pages 836-37-38:
The law with regard to the deduction of what might be
called border-line expenses or "nothings" has moved con
siderably ahead in the last few years, as can be seen from
the above decisions. The Chief Justice of the Supreme
Court, in dismissing the appeal from the decision of the
President in M.N.R. v. Algoma Central Railway (supra) at
page 162, referred with approval to the following statement
of Lord Pearce in B.P. Australia Ltd. v. Commissioner of
Taxation of the Commonwealth of Australia, [1966] A.C.
224, at page 264:
The solution to the problem is not to be found by any
rigid test or description. It has to be derived from many
aspects of the whole set of circumstances some of which
may point in one direction, some in the other. One consid
eration may point so clearly that it dominates other and
vaguer indications in the contrary direction. It is a com-
monsense appreciation of all the guiding features which
must provide the ultimate answer.
The solution, therefore, "depends on what the expendi
ture is calculated to effect from a practical and business
point of view rather than upon the juristic classification of
the legal rights, if any, secured, employed or exhausted in
the process" (Hallstroms Pty Ltd. v. Federal Commissioner
of Taxation, 8 A.T.D. 190 at 196). The question of deducti-
bility of the expenses must therefore be considered from
the standpoint of the company, or its operations, as a
practical matter.
... In distinguishing between a capital payment and a
payment on current account, regard must always be had to
the business and commercial realities of the matter.
The heaters, when installed, are fixed capital
assets. Thereafter, but not before, they are
revenue earning assets. The expenses of install
ing them are preliminary and necessary to the
revenue earning use of the heaters and the
expenses are incurred in order to bring them
into such use. I think that if the appellant had
purchased from some supplier heaters which at
the time of purchase were installed and ready to
be used, the capital cost of the heaters to the
appellant as so installed would be the price paid
to the supplier, including installation charges. If
that be so, why should the installation expenses
be classified differently when the appellant
instals the heaters? The respondent takes the
position that the installation expenses are part
of the capital cost to the appellant of the heat
ers, as and when installed, in respect of which
capital cost allowances may be claimed.
The lease agreement for the heaters provides
for a minimum term of 2 years and thereafter
from year to year, terminable at the expiry of
the 2 year term or of any subsequent year by
prior written notice of 2 months. There is
always the possibility that a customer may ter
minate the lease at any time, and some have
done so within the 2 years, but heaters are
installed in the expectation on the company's
part that by and large the heaters will be
retained for a period of years, and the compa-
ny's experience is that the majority of the
leases continue for at least several years and
that the heaters have an average useful revenue
earning life of upwards of 8 years. The installa
tion expenditures are made once and for all
with a view to bringing into use a capital asset
for the enduring benefit of the company's busi
ness, at least in the sense that the objective of
the company when it enters into a lease of a
heater is that the benefit will endure for some
years and that the heater will earn revenue
throughout that period. The company would
hardly be in the business of leasing heaters
without having that objective, having regard to
the cost of the heater plus the cost of installa
tion vis-à-vis the resulting net revenue. The
outlay for installation is an initial expenditure,
substantial relative to the cost of the heater
itself, and while the expense recurs when a
heater reaches the end of its useful life and has
to be replaced, or when a lease is cancelled and
the heater is removed and installed elsewhere, I
do not think that the expenditure involved can
be classed as made to meet a continuous
demand or as a recurrent expenditure that may
be deducted as a current expense from the
income of the year in which the outlay is made.
The heaters meet, it is true, a continuous
demand for fuel oil and they serve the general
purposes and general interests of the company's
business, but so do storage tanks and other
fixed assets of the company that unquestion
ably are capital assets.
As to the practice of the major oil companies
in their treatment of the expenses of installing
water heaters, there is not unanimity among
them. The majority charge the expenses to cur
rent account, while some charge them to capi
tal. The appellant is among those who choose to
charge them to income of the year of the instal
lation. They may find it more convenient to
charge the expenses once and for all in the year
in which they are incurred, rather than to add
them to the price paid for the heaters and claim
capital cost allowances on the total cost of the
installed capital asset. The appellant company's
auditor supported that treatment, based mainly
on the uncertainty as to how long customers
would retain the heaters, and on uncertainty as
to whether the installation expenses would be
recovered, because customers might cancel
their contract before the expenses are recov
ered. The practice of the oil companies, differ-
ing as it does between the companies, is a
consideration to be taken into account, but I do
not think that the practice followed by the
majority of them is a paramount factor. I also
think that the uncertainty above referred to is
hardly a valid basis upon which to found a
decision as to the category in which the
expenses naturally fall.
The auditor also regarded the expenses as
promotional expenses incurred to increase sales
of fuel oil and to meet the competition of natu
ral gas. I am satisfied that the expenses were
incurred with the objective of increasing oil
sales and meeting competition. But I find it
difficult to put them in a promotional category
or to treat them, as advertising expenses are
treated, as current expenses deductible in the
year in which they were expended. To me, they
have little resemblance to promotional or adver
tising expenses.
As previously indicated, Finney and Miller's
Principles of Accounting, chapter 19 deals with
Tangible Fixed Assets and states at page 431:
The cost of machinery includes the purchase price,
freight, duty, and installation costs. If machinery has to be
operated for a time for the purpose of breaking it in and
testing it, the costs of such necessary preliminary operation
may be capitalized.
The appellant's auditor did not dispute that
the statement was correct in respect of machin
ery, but he was unwilling to agree that it applied
to the oil heaters here concerned. I do not think
that I should treat it as applying to the heaters,
even although they are tangible fixed assets, as
it is possible that the authors would not have
treated heaters the same as they treated
machinery.
On my appreciation of the facts and the guid
ing features, which I hope is a common-sense
appreciation made with proper regard for the
business and commercial realities of the matter,
I find that the expenses of $14,450 and $27,200
incurred by the appellant during its 1966 and
1967 taxation years on account of various costs
relating to the installation of water heaters con
stituted an outlay or payment on account of
capital within the meaning of section 12(1)(b) of
the Income Tax Act and, accordingly, were not
deductible from income. The appeal will, there
fore, be dismissed. The respondent is entitled to
his costs.
1 The Department has not challenged the writing-off of
the removal costs and they are not in issue here.
2 Cases cited:
B. P. Australia Ltd. v. Comm'r of Taxation [ 1966] A.C.
224, applied in M.N.R. [1968] C.T.C. 161 at 162;
Canada Starch Co. v. M.N.R. [1968] C.T.C. 466 per
Jackett P. at 471; Bowater Power Co. v. M.N.R. [1971]
C.T.C. 818 per Noël A.C.J. at 836-37.
3 Cases cited:
Hallstroms Pty. Ltd. v. Federal Comm'r of Taxation
(1946) 72 C.L.R. 634 at 648 per Dixon J., (1948) 8
A.T.D. 190 at 196 (applied: B. P. Australia Ltd. v.
Comm'r of Taxation [1966] A.C. 224 at 264); C.I.R. v.
Carron Co. (1968) 29 T.R. 173 at 177 per Lord Guest;
C.LR. v. Carron Co. (1967) 28 T.R. 101 at 109 per
Lord Guthrie; C.I.R. (N.Z.) v. Murray Equipment Ltd.
(1965) 14 A.T.D. 212 at 219 and 220 per Moller J.;
Bowater Power Co. v. M.N.R. [1971] C.T.C. 818 at 837
and 838.
Cases cited:
Jackett P. in Canada Starch Co. v. M.N.R. [1968]
C.T.C. 466.
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