Judgments

Decision Information

Decision Content

A-772-90
Her Majesty The Queen (Appellant)
v.
Mohawk Oil Co. Ltd. (Respondent)
INDEXED AS: MOHAWK OIL CO. Y. CANADA (CA.)
Court of Appeal, Heald, Hugessen and Stone JJ.A.— Vancouver, December 10, 1991; Ottawa, January 27, 1992.
Income tax — Income calculation — Taxpayer having con tracted for installation of waste oil reprocessing plant — Plant did not work — Negotiating . financial settlement of claims — Treating payment as non-income extraordinary item — M.N.R. reassessing as part income, part capital gain — Trial Judge holding payment tax exempt as akin to windfall — M.N.R. arguing Trial Judge ignoring context of payment — How payor characterized settlement unsafe test for determining true nature — Settlement including compensation for lost profits, expenditures thrown away — Reference to English cases as to whether payment truly voluntary — Correctness of reassess ment.
This was an appeal from a Trial Division judgment allowing the respondent's appeal from a reassessment for the 1982 taxa tion year.
In 1978, the respondent contracted with Phillips Petroleum Company for the installation at the respondent's facility of a plant to recycle waste oil into lubricating oil. That plant was installed in January 1980. The respondent paid Phillips $3.9 million. The respondent also spent $6 million to put in place such infrastructure and ancillary services as fire protection and roadways. The company treated both of these outlays as capital expenditure. It also incurred and claimed, for travel, office and other costs related to the installation, just under $1.2 million for each of 1981 and 1982.
The respondent found the plant to be unworkable, and noti fied Phillips that it held the latter responsible to indemnify and keep it whole in respect of all costs and losses related to the failure of the plant. Representatives of the two companies met, with the respondent providing a list of every expenditure possi bly related to the project, adding up to some $15 million. The parties entered into a settlement agreement terminating the ear lier agreement and providing for Phillips to recover most of the
components, an exchange of releases and a payment by Phil- lips of over $7 million in Canadian funds. The respondent did eventually have a waste oil recycling plant installed by another company, and re-used the ancillary installations.
The respondent's directors initially planned to account for the settlement amount by dividing it among deferred develop ment costs, operating losses, and proceeds of disposal of the plant; but, upon the advice of its auditors, the company put it into its financial statements as an extraordinary item. It treated it, on its income tax return, as a non-income receipt and did not include it in taxable income. The Minister reassessed, treating $3.4 million as recovery of operating losses and, therefore, income, and $3.7 million as proceeds of disposition of depre- ciable property and, therefore, a capital gain. The Trial Judge found that the money was not paid by Phillips against any of the specific items of cost borne by the respondent, but simply to prevent a lawsuit and the consequent embarrassment; the money was "akin to a windfall", and not part of taxable income.
Held, the appeal should be allowed.
Whether a payment is part of business income depends, not on the motive of the payer, but on the character of the payment in the hands of the payee. It does not matter whether the pay ment is made because of reduced income or increased expendi ture. The respondent sought, in the settlement negotiations, to be made whole including compensation for both lost profits and wasted capital expenditures. The explicit object of the set tlement agreement was to terminate the business transaction out of which those losses arose, and the payment was made as required by the terms of that agreement. The evidence supports the assessment for lost profits and expenditures incurred. The respondent had recorded losses from the operating expenses of the defective plant. The payer agreed to a settlement, beyond the original sale price, to recognize those losses. The allocation to proceeds of disposition of capital property is also supported by the evidence, as Phillips took back the physical plant it had installed two years earlier.
STATUTES AND REGULATIONS JUDICIALLY CONSIDERED
Income Tax Act, S.C. 1970-71-72, c. 63, ss. 9(1), 13(21)(d) (as am. by S.C. 1977-78, c. 1, s. 6(8)), 14(1) (as am. idem, s. 7).
CASES JUDICIALLY CONSIDERED
CONSIDERED:
Federal Farms Ltd. v. Minister of National Revenue, [1959] Ex.C.R. 91; [1959] C.T.C. 98; (1959), 59 DTC 1050; Simpson (Inspector o f Taxes) v John Reynolds & Co (Insurances) Ltd, [1975] 2 All ER 88 (C.A.); Murray
(Inspector of Taxes) y Goodhews, [1978] 2 All ER 40 (C.A.); Donald Fisher (Ealing) Ltd y Spencer [Inspector of Taxes], [1987] STC 423 (Ch. D.); Raja's Commercial College y Gian Singh & Co Ltd, [1976] STC 282 (P.C.); MNR y Import Motors Ltd, [1973] CTC 719; (1973), 73 DTC 5530 (F.C.T.D.).
REFERRED TO:
R. v. Cranswick, [1982] 1 F.C. 813; [1982] CTC 69; (1982), 82 DTC 6073; 40 N.R. 296 (C.A.); Courrier M H Inc y The Queen, [ 1976] CTC 567; (1976), 76 DTC 6331 (F.C.T.D.); Glisic v. Canada, [1988] 1 F.C. 731; (1987), 80 N.R. 39 (C.A.); TRW Inc. v. Walbar of Canada Inc., A- 107-91, Stone J.A., judgment dated 3 1 / 1 0/91, F.C.A., not yet reported.
APPEAL from a Trial Division judgment ([1990] 2 CTC 173) allowing the taxpayer's appeal from a reassessment for its 1982 taxation year concerning money received in settlement of claims for breach of a contract. Appeal allowed.
COUNSEL:
Ian S. MacGregor and Al Meghji for appellant. I. H. Pield and Karen R. Sharlow for respon dent.
SOLICITORS:
Deputy Attorney General of Canada for appel
lant.
Thorsteinssons, Vancouver, for respondent.
The following are the reasons for judgment ren dered in English by
STONE J.A.: This is an appeal from a judgment of the Trial Division rendered July 11, 1990 [[1990] 2 C.T.C. 173], which allowed the appeal of the respon dent from the reassessment of the Minister of National Revenue dated August 6, 1987, in respect of its 1982 taxation year. In that judgment, the Trial Judge determined that an amount of $7,062,187, which the respondent had received in that year from Phillips Petroleum Company in settlement of claims for breach of a contract, was not subject to tax on the basis that the amount was "akin to a windfall".
The facts may be summarized as follows. In Nov- ember, 1978, the respondent entered into a contract
with Phillips Petroleum Company ("Phillips") of Bar- tlesville, Oklahoma, under which Phillips agreed to supply and install at the respondent's premises in North Vancouver a waste oil re-processing plant ("the plant") for the purpose of extracting high quality lubricating fluids from waste oil. The plant was installed in January, 1980. The respondent paid Phil- lips $3,942,000 ($2,885,000 U.S.) as consideration for the plant. It also incurred expenses in the amount of $6,042,000 for land, storage tanks, electrical sup ply services, fire fighting facilities, warehouse, road ways and steam plant in connection with the acquisi tion and installation of the plant. In addition, further expenses in respect of wages, travel and office costs were incurred and were deducted by the respondent in computing its income. For the fiscal years ending September 30, 1981, and September 30, 1982, the respondent deducted the amounts of $1,184,235 and $1,164,296 respectively as "net expenses incurred" in respect of the plant. The respondent included the cost of the plant and of the above-mentioned land and auxiliary facilities, totalling $9,984,000, in the capital cost of depreciable property or capitalized them as deferred development costs, instead of deducting them in computing its income.
In 1981 the respondent ordered the cessation of the plant's operation after attempts to make it work satis factorily were unsuccessful.
By letter of October 21, 1981, the respondent for mally put Phillips on notice that it should recognize its "responsibility to keep us whole including interest on all the capital invested (as it is all borrowed money in the end) and loss of profits" and asserted that Phillips "should pay a penalty for the problems, distress, loss of good will and financial loss from other opportunities we have had to forego." The respondent also proposed that Phillips, in effect, acquire the plant and attempt to make it work and that the respondent have the option of reacquiring it within two years. The letter went on to conclude: "If you do not wish to proceed, then we have to arrive at a fair financial settlement to keep Mohawk whole and recognize the damage this project has done to our company." Enclosed with this letter was a schedule
containing a breakdown of the respondent's "costs to September 30th 1981" in the aggregate amount of $15,612,000.
Phillips rejected this proposal by letter dated Nov- ember 18, 1981, and offered, instead, to redesign the plant. As an alternative, Phillips proposed:
In the absence of a solution to this apparent impasse, a pro posed settlement per terms of the contract appears to be the only alternative. In this event we would propose, subject to Phillips management approval, removal of the plant, refunding the purchase price, and a cash settlement of $1.5 million (U.S.) for excess costs incurred by Mohawk from February 1, 1981 forward.
This latter proposal was rejected by the respondent by letter dated December 2, 1981. One element of the counter-proposal contained in that letter was that Phillips would "forthwith pay to Mohawk an agreed sum on account of the actual additional costs that will have been sustained by Mohawk up to the date the proposal comes into effect."
Negotiations leading to a settlement of the dispute came to a head at face-to-face talks which were con ducted at the site of Phillips head office in Oklahoma, in early January, 1982. Mr. Frederick Gingell, a director, vice chairman and secretary-treasurer of the respondent, was the only witness called at the trial. He testified as to the course of these negotiations. He was one of five individuals, including the respon dent's president, who made up its negotiating team. The respondent had drawn up a list of every possible expenditure it had incurred in the years 1978 to 1981 respecting the plant, which expenditures, he testified, were "up in the $15 million range" because they included the incidental expenses referred to above. The parties were unable to settle their differences over the course of several days of negotiations until the morning of January 8, 1982. On that date, as Mr. Gingell testified, Phillips "came ... and said we'll pay you $6 million if you will go away." The terms and conditions upon which the parties agreed to ter minate the January 27, 1978 agreement, as well as a subsequent option agreement, were recorded in a let ter agreement dated January 8, 1982, which also allowed Phillips to reclaim any parts and components
of the plant except the hydrotreater. The settlement included a mutual release "from liability of all claims of any nature whatsoever whether, contract or tort, arising out of or related in any way to the Purchase Agreement."
At a meeting of the respondent's board of directors held on February 15, 1982, the following treatment of the settlement amount was approved:
Proceeds in Canadian funds (U.S.$6,100,000) $7,277,906
Allocated to:
Option Agreement Deposit (U.S.$100,000) $ 115,718
Deferred Development Costs $2,640,614
1981 Operating loss $1,184,234
Loss, October 1 to December 31, 1981
Operating expense 542,304
Demand Loan expense 289,966
Proceeds of disposal of lubricant plant $2,505,069
(U.S.$6,000,000) $7,162,187
Total (U.S.$6,000,000) $7,277,905
The objective of this treatment, according to the evi dence, was to get rid of the project account and improve the financial statements for the respondent's bankers. However, on the advice of its auditors, the respondent later decided to treat the amount differ ently, as of its fiscal year which ended September 30, 1982. The result was that the payment was included in income as "an extraordinary item," as explained in
the following Note 13 to its financial statements for that fiscal year:
13. EXTRAORDINARY ITEM
During the year the company accepted a settlement with the original lubricant plant supplier, terminating the original purchase agreement of January 27, 1978 and a damage pay ment of $7,062,187 ($6,000,000 U.S.) was received as a conse-
quence. The major part of the original plant was scrapped and the transaction has been accounted for as follows:
Damage Proceeds $7,062,187
Less:
write-down of lubricant plant $2,086,873 write-off of deferred
development costs 2,640,614 (4,727,487)
Deferred income tax recovery $2,412,020
Net extraordinary item $4,746,720
In computing its income for tax purposes for the fiscal year in question, the respondent treated all but $100,000 of the settlement amount as a "non-income receipt" and did not include the balance in its taxable income. The $100,000 amount, which represented a deposit paid under the subsequent option agreement, is not in issue.
The Minister's notice of reassessment dated August 6, 1987, allocated the settlement payment as follows in respect of the taxation year 1982:
Tax Treatment
Income Capital
Deferred Development Costs $1,427,203 $1,213,411
Recovery of '81 operating
loss 1,184,233
Loss for the '82 Year
to December 31, 1981
Demand Loan interest 289,966
operating loss 542,304
Prop Plant 2,505,069
Total $3,443,708 $3,718,430
The reassessment had the effect of allocating the amount of $3,443,708 as income, and the amount of $3,718,430 as capital, represented by proceeds of dis position of depreciable property. When this latter
amount was credited to the respondent's class 29 cap ital cost allowance pool, it resulted in a capital gain of $350,884.
On June 27, 1989, in response to the respondent's notice of objection filed August 26, 1987, the Minis ter confirmed the reassessment on the basis that the settlement amount was not a "non-taxable receipt", but rather that $3,443,708 was required to be included in the respondent's 1982 income pursuant to subsection 9(1)' of the Income Tax Act [S.C. 1970- 71-72, c. 63] and that $3,718,430 was required to be treated as "proceeds of disposition of property" within the meaning of paragraph 13(21)(d) 2 [as am. by S.C. 1977-78, c. 1, s. 6(8)] of the Act.
In his reasons for judgment, the learned Trial Judge [at page 181] defined the issue before him as whether the settlement amount "should be included
Subsection 9(1) reads:
9. (1) Subject to this Part, a taxpayer's income for a taxa tion year from a business or property is his profit therefrom for the year.
Z Paragraph 13(21)(d) reads:
13....
(21)...
(d) "proceeds of disposition" of property includes
(i) the sale price of property that has been sold,
(ii) compensation for property unlawfully taken,
(iii) compensation for property destroyed and any amount payable under a policy of insurance in respect of loss or destruction of property,
(iv) compensation for property taken under statutory authority or the sale price of property sold to a person by whom notice of an intention to take it under statu tory authority was given,
(v) compensation for property injuriously affected, whether lawfully or unlawfully or under statutory authority or otherwise,
(vi) compensation for property damaged and any amount payable under a policy of insurance in respect of damage to property, except to the extent that such compensation or amount, as the case may be, has within a reasonable time after the damage been expen ded on repairing the damage,
(vii) an amount by which the liability of a taxpayer to a mortgagee is reduced as a result of the sale of mortga ged property under a provision of the mortgage, plus
(Continued on next page)
into taxable income or whether the money received is akin to a windfall," and he then added, at page 182:
I am of the view that in order to make such a determination, it is necessary to examine all of the reasons as to why the money was paid, that is, why did Phillips pay Mohawk the US$6,000,000. Was this sum of money paid in respect of a breach of contract and thus cannot be categorized either as income from office or employment or income from a business or trade or must I look beyond the damage settlement to the reasons which gave rise to the payment and determine on that basis whether the money were compensation for money which should have been paid pursuant to a business contract and if so, whether any or all monies paid under the contract would have been considered income or capital receipts.
His answer to this question appears at pages 182-183, where he stated:
The uncontradicted evidence of Gingell is that when Mohawk first submitted its claim to Phillips, it included money paid to Phillips, it included all costs for what was spent for "on site" work, such as tanks and roadways and it included what was calculated to be lost profits. This first claim made by Mohawk to Phillips was for the sum of approximately US$15,000,000. I was not given a breakdown for this sum of US$15,000,000 but it included a sum for loss of future profits. The evidence is that this original claim was not accepted and after a number of days of negotiation a settlement was reached for US$6,000,000. Gingell states he does not know why Phil- lips offered US$6,000,000 but after receiving the offer he and his associates discussed the offer and accepted the offer of US$6,000,000 provided a hydrotreater would be included. The evidence is that this was agreed to by Phillips in order to "get rid" of the claim of Mohawk.
I am satisfied that the offer made by Phillips was made, not based on Mohawk's loss of future profits nor on anything other than to rid themselves of a serious embarrassment as Phillips had and may still have an excellent reputation in the field of oil technology.
Had I been given any evidence that part of the US$6,000,000 was to compensate Mohawk for loss of profit, I would have concluded that that part of the settlement should be considered income from a business as it would have been paid as a loss of profit that Mohawk would have made. The facts
(Continued from previous page)
any amount received by the taxpayer out of the pro ceeds of such sale, and
(viii) any amount included in computing a taxpayer's proceeds of disposition of the property by virtue of paragraph 79(c);
only indicate that the money was paid as damages to prevent a lawsuit that could have been considered an embarrassment to Phillips and nothing more.
I accept the submission of counsel for Mohawk that the reimbursement of money previously deducted as an expense does not make this reimbursement taxable income.
The money received by Mohawk is income and must be shown as such. The fact that the sum of US$6,000,000 was shown as income, does not make that income taxable. The income of US$6,000,000 had to be shown in the tax return of the plaintiff Mohawk in accordance with generally accepted accounting principles but 1 am satisfied from all of the evi dence it is not income to be counted for income tax purposes as the income is not income as contemplated in sections 3, 4 or 9 of the ITA.
I have not discussed the fact of Mohawk's Board of Direc tors (Gingell) allocating the funds in a specific manner. Both counsel agree that what was put into the books of the company does not, by itself, make the sum received from Phillips taxa ble income and, therefore, nothing more need be said.
I am therefore satisfied that the sum of US$6,000,000 (C$7,162,138) is not taxable income but income as damages as a result of a breach of contract paid not to compensate loss of profits but paid to prevent a lawsuit and loss of reputation.
The appellant submits that the Trial Judge erred by treating the settlement amount as "akin to a windfall" because in doing so he failed to take account of the business context in which the payment was made and also because his conclusion was based on the errone ous view that the character of the payment should be determined by reference to the motivation of the payor, instead of the true nature of the loss in respect of which the payment was received.
The respondent, for its part, supports the judgment below and submits that the settlement amount was paid as a result of its claim that Phillips had funda mentally breached the purchase agreement and had, in effect, agreed to pay damages. These damages, it is said, could only be taxable if they had been paid as a result of a breach of a trading contract the perform ance of which would have resulted in the receipt of revenue or were paid otherwise than in respect of a breach of contract in order to compensate for income or profits which would have been earned but for the injury done to the recipient. This alternative argu-
ment is coupled with the submission that there was no contractual trading or business relationship between Phillips and the respondent in respect of which it could be said that, but for the breach by Phil- lips, it would have been obliged to pay any amount to the respondent as revenue. Finally, the respondent says that no amount was paid for lost profits as such, that no claim for lost profits was ever quantified and that Phillips never agreed to pay any amount for loss of profits.
No authority has been brought to the Court's atten tion in which a payment that is not a "windfall" should nevertheless be treated for income tax pur poses as "akin to a windfall." The decided cases do appear to support the appellant's contention that in determining whether a taxpayer has received a non taxable "windfall," account must be taken of the busi ness context in which a particular payment was made and received. In Federal Farms Ltd. v. Minister of National Revenue, [1959] Ex.C.R. 91, the Court set aside an assessment of income tax of an amount paid to the taxpayer from a fund which had been created from public donations made for the relief of persons who had suffered as a result of Hurricane Hazel, which struck the Province of Ontario in the month of October 1954. In doing so, Cameron J., after review ing cases cited by both parties, including those which had dealt with the treatment to be accorded insurance proceeds in respect of stock-in-trade destroyed by fire, stated, at pages 97-98:
In the present case, I can find no analogy between the mon ies received from the Relief Fund and the monies received from insurance policies on stock-in-trade which has been destroyed by fire. Here the Relief Fund received nothing whatever from the appellant by way of contribution, insurance premiums, services, salvage or otherwise. The appellant had no legal right at any time to demand payment of any amount from the Relief Fund and clearly, at the time of its loss, had no expectation of getting anything. There was no contract of any sort between the donor and the donee, and the trustees of the Relief Fund, had they so desired, need not have paid the appel lant anything. I can find nothing in the circumstances outlined which would indicate that the giving and receiving of the amount was in any sense a business operation or arose out of the taxpayer's business.
The gift here in question, it seems to me, is of an entirely personal nature, wholly unrelated to the business activities of the appellant. The fact that the recipient is incorporated and that the gift was a large one does not affect the true nature of the payment, which, in my view, is precisely of the same kind as if the amount had been received by a neighbour of the appellant who had suffered flood damage but who was an indi vidual and received less than did the appellant.
And, at page 100, he added:
In this case, as I have suggested above, the payment was in no proper sense "compensation" or "income"; it was unlikely to ever occur again and did not result directly or indirectly from any business operation.
See also R. v. Cranswick, [1982] 1 F.C. 813 (C.A.).
The findings of the learned Trial Judge were that the settlement payment was agreed to by Phillips in order to "get rid" of Mohawk's claim and to preserve its reputation and that it was in excess of the amount provided for in the limitation of damages clause con tained in the January 27, 1978 purchase agreement. The manner in which a settlement amount has been characterized by the payor in the course of negotia tions would seem to be an unsafe test for determining its true nature. The payor's motives for settling a dis pute may be many and varied in any given case, and it must be a difficult thing to know precisely what his true motivation may have been, especially where the settlement amount is represented by a lump sum which the documentation does not assign to any par ticular head of claim. I do not see how the settlement amount can be viewed as being "akin to a windfall" merely because the respondent says it was paid by Phillips to get rid of the claim.
Nor am I persuaded that the settlement amount is to be viewed as "akin to a windfall" because it exceeded the amount provided for in the termination of damages clause of the purchase agreement. The evidence is clear that, while Phillips would not agree, the respondent sought from the outset and throughout the settlement negotiations to be made whole includ ing compensation for lost profits and expenditures thrown away. The record suggests that apart from lost profits, the respondent's other losses were for the cost of the plant itself and certain expenditures which
were laid out either to acquire land and install auxil iary facilities or in attempting to make the plant oper able. The evidence is also clear that the loss in respect of the land and auxiliary facilities did not materialize because those facilities were required for operating the new plant. As I see it, the settlement amount, of necessity, included compensation for lost profits and expenditures thrown away. Such compen sation cannot, in my view, be regarded as "akin to a windfall."
In the United Kingdom, the courts have had to deal with the question of whether a particular payment was truly voluntary or was paid for some other rea son. A payment that is voluntary is, apparently, not subject to taxation in that country. The provisions of the United Kingdom legislation are not, of course, the same as those which are here invoked, but I believe the principles of the English cases and the reasoning from which they have emerged, are relevant. I shall refer to some of these cases.
In Simpson (Inspector of Taxes) y John Reynolds & Co (Insurances) Ltd, [ 1975] 2 All ER 88 (C.A.), Stamp L.J., in referring to the nature of the payment there in issue, stated at pages 91-92:
It is not in question that the series of payments, of which this payment of £1,000 was one, was made and promised volun tarily. The payments were promised to be made by the former customer after the relationship of customer and broker had ter minated. They were not made to satisfy any legal liability, real or imagined, to which the customer was or believed itself to be subject. The payments were not made by way of additional reward for any particular service rendered by the brokers or for their services generally. They were not made pursuant to the terms of a trading contract or as compensation for the breach of any such contract.
In Murray (Inspector of Taxes) y Goodhews, [1978] 2 All ER 40 (C.A.), Buckley L.J., after reviewing a number of earlier decisions including Simpson, supra, enunciated the following principles, at page 46:
In my opinion a perusal of these authorities leads to the con clusion that every case of a voluntary payment, and we are only concerned with cases of that kind in the present appeal,
must be considered on its own facts to ascertain the nature of the receipt in the recipient's hands. All relevant circumstances must be taken into account. These may include the purpose for which the payer makes the payment, or the terms, if any, on which it is made, as for example in the Falkirk case, ([1975] STC 434), where the payment was made for the purpose of its being applied - in the recipient's business in the future; or it may be made by way of voluntarily supplementing the price paid for goods or services provided by the taxpayer in the course of his trade or business in the past, as in Australia (Common- wealth) Comr of Taxation v Squatting Investment Co Ltd ([1954] 1 All ER 349, [1954] AC 182) and Severn v Dadswell ([1954] 3 All ER 243, [1954] 1 WLR 1204, 35 Tax Cas 649) and McGowan v Brown and Cousins ([1977] 3 All ER 844, [1977] 1 WLR 1403, [1977] STC 342); or the payment may be merely in the nature of a testimonial or a solatium which, although it recognises the value of past services, is not paid specifically in respect of any of those services, or of expected future services, by the taxpayer to the payer, as in the case of Chibbett v Joseph Robinson & Sons ((1924) 9 Tax Cas 48, [1924] All ER Rep 684), Walker v Carnaby, Harrower, Bar- ham & Pykett ([1970] 1 All ER 502, [1970] 1 WLR 276, 46 Tax Cas 561) and Simpson v John Reynolds & Co (Insurances) Ltd ([1975] 2 All ER 88, [1975] 1 WLR 617, [1975] STC 271). I stress that it is the character of the receipt in the recipient's hands that is significant; the motive of the payer is only signifi cant so far as it bears, if at all, on that character.
Sir John Pennycuick, in a concurring judgment, added the following, at page 48:
Counsel for the Crown accepted that there is no universal rule under which a trader is bound to bring a voluntary pay ment into account. Unless I misunderstood him, he did, how ever, advance a general principle in these terms: the determin ing factor is the payer's reason for making the payment; if that was a commercial reason, the payment is taxable in the hands of the recipient. With all respect, I do not think that that is a correct formulation of principle. The basic principle in the pre sent connection is that one looks at the character of the receipt from the point of view of the recipient. In so doing, as has often been pointed out, one must take into account the motive of the payer in making the payment, but it is an inversion of the basic principle to treat the motive of the payer as the con clusive factor in the character of the receipt in the hands of the recipient.
It seems also that the result is no different if the payment is made because of increased expenditures rather than for loss of profits per se. Thus, in Donald Fisher (Ealing) Ltd y Spencer [Inspector of Taxes], [1987] STC 423 (Ch. D.), Walton J. stated, at page
433:
Of course, in the present case we have what counsel for the Crown felicitously called the mirror image of that. Here the
compensation is compensation because of increased expendi ture, and because it is that and not for the trader's failure to receive money which if it had been received would have been credited to the amount of profits (if any) arising in any year from the trade carried on by him at the time the compensation was so received, one has the mirror image; that is to say, that the compensation is payable for increased expenditure—not diminished receipts but increased expenditure. But from the point of view of the trader the result is in both cases the same; that is to say, that the profits are less than they ought to have been. If compensation is received which is in substance paya ble in respect of either the non-receipt of what ought to have been received or the extra expense which would not have been incurred if all had gone properly, it seems to me that the princi ple is exactly the same.
Finally, in Raja's Commercial College y Gian Singh & Co Ltd, [1976] STC 282 (P.C.), Lord Fraser stated, at pages 284-285:
Questions of whether sums awarded by courts are income, liable to income tax, or not, have arisen in a number of reported cases. The names given to the sums awarded have varied: `damages', `interest', `compensation' have all been used, but the court has declined to be bound by the label and has always tried to look through it and `to solve the question of substance' in the words of Rowlatt J in Simpson y Bonner Maurice's Executors ((1929) 14 Tax Cas 580, at 592) by refer ence to the true character of the award. [Emphasis added.]
Here in Canada as well, the courts have had to deal with the same general question. In MNR y Import Motors Ltd, [1973] CTC 719 (F.C.T.D.), Mr. Justice Urie, sitting as a trial judge, articulated a test for determining whether a loss is deductible from income. He stated, at page 727:
It is the true nature of the loss not the subjective views of the parties as to its nature which is important.
See also Courrier M H Inc y The Queen, [ 1976] CTC 567 (F.C.T.D.), per Dubé J., at page 571.
It seems to me that the principles laid down in these cases have application to the case at bar. The effect of the settlement was to bring to an end a busi ness transaction that had plainly gone bad and repre sented a recognition on the part of Phillips that the respondent should be compensated to the extent of the amount actually paid. Plainly, this payment was made because it was required to be made under the terms of the settlement agreement of January 8, 1982. It was one of the terms by which the parties agreed to
terminate the relationship created by the agreement of January 27, 1978. Another term required the exchange of mutual releases. Nothing in the settle ment agreement suggests that the amount in question was paid other than as in partial satisfaction of a binding settlement. In the circumstances, it can scarcely be regarded as being "akin to a windfall."
I must now pass to consider the correctness of the reassessment itself. The first question here is whether the Minister was right in assessing the sum of $3,443,708 as compensation for lost profits and expenditures incurred. In my view, there was evi dence which supported this assessment. I have already referred to the correspondence and documen tation which indicate that the respondent did seek to be made whole including compensation for lost prof its. Its treatment of the settlement amount in its accounting records is to the same effect. Moreover, the evidence reveals that in its fiscal years 1981 and 1982 the respondent suffered a loss of profits by vir tue of operating expenses associated with the inoper able plant. The evidence further shows that in com puting its income for these fiscal years the respondent deducted as "net expenses incurred" the amounts of $1,184,235 and $1,164,296, respectively. What is apparent in the present case is that Phillips agreed to take back the plant and, obviously, to rec ognize in the settlement a portion of the respondent's claim that was not represented by the expenditures for land, storage tanks and other auxiliary facilities which the respondent decided in the end to retain and, indeed, apparently put to use again after it acquired a new plant from another source.
We must also decide whether the reassessment was right in allocating a portion of the settlement amount to "proceeds of disposition of capital property" to the extent of $3,718,430. It seems to me that this too depends on whether the evidence supports that allo cation as made by the Minister in the reassessment. In my respectful view, it does. To begin with, it is clear beyond doubt that the settlement amount did include compensation for the plant itself which, apart from the hydrotreater, was turned back to Phillips who then decided to have it dismantled on site. This
item alone had represented a capital outlay by the respondent of $3,942,000 Canadian ($2,850,000 U.S.) as the purchase consideration. Again, the respondent, in endeavouring to be made whole, sought to be compensated in respect of its capital investment. Moreover, its own accounting records, as approved by its board of directors, allocated a portion of the settlement amount as "proceeds of disposal of lubricant plant" and allocated a portion of the settle ment amount to "deferred development costs."
Finally, the appellant advances an alternative argu ment based upon subsection 14(1) [as am. by S.C. 1977-78, c. 1, s. 7] of the Income Tax Act. The argu ment is that, if the settlement amount was paid by Phillips to preserve its reputation, it constituted the receipt of an "eligible capital property" and, accord ingly, that the respondent is required to include in its 1982 income one-half of the settlement amount.
In view of the conclusions I have expressed above, it is unnecessary to deal with the merits of this argu ment. In any case, I would have been disinclined to do so because of the pleadings. Nowhere in the appellant's statement of defence was this issue expressly pleaded. That omission, in my view, fore closes the appellant from raising it on this appeal. See Glisic v. Canada, [1988] 1 F.C. 731 (C.A.), at pages 739-740; TRW Inc. v. Walbar of Canada Inc. (Court File No. A-107-91, Stone J.A., judgment rendered October 31, 1991 not yet reported), at page 24.
For the foregoing reasons, I would allow this appeal with costs, set aside the judgment of the Trial Division dated July 11, 1990, and dismiss the action with costs.
HEALD J.A.: I agree. HUGESSEN J.A: I agree.
 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.