A-31-74
Minister of National Revenue (Appellant)
(Respondent)
v.
Canadian Glassine Co., Ltd. (Respondent)
(Appellant)
Court of Appeal, Pratte and Le Dain JJ. and Kerr
D.J.—Ottawa, January 7 and February 17, 1976.
Income tax—Expenses incurred in constructing pipelines—
Whether deductible as expenses for purpose of earning
income—Income Tax Act, R.S.C. 1952, c. 148, s. 12(1)(a).
Respondent entered into an agreement with A Co. under
which the latter constructed steam and pulp pipelines which
remained the property of A Co. and were used by respondent in
the course of its business. Toward the cost of construction,
respondent paid A Co. $268,623.48 over 25 years, and deducted
1/25 of the total from income over each year. The Minister
disallowed the deductions, but the Trial Division held that they
were proper. The Minister appealed.
Held, allowing the appeal, the expenditure was not properly
deductible, but was an outlay of capital resulting in an advan
tage which was not subject to capital cost allowance. In its
balance sheet, respondent describes as "leasehold improve
ments" the advantage for which it paid $268,623.48, an indica
tion that the real consideration was construction of the pipe
lines, rather than execution of the two supply contracts. The
sum cannot be seen as part of the cost of the pulp and steam.
The payment was for an advantage which increased the value
of respondent's plant. It was paid "once and for all" "with a
view to bringing into existence an asset or an advantage for the
enduring benefit of' respondent's trade. And, it was an expen
diture for the establishment of the profit-making structure of
the trade; it was not incurred in the operation of that structure.
As to whether, assuming a capital outlay, the expenditure was
made to acquire a franchise, this condition rests on the false
assumption that there is a franchise every time a person enjoys
a right. A "franchise" refers to the right to carry out an activity
which otherwise could not be, at least under similar conditions.
Per Le Dain J. (dissenting): The appeal should be dismissed.
Expenditures were part of the operating cost in obtaining a
supply of pulp and steam, and respondent did not obtain
anything that can be seen as an asset or advantage in the
nature of fixed capital. A supply contract is not an asset or
advantage in the nature of fixed capital. It is what is supplied
that is used to make a profit. Payment for the contract must be
considered payment for the supply. It is not necessary, in order
for the expenditure as a whole to be regarded as a payment for
pulp and steam, that it be clearly applicable in certain propor
tions to the price to be paid for units of pulp and steam. And, in
view of the fact that expenditures were for pulp and steam with
no indication of the proportions to be assigned to each, and that
both contracts have remained in force beyond the initial period,
as might have been expected when they were entered into, it
was not unreasonable to apportion the expenditure over 25
years.
British Insulated and Helsby Cables, Limited v. Atherton
[1926] A.C. 205; Anglo-Persian Oil Company, Limited v.
Dale [1932] 1 K.B. 124; M.N.R. v. Tower Investment Inc.
[1972] F.C. 454; M.N.R. v. Algoma Central Railway
[1968] S.C.R. 447; Van Den Berghs Ltd. v. Clark [1935]
A.C. 431; Canada Starch Company Limited v. M.N.R.
[1969] 1 Ex.C.R. 96; Bowater Power Company Ltd. v.
M.N.R. [1971] F.C. 421; Pigott Investments Limited v.
The Queen 73 DTC 5507; The Queen v. F. H. Jones
Tobacco Sales Co. Ltd. [1973] F.C. 825; Rossmor Auto
Supply Limited v. M.N.R. [1962] C.T.C. 123; Con
solidated Textiles Limited v. M.N.R. [1947] Ex.C.R. 77;
Associated Investors of Canada Limited v. M.N.R. [1967]
2 Ex. C.R. 96; M.N.R. v. Anaconda American Brass Ltd.
[1956] A.C. 85; B.P. Australia Ltd. v. Commissioner of
Taxation [1966] A.C. 224; Regent Oil Co. Ltd. v. Strick
[1966] A.C. 295; Sun Newspapers v. Federal Commis
sioner of Taxation (1938-39) 61 C.L.R. 337; Hallstroms
Proprietary Limited v. Federal Commissioner of Taxation
(1945-46) 72 C.L.R. 634; Commissioner of Taxes v.
Nchanga Consolidated Copper Mines Ltd. [1964] A.C.
948; John Smith and Son v. Moore [1921] 2 A.C. 13;
Hood Barrs v. Inland Revenue Commissioners [1957] 1
All E.R. 832 and Stow Bardolph Gravel Co. Ltd. v. Poole
[1954] 3 All E.R. 637, discussed.
APPEAL.
COUNSEL:
A. Garon, Q.C., and W. Lefebvre for
appellant.
R. de Wolfe MacKay, Q.C., and B. A. Crane
for respondent.
SOLICITORS:
Deputy Attorney General of Canada for
appellant.
Duquet, MacKay, Weldon & Bronstetter,
Montreal, and Gowling and Henderson,
Ottawa, for respondent.
The following are the reasons for judgment
rendered in English by
PRATTE J.: I have had the advantage of reading
the reasons for judgment of my brother Le Dain.
While I agree with much of what he says, I do not
share his view that the expenditure here in ques
tion was properly deductible in the computation of
the respondent's income. In my opinion, that ex
penditure was an outlay of capital which resulted
in an advantage which was not subject to capital
cost allowance.
In its balance sheet, the respondent described as
"leasehold improvements" the advantage for
which it had paid $268,623.48. This is, in my view,
a clear indication that the real consideration for
that payment was the construction of the pipelines
rather than the execution of the two supply con
tracts. For this reason, I cannot consider the sum
of $268,623.48 as part of the price or cost of the
pulp and steam. That sum appears to me to have
been paid for the establishment of a permanent
physical connection between the respondent's plant
and that of Anglo-Canadian. Thanks to that physi
cal arrangement, the respondent's plant could
easily and cheaply be supplied with steam and
pulp. The sum of $268,623.48, in my opinion, was
paid for an advantage which, in fact, increased the
value and desirability of the respondent's plant.
That payment was made "once and for all"; it was
also made, in my opinion, "with a view to bringing
into existence an asset or an advantage for the
enduring benefit of" the respondent's trade. Fur
thermore, it was, in my view, an expenditure
incurred for the establishment of the profit-making
structure of the respondent's trade; it was not
incurred in the operation of that structure. Wheth
er I consider that expenditure from a legal or
practical point of view, I cannot escape the conclu
sion that it was a capital outlay.
I must now consider the respondent's submission
that the expenditure, assuming it to have been an
outlay on account of capital, had been made to
acquire a franchise with the result that the
respondent could, in the computation of its income
for the years under consideration, deduct a capital
cost allowance under section 11(1) (a) of the
Income Tax Act and section 1100(1)(c) of the
Regulations. That contention appears to me to rest
on the false assumption that there is a franchise
every time a person enjoys a right. This is not so.
Whatever may be the precise meaning of the
expression "franchise" in the Income Tax Regula
tions that expression refers to the right, granted to
a person, to carry on an activity which, otherwise,
that person could not have carried on, at least in
the same conditions.
For these reasons, I would allow the appeal with
costs both in this Court and in the Trial Division.
* * *
The following are the reasons for judgment
rendered in English by
LE DAIN J.: This is an appeal from a judgment
of the Trial Division allowing the respondent's
appeal from income tax assessments for the taxa
tion years ending in February 1966, 1967, 1968
and 1969.
What is in issue is the nature of an expenditure
of $268,623.48 made by the respondent in 1953
but amortized by it over a period of twenty-five
years and deducted in the proportion of 1/25, or
the amount of $10,744.94, from income in each of
the taxation years in question. The issue is whether
the expenditure was an income expenditure or an
outlay of capital, and if the latter, whether it
resulted in an asset or advantage that is subject to
capital cost allowance.
The respondent was incorporated in 1952 under
the Canada Corporations Act, pursuant to an
agreement dated August 15, 1951 (hereafter
referred to as the "main agreement") between
Anglo-Canadian Pulp and Paper Mills Ltd. (here-
after referred to as "Anglo-Canadian") and Deer-
field Glassine Company Inc. (hereafter referred to
as "Deerfield"). The respondent was incorporated
as a subsidiary of Deerfield, a Massachusetts com
pany, to manufacture glassine and grease-proof
papers and other lightweight speciality papers. The
interest of Anglo-Canadian in the arrangement
was to supply the respondent with the pulp it
required. The proposed arrangement permitted
Anglo-Canadian to offer the respondent its pulp
requirements on a long-term basis at a price suf
ficiently advantageous to make it worthwhile for
Deerfield to establish a subsidiary business in
Canada. The inducement also included an under
' [1974] 1 F.C. 131.
taking by Anglo-Canadian to supply the respond
ent's requirements of steam upon certain terms
and conditions.
The main agreement provided for incorporation
of the respondent with a certain authorized share
capital, the sale by Anglo-Canadian to the
respondent of land for the location of its plant, and
the execution by Anglo-Canadian and the respond
ent of an agreement (hereafter referred to as the
"construction contract") whereby Anglo-Canadian
would undertake to construct at its own expense
two underground pipelines to convey slush pulp
and steam from its plant to that of the respondent,
an agreement (hereafter referred to as the "pulp
contract") whereby Anglo-Canadian would under
take to supply the respondent for an initial period
of twenty years with its requirements of slush pulp,
and an agreement (hereafter referred to as the
"steam contract") whereby Anglo-Canadian
would undertake to supply the respondent for an
initial period of five years with its requirements of
steam. The construction contract, the pulp con
tract and the steam contract were executed on
April 25th, 1952, in essentially the form provided
for in the main agreement.
The main agreement provided that in consider
ation of the sale by Anglo-Canadian of land to the
respondent, the construction by Anglo-Canadian
of the pulp and steam pipelines, and the execution
by Anglo-Canadian of the pulp contract and the
steam contract, the respondent would allot and
issue to Anglo-Canadian Class "B" shares and
other securities to an amount or value equal to
twenty-five per cent of the issued and outstanding
shares and other securities of the respondent. In
accordance with this provision Anglo-Canadian
subscribed for and was allotted and issued in June,
1953, Class B shares and 5% notes of the respond
ent upon the following terms:
THAT the subscription of Anglo-Canadian Pulp and Paper
Mills Limited (hereinafter called "Anglo-Canadian") for 100,-
000 fully paid and non-assessable Class "B" Shares without
nominal or par value of the capital stock of the Company at an
aggregate price of $171,518.22 and for 5% Notes of the
Company in the aggregate principal amount of $281,250, the
whole for and in consideration of the aggregate sum of $452,-
768.22 made up as follows:
(a) The sum of $150,922.74, which represents cash advances
already made by Anglo-Canadian to the Company, and
(b) The sum of $301,845.48, which represents the value of
(i) the land in the City of Quebec transferred by Anglo-
Canadian to the Company,
(ii) the agreement made by Anglo-Canadian to complete,
at its expense, the construction, before the Company's
plant is ready to begin operations, of underground steam
and pulp pipelines from Anglo-Canadian's plant to the
Company's plant, both in the City of Quebec, subject to
the condition that the cost of the steam pipeline be reim
bursed to Anglo-Canadian by the Company, and
(iii) the execution by Anglo-Canadian of the Pulp Con
tract and the Steam Contract with the Company;
as set forth in the Agreement made between Anglo-Canadian
and the Company on the 25th day of April, 1952;
be and it is hereby accepted; and
THAT the sum of $171,518.22 be and it is hereby fixed as the
aggregate price or consideration for the allotment and issue of
the said Class "B" Shares and;
THAT the said land transferred by Anglo-Canadian to the
Company for the sum of $1.00 be and it is hereby valued at
$33,222; and
THAT the said agreement made by Anglo-Canadian to com
plete the construction, at its expense, of underground steam and
pulp pipelines, which agreement has been carried out by Anglo-
Canadian and the execution by Anglo-Canadian of the Pulp
Contract and the Steam Contract with the Company be and
they are hereby valued at $268,623.48;
The construction contract provided that the
underground pipelines running from the plant of
Anglo-Canadian to the plant of the respondent
would remain the property of Anglo-Canadian,
although the respondent was to reimburse Anglo-
Canadian for the cost of their maintenance and
repair. The contract further provided that t`
respondent was to reimburse Anglo-Canadian f Jr
the cost of construction of the steam pipeline to the
extent of advances made by Anglo-Canadian, and
it is agreed by the parties that the full cost of the
steam pipeline in the amount of $71,882 was in
fact reimbursed by the respondent. There was no
obligation to reimburse Anglo-Canadian for the
cost of the pulp pipeline. In determining the cost of
pulp and steam for purposes of the pulp and steam
contracts no charge was to be included by Anglo-
Canadian for depreciation of the pipelines.
The pulp contract has an initial term of twenty
years, and is automatically renewable for succes
sive periods of five years, unless terminated by
either party upon giving at least five years' notice
to take effect at the end of the initial period or a
subsequent period of renewal. The comptroller of
the respondent testified that the pulp contract was
still in force, having been automatically renewed at
the end of the initial period. Under the pulp con
tract Anglo-Canadian undertakes to supply all the
pulp requirements of the respondent up to a max
imum of 12,000 tons per annum. It agrees that it
will not, without the prior written consent of the
respondent, deliver pulp to any other producer of
glassine or grease-proof papers or other light
weight speciality papers. The respondent, for its
part, agrees that it will not, without the prior
written consent of Anglo-Canadian, use the pulp
delivered to it by Anglo-Canadian for the manu
facture of any pulp or any kind or variety of
papers other than glassine and grease-proof papers
and other lightweight speciality papers. The cen
tral provision of the pulp contract is, of course, the
clause respecting price, which provides, in effect,
that the price to the respondent will be the prevail
ing price to destinations in the United States east
of the Mississippi River less one half the amount
of freight from Anglo-Canadian's plant in Quebec
City to the Deerfield plant in Massachusetts. Since
the prevailing price includes freight to destination,
the essence of the agreement between Anglo-
Canadian and the respondent is to share the saving
in freight resulting from the pipeline supply
arrangement. This appears to have been the princi
pal consideration that led Deerfield to establish a
Canadian subsidiary on land adjacent to the
Anglo-Canadian plant. The saving in the cost of
pulp to the respondent during the years 1955-1972
was some $802,000.
The steam contract is for an initial period of five
years and is automatically renewable for succes
sive periods of one year unless terminated by either
party upon two years' notice given at any time
after the first three years of the contract. The
evidence in the Trial Division showed that the
steam contract was still in force. An assured
supply of steam is essential to the respondent since
its machinery is operated by steam turbines.
The respondent set up what it obtained for the
sum of $268,623.48, namely the construction of
the pipelines and the execution of the pulp and
steam contracts, as an asset on its financial state
ments, and showed the annual amortization of it as
a charge against income. It was shown as "lease-
hold improvements" on the balance sheet and
other documents reflecting the assets of the com
pany and their depreciation.
The deductions from income were disallowed by
the appellant. The notices of re-assessment con
tained the following notation:
Add:
Capital cost allowance claimed on land
improvements 10,744.94
In its notice of objection the respondent indicat
ed its reasons for objection as follows:
The taxpayer alleges that the sum of $268,623.48 paid to
Anglo constitutes the cost of the right of using the steam and
slush pulp pipelines and was therefore a leasehold interest on
which deductions could be claimed under the provisions of
sub-paragraph (a) of paragraph (1) of Section 11 of the
Income Tax Act of Canada, and sub-paragraph (b) of para
graph (1) of Section 1100 of the Regulations, AND ALTERNA
TIVELY constitutes an outlay or expense, incurred by the tax
payer for the purpose of earning income from its business and
as such deductible under the provisions of sub-paragraph (a) of
paragraph (1) of Section 12 of the Income Tax Act of Canada,
properly amortized over the lifetime of the Pulp and Steam
Contracts in accordance with proper accounting practice in a
business of the kind with which the taxpayer is concerned.
In the Trial Division the respondent made three
alternative submissions:
(a) that the expenditure of $268,623.48 con
stituted the cost of the right to use the steam
and slush pulp pipelines and was a leasehold
interest on which capital cost allowance could be
claimed under section 11(1)(a) of the Act and
section 1100(1)(b) of the Regulations;
(b) that the said expenditure constituted money
paid for a franchise on which capital cost allow
ance could be claimed under section 11(1)(a) of
the Act and section 1100(1)(c) of the Regula
tions; and
(c) that the said expenditure was an outlay or
expense for the purpose of earning income from
its business and not an outlay or payment on
account of capital, and that it was properly
amortized for purposes of deduction from
annual income over a period of twenty-five
years, being the initial term, plus one renewal
period, of the pulp contract.
The learned Trial Judge held that the contracts
did not give the respondent a leasehold interest in
the pipelines since Anglo-Canadian retained the
possession of them and the contracts therefore
lacked an essential element of a contract of lease,
namely, the delivery of the thing leased to the
lessee so as to give him the possession or enjoy
ment of it.
The Trial Judge further held that the contracts
did not give the respondent a franchise within the
meaning of Class 14 of Schedule B of the Regula
tions since, even assuming that the rights acquired
by the respondent could be considered to be a
franchise, they were not a franchise for a limited
period as required by the terms of Class 14.
Finally, the Trial Judge held that the expendi
ture in question was an expenditure incurred for
the purpose of earning income from the business of
the taxpayer within the meaning of section
12(1)(a) of the Act, that it was not an outlay or
payment on account of capital within the meaning
of section 12(1) (b), and that it was properly
deductible and could be amortized for such pur
poses, in accordance with proper accounting prac
tices and principles, over a twenty-five year period.
The reasoning of the learned Trial Judge in
support of this conclusion was that the advantage
which the taxpayer obtained by the expenditure in
question was not one for the "enduring benefit" of
its trade, within the meaning of the well-known
dictum of Viscount Cave L.C. in British Insulated
and Helsby Cables, Limited v. Atherton [1926]
A.C. 205, at 213-214, which reads:
But when an expenditure is made, not only once and for all, but
with a view to bringing into existence an asset or an advantage
for the enduring benefit of a trade, I think that there is very
good reason (in the absence of special circumstances leading to
an opposite conclusion) for treating such an expenditure as
properly attributable not to revenue but to capital.
The Trial Judge held that "enduring" meant
" permanent " , and that since the pulp contract and
the steam contract were for fixed terms and termi
nable by Anglo-Canadian upon giving the required
notice they could not be said to confer enduring
benefits.
He relied on the decision in Anglo-Persian Oil
Company, Limited v. Dale [1932] 1 K.B. 124, as
reflecting principles or considerations that covered
the facts of the present case, and concluded that
like the payment made in that case for the cancel
lation of an onerous agency agreement, the expen
diture in question here was made for the purpose
of reducing the taxpayer's operating expenses and
did not make any addition to its fixed capital.
The Trial Judge held that the expenditure could
be amortized over a twenty-five year period in
accordance with the "matching principle" allowed
in M.N.R. v. Tower Investment Inc. [1972] F.C.
454.
It has been said on the highest authority that
there is no single, clear test for determining wheth
er a particular expenditure is to be considered an
income expenditure or a capital expenditure, and
that the decisions afford at most a series of illus
trations indicative of the various factors to be
considered and on which a court must in the final
analysis exercise a common-sense judicial judg
ment in the light of the particular circumstances of
each case. See B.P. Australia Ltd. v. Commission
er of Taxation of the Commonwealth of Australia
[1966] A.C. 224, at 264; Regent Oil Co. Ltd. v.
Strick (Inspector of Taxes) [1966] A.C. 295, at
312-313; M.N.R. v. Algoma Central Railway
[1968] S.C.R. 447, at 449.
A number of criteria or expressions of the essen
tial distinctions have been suggested as working
approaches in the cases. The one most frequently
referred to and, indeed, the one treated in many of
the decisions as the authoritative test is the con
cept of "an asset or an advantage for the enduring
benefit" of the trade of the taxpayer, expressed by
Lord Cave in British Insulated and Helsby
Cables, Limited v. Atherton (supra). Then there is
the distinction between an expenditure for the
establishment or enlargement of the profit-making
structure or organization of a company and an
expenditure incurred in the operation of that struc
ture or organization. See Van Den Berghs Ltd. v.
Clark [1935] A.C. 431, at 442-3; Sun Newspapers
Limited v. Federal Commissioner of Taxation
(1938-39) 61 C.L.R. 337, at 359-361; Hallstroms
Proprietary Limited v. Federal Commissioner of
Taxation (1945-46) 72 C.L.R. 634, at 646-647;
Canada Starch Company Limited v. M.N.R.
[1969] 1 Ex.C.R. 96 [68 DTC 5320 at 5323].
Emphasis has also been placed on the distinction
between fixed capital and circulating capital:
Anglo-Persian Oil Company, Limited v. Dale
[1932] 1 K.B. 124, at 138. There has been approv
al of the following formulation of the essential
considerations by Dixon J. (as he then was) in the
Sun Newspapers case (supra) at page 363:
There are, I think, three matters to be considered, (a) the
character of the advantage sought, and in this its lasting
qualities may play a part, (b) the manner in which it is to be
used, relied upon or enjoyed, and in this and under the former
head recurrence may play its part, and (c) the means adopted
to obtain it; that is, by providing a periodical reward or outlay
to cover its use or enjoyment for periods commensurate with
the payment or by making a final provision or payment so as to
secure future use or enjoyment.
There has, however, been a certain amount of
judicial skepticism expressed from time to time
with respect to the suggested criteria, and there
has been an increasing disposition to emphasize
the approach suggested by Dixon J. himself in the
Hallstroms case (supra) when he said [at page
648] that the distinction between income expendi
ture and capital expenditure must depend upon
".. . what the expenditure 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". This approach has been character
ized as a search for the business or commercial
reality of what was sought by the expenditure:
Bowater Power Company Limited v. M.N.R.
[1971] F.C. 421 [71 DTC 5469 at 5480-1]; Pigott
Investments Limited v. The Queen 73 DTC 5507,
at 5514; The Queen v. F. H. Jones Tobacco Sales
Co. Ltd. [1973] F.C. 825 [73 DTC 5577, at 5581].
What the respondent obtained by the expendi
ture in this case was the construction by Anglo-
Canadian of underground pipelines for the delivery
of pulp and steam from its plant to that of the
respondent and the execution by Anglo-Canadian
of long-term contracts for the supply of pulp and
steam to the respondent. The appellant contends
that what the respondent thus obtained was an
assured means of supplying itself with pulp and
steam, and that this was an advantage of enduring
benefit to its business. It is said that the expendi
ture was part and parcel of the fundamental finan-
cial arrangements—the basic capital transac-
tions—by which the respondent was established,
and that the construction contract, the pulp con
tract, and the steam contract constituted the basis
on which it was to operate. The respondent con
tends that the expenditure was part of the cost of
obtaining pulp and steam, an advance or "front-
end" payment that must be included in operating
costs. -Alternatively, the respondent contends that
if the expenditure be regarded as an outlay of
capital, what was obtained by it was a franchise
for which capital cost allowance may be taken. In
this Court the respondent abandoned the conten
tion that it obtained a leasehold interest.
There are, therefore, two aspects to the con
sideration for which the respondent paid $268,-
623.48 in the form of Class B shares and 5% notes:
the pipelines and the supply contracts. Obviously,
they are closely related; the one would not exist
without the other. Together they constitute a spe
cial arrangement or system for the long-term
supply of pulp and steam upon particularly favour
able conditions.
Anglo-Canadian remains owner of the pipelines
and retains full possession and control of them. As
such, they are assets of Anglo-Canadian and not of
the respondent. The respondent has no right to
them whatever. It was obliged to reimburse Anglo-
Canadian for the cost of the steam pipeline and for
the maintenance and repair of both pipelines, but
it has acquired no interest in them. At the same
time the pipelines exist for the exclusive purpose of
delivering pulp and steam to the respondent.
Although the respondent enjoys no right of prop
erty in them they afford it a direct, immediate
physical access to its source of supply of pulp and
steam which undoubtedly carries with it particular
advantages. It may be assumed, for example, that
such physical access assures ready and rapid
supply with close control over delivery problems.
Can this access to the pipelines be considered to be
an advantage of enduring benefit to the business of
the respondent, within the meaning of Lord Cave's
dictum? For a time I was much impressed with the
possibility that it could. Upon further consider
ation, however, I am of the opinion that the access
to the pipelines is indistinguishable in its essential
nature from the advantage which any customer
may be said to derive from the means by which his
supplier makes delivery to him. The physical assets
of a supplier cannot be said to be an advantage of
enduring benefit to the business of its customer,
for purposes of income tax, merely because they
are essential to the maintenance of supply.
It is true that what was obtained by the expendi
ture in this case was indicated on the financial
statements of the respondent as an asset under the
designation "leasehold improvements", but that
does not, as I see it, prevent the respondent from
adopting the alternative position that it adopted in
its notice of objection to the assessments and
before this Court, that the expenditure was an
income expenditure that could be spread over
twenty-five years. The manner in which the
respondent amortized the expenditure and charged
it against income in each of the taxation years in
question was consistent with this alternative posi
tion. The character of this expenditure or what
was obtained for it is to be determined by refer
ence to the applicable agreements and the terms
upon which the Class B shares and 5% notes were
allotted and issued, and not by subsequent desig
nations of it on the financial statements of the
respondent. I agree with the conclusion of the
Trial Judge that the agreements, in so far as the
pipelines are concerned, lack an essential require
ment or characteristic of the civil law contract of
lease, namely, the obligation to deliver the thing so
as to afford a peaceable enjoyment of it; and,
indeed, in this Court, the respondent abandoned
the contention that it had obtained a leasehold
interest. I do not think that a mistaken legal
characterization in the respondent's financial
statements should prevent it taking the alternative
position as to the nature of the expenditure. Fur
ther, it is clear, I think, that the operation by
Anglo-Canadian of the pipelines for the exclusive
purpose of delivering pulp and steam to the
respondent cannot be said to be a franchise
obtained by the respondent. Even if the term
"franchise" were appropriate to designate an
exclusive right to use pipelines, the respondent has
not been given such a right. Anglo-Canadian has
the use of the pipelines to deliver pulp and steam
to the respondent; whatever advantage this confers
on the respondent, it is not one that is subject to
capital cost allowance. The elusive character of
this advantage, viewed from the point of view of
capital, reinforces my conviction that the expendi
ture should be regarded, in so far as the pipelines
are concerned, not as an outlay of capital but as an
operating cost of obtaining pulp and steam.
In so far as the expenditure was made for the
execution by Anglo-Canadian of the pulp contract
and the steam contract, can it be said to have
created an advantage of enduring benefit to the
business of the respondent, within the meaning of
Lord Cave's dictum? There would appear to be
little or no direct authority on the nature of a lump
sum payment to obtain a supply contract. In John
Smith and Son v. Moore [1921] 2 A.C. 13, a
taxpayer who had acquired the coal merchant's
business of his father attempted unsuccessfully to
deduct in the determination of profits an amount
of £30,000 which was the value that had been,
placed in the acquisition on certain short-term
contracts with collieries for the supply of coal to
the business. The son had not actually disbursed
this sum but had paid something less as the net
value of the business as a whole. A majority in the
House of Lords held that the sum of £30,000 was
not a permissible deduction for the purpose of
determining profits. Two of the members of the
majority, Lord Haldane and Lord Sumner, held
that it was in the nature of a capital expenditure—
a sum to be employed in fixed capital. The third
member of the majority, Lord Cave, rested his
conclusion on the view that the business was a
continuing one, and that the expenditure for the
supply contracts was not made by the business for
its trading purposes but by the son out of his own
pocket. It was a payment that could have no
bearing on the profits of the continuing business.
Viscount Finlay, dissenting, held that the sum in
question was a payment for coal.
There has been considerable judicial commen
tary on the Smith case, but the general conclusion
would appear to be that in view of its very special
facts and the differing reasons for the majority
opinions there is little, if anything, in the way of
general principle to be drawn from it. See Com
missioner of Taxes v. Nchanga Consolidated
Copper Mines Ltd. [1964] A.C. 948, at 962-964;
B.P. Australia Ltd. v. Commissioner of Taxation
of the Commonwealth of Australia [1966] A.C.
224, at 268-269; Regent Oil Co. Ltd. v. Strick
(Inspector of Taxes) [1966] A.C. 295, at 322-323
and 353. It cannot be said to be authority for the
proposition that a lump sum payment made to a
supplier to obtain a supply contract is to be con
sidered a capital expenditure. As Lord Pearce put
it in the B.P. Australia case (supra) at page 269:
"One certainly cannot deduce that the result
would have been the same if the son had paid
£30,000 to the collieries for the contracts."
In my opinion a supply contract, whatever its
term and however advantageous it may be, is not
an asset or advantage in the nature of fixed capi
tal. It cannot be considered in any sense a part of
the profit-making structure or organization of an
enterprise. It is not productive or generative or
distributive of anything. It is what is supplied
under it that is used to make profit. The contract is
simply evidence of legal obligations with respect to
operating transactions. No doubt it is a thing of
value to the enterprise but that does not mean that
it has the value of fixed capital. Its value is
reflected by and is of the same nature as that
which is to be supplied under it. In my view a
payment for the contract must be considered to be
a payment for the supply.
The appellant relied particularly on the decision
in Hood Barrs v. Inland Revenue Commissioners
[1957] 1 All E.R. 832, as indicating that a lump
sum payment to obtain a means of supplying
oneself with raw material or stock-in-trade is a
capital expenditure. In that case payments were
made for the right to cut large quantities of stand
ing timber. It was held by a majority in the House
of Lords that they were capital expenditures. The
taxpayer had not purchased stock-in-trade but a
means by which he could obtain stock-in-trade.
Lord Keith of Avonholm said:
I find it impossible to hold that this very peculiar right is
capable of being treated as stock-in-trade of the appellant. The
nature of the right, the indefiniteness of the period for its
exercise, and the lack of identification of the trees on which the
right was to be exercised, to which may be added the size of the
transaction and the absence of any evidence of intention or
means to complete it within any foreseeable time, all, in my
opinion, negative the idea that the appellant had anything that
could be called stock-in-trade.
In my opinion, what the appellant acquired here was merely
a right to go on to the company's land to mark, cut and carry
away such trees, up to a specified number, as fell within the
size and description mentioned in the agreements. The money
paid for this right was, in my opinion, a capital and not a
revenue expenditure.
Their lordships referred with approval to the
decision in the similar case of Stow Bardolph
Gravel Co. Ltd. v. Poole [ 1954] 3 All E.R. 637, in
which it was held that payments made for deposits
from which the taxpayers excavated sand and
gravel for sale in their business were capital
expenditures.
In my opinion the rights which were obtained by
the expenditures in these cases are not truly analo
gous to the supply contracts in the present case, or
to the whole supply arrangement, including the
physical means of delivery provided by the pipe
lines. By virtue of the supply contracts and by
means of the pipelines the respondent is supplied
directly with pulp and steam without the necessity
of any intervening productive or extractive activity
on its part, such as was involved in the exercise of
the right to cut timber or to excavate sand and
gravel. Whether the rights in these cases be
regarded as an interest in land or otherwise they
are clearly different in their essential nature from
the rights which the respondent enjoys under the
pulp and steam contracts.
Counsel for the appellant laid great stress on the
contention that, to use his words, the expenditure
was part and parcel of the fundamental financing
arrangements, the basic capital transactions, by
which the respondent was established. The expen
diture was incurred before the respondent com
menced manufacturing, as part of the contractual
and financial arrangements by which it was estab
lished, but this is not, in my opinion, conclusive
that it was a capital rather than an income expen
diture. Entering into supply contracts is a neces
sary part of the operations of a company, and if
the expenditure was a special lump sum payment
in advance to obtain raw material and power, as I
think it was, it would be an income expenditure
although incurred at the time the company was
organized. Operating expenses may be incurred
contemporaneously with organizational and capital
expenses. Considerable emphasis was placed on
the form in which Anglo-Canadian took payment,
namely, Class B shares and 5% notes, in accord
ance with the provision in the main agreement that
it would hold at least twenty-five per cent of the
outstanding shares and other securities of the
respondent with a right to representation on its
board of directors. Obviously, it is not because a
payment takes the form of shares or other securi
ties of a company that it is to be considered a
capital expenditure; payment may be made in such
a form to meet an income expenditure. It is
argued, however, from the manner in which the
amount of the expenditure was determined and
related to the financing operations by which the
respondent was established that the expenditure
bore no relationship to the cost of pulp and steam.
As it was put by counsel, the expenditure was not
referable to units of pulp and steam. It is not
necessary, in my opinion, in order for the expendi
ture as a whole to be regarded as a payment for
pulp and steam that it be clearly applicable in
certain proportions to the price to be paid for units
of pulp and steam. It need not be a prepayment, in
the strict sense, to be considered as part of the
operating cost of obtaining pulp and steam.
While I arrive at the same conclusion as the
learned Trial Judge I do so for somewhat different
reasons. As I see it, the expenditure was simply
part of the operating cost to the respondent of
obtaining a supply of pulp and steam and did not
obtain for it anything that can be regarded as an
asset or advantage in the nature of fixed capital. I
would not rest this conclusion on the meaning to
be given to the term "enduring" in the dictum of
Viscount Cave nor on the idea that the purpose of
the expenditure was to reduce operating expenses.
If a supply contract could be considered to be an
advantage in the nature of fixed capital, I would
be disposed to hold that the contracts in this case
were sufficiently lasting to be treated as of endur
ing benefit. The life of every asset has some limit.
The broad distinction is between what is intended
to be kept for its entire life and that which is to be
turned over. Nor do I think the fact that an
expenditure is intended to reduce operating
expenses is conclusive that it is an income expendi
ture. One of the purposes of many, if not most,
expenditures in the form of fixed capital is to
reduce operating expenses. Certain locations and
designs of plant and certain kinds of manufactur
ing machinery and process are adopted in order to
effect operating economies. The whole purpose of
capital expenditure is to achieve a profitable cost
of operation.
There remains the question of whether the ex
penditure may be spread over a period of twenty-
five years and deducted in the proportion of 1/25,
or $10,744.94, as the respondent has done, in each
of the taxation years in question. The proper treat
ment of income and expense in determining profits
for income tax purposes, so as accurately to reflect
the true income position of the taxpayer, is a
question of law for determination by a court,
having regard to evidence of accepted accounting
practice and principles. Accounting practice does
not by itself automatically determine the issue. If
it is to be adopted in a particular case as the rule
for income tax purposes it must not be in conflict
with the provisions of the Income Tax Act, how
ever prudent or reasonable it may appear to be
from a business point of view: M.N.R. v. Anacon
da American Brass Ltd. [1956] A.C. 85.
The only evidence in the present case of accept
ed or proper accounting practice was that of an
accountant in the respondent's firm of auditors.
The essentials of his opinion as to the proper
treatment of the expenditure are contained in the
following passages of an affidavit which were read
into the record and on which he was cross-exam
ined by counsel for the appellant:
On the assumption that such sum constitutes an expenditure
properly deductible in determining the income of Canadian
Glassine Co. Ltd., it is my opinion that in accordance with
proper accounting practices and principles such sum should be
amortized or written off over a reasonable period of years. My
opinion is based on the fact that revenues are normally matched
with expenditures. This expenditure has permitted the company
to reduce their cost of production in each subsequent year.
Therefore, this amount of $268,623.48 is properly amortized
over such reasonable period of years.
In view of the fact that the contractual arrangements be
tween the companies for the supply of pulp extend for a period
of 20 years, renewable in 5 year periods, unless appropriate
notice of termination is given, it is my opinion that in these
circumstances a reasonable period for such amortization would
be a term of 25 years.
This uncontradicted evidence must be taken to
establish the fact of accepted accounting practice
in a case such as this. The question is whether such
practice is permitted by the Income Tax Act. On
this question the learned Trial Judge relied on the
judgment in M.N.R. v. Tower Investment Inc.
[1972] F.C. 454, in which after a review of the
pertinent decisions, Collier J. came to the conclu
sion that the "matching principle" was proper in
that case, as reflecting the true income position of
the taxpayer, and was not prohibited by the Act.
The question is whether we are to infer from the
terms of section 12(1)(a) of the Income Tax Act
that is applicable in the present case—"In comput
ing income, no deduction shall be made in respect
of 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"—that an
expenditure must be wholly deducted from income
in the year in which it was made or incurred. In
Rossmor Auto Supply Limited v. M.N.R. [1962]
C.T.C. 123, at 126, Thorson P. expressed the
following opinion on this point:
As I view Section 12(1)(a), the outlay or expense that may be
deducted in computing the taxpayer's income for the year,
namely, an outlay or expense made or incurred by the taxpayer
for the purpose of gaining or producing income from property
or a business of the taxpayer is limited to an outlay or expense
that was made or incurred by the taxpayer in the year for
which the taxpayer is assessed.
The learned President referred to his earlier
opinion in Consolidated Textiles Limited v.
M.N.R. [1947] Ex.C.R. 77, at pages 82-83, to the
same effect, with reference to section 6(a) of the
Income Tax Act, R.S.C. 1927, c. 97, in which he
said:
In my opinion, section 6(a) excludes the deduction of dis
bursements or expenses that were not laid out or expended in or
during the taxation year in respect of which the assessment is
made. This is, I think, wholly in accord with the general scheme
of the Act, dealing as it does with each taxation year from the
point of view of the incoming receipts and outgoing expendi
tures of such year and by the deduction of the latter from the
former with a view to reaching the net profit or gain or gratuity
directly or indirectly received in or during such year as the
taxable income of such year.
In Associated Investors of Canada Limited v.
M.N.R. [1967] 2 Ex.C.R. 96, at page 100 (note),
Jackett P. expressed the opinion that the principle
affirmed by Thorson P. was not "applicable in all
circumstances", and that "there are many types of
expenses that are deductible in computing profit
for the year 'in respect of' which they were paid or
payable." In the Tower Investment case Collier J.
concluded [at pages 461-462]: "In my view, the
distinctions made by Jackett P. are applicable in a
case such as this. The advertising expenses laid out
here were not current expenditures in the normal
sense. They were laid out to bring in income not
only for the year they were made but for future
years."
I agree with the learned Trial Judge that this
conclusion is equally applicable to the expenditure
in this case. The opinion of Thorson P. is not a
conclusion that is dictated by the terms of section
12(1)(a) but a principle deduced from "the gener
al scheme of the Act", and as such it should be
subject to necessary qualification for cases such as
the present one in which its application would
seriously distort rather than fairly and reasonably
reflect the taxpayer's position with respect to
income and expenditure. Indeed, in this Court
counsel for the appellant did not dispute the right
to apply the "matching principle" to the present
case, assuming that the expenditure was found to
be one that was deductible in determining income.
He merely contended that it was not appropriate
to apportion the whole of the expenditure over the
life of the pulp contract since some part of it must
be attributable to the cost of steam. In view of the
fact that the expenditure was for pulp and steam,
without any indication of the proportions to be
assigned to each, and that both the pulp and steam
contracts have remained in force beyond the initial
period of twenty years, as might have been expect
ed at the time they were entered into, I am of the
opinion that it was not unreasonable to apportion
the expenditure as a whole over a period of twenty-
five years.
I would dismiss the appeal with costs.
* * *
The following are the reasons for judgment
rendered in English by
KERR D.J.: The facts and issues, and numerous
decisions that enunciate various indicia and tests,
are sufficiently set forth in the reasons for judg
ment of Le Dain J., which I have had the advan
tage of considering. I have also had a like advan
tage of considering the reasons for judgment of
Pratte J.
The case, as I see it, is not easy to decide, for
there is an unusual combination of features to be
considered. Some point one way, some another
way. They are dealt with extensively in the reasons
for judgment of my fellow judges in this appeal,
and I will comment briefly on several of them.
The pulp contract provides expressly for the
price payable for the pulp and for payment there
of. The price includes in its make-up the
announced price from time to time of similar pulp
for the time being in effect, as set forth in para
graph 5 of that contract. It seems to me that
payments for the pulp delivered to the respondent
were made in the normal course of the operation of
its business and at the agreed price pursuant to
that contract, and that no part of the $268,623.48
here in question was expended to make such
payments.
The steam contract also provides expressly for
the price payable for the steam and for payment
thereof. No part of the $268,623.48 was expended
to make such payments.
The respondent never owned the pulp and steam
pipelines, the construction of which was to be
completed by Anglo-Canadian pursuant to the
construction contract, and the pipelines never
became fixed physical assets owned by the
respondent. However, by that contract Anglo-
Canadian obligated itself to complete the construc
tion of the pipelines, and the respondent had a
right to compel Anglo-Canadian to perform its
obligation in that respect. In the agreement of
facts in this appeal it is stated that the $268,-
623.48 represents the value of the agreement by
Anglo-Canadian to complete the construction of
the pipelines and the execution by it of the pulp
contract and the steam contract. Whether that
expenditure is regarded as being in reality pay
ment for the construction of the pipelines or as
representing the value of Anglo-Canadian's agree
ment to complete the pipelines and its execution of
the pulp contract and the steam contract, I do not
think that in the circumstances the fact that the
pipelines were not owned by the respondent is a
strong indication that the expenditure was not of a
capital nature.
I agree substantially with the conclusions of
Pratte J. In my view, the expenditure in question
was made once and for all and with a view to
obtain for the respondent advantages for the long-
term benefit of its trade and business. Also, from
the overall concept and planning indicated in the
main agreement between Deerfield Glassine Com
pany Inc. and Anglo-Canadian and the subsequent
agreements and events, I think that an inference
may reasonably be drawn that the expenditure was
made for the establishment of the profit-making
structure of the respondent's trade.
Upon considering and weighing all the facts and
the circumstances in which the expenditure was
made, I find that the scales incline in favour of the
expenditure being an outlay of capital within the
meaning of those words in section 12(1)(b) of t ie
Income Tax Act; and I do not find anything in
that Act that would allow all or any part of the
expenditure to be deducted in computing the
income of the respondent for income tax purposes.
Therefore, I would allow the appeal with costs.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.