|
Docket: 2001-1245(IT)G |
|
BETWEEN: |
|
656203 ONTARIO INC., |
|
Appellant, |
|
and |
|
|
|
HER MAJESTY THE QUEEN, |
|
Respondent. |
____________________________________________________________________
Appeal heard on October 16, 2002, at Ottawa, Ontario.
|
Before: The Honourable Judge Lucie Lamarre |
|
|
|
|
|
Appearances: |
|
|
|
|
|
Counsel for the Appellant: |
Emilio Binavince Marc Binavince |
|
|
|
|
Counsel for the Respondent: |
Daniel Bourgeois |
____________________________________________________________________
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1997 taxation year is dismissed with costs.
Signed at Ottawa, Canada, this 14th day of April 2003.
|
"Lucie Lamarre" |
J.T.C.C.
|
Citation: 2003TCC264 |
|
Date: 20030414 |
|
Docket: 2001-1245(IT)G |
|
BETWEEN: |
|
656203 ONTARIO INC., |
|
Appellant, |
|
and |
|
|
|
HER MAJESTY THE QUEEN, |
|
Respondent. |
REASONS FOR JUDGMENT
Lamarre, J.T.C.C.
[1] This is an appeal against an assessment made by the Minister of National Revenue ("Minister") under the Income Tax Act ("Act") for the appellant's 1997 taxation year.
[2] In computing its income for that year, the appellant reported an amount of $3,698,935 ($3,248,935 as proceeds of disposition and $450,000 for a business interruption loss) received in 1997 from the Simcoe & Erie General Insurance Company, Gan Canada Insurance Company and New Rotterdam Insurance Company ("Insurers"). This amount was awarded to the appellant by a judgment of Madam Justice Bell of the Ontario Court (General Division) in an action brought by the appellant against the Insurers in respect of the loss of its lumber mill in a fire that occurred in January 1991. The appellant, however, failed to report a further amount of $1,500,000 that it received from the Insurers in the same year, 1997, in settlement of all actions brought against them by the appellant. (See the 1997 tax return, Exhibit R-1, Tab 1, and the appellant's financial statements as at April 30, 1997, Exhibit R-1, Tab 4.)
[3] In reassessing the appellant for the 1997 taxation year, the Minister accepted the inclusion of the amount awarded by Bell J. as reported by the appellant in its tax return. However, as stated in paragraph 14 of the Reply to the Notice of Appeal, the Minister treated as proceeds of disposition of property the extra amount of $1,500,000 received by the appellant and included 75 per cent of this amount in the appellant's income pursuant to paragraph 38(a) and subsection 14(1) of the Act. The Minister allocated these proceeds of disposition between tangible and intangible property as follows:
|
Property |
Proceeds of disposition |
Inclusion |
|
|
|
|
|
Buildings |
$ 517,011 |
$ 387,758 |
|
Lost Income |
$ 982,989 |
$ 737,242 |
|
Total |
$ 1,500,000 |
$ 1,125,000 |
[4] In its Notice of Appeal, the appellant takes issue with the inclusion in income not only of 75 per cent of the $1,500,000 but also of a substantial portion of the amount awarded to it by Bell J. Counsel for the appellant argued at the hearing that only the amount of $450,000 was correctly so included, as having been received for a business interruption loss. In counsel's view, the balance of the amount paid by the Insurers in 1997 does not constitute income from any relevant source and should not have been reported as a taxable capital gain (as it was originally in the appellant's 1997 tax return). Rather, he argued, the amount at issue was paid "on account of the value of the properties destroyed or for damages suffered, by the Appellant. Alternatively, the receipts constitute a non-taxable windfall". (See paragraph (E)1 of the Notice of Appeal.)
Facts
[5] The salient facts giving rise to the reassessment centre around the acquisition by the appellant of the Harcourt sawmill ("sawmill") in Barry's Bay, Ontario, and the subsequent destruction by fire of a large portion of the said sawmill.
[6] The appellant was incorporated under the laws of the province of Ontario and is owned by Mr. Frank P. Yantha, who testified at the hearing, and Mr. Don Foley.
[7] In her Reasons for Judgment (Exhibit A-1, Tab 6, at pages 5-7), Bell J. set out the facts leading up to the purchase of the sawmill by the appellant (which were not disputed before me by the parties). I will reproduce hereinafter a summary of those facts. The sawmill was part of a group of sawmills owned and operated by G.W. Martin Limited before it closed in 1989, at which time it had been taken over by a receiver. Mr. Yantha and Mr. Foley allegedly met each other that same year and incorporated the appellant company with the goal of acquiring and operating the sawmill. The appellant first offered to buy the sawmill from the receiver in 1989 at a price of $1,190,000. That offer included the Crown timber rights previously enjoyed by G.W. Martin Limited. Nothing came of the offer because the receiver obtained a better one from another company, Commonwealth Papers Products ("Commonwealth"). However, the Commonwealth transaction did not close either, so a second offer was put in by Mr. Yantha to purchase the sawmill for $725,000. This second offer did not include the Crown timber rights or certain buildings and equipment, which had been included in the first offer. The receiver finally accepted this offer and the transaction closed on October 5, 1990.
[8] In its Notice of Appeal filed with this Court, the appellant said that what it paid for the sawmill was substantially less than its fair market value at the time. Indeed, Mr. Yantha and Mr. Foley had received from S. Rayner & Associates Ltd. a replacement cost appraisal for the sawmill as at October 4, 1990, which put its optimum value at $11,507,185 and its minimum value at $1,850,000 (Exhibit A-3).
[9] According to the appraisal report, as at October 4, 1990, the subject property was at its minimum value.
[10] Once the appellant had entered into the agreement to purchase the sawmill, Mr. Yantha communicated with the Insurers and apparently told them that he wanted enough insurance to cover the mortgages. The Insurers suggested that the property would in that case be underinsured having regard to the appraisal value determined by S. Rayner & Associates Ltd. Also, Mr. Yantha was aware that G.W. Martin Limited had obtained a "value in use" appraisal in January 1987 of between $5,950,000 and $6,710,000. The Insurers and Mr. Yantha finally agreed to a figure of $4,500,000 for insurance coverage. (See Reasons for Judgment of Bell J., Exhibit A-1, Tab 6, pages 11 and 12 of her reasons.) The $4.5 million coverage was subsequently increased to $5,750,000 on January 7, 1991. (See Exhibit A-1, Tab 5.)
[11] On the first day of operation of the sawmill, on January 7, 1991, a fire occurred which destroyed the mill. The Insurers refused to pay the insurance proceeds, which resulted in an action being brought against the Insurers by the appellant in the Ontario Court (General Division) ("First Action"), which action was heard by Bell J.
[12] In its Statement of Claim in this First Action (which is found in Exhibit A-1, Tab 6, pages 82-85 in black marker), the appellant claimed the replacement cost value of the building and contents and an amount for business interruption, for a total of $5,750,000 detailed as follows:
|
Item Involved |
Replacement Cost |
Cash Value |
Claimed under Policy |
|
|
|
|
|
|
Building |
$1,119,709 |
$ 932,839 |
$1,119,709 |
|
Contents |
$3,592,271 |
$ 2,271,612 |
$3,592,271 |
|
Business Interruption |
N/A __________ |
$ 1,117,247 ___________ |
$1,117,247 __________ |
|
Total |
$4,701,980 |
$ 4,321,698 |
$5,750,000 |
The appellant also claimed damages in the amount of $500,000.
[13] The First Action resulted in a decision by Bell J. in favour of the appellant (Reasons for Judgment signed on September 5, 1995; Supplementary Reasons for Judgment signed on October 25, 1995; Judgment signed on February 13, 1996). The appellant was awarded the cash value of the building and contents, that is, $711,384 for the building and $2,271,612 for the contents for a total of $2,982,986, as well as $450,000 for the business interruption loss, plus pre-judgment interest at 6.5 per cent per annum from July 16, 1991 to the date of judgment. Bell J. also ordered that upon compliance with the terms of the replacement cost endorsement in the insurance policies (meaning upon the destroyed property being replaced at the appellant's own expense), the appellant would be entitled to receive from the Insurers a further sum of $2,017,004 (being the excess of the replacement cost over the cash value of the building and contents up to the limit of the insurance policy). (See Judgment of Bell J. and her Reasons for Judgment, Exhibit A-1, Tab 6 at page 77.) The Insurers appealed that judgment to the Ontario Court of Appeal and the appeal was apparently scheduled to be heard on December 16 and 17, 1996.
[14] On July 17, 1996, the appellant launched a second action ("Second Action") in the Ontario Court (General Division) against the Insurers. This was an action for damages suffered by the appellant from the failure by the Insurers to pay the insurance proceeds when due, or within a reasonable time thereafter. (See letter from appellant's counsel at the time, Mr. Paull N. Leamen, dated April 2, 1997, Exhibit A-1, Tab 11.) The claims were for $10,000,000 for reconstruction costs and lost revenue and for $1,000,000 in punitive damages (Exhibit A-1, Tab 12). It is to be understood from Mr. Leamen's letter that the damages were being sought by the appellant for loss of personnel, deterioriation (and subsequent demolition) of outbuildings and loss of market share.
[15] The Insurers failed to deliver a Statement of Defence in the Second Action, which led to a default judgment by Mercier J. of the Ontario Court (General Division) on November 29, 1996, awarding damages to the appellant. This judgment ordered the Insurers to pay the appellant: (a) damages in the amount of $483,188.30 plus goods and services tax ("GST"); (b) $450,000 per year for lost income from 1992 to 1997 inclusive, plus pre-judgment interest at the rate of 5 per cent per year (Exhibit A-1, Tab 13).
[16] Following the default judgment in the Second Action, the Insurers presented a motion to set aside that judgment. The Insurers principally argued in their motion that the claims in the First Action had been, in effect, repeated in the Second Action notwithstanding the fact that the allegations made already had been or ought to have been put forward in the First Action. The Insurers also maintained in their motion that if they were successful on the appeal from the judgment rendered by Bell J. in the First Action, the entire foundation of the appellant's Second Action would disappear. In the Insurers' view, the appellant's Second Action related to the denial of coverage by them under the insurance policies in issue in the First Action. (See Affidavit of David Sherriff-Scott attached to the Notice of Motion, Exhibit A-1, Tab 10, paragraphs 4 to 7.)
[17] On December 5, 1996, the default judgment dated November 29, 1996, was set aside by an order of Cunningham J. of the Ontario Court (General Division) (Exhibit A-2). At the same time, the Insurers seriously engaged in settlement discussions with the appellant. In his letter sent to the appellant on April 2, 1997 (Exhibit A-1, Tab 11), Mr. Leamen summarized the progress of the negotiations as follows:
. . . Although the insurers had previously been prepared to pay the actual cash value indemnity provisions awarded by the Trial Judge [Bell J.], no agreement could be reached with respect to the approximately $2,000,000.00 of replacement cost coverage that was available to the Plaintiff in the event that the sawmill was actually reconstructed at a cost in excess of that actual cash value.
For the first time, during the week of December 9, 1996, the insurers waived the policy requirement that the sawmill be rebuilt before payment of the replacement cost coverage. This steadily increased their offer to pay up to the sum of $1,500,000.00 which was made and accepted on December 13, 1996. In exchange for the insurers' agreement to pay this $1.5 million the Plaintiff was obliged to release its claim with respect to action number 101303/96. [Second Action]
As a result, the settlement was made on the following basis:
a) For the actual cash value portion of the Judgment, payment of the sum of $3,698,935.04 as of December 15, 1996 plus per diem interest of $759.77 thereafter to the date of payment, this figure includes an award of $450,000.00 for business interruption coverage for the calendar year 1991, and a credit of $750,000.00 for the two purchase money mortgages assigned to the Defendant insurers which have subsequently been discharged by them from the title to the Harcourt sawmill;
b) Legal costs in the amount of $500,000.00;
c) For release of damage claim, the sum of $1,500,000.00;
[18] At the trial before me, Mr. Yantha testified that he knew in December 1996 that they were not going to rebuild the destroyed sawmill. He said that on the day of settlement with the Insurers, he and Mr. Foley told their lawyer that they would not accept anything less than $1.5 million for damages, on top of the award already granted by Bell J. He characterized the $1.5 million as punitive damages as it was not paid for the replacement cost of a new sawmill. He also said that their accountant had advised them that punitive damages were not taxable. There is no document, however, to show how the Insurers and the appellant actually characterized the payment of $1.5 million provided for in the settlement agreement.
[19] Indeed, the Insurers finally signed, on December 20, 1996 a Full and Final Release whereby they accepted to pay to the appellant an amount of $5,208,052 plus $500,000 for costs and the discharge of the mortgages (Exhibit A-1, Tab 1). In consideration of that payment, they released and forever discharged "[the appellant], Don Foley and Frank Yantha from any and all actions, causes of actions, claims and demands, for damages, loss or injury, howsoever arising, which heretofore may have been or may hereafter be sustained by it in consequence of or relating to a fire at the Harcourt Sawmill and the subsequent demolition of the sawmill on the 7th day of January, 1991, insurance policy numbers RSL3091 and RSL3092 and action numbers 56202/91 [the First Action] and 101,303/96 [the Second Action] including the Order for Costs made by Justice Cunningham on December 5, 1996, including all damage, loss, and injury not now known or anticipated or which may arise in the future and all effects and consequences thereof" (Exhibit A-1, Tab 1).
[20] No allocation was made, in the Full and Final Release, of the amount of $5,208,052. However, in paragraph 16 of the Notice of Appeal, there is the following:
16. In the result, the insurers and the Appellant reached a settlement and Releases were executed. The settlement, in substance, was as follows:
A. Judgment Action 56202/91 [First Action]:
(i) actual cash value indemnity of $3,698,935.04 as of December 15, 1996, plus interest of $759.77 thereafter to the date of payment;
(ii) the figure includes an award of $450,000 for business interruption coverage for the calender [sic] year 1991;
(iii) and a credit of $750,000 for two purchase money mortgages assigned to the insurers.
B. Action 101303/96 [Second Action]: release of the damage claim upon payment of the sum of $1,500,000;
C. Legal costs for both actions in the sum of $500,000.
[21] In paragraph 10 of the Reply to the Notice of Appeal, the respondent admits that allocation except for the amount of $3,698,935 referred to in the above-cited paragraph 16(A)(i) of the Notice of Appeal, which amount, the respondent submits, is comprised of the amount of $3,432,996 awarded by Bell J. (which is the total of $711,384 awarded for the building, $2,271,612 for the contents and $450,000 for the loss from business interruption) and accrued interest.
[22] The appellant received in its 1997 taxation year the amounts to which it was entitled pursuant to the settlement. The appellant reported an amount of $3,698,935 in its taxable income for 1997 ($450,000 as business income and the balance as the proceeds of disposition of capital property resulting in a taxable capital gain) but did not include the amount of $1,500,000 allegedly received as non-taxable damages in settlement of the Second Action and shown in its financial statements as an extraordinary item of revenue.
Issues
[23] The issues to be determined in the present appeal are defined as follows in section (D) of the Notice of Appeal:
1. What portion, if any, of the sum of $3,698,935.04 paid by the insurers pursuant to the judgment in Action No. 56202/91 [First Action] constitutes capital gain and as such may be included as income pursuant to section 3 of the Income Tax Act?
2. What portion, if any, of the settlement payment of $1,500,000 in Action No. 101303/96 [Second Action] constitutes business income and, as such, may be included as income pursuant to section 3 of the Income Tax Act?
[24] In paragraph 17 of the Amended Reply to the Notice of Appeal, the respondent states the issues as follows:
a) whether the amounts received by the Appellant in settlement of its actions have been correctly treated as proceeds of disposition of capital property, resulting in:
i) a taxable capital gain pursuant to paragraph 38(a), 39(1)(a) and 40(1)(a) of the Act;
and,
ii) business income to be included pursuant to subsection 14(1) of the Act or, alternatively, pursuant to section 9 of the Act.
Appellant's Submissions
[25] Counsel for the appellant broke down the payment received by the appellant in 1997 into two components:
(1) all payments received pursuant to the judgment of Bell J. were payments made pursuant to the insurance policy and he argued, that being so, the proceeds received under this insurance policy, other than the business interruption loss amount of $450,000, do not constitute a capital gain, but rather are a windfall, the $450,000 is to be treated as business income;
(2) the payment of $1,500,000 was in settlement of the Second Action and constituted punitive damages, and therefore is not subject to tax; alternatively, if it does not constitute punitive damages, it constitutes a non-taxable windfall and not business income.
Respondent's Submissions
[26] With respect to the payments received pursuant to the judgment of Bell J., counsel for the respondent agreed that they are amounts received as proceeds under the insurance policy. He was however of the view that, with the exception of the $450,000, which the appellant accepted as being income, those amounts constitute proceeds of disposition of capital property, giving rise to a taxable capital gain.
[27] With respect to the $1.5 million, counsel for the respondent first submitted that this amount was paid to the appellant in compliance with the judgment of Bell J. as the replacement cost of the property destroyed and therefore should be characterized as proceeds of disposition of the destroyed property, thus giving rise to a capital gain. The respondent further argued that if this Court were to conclude that it was not made under the insurance policies, the payment at issue would nonetheless not be a windfall. It would constitute, in his view, compensation for lost future income, as the appellant's business had been materially crippled. The appellant would therefore be deemed to have disposed of an intangible property and the amount to be included in income would consequently fall under subsection 14(1) of the Act and be taxed at the same rate as a capital gain (that is, in 1997, on 75 per cent of the amount received). In any event, the payments do not constitute a non-taxable windfall in the form of punitive damages.
Analysis
I. Tax treatment of the amount of $3,698,935 awarded by Bell J.
[28] The amount of $3,698,935 is comprised of an amount of $450,000 awarded for the business interruption loss and an amount of $2,982,986 awarded for the cash value of the building and its contents, plus interest.
[29] The appellant conceded that the $450,000 received for the business interruption loss should be included in income as business income.
[30] The appellant however took issue with the inclusion in income of the balance of the amount awarded by Bell J. Although counsel for the appellant conceded that all payments made pursuant to the judgment of Bell J. were payments pursuant to the insurance policy, he stated that the proceeds of disposition from the insurance policy do not give rise to a capital gain here. This argument was based on the fact that the fair market value of the sawmill was higher than the amount received by the appellant in satisfaction of its claims. It has been seen previously that the appellant purchased the sawmill at a price substantially under fair market value. Indeed, the purchase price was $725,000 whereas an appraisal report valued the property at $1,850,000 minimum at the time of acquisition. Furthermore, the Insurers agreed to insure the improved property for $5,750,000.
[31] Counsel for the appellant considered this valuation to be instrumental in the determination of a gain. He defined a gain as "an increase in the wealth of value, generated by economic circumstances" (see transcript at page 131). In paragraph 14 of his written submissions, counsel for the appellant states that "[t]he case represents an acquisition of an asset below fair market value where the difference between fair market value and the consideration represents windfall, and there is no 'gain', since there is no real increase in wealth".
[32] This argument cannot stand in law. The Act is so structured that, except where otherwise mentioned, it is not the valuation of the property which determines the existence of a potential capital gain, but rather the disposition of the property for proceeds of disposition that exceed the adjusted cost base. The calculation of a capital gain or loss is found in subparagraph 40(1)(a)(i) of the Act, which reads as follows:
SECTION 40: [Calculation of gain, loss or reserve].
440(1)3
(1) General rules. Except as otherwise expressly provided in this Part
(a) a taxpayer's gain for a taxation year from the disposition of any property is the amount, if any, by which
(i) if the property was disposed of in the year, the amount, if any, by which the taxpayer's proceeds of disposition exceed the total of the adjusted cost base to the taxpayer of the property immediately before the disposition and any outlays and expenses to the extent that they were made or incurred by the taxpayer for the purpose of making the disposition, or . . .
[33] A disposition was defined as follows in section 54, as applicable for the taxation year at issue:
"disposition" - "disposition" of any property, except as expressly otherwise provided, includes
(a) any transaction or event entitling a taxpayer to proceeds of disposition of property.
[34] An amount payable under a policy of insurance in respect of the loss or destruction of property constitutes "proceeds of disposition" pursuant to the definition of that term in section 54.
"proceeds of disposition" - "proceeds of disposition" of property includes,
. . .
(c) compensation for property destroyed, and any amount payable under a policy of insurance in respect of loss or destruction of property.
[35] Adjusted cost base is also defined in section 54, as follows:
"adjusted cost base" - "adjusted cost base" to a taxpayer of any property at any time means, except as otherwise provided,
(a) where the property is depreciable property of the taxpayer, the capital cost to the taxpayer of the property as of that time, and
(b) in any other case, the cost to the taxpayer of the property adjusted, as of that time, in accordance with section 53,
. . .
(d) in no case shall the adjusted cost base to a taxpayer of any property at any time be less than nil.
[36] Except for specific transactions with respect to which the Act stipulates otherwise, fair market value does not play any role in the calculation of a capital gain or loss. As noted by counsel for the respondent, there is no "automatic bump-up" of the adjusted cost base of property purchased at a bargain price in relation to its fair market value. Fair market value only comes into play where, for example, a taxpayer acquires property by way of gift, bequest or inheritance. In such a case, the taxpayer is deemed to have acquired the property at its fair market value in accordance with paragraph 69(1)(c) of the Act.
[37] In the present case, the appellant did not acquire the sawmill for nothing by way of gift, bequest or inheritance. The appellant, after negotiations with the receiver, was able to purchase the property at a certain price. There is, therefore, no deeming provision applicable here to boost the acquisition price to the property's fair market value at the time of acquisition. Consequently, the gain must be calculated in accordance with the general rule stated in paragraph 40(1)(a) of the Act, referred to above.
[38] In the present matter, the appellant's tax return was assessed as filed and the capital gain was calculated based on the various proceeds of disposition and adjusted cost base figures given by the appellant. None of those figures was readjusted and the appellant did not challenge them at the hearing.
[39] Consequently, the assessment will stand with respect to the amount awarded by Bell J.
II. The $1.5 million agreed upon between the Insurers and the appellant in settlement of all actions.
[40] The question with respect to this issue is: "What did the payment made by the Insurers purport to compensate?"
[41] Counsel for the respondent first submitted that this amount was paid to the appellant in compliance with the judgment of Bell J., as the replacement cost of the property destroyed, and therefore should be characterized as proceeds of disposition of that destroyed property, thus giving rise to a capital gain. Indeed on page three of her judgment, Bell J. stated that "upon compliance with the terms of the replacement cost endorsement in [the] insurance policies [. . .], the [appellant] will then be entitled to receive from the [Insurers] a further sum of $2,017,004.00" (Exhibit A-1, Tab 6).
[42] In counsel's view, this is what was compensated by the Insurers in making the $1.5 million payment.
[43] Counsel for the respondent relied on the letter (Exhibit A-1, Tab 11) signed by Mr. Leamen (appellant's counsel at the time) wherein the latter indicates that, during the week of December 9, 1996, the Insurers waived the insurance policy requirement that the sawmill be rebuilt before payment of the replacement cost coverage. This was apparently followed by a steady increase - to $1.5 million - in the amount the Insurers were offering to pay.
[44] Mr. Leamen however went on to say that "[i]n exchange for the insurers' agreement to pay this $1.5 million the [appellant] was obliged to release its claim with respect to [the Second Action]".
[45] This brings us to the appellant's argument that the $1.5 million was not paid pursuant to the insurance policy but represented damages for wrongful acts of the Insurers, namely for refusal to make, and for delay in making, payments under the insurance policies. In counsel for the appellant's view, this amount of $1.5 million was paid as punitive damages, and these are not taxable. The appellant further submitted that this amount was paid as a means for the Insurers to rid themselves of an embarrassing and potentially very costly contingent liability. Counsel relied on the decision of the Federal Court - Trial Division in Mohawk Oil Co. v. Canada,[1990] F.C.J. No. 617 (Q.L.), in arguing that such a payment is not taxable. Before going any further, it is important to note here that this decision was reversed by the Federal Court of Appeal which held, in a judgment to be found at [1992] 2 F.C. 485, that a settlement amount cannot be viewed as being "akin to a windfall" merely because the recipient of the payment says that it was paid by the payer to get rid of a claim.
[46] The respondent argued finally that if this Court were to conclude that the payment at issue was not made under the insurance policies, that payment would nonetheless not be a windfall. The payment would receive the same tax treatment as that which would be given the transaction for which the appellant was compensated. Counsel for the respondent relied on a passage in The Queen v. Manley, 85 DTC 5150, in which the Federal Court of Appeal applied in Canadian law the surrogatum principle stated by Diplock L.J. in London and Thames Haven Oil Wharves, Ltd. v. Attwooll, [1967] 2 All E.R. 124 at 134 FF. I quote the following from Manley, supra, at pages 5154-55:
In that case, the taxpayer had received, in settlement of a claim in negligence, £ 21,404 for loss of use of an income earning asset during its period of repair. The issue before the court was the assessment of that sum to tax. While the rule itself is stated in the second sentence of the second paragraph below, it is desirable to quote Diplock, L.J., at some length as its context is, in my opinion, compelling argument for its validity.
. . . The question whether a sum of money received by a trader ought to be taken into account in computing the profits or gain arising in any year from his trade is one which ought to be susceptible of solution by applying rational criteria; and so, I think, it is. I see nothing in experience as enbalmed in the authorities to convince me that this question of law, even though it is fiscal law, cannot be solved by logic, and that, with some temerity, is what I propose to try to do.
I start by formulating what I believe to be the relevant rule. Where, pursuant to a legal right, a trader receives from another person compensation for the trader's failure to receive a sum of 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 when the compensation is so received, the compensation is to be treated for income tax purposes in the same way as that sum of money would have been treated if it had been received instead of the compensation. The rule is applicable whatever the source of the legal right of the trader to recover the compensation. It may arise from a primary obligation under a contract, such as a contract of insurance; from a secondary obligation arising out of non-performance of a contract, such as a right to damages, either liquidated, as under the demurrage clause in a charterparty, or unliquidated; from an obligation to pay damages for tort, as in the present case; from a statutory obligation; or in any other way in which legal obligations arise.
The source of a legal right is relevant, however, to the first problem involved in the application of the rule to the particular case, viz., to identify for what the compensation was paid. If the solution to the first problem is that the compensation was paid for the failure of the trader to receive a sum of money, the second problem involved is to decide whether, if that sum of money has been received by the trader, it would have been credited to the amount of profits (if any) arising in any year from the trade carried on by him at the date of receipt, i.e., would have been what I shall call for brevity an income receipt of that trade. The source of the legal right to the compensation is irrelevant to the second problem. The method by which the compensation has been assessed in the particular case does not identify for what it was paid; it is no more than a factor which may assist in the solution of the problem of identification.
[47] In order to determine the tax treatment of the $1.5 million settlement amount, one has to look at the true character of the payment. It is worthwhile reproducing the following passage written by Lord Fraser in Raja's Commercial College v. Gian Singh & Co Ltd., [1976] STC 282 (P.C.) at pages 284-85, cited by the Federal Court of Appeal in Mohawk Oil, supra, at page 499:
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 v Bonner Maurice's Executors ((1929) 14 Tax Cas 580, at 592) by reference to the true character of the award. [Emphasis added.]
[48] The Statement of Claim filed by the appellant in the Second Action claims compensatory damages including reconstruction costs and lost revenue in the amount of $10 million and punitive damages in the amount of $1 million. In its claim, the appellant refers to the fact that the Insurers were ordered, by the judgment of Bell J. in the First Action, to indemnify the appellant under the insurance policies. The allegations made in support of the appellant's claim in the Second Action referred first to the Insurers' negligence in carrying out the demolition of the sawmill building that was destroyed by the fire. The appellant submitted in its claim that this negligence caused damage to two adjacent buildings, generating a replacement cost of approximately $500,000, for which the appellant held the Insurers responsible.
[49] The other allegations made in the Statement of Claim in the Second Action concern principally the fact that the Insurers' failure to honour their indemnity obligations prevented the appellant from recommencing its business operations within the first year after the fire - that is, within the twelve months ending on January 7, 1992 - and thereafter. It is worth reproducing those allegations, which are found in paragraphs 11 to 17 of the Statement of Claim in the Second Action (Exhibit A-1, Tab 12):
11. The insurance policies referred to in paragraph 3 hereof, provided the Plaintiff with indemnity for business interruption losses for a maximum period of one year which expired on or before the 7th day of January, 1992. It was contemplated by the Plaintiff and a term of the insurance policies that the insurance proceeds to which the Plaintiff was entitled in the event of a fire loss, would provide the Plaintiff with sufficient funds to rebuild the damaged sawmill and to resume business operations. Once the Plaintiff has re-built the destroyed sawmill building and replaced the lost contents the Plaintiff would become entitled to the Replacement Cost benefits under the insurance policies.
12. According to the terms of the insurance policies the actual cash value of the destroyed building and its contents plus the Business Interruption loss of the Plaintiff were to have been paid by the Defendants prior to July 1, 1991. It was the failure of the Defendants to honour their indemnity obligations to the Plaintiff that has prevented the Plaintiff from recommencing its business operation within the first year after the fire, ending on January 7, 1992. The Defendants' breach of their indemnity obligations continues and therefore the Plaintiff has been unable to rebuild the sawmill or to resume its sawmill operations, to this date and for the foreseeable future.
13. In addition the Defendants refused to co-operate in any respect with the Plaintiff's attempt to recommence its business operations:
(a) the Defendants would not agree to postpone the Defendants' mortgages to any financing the Plaintiff might obtain for that purpose;
(b) the Defendants would not agree to postpone the Defendants' mortgages or to sign a non-disturbance agreement to permit the Plaintiff to lease its dry kiln operation to an interested party; and
(c) the Defendants, in the spring of 1996, would not provide the necessary assistance to the Plaintiff to prevent the demolition of two additional structures referred to in paragraphs 7 and 8 hereof, despite their opportunity to do so.
14. The Plaintiff states that in addition to preventing the Plaintiff from recommencing its sawmill operations in an economic climate that would have allowed the Plaintiff to earn substantial profit, and to pay the ongoing expenses including the municipal taxes on the sawmill property, the Defendants' conduct has been wanton, reckless, in bad faith and in total disregard of the Plaintiff's rights and the Defendants' fiduciary obligations to the Plaintiff.
15. The Plaintiff states that for each year commencing January 7, 1992 to the date when the sawmill is reconstructed it would have covered its operating costs, including the municipal taxes and the ordinary maintenance costs of the sawmill property and earned a profit in excess of $500,000.00.
16. Because the Plaintiff has been prevented by the Defendants from recommencing its sawmill operations the Plaintiff has suffered the encroachment by other sawmills into its supply of logs and to its customer base which will reduce the Plaintiff's revenues and profit once the Plaintiff's sawmill recommences operations.
17. As a result of the Defendants' failure to honour their indemnity obligations to the Plaintiff in a timely manner, the Plaintiff has suffered and will continue to suffer damages.
[50] It is clear, in my view, that the Second Action was launched by the appellant to seek damages for the failure by the Insurers to honour their obligations either under the insurance policies or under the judgment of Bell J. It is also clear that the settlement amount was arrived at by negotiation between the parties concerned and that there was express agreement by those parties to mutual releases from all actions relating to the fire (Exhibit A-1, Tab 1).
[51] Although Bell J. awarded in her judgment an amount of $2,017,004 for the reconstruction cost of the building, and although I recognize that this was surely important in the negotiations between the appellant and the Insurers, I am not convinced that the $1.5 million settlement amount was paid in compliance with the judgment. Indeed, the judgment imposed a requirement that the building be rebuilt, which was never done, and Mr. Yantha testified that when the settlement was reached in December 1996, they knew that they would never rebuild.
[52] The question therefore remains whether the reassessment under appeal correctly treated that extra amount of $1.5 million as proceeds of disposition, of which 75 per cent was included in income. The reassessment allocated $517,011 to proceeds of disposition of the buildings and $982,989 to lost income, which amount was treated as the proceeds of disposition of intangible property, being compensation for the entire goodwill of the business.
[53] The appellant submitted that the whole amount of $1.5 million was paid as punitive damages and is therefore not taxable (see Bellingham v. The Queen, 96 DTC 6075 (F.C.A.)). This argument cannot stand. First, the amount claimed as punitive damages was $1 million and not $1.5 million. Second, punitive damages are awarded by a court in exceptional cases for "malicious, oppressive and high-handed" misconduct that "offends the court's sense of decency" (see Hill v. Church of Scientology of Toronto, [1995] 2 S.C.R. 1130, at paragraph 196). In Vorvisv. Insurance Corporation of British Columbia, [1989] 1 S.C.R. 1085 at pages 1105-06, McIntyre J. wrote the following:
When then can punitive damages be awarded? It must never be forgotten that when awarded by a judge or jury, a punishment is imposed upon a person by a Court by the operation of the judicial process. . . . The only basis for the imposition of such punishment must be a finding of the commission of an actionable wrong which caused the injury complained of by the plaintiff.
[54] Here, there was no court order granting punitive damages to the appellant. Indeed, the default judgment that was later set aside granted damages in the amount of $483,188 plus GST and $2,700,000 for lost income during six years (1992-1997) plus pre-judgment interest. After the default judgment was set aside, the parties finally settled, agreeing on the payment of an extra amount of $1.5 million by the Insurers on top of what had already been awarded by Bell J. In reassessing the appellant, the Minister allocated an amount of $517,011 to the buildings, based on the award for damages in the default judgment ($483,188 + 7% GST = $517,011). In fact, this corresponds to the amount of approximately $500,000 referred to by the appellant in its Statement of Claim in the Second Action as the replacement cost for two demolished buildings. The Minister allocated the balance to lost income, as was done in the default judgment.
[55] The appellant submitted that the default judgment has been set aside and that there is no basis for the allocation made by the Minister. This might be, but the appellant had the burden of showing that this allocation is unreasonable in the circumstances. The Full and Final Release reflects the final lump-sum amount agreed on by the parties in settlement of all actions but does not assign that amount to any particular head of claim. Mr. Yantha testified that the whole amount of $1.5 million was attributable to punitive damages. No one from the Insurers was called to testify.
[56] In my view, the testimony of Mr. Yantha is not relevant in that regard. He testified that the $1.5 million settlement amount should be characterized as punitive damages only because his accountant had told him that punitive damages were not taxable. This is self-serving evidence, which I cannot rely upon. Bearing in mind that punitive damages are normally awarded by a court for malicious and oppressive misconduct, it would be surprising that the Insurers would have voluntarily agreed to pay damages to the appellant on that basis.
[57] Furthermore, in light of the Statement of Claim in the Second Action, it is reasonable to believe that the $1.5 million constituted compensation for the destroyed buildings and for lost income. Indeed, it can be inferred from the judgment of Bell J. and from the pleadings in the Second Action that, while the Insurers would not agree thereto, the appellant sought from the outset, and presumably throughout the settlement negotiations, to be made whole. This included compensation for lost profits and for destroyed property. As was said in Mohawk Oil, supra, such compensation cannot be regarded as akin to a windfall.
[58] The situation here is distinguishable from that which prevailed in Bellingham, supra, referred to by counsel for the appellant. In deciding that a punitive award constituted a windfall gain, Robertson J.A. stated that "[t]he critical factor is that the punitive damage award does not flow from either the performance or breach of a market transaction" (page 6082). In Bellingham, the true source of the punitive award was the Expropriation Act of Alberta, which dictated as a matter of public policy that expropriating authorities be obligated to pay a penal sum in circumstances where their behaviour falls below a prescribed standard. Therefore, "[t]he payment in question [did] not flow from either an express or implied agreement between the parties. There [was] no element of bargain or exchange. There [was] no consideration. There [was] no quid pro quo, on the part of the taxpayer. The payment [was] simply a windfall and, therefore, not income under paragraph 3(a) of the Act". (See Bellingham, supra, page 6082.)
[59] In the present case, none of the above is true. There is simply no evidence to justify the characterization of the payment of the settlement amount as punitive damages. It is my opinion that the evidence supports the allocation made by the Minister. The Minister considered the amount allocated for lost income as proceeds of disposition of intangible property, with the result that the amount included in income was 75 per cent of the settlement amount. It is my understanding that the Minister took the position that the appellant's business was materially crippled after it had waited for so long before being compensated, so as to amount to a total loss of goodwill. This led the respondent to conclude that the appellant had disposed of an intangible property. That position is to the advantage of the appellant, which was not taxed on the full amount received but only on 75 per cent thereof.
[60] The appellant argued its case on the sole basis that none of the settlement amount was taxable. In view of my conclusion, it is not necessary for me to determine whether the Minister was right in treating the settlement amount as proceeds of disposition of intangible property rather than income. Indeed, it is not in the power of this court to increase federal tax liability.
[61] In the circumstances, I find that the appellant has not shown on a balance of probabilities that the Minister was in error in reassessing the appellant as he did.
[62] For these reasons, I will dismiss the appeal with costs.
Signed at Ottawa, Canada, this 14th day of April 2003.
|
"Lucie Lamarre" |
J.T.C.C.
|
CITATION: |
2003TCC264 |
|
COURT FILE NO.: |
2001-1245(IT)G |
|
STYLE OF CAUSE: |
656203 Ontario Inc. v. The Queen |
|
PLACE OF HEARING: |
Ottawa, Ontario |
|
DATE OF HEARING: |
October 16, 2002 |
|
REASONS FOR JUDGMENT BY: |
The Honourable Judge Lucie Lamarre |
|
DATE OF JUDGMENT: |
April 14, 2003 |
|
APPEARANCES: |
|
Counsel for the Appellant: |
Emilio Binavince & Marc Binavince |
|
Counsel for the Respondent: |
Daniel Bourgeois |
|
COUNSEL OF RECORD: |
|
For the Appellant: |
|
Name: |
Emilio Binavince & Marc Binavince |
|
Firm: |
|
|
For the Respondent: |
Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada |