T-2130-72
Valley Camp Ltd. (Appellant)
v.
Minister of National Revenue (Respondent)
Trial Division, Urie J.—Toronto, May 14;
Ottawa, May 30, 1974.
Income tax—Agreement between taxpayer and railway for
unloading and processing—Payment to taxpayer for hand-
ling—Further payment for construction of facilities—
Whether second payment capital or revenue—Income Tax
Act, s. 20(6)(h).
The Minister re-assessed the appellant corporation so as
to include as revenue in its taxable income the sum of
$520,655 received by the appellant from the Canadian Na
tional Railway ("C.N.") under an agreement between C.N.
and the appellant. The re-assessment was affirmed by the
Tax Review Board and from this judgment the taxpayer
appealed.
In the C.N. agreement, the appellant undertook to provide
and operate on property of the C.N., complete facilities,
exclusive to C.N., for the unloading of railway cars contain
ing iron ore concentrated pellets; the stockpiling of such
pellets; and the loading of the pellets into vessels for further
carriage. In return, C.N. agreed, by paragraph 10, to pay the
appellant a handling charge per long ton; and, by paragraph
9, to pay the appellant annually a percentage of the final
actual cost of the facilities. The sum in question here was
the amount received under paragraph 9 for 1968.
Held, dismissing the appeal, the liability of the appellant is
not to be determined by the fact that in its initial return it
treated the payment under paragraph 9 as "revenue"; nor
does the reference in the agreement to "the actual capital
cost" determine the true character of the payments made to
amortize such cost. The whole transaction must be analyzed
before the nature of the payment is revealed. Such analysis
does not lead to the conclusion that C.N. either subsidized
the construction, or that, in effect, the appellant arranged
for the borrowing of money for the construction of a capital
asset on behalf of C.N., which was to be repaid by C.N.
over the term of the agreement. The opposite conclusion is
reached, for a number of reasons, one of which is very
compelling: at the end of the term of the agreement, while
C.N. will have fully paid for the facilities it will not be the
owner thereof but only entitled to an option to purchase the
facilities (paragraph 17) at a price without crediting the
annual payments under paragraph 9. This reason is con
sistent with the whole plan under which the handling charge
and the flat annual payment are not separate bargains but
part of the same transaction and constitute revenue in the
hands of the appellant.
St. John Dry Dock & Shipbuilding Company Limited v.
M.N.R. [1944] Ex.C.R. 186; The Seaham Harbour
Dock Co. v. Crook (H.M. Inspector of Taxes) (1931) 16
T.C. 333, distinguished. Ottawa Valley Power Company
v. M.N.R. [1969] 2 Ex.C.R. 64, applied.
INCOME tax appeal.
COUNSEL:
L. T. Forbes and C. W. Lewis, Q.C., for
appellant.
R. B. Thomas and K. C. Cancellara for
respondent.
SOLICITORS:
Miller, Thomson & Co., Toronto, for
appellant.
Deputy Attorney General of Canada for
respondent.
URIE J.—This is an appeal from a judgment
of the Tax Review Board dated June 8, 1972
wherein the Board dismissed the appellant's
appeal from the respondent's assessment which
included in the appellant's taxable income for
the year 1968 the sum of $520,655.00 received
by the appellant from the Canadian National
Railway Company (hereinafter called "C.N."),
pursuant to an agreement between those parties
for the provision and operation of a facility to
handle iron ore concentrate pellets delivered by
C.N. trains to a dock operated by the appellant
at Fort William, now Thunder Bay, Ontario.
The Valley Camp Coal Company of Canada,
Limited, the name of which was changed to
Valley Camp Limited (hereinafter sometimes
referred to as "Valley Camp") by supplemen
tary letters patent dated December 12, 1968,
entered into an agreement with C.N. dated
August 8, 1967 in which Valley Camp agreed to
provide and operate on certain property owned
by C.N. at Fort William, Ontario, complete
facilities (hereinafter referred to as the "facili-
ties") for the unloading of railway cars contain
ing iron ore concentrate pellets, the stockpiling
of such pellets and the loading thereof into
vessels for further carriage. The term of the
agreement is 25 years and for such term C.N.
has leased to Valley Camp, at a rental of $1.00
per year, the lands whiçh are required by Valley
Camp to provide and operate the said facilities.
During the term C.N. has agreed to pay all
taxes, including laical improvement taxes,
assessed against t l e facilities or any addition,
extension or modification thereof. Valley Camp
covenanted that the facilities would be free and
clear of all lien§, claims or charges other than
any charge created by Valley Camp for bor
rowed monies' which, in any event, would be
junior to the/ights of C.N.
The use of the facilities provided is exclusive
ly for C.N. and if at any time any extension or
modification of the facilities is required it is to
be provided by Valley Camp on the terms set
forth in the agreement.
During the term of the agreement C.N. is
required by the provisions of paragraph 10 of
the agreement to pay to Valley Camp a handling
charge, in accordance with the rate schedule
attached to the agreement, for each long ton of
pellets which is handled through the facilities
for C.N. In addition, paragraph 9 of the agree
ment requires that during the term thereof C.N.
shall pay to the appellant in each and every year
during the term of the agreement an annual
payment equal to 101% of the final actual capi
tal cost of the facilities without any right of
C.N. to "cancel, reduce, abate, counterclaim
against, delay the payment of, set off against, or
withhold any amount from the said annual pay
ment" and, in fact, if under the terms of the
agreement, Valley Camp is in breach thereof
and C.N. takes over the operation of the facili
ties, as it is permitted to do in such a circum
stance, it will be required nevertheless to meet
the balance of the annual payments so pre
scribed. The agreement also provides that the
appellant may from time to time mortgage,
transfer and assign its right to receive the
annual instalments to any lending institution or
any trustee appointed under a trust indenture or
trust deed made by Valley Camp. In fact, Valley
Camp did enter into a trust indenture dated as
of April 1, 1968 wherein it issued debentures
secured by such indenture in the aggregate sum
of $4,500,000. Article III of the Trust Indenture
specifically charges and assigns to the trustee
under the indenture, with equal benefit to the
holders of the debentures, all its right, title,
interest and benefit in respect of the annual
payments to be made under the agreement by
C.N. As required by the terms of the agreement,
C.N. acknowledged that it had received notice
of the mortgage and assignment by the appellant
to Montreal Trust Company as trustee of all
rights of Valley Camp to the annual payments to
be made by C.N. and agreed to make the said
payments to the Montreal Trust Company as
trustee.
The only witness called for the appellant was
its president, Kenneth David Mooney, who tes
tified that the annual payments to be made by
C.N. pursuant to the agreement amortized the
capital cost of the facilities at Thunder Bay over
the term of the contract, viz, 25 years, at an
interest rate of 9%. The agreement stipulates
that each such annual payment is to be paid in
12 consecutive, equal monthly instalments, the
first of which was to be made and was in fact
made on January 31, 1968. At that date the final
actual capital cost of the facilities had not yet
been established because of the fact that the
construction thereof had not then been com
pleted. The payment on January 31st, and some
subsequent payments, therefore, were based
upon the estimated final actual capital cost of
the facilities and any adjustments required in
the monthly or annual payment were to be made
when the final actual capital cost had been
determined. There was no evidence adduced of
the precise day upon which such determination
was made but, in any event, the amount which
was paid by C.N. to Valley Camp during the
year 1968 was $520,655. Apparently the month
ly instalments were taken into the revenue of
the company because the appellant's statement
of income for the year ending December 31,
1968 included under the heading "Revenue" the
sum of $909,439 as revenue from its pellet
handling facilities. Mr. Mooney testified that
this figure included the annual payment of
$520,655 referred to above.
In its corporation income tax return for the
taxation year 1968 both the appellant and
respondent included as income the payment
received from C.N. in the sum of $520,655. The
notice of assessment in respect of this return
showed no tax owing.
Subsequently an amended corporation income
tax return for the 1968 taxation year was filed
by the appellant and by notice of re-assessment
dated December 30, 1969 the respondent
revised the appellant's taxable income for the
year to the amount of $10,008.84 and claimed
tax payable in the amount of $1,155.02 together
with interest thereon of $47.64 or the sum of
$1,202.66 in the aggregate. Both the appellant
and respondent again included the annual pay
ment in the calculation of the appellant's taxable
income for the year 1968. It is from this re
assessment, which was confirmed by the Tax
Review Board, that the appellant appeals.
After the time for the filing of a notice of
objection to the re-assessment had expired, the
appellant filed a second amended return in
which it did not include the annual payment of
$520,655 as revenue with the result that it
showed a loss of $114,221.86. This return
would appear to have no status due to the
failure of the appellant to file a notice of objec
tion to the re-assessment within the requisite
time. However, it does serve the purpose of
showing the position that the appellant now
takes with respect to its taxable income for
1968.
I might point out that in the statement of
income filed with each of the three returns the
interest paid on the debentures above referred
to, in the sum of $243,570, was deducted as an
expense. In addition, in Schedule 2(a) to the
original return and to the amended return the
appellant claimed capital cost allowance on the
above mentioned facilities. However, in the
second amended return it was unnecessary for it
to claim any capital cost allowance because the
appellant already showed the loss for tax pur
poses referred to above.
The appellant alleges that the payment of
$520,655 should not have been included in com
puting its taxable income for the year 1968 on
the ground that it was a capital payment made
to subsidize the construction of the pellet facili
ty and so was not an income receipt. In its
notice of appeal the appellant stated that it
relied on section 20(6)(h) of the Income Tax
Act, inter alia, in support of its submission but
in argument its counsel did not stress this argu
ment, conceding that he used this section only
to buttress his submission by way of analogy,
arguing that the word "subsidy" as used in that
section meant the same as "capital contribu
tion". In his submission C.N. had made in the
year 1968 and would make in succeeding years
thereafter, for the whole of the term of the
agreement, capital contributions to the appel
lant, i.e. the 1968 payment was and succeeding
payments have been and will continue to be
capital payments to reimburse the appellant for
the construction of the facilities above referred
to.
On the other hand, counsel for the respondent
argued with great force that the payment was
not part of a subsidy either in the sense that that
word is used in section 20(6)(h) or in ordinary
business parlance, nor was it, on the analysis of
the agreement, a capital repayment or the repay
ment of what might be termed a construction
loan and therefore capital in nature. The agree
ment, in his view, was an ordinary business
contract negotiated by both parties to the con
tract for business reasons and, therefore, reve
nue derived therefrom was income to the recipi
ent. It was not a subsidy, grant nor other
assistance from a public authority within the
meaning of section 20(6)(h) nor was it a subsidy
outside of that section. However, even if it was,
that did not, in his view, automatically make it a
capital payment. He argued that one must look
at the purpose for which it was given to deter
mine its true nature and to that extent he was in
agreement with counsel for the appellant since
both argued that the true nature of the business
transaction must be determined to characterize
the payment as capital or revenue as the case
may be. They differed, therefore, only in the
conclusions derived from their respective
analyses.
Perhaps it should first be recalled that income
tax liability does not depend on the manner in
which the recipient enters an amount in its
books of account or disposes of it after it has
received it or, for that matter, whether the
amount is assigned to a creditor prior to its
receipt for the purpose of the repayment of the
loan as the appellant did here. That being so, the
fact that it appears that the appellant initially
treated the 1968 annual payment as revenue
does not in any way deprive it of the right to
assert that the payment is in fact on account of
capital in the determination of taxable income
under the Income Tax Act. By the same token I
do not think that because in the agreement
between Valley Camp and C.N. reference is
made to "the actual capital cost of the facilities"
that the use of the word "capital" therein is
necessarily determinative of the true character
of the payments made to amortize such cost.
The description adopted by the parties does not
create the presumption that the designation is
correct for tax purposes. The whole transaction
must be analyzed before the character of the
payment can be determined.
In this instance my analysis of the agreement
and the subsidiary agreement with the engineer
ing firm retained by the appellant to design and
supervise the construction of the facilities does
not lead me to the conclusion that C.N. either
subsidized the construction or that, in effect,
Valley Camp arranged for the borrowing of
money for the construction of a capital asset on
behalf of C.N. which was to be repaid by C.N.
over the term of the agreement. In fact, the
opposite conclusion is reached for a number of
reasons, one of which is very compelling. That
compelling reason is that at the end of the term
of the agreement while C.N. will have fully paid
for the facilities it will not be the owner thereof
but, at that time, as set forth in paragraph 17 of
the agreement, "shall at its sole option on 12
months' prior notice given to Valley Camp have
the right to purchase the facilities outright at a
price, without crediting the said annual pay
ments made under paragraph 9 hereof:- ..."
[the emphasis is mine]. The price to be paid if
the option is exercised is by agreement between
the parties or by arbitration.
It is provided that in the event that arbitration
is resorted to the price shall be "the value of the
facilities (determined with reference to replace
ment cost, including site preparation and engi-
neeiing, taking into account the condition of the
buildings and equipment and of the site as at
December 31, 1992)" plus any insurance pro
ceeds held and receivable by C.N. as at that
date. If C.N. does not exercise its option, Valley
Camp has 12 months in which to remove the
facilities failing which absolute title will vest in
C.N. In my view the fact that C.N. does not
own the facilities at the end of the agreement
but may purchase them at an adjusted replace
ment cost figure clearly contradicts the submis
sions of the appellant that the payments made
under paragraph 9 are repayment of capital
advanced by the appellant. This belief is rein
forced by a consideration of the whole tenor of
the agreement which throughout requires the
appellant "to provide and operate" the facilities,
to maintain, repair and keep the facilities in
good repair and condition as well as to insure
such facilities.
It is quite apparent that C.N. required the
loading and unloading expertise of the appellant
for which it was willing to pay charges not only
for the actual handling of the pellets but also for
the amount required to reimburse the appellant
for the outlays it was required to make "to
provide" the facilities for the services to be
performed. Quite naturally each party wished to
be protected in its particular liability in the
complete recovery of such outlays. C.N., for its
part, had to be assured that it was paying only
for the actual cost of the facilities and, there
fore, strict conditions were imposed in the
agreement for the determination of such cost.
Valley Camp, on the other hand, had to be
assured that the substantial outlays required
would be wholly recovered even if, for some
unforeseen reason, the agreement was terminat
ed before the end of its term. The parties thus
agreed on the stringent provisions relating to the
calculation of cost and to the payment of such
cost even if the agreement was terminated and
the facilities taken over and operated by C.N. It
is obvious that it was for this reason that loss
was payable to C.N. under the terms of the
insurance policy, i.e. to protect it in the event of
total or partial destruction of the facilities while
it was still responsible for paying the outstand
ing balance of cost. The whole transaction was
clearly a commercial one in which Valley Camp
prudently ensured the recovery of its expendi
tures for this apparently single purpose facility
whereas C.N. assured itself of facilities pro
vided and operated by experts, in part at least at
a predetermined annual cost.
Therefore, the payments in both paragraphs 9
and 10 are, in my view, revenue in nature. As
indicated before, the payment required to be
made pursuant to paragraph 9 was assigned,
with the concurrence of C.N., to the trustee for
the debenture holders as security for the appel
lant's loan. It is quite probable that the monthly
payments were divided under the terms of the
agreement into two parts to ensure that this flat
annual payment could be paid directly to the
trustee. The fact that it was so assigned for the
purpose of repayment of the loan made to
finance construction of a capital asset does not
make it any less revenue vis-Ã -vis the agreement
between C.N. and Valley Camp. To regard the
payments as being independent of one another
is to disregard the fact that, without the inclu
sion of the payments made pursuant to para
graph 9 in appellant's revenue accounts, its
operations resulted in a loss of $114,221.86 in
1968.
In cross examination Mr. Mooney admitted
that this was so but he pointed out that at the
beginning of the amortization, the interest por
tion of the payment was at its highest which
portion would gradually reduce over the years.
However, I think I am entitled to take notice
that it will not be for many years that it will be
reduced sufficiently to make any real impact on
the profit picture unless the annual payment is
included in whole as income. Moreover, it was
conceded by counsel for the respondent that the
appellant was entitled to deduct the interest/
portion of the payment as an expense and, of
course, to claim capital cost allowance on the
facilities. As previously noted, in its original and
first amended tax returns for 1968 it not only
included the annual payment as revenue but
also deducted both the interest paid on the
debentures as an expense and the capital cost
allowance on the facilities in the calculation of
its taxable income. It appears clear that the
appellant cannot have it both ways; that is, it
cannot fail to include the annual payment in its
revenue receipts and yet deduct the interest
payment as well as capital cost allowance in
computing its taxable income. The gist of the
transaction then must be that both payments, viz
the handling charge and the flat annual payment
are part of the same transaction and are income
payments in the hands of the appellant.
Appellant's counsel relied largely on St. John
Dry Dock & Shipbuilding Company Limited v.
M.N.R. [1944] Ex.C.R. 186,a decision of Thor-
son P. That case arose out of an appeal from the
decision of the--r-espondent-thut - certain subsidy
payments received by the appellant in that case
were income in nature and subject to tax under
the Income-Tax Act. -T-he appellant in 1918 had
entered into a subsidy agreement with His
Majesty the King pursuant to the Dry Dock
Subsidies Act, to build a dry dock after having
satisfied the Governor in Council that the con
struction of such a dry dock was in the public
interest. On its completion a subsidy was to be
paid based on the cost of construction. The
subsidy payable was described as a sum not
exceeding 44% of the cost of the work as fixed
by the Governor in Council, half yearly during a
period not exceeding - thirty-five years. These
payments were assigned to a trustee for bond- -
holders. Originally it included in its corporation
income tax returns, as revenue the=annuual-pay-
ments and claimed deduction of interest as well
as capital cost allowance. However, later it
objected to an assessment with the payment
included thus resulting in this appeal to the
Exchequer Court.
At p. 193 Thorson P. makes this observation:
The fact that an amount is described as a Government
subsidy does not of itself determine its character in the
hands of the recipient for taxation purposes. In each case
the true character of the subsidy must be ascertained and in
so doing the purpose for which it was granted may properly
be considered.
Relying on the decision of the House of
Lords in The Seaham Harbour Dock Co. v.
Crook (H.M. Inspector of Taxes) (1931) 16 T.C.
333 as authority for the proposition that when a
payment is made under the authority of an Act
of Parliament, the statutory purpose for which
such payment is authorized may be considered
in determining whether the payment is to be
regarded as an item of annual net profit or gain
and taxable income in the hands of the recipi
ent, he found the purpose of the subsidy pay
ments could be found in the Act, the agreement
and the Orders-in-Council made under its auth
ority. He found at page 205 that "the whole Act
shows the concern of Parliament for the con
struction of such a dock as would meet public
requirements." The payments were not made to
supplement the operational income of the appel
lant. They were made to accomplish a special
purpose, in the national interest, quite apart
from the trade or business operations of the
appellant and not connected with them.
In that it differs from the case at bar. The
payments here were not made apart from the
trade or business operations of the appellant but
were made as part of them as consideration for
providing and operating the pellet facilities. This
was not a payment or series of payments in the
nature of a grant or subsidy paid by a public
authority to encourage employment as in the
Seaham case or to encourage the construction
of a dry dock as in the St. John Dry Dock case
(supra). If it was, the appellant's argument
might have some validity. However, in my opin
ion the reasoning of Jackett P. (as he then was)
in Ottawa Valley Power Company v. M.N.R.
[1969] 2 Ex.C.R. 64 is more appropriate in this
case than that employed in the particular factual
situation found in the St. John case. He found at
page 71 in relation to the application of section
20(6)(h) to the facts of that case:
What this rule appears to contemplate is the case where a
taxpayer has acquired property at a capital cost to him and
has also received a grant, subsidy or other assistance from a
public authority "in respect of or for the acquisition of
property" in which case the capital cost is deemed to be
"the capital cost thereof to the taxpayer minus ... the grant,
subsidy or other assistance". That rule would not seem to
have any application to a case where a public authority
actually granted to a taxpayer capital property to use in his
business at no cost to him. Quite apart from the fact that the
rule so understood would have no application here, I do not
think that the rule can have any application to ordinary
business arrangements between a public authority and a
taxpayer in a situation where the public authority (I assume,
for purposes of this discussion, that Ontario Hydro is a
public authority within paragraph (h) without deciding that
question) carries on a business and has transactions with a
member of the public of the same kind as the transactions
that any other person engaged in such a business would
have with such a member of the public. I do not think that
the words in paragraph (h)—"grant, subsidy or other assist
ance from a ... public authority"—have any application to
an ordinary business contract negotiated by both parties to
the contract for business reasons. If Ontario Hydro were
used by the legislature to carry out some legislative scheme
of distributing grants to encourage those engaged in business
to embark on certain classes of enterprise, then I would
have no difficulty in applying the words of paragraph (h) to
grants so made. Here, however, as it seems to me, the
legislature merely authorized Ontario Hydro to do certain
things deemed expedient to carry out successfully certain
changes in its method of carrying on its business and the
things that it was so authorized to do were of the same
character as those that any other person carrying on such a
business and faced with the necessity of making similar
changes might find it expedient to do. I cannot regard what
is done in such circumstances as being "assistance" given
by a public authority as a public authority. In my view,
section 20(6)(h) has no application to the circumstances of
this case. [The underlining is mine.]
Those words, I believe, are completely appli
cable to this case. Moreover, at page 77 in
analyzing the nature of the transaction with
which he was dealing he envisaged the following
situation which is very similar to the factual
situation in the case at bar:
It seems a little easier to analyze if one considers the
somewhat simpler case of a supplier entering into a term
contract with a purchaser under which the purchaser agrees
to provide the supplier with his physical plant and to pay a
fired [sic] price per unit for the commodity purchased
instead of paying a larger price per unit without providing
the supplier with his plant. In that case, my first impression
is
(a) that what the purchaser is paying for what he is
acquiring is the value of the plant supplied plus the price
per unit paid and that the whole amount would have to go
into the supplier's revenue account; and
(b) that the supplier is not getting his plant for nothing, but
is paying for it by entering into the low-priced supply
contract and that, prima facie, what he pays for the plant
is the value of the plant.
President Jackett was unable to make any
findings on this set of facts because the issues
were not raised in the notice of appeal. How
ever, at page 78 he did express the view that if
capital additions and improvements were
received as consideration for agreeing to deliver
the power the appellant was required to provide
at a price that was lower than would otherwise
have been economic, it was probably received
on revenue account in accordance with ordinary
principles of commercial trading.
As I have earlier found the handling charge
made for the services provided by the appellant
in this case was insufficient to permit a profit
able operation. In fact it was so low that it
resulted in a loss and it is clear to me, therefore,
that the annual payments made pursuant to
paragraph 9 duly assigned to the trustee for the
debenture holders to retire a debt incurred in
the construction of a capital asset, were
received as consideration for the supply of ser
vices at a price that was lower than would have
been otherwise economic. The two items of
consideration received by the appellant were
not as a result of separate and independent
bargains but part of the same commercial trans
action set up in the manner in which they were
for the reasons to which I have previously allud
ed. The payments under paragraph 9 were just
as much a part of the appellant's revenue as the
payments made pursuant to paragraph 10. They
constituted revenue in the hands of the recipient
and, therefore, must be taken into account in
the calculation of the appellant's taxable income
under the Income Tax Act for the year 1968.
The appeal, therefore, will be dismissed with
costs.
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