The Elias Rogers Company Limited (Appellant)
v.
Minister of National Revenue (Respondent)
Court of Appeal, Jackett C.J., Bastin and Shep-
pard D.JJ.—Ottawa, December 4, 1972.
Income tax—Business income, computation of—Cost of
installing rented heaters by fuel oil sales company—Whether
current or capital expense—Income Tax Act, section
12(1)(b).
Appellant company was in the business of selling fuel oil.
In order to increase its sales of fuel oil and meet competi
tion it also went into the business of leasing water heaters to
fuel oil customers and sought to deduct the cost of installing
the water heaters in 1966 ($14,450) and 1967 ($27,200) as
current expenses in computing its income for those years.
Held, reversing Kerr J. [1972] F.C. 543, the cost of
installing the water heaters was not a payment on account
of capital within the meaning of section 12(1)(b) of the
Income Tax Act, but a deductible business expense. The
fact that as part of the contract for the lease of the water
heaters the lessee promised to purchase oil exclusively from
appellant did not change the character of the expense.
APPEAL from Kerr J. [1972] F.C. 543.
Bruce Verchère for appellant.
G. W. Ainslie, Q.C., for respondent.
JACKETT C.J. (orally)—This is an appeal from
a judgment of the Trial Division [1972] F.C.
543 dismissing an appeal by the appellant from
its assessments under Part I of the Income Tax
Act for the 1966 and 1967 taxation years.
The appellant carried on a business that
included the selling of fuel oil. As part of its
fuel oil business and, in particular to facilitate
the marketing of fuel oil, the appellant acquired
and leased water heaters to fuel oil customers
or prospective customers.
The sole question involved in this appeal is
the question whether one element of the
expenses incurred by the appellant in connec
tion with the leasing of water heaters was an
expense of earning income that was deductible
in computing its annual profit from the business
notwithstanding section 12(1)(b) of the Income
Tax Act, which reads as follows:
12. (1) In computing income, no deduction shall be made
in respect of
(b) an outlay, loss or replacement of capital, a payment on
account of capital or an allowance in respect of deprecia
tion, obsolescence or depletion except as expressly per
mitted by this Part,
Each of the water heaters cost the appellant
$197.
When a water heater was leased, it was
leased under an agreement of which a sample
copy reads, in part, as follows:
Lease Agreement dated August 5, 1966 between THE
ELIAS ROGERS COMPANY LIMITED, 2200 Yonge
Street, Toronto 1, Ontario, hereinafter called the "Compa-
ny", and:
NAME MR. SAMUEL S. SUGAR
BILLING ADDRESS 609 COLDSTREAM AVE. TORONTO 19 ONT.
hereinafter called the "Customer".
The Customer hereby applies to and requests the Compa
ny to lease to the Customer a Rogers oil fired water unit
(hereinafter called the "appliance") Model No. 1000-30 for
use in the Customer's residence at 609 COLDSTREAM AVE.
The Customer agrees to lease from the Company and the
Company to lease to the Customer said appliance, subject
to the terms and conditions hereinafter contained:
1. Installation and all maintenance of the appliance shall
be provided solely by the Company and none other. The
Company reserves the right to refuse to rent the appliance
to the customer if in the opinion of the Company and at its
sole discretion, the cost of installation of the appliance is
excessive or abnormally high, unless the Customer agrees to
pay the additional cost of such installation.
2. The Company shall subject to the provisions of clause
7(b) hereof, at its expense maintain the appliance in effi
cient operating condition, provided, however, that the Cus
tomer shall, at all times, report promptly to the Company
any and every indication of defective operation of the
appliance. The Customer agrees not to remove, transfer,
tamper with, adjust, repair or otherwise in any way interfere
with the appliance without written permission from the
Company.
3. In consideration of this lease of the appliance, the
Customer will pay to the Company a monthly rental of
$2.50, payment whereof shall begin on the first day of the
month following installation of the appliance and thereafter,
such monthly rental shall be due and paid on the first day of
each and every month of the term hereinafter stipulated.
The Customer shall also pay to the Company together with
the aforesaid monthly rental and on the dates of payment
thereof during the term of this lease Provincial Sales Tax of
NO RENTAL CHARGE DURING THE FIRST SIX MONTHS OF THIS
AGREEMENT
4. As a condition precedent of this lease, the Customer
agrees to purchase from the Company exclusively during
the term of this lease all furnace fuel oil required to heat the
said residence and for the operation of the said appliance.
The sale to you of the furnace fuel oil and conditions of
payment thereof are covered by a separate oil contract.
7. This lease is hereby made for a minimum term of two
(2) years from the date hereof and shall thereafter continue
in full force and effect from year to year, subject however,
to right of termination thereof by either party hereto at the
expiry of the said two (2) year term or of any subsequent
year thereafter, as the case may be, by prior written notice
of two (2) months from one party to the other.
8. Upon termination of this lease, the Customer shall
surrender the appliance to the Company in the same general
appearance and condition as it was at the time of installa
tion thereof, ordinary wear and tear excepted.
9. The Company shall always remain the indisputable
owner of the appliance leased by virtue of these presents
and upon termination of this lease shall be entitled to
disconnect and remove the appliance from the aforesaid
residence. The Company will not be responsible for the
re-installation or installation or connecting of either the
former or any replacement water heater upon the termina
tion of this lease.
It is to be noted that, having purchased the
heater for $197, the appellant used it as a
source of profit by parting with possession of it
to a customer for a net rental of $2,50 or $2.99
per month and that, in addition to parting with
possession of the heater during that period, to
earn that rental, the appellant had to incur cer
tain expenses, namely,
(a) it had to install the heater at the beginning
of each lease, which involved, in 1966,
labour $27.05
wiring (labour & material) 22.45
material 14.90
transportation 12.00
Hydro inspection 3.00
overhead and profit 5.60
$85.00
and, in 1967, similar amounts totalling $100;
(b) it had to service the heaters during the
term of the lease;
(c) it had to remove the heater at the end of
the lease; and
(d) it had, in certain cases, to pay the manu
facturer either $28 or $36 for reconditioning
the heater between leases.
The plumbing and wiring fixtures and other
material that were placed in a customer's resi
dence as part of the installation of a heater were
of no value to the appellant when the heater
was removed and were simply left there.
The learned trial judge found that, while the
lease provided for a minimum term of 2 years,
the heaters were installed in the expectation
that they would be retained for a period of
years and the appellant's experience was that a
majority continued for several years.
The appellant treated the purchase price of
the heaters as the cost of capital assets. The
other disbursements connected with this branch
of the appellant's business, with the possible
exception of costs of reconditioning, were
deducted by it as operating costs. The respond
ent allowed all such costs as operating costs
except the costs of installation, which were
disallowed by him as being expenses the deduc
tion of which was prohibited by section 12(1)(b)
supra.
The learned trial judge approached the prob
lem by saying [at page 552]:
The heaters, when installed, are fixed capital assets.
Thereafter, but not before, they are revenue earning assets.
The expenses of installing them are preliminary and neces
sary to the revenue earning use of the heaters and the
expenses are incurred in order to bring them into such use. I
think that if the appellant had purchased from some supplier
heaters which at the time of purchase were installed and
ready to be used, the capital cost of the heaters to the
appellant as so installed would be the price paid to the
supplier, including installation charges. If that be so, why
should the installation expenses be classified differently
when the appellant instals the heaters?
The lease agreement for the heaters provides for a mini
mum term of 2 years and thereafter from year to year,
terminable at the expiry of the 2 year term or of any
subsequent year by prior written notice of 2 months. There
is always the possibility that a customer may terminate the
lease at any time, and some have done so within the 2 years,
but heaters are installed in the expectation on the compa-
ny's part that by and large the heaters will be retained for a
period of years, and the company's experience is that the
majority of the leases continue for at least several years and
that the heaters have an average useful revenue earning life
of upwards of 8 years. The installation expenditures are
made once and for all with a view to bringing into use a
capital asset for the enduring benefit of the company's
business, at least in the sense that the objective of the
company when it enters into a lease of a heater is that the
benefit will endure for some years and that the heater will
earn revenue throughout that period. The company would
hardly be in the business of leasing heaters without having
that objective, having regard to the cost of the heater plus
the cost of installation vis-Ã -vis the resulting net revenue.
The outlay for installation is an initial expenditure, substan
tial relative to the cost of the heater itself, and while the
expense recurs when a heater reaches the end of its useful
life and has to be replaced, or when a lease is cancelled and
the heater is removed and installed elsewhere, I do not think
that the expenditure involved can be classed as made to
meet a continuous demand or as a recurrent expenditure
that may be deducted as a current expense from the income
of the year in which the outlay is made. The heaters meet, it
is true, a continuous demand for fuel oil and they serve the
general purposes and general interests of the company's
business, but so do storage tanks and other fixed assets of
the company that unquestionably are capital assets.
The learned trial judge then referred to the
practice of the major oil companies in the treat
ment of such expenditures and to the account
ing evidence and concluded [at pages 554, 555]:
On my appreciation of the facts and the guiding features,
which I hope is a commonsense appreciation made with
proper regard for the business and commercial realities of
the matter, I find that the expenses of $14,450 and $27,200
incurred by the appellant during its 1966 and 1967 taxation
years on account of various costs relating to the installation
of water heaters constituted an outlay or payment on
account of capital within the meaning of section 12(1)(b) of
the Income Tax Act and, accordingly, were not deductible
from income.
In my view, the result in this case does not
depend in any way on the fact that the water
heater rental branch of the appellant's business
was started with a view to improving its sales of
fuel oil. I am of the opinion that the character
of the expenses is just the same as it would be
if the water heater rental business was carried
on quite independently. I see no parallel
between cases such as Regent Oil Co. Ltd. v.
Strick [1965] 3 W.L.R. 636, dealing with trans
actions whose sole purpose is the acquisition of
long term "ties" and a case such as this where
there are transactions that are a part of the
ordinary current operations of the business with
an incidental provision for "ties" in respect of
other business.
It is common ground that the expenses in
question were expenses of the appellant's busi
ness and were therefore deductible unless their
deduction is prohibited by section 12(1)(b) of
the Income Tax Act. Compare B. C. Electric
Ry. Co. v. M.N.R. [1958] S.C.R. 133, per
Abbott J. at pages 137-38.
The significant prohibition in section 12(1)(b)
is the prohibition of the deduction, in computing
income, of a "payment on account of capital".
These words clearly apply, in the ordinary case,
to the cost of installing heavy plant and equip
ment acquired and installed by a business man
in his factory or other work place so as to
become a part of the realty. In such a case the
cost of the plant and the cost of installation is a
part of the cost of the factory or other work
place as improved by the plant or equipment.
Clearly this is cost of creation of the plant to be
used for the earning of profit and not an
expenditure in the process of operating the
profit making structure. Such an expenditure is
a classic example of a payment on account of
capital.
What we are faced with here is, however,
quite different. The appellant has not used the
water heaters to improve or create a profit
making structure. Quite the contrary, the appel
lant has parted with possession of the heaters in
consideration of a monthly rental and it has no
capital asset that has been improved or created
by the expenditure of the installation costs. I
think it must be kept clearly in mind that, while
the installation costs are exactly the same as a
business man would have incurred if he had
bought a water heater and installed it in his own
factory, from the point of view of the question
as to whether there is a payment on account of
capital, there is no similarity between such an
expenditure and an expenditure made by a
lessor of a water heater to carry out an obliga
tion that he has undertaken as part of the con
sideration for the rent that he charges for the
lease of the water heater.
With great respect to the learned trial judge,
as it seems to me, once the matter is regarded
as an expenditure by a renter of equipment to
carry out one of the covenants in his leasing
arrangement, it becomes quite clear that it is not
an expenditure to bring into existence a capital
asset for the enduring benefit of the appellant's
business. It does not bring into existence any
asset belonging to the appellant. On the con
trary, as I view it, there is no difference
between the installation costs and any other
expenditure, such as those for repairs or remov
al of the heaters, that the appellant has to make
in the course of its rental business.
I should have thought that, in any equipment
rental business, while the cost of the equipment
and money spent to improve the equipment is
payment on account of capital, because the
thing rented is the capital asset of such a busi
ness, money spent in order to carry out the
lessor's obligations under the rental agreements
is cost of earning the income just as rents
received under such agreements is the revenue
of such a business.
If, for example, such a person rented a crane
on terms that he would move it to the site
where it is required and install it there, I should
have thought that the money spent on such
movement and installation would be costs of
earning the rental whether the period of the
lease was a day, a month, a year or five years.
Testing the matter another way, if in this case
the water heaters were rented at the appellant's
premises at a somewhat lower rental under an
agreement whereby, if the renter so desired, the
appellant would transport and install them at
the renter's expense, the transaction, from a
business point of view, would come to the same
thing but I do not think that there could be any
question of applying section 12(1)(b) to prohibit
the appellant from setting off the expenses of
movement and installation against the reim
bursement received from the renter.
Once it is established that the expenses in
question are otherwise expenses of operating
the business, the mere fact of extracting from
the customer an incidental promise to use the
appellant as his exclusive supplier of oil cannot,
in my view, change the character of the
expenses.
In my opinion the appeal should be allowed
with costs in this Court and in the Trial Divi
sion, the judgment of the Trial Division should
be reversed and the assessments under appeal
should be referred back to the respondent for
re-assessment on the basis that the installation
costs in question were deductible in computing
the appellant's income for each of the years in
question.
* * *
Bastin D.J. concurred.
* * *
SHEPPARD D.J. (orally)—This appeal arises
out of the outlays by the appellant, The Elias
Rogers Company Limited, in installing water
heaters free of charge and as a result had an
expenditure of $14,450 in the taxation year
1966, and $27,200 in the taxation year 1967,
which outlays the appellant contends were
made or incurred for the purpose of gaining or
producing income from its business and were,
therefore, deductible from its income under sec
tion 12(1)(a) of the Income Tax Act. On the
other hand the respondent contends that the
outlays were not deductible from the income as
they were part of the capital costs within sec
tions 11(1)(a) or 12(1 )(b).
The appellant company of Toronto, Ontario
sells fuel oil, sells and installs furnaces and
services heating equipment and also leases fuel
oil water heaters to customers. The fuel oil
business had been opposed by the use of gas for
purposes of heating and to meet that competi
tion and retain a market for fuel oil the appel
lant decided to install at its own expense fuel oil
water heaters.
In 1966 the appellant entered into several
agreements for the lease of water heaters to
customers for fuel oil (Exhibit A3) providing
for monthly rental of $2.50 to begin six months
following installation and 10 cents a month for
sales tax and for the appellant installing and
maintaining the water heaters. In 1967 the
monthly rental and the sum for sales tax were
to commence on the first day of the month
following installation, the other terms remained
the same.
The benefits which the appellant received
under such agreements were as follows:
(a) The rental of $2.50 per month or $30 per
year.
(b) The sale of 300 gallons of fuel oil at 20
cents a gallon or $60 per year. This is the
gross sum. The net is not given. The average
householder used 900 gallons of fuel oil per
year to heat his house.
(c) "As a condition precedent of this lease"
the customer agreed to purchase exclusively
from the appellant during the term of the
lease all furnace fuel oil to heat the custom
er's house and to operate the water heater.
(d) There were fewer cancellations among
customers who had rented the water heaters
than among other customers of the appellant.
In 1969, 1.7 per cent of the customers having
water heaters cancelled and 6.49 per cent of
those customers who did not have water heat
ers. In 1970, 2.2 per cent of those having
water heaters cancelled while 6.28 per cent
customers without water heaters cancelled.
(Exhibit Al)
Under the agreements the appellant incurred
the following liabilities:
(a) The purchase price of each water heater in
the amount of $197. The cost of installing the
water heaters was in 1966, $85 each and in
1967, $100 each.
Also, the appellant, under clause 2, under
took the cost of maintaining the water heater
in an efficient operating condition and in pur
suance of this clause, had contracted with a
third party for the cost of re-conditioning the
water heaters as required. The tanks were
expected to last eight years and the oil burner
20 years. The agreement provided for the
duration of the lease for a minimum of two
years and thereafter from year to year with
the right to termination on two months' notice
at the end of the year. However, as a matter
of public relations, the appellant had to
permit termination within the two years, but
the average duration of the lease agreement
was 6.8 years.
(b) The outlays here in question were made
by the appellant for installing those water
heaters under the agreements and the appel
lant, therefore, contends that the cost of
installing was for the purpose of gaining or
producing income from its business and there
arises the issue on this appeal.
In M.N.R. v. Algoma Central Ry. [1968]
S.C.R. 447 the Railway Company employed
another company to make a geological survey
of the district in which the railway operated
with a view to increasing the population and
thereby its traffic. Fauteux J. in delivering the
judgment of the Court stated at page 449:
Parliament did not define the expressions "outlay ... of
capital" or "payment on account of capital". There being no
statutory criterion, the application or non-application of
these expressions to any particular expenditures must
depend upon the facts of the particular case. We do not
think that any single test applies in making that determina
tion and agree with the view expressed, in a recent decision
of the Privy Council, B.P. Australia Ltd. v. Commissioner
of Taxation of the Commonwealth of Australia ([1966] A.C.
224, [1965] 3 All E.R. 209), by Lord Pearce. In referring to
the matter of determining whether an expenditure was of a
capital or an income nature, he said, at p. 264:
The solution to the problem is not to be found by any
rigid test or description. It has to be derived from many
aspects of the whole set of circumstances some of which
may point in one direction, some in the other. One consid
eration may point so clearly that it dominates other and
vaguer indications in the contrary direction. It is a com-
monsense appreciation of all the guiding features which
must provide the ultimate answer.
The learned President, after considering all the facts in
the present case, decided that the expenditures in issue
were not of a capital nature within the provisions of s.
12(1)(b) of the Income Tax Act. We agree with his conclu
sion. Hence, the appeal should be dismissed with costs.
The absence of a rigid test and the necessary
regard to the "whole set of circumstances" has
led to some difficulties in such cases.
In Usher's Wiltshire Brewery Ltd. v. Bruce
[1915] A.C. 433, the Brewery reduced the
rental of a public house in order to obtain
covenants making it a tied house and the Brew
ery Company was held entitled to deduct the
reduction in rental from its revenue.
In B. P. Australia Ltd. v. Com'r of Taxation
[1966] A.C. 224 the Company agreed to pay to
garage owners a sum for the promise to buy gas
exclusively from B. P. and the Privy Council
held that the amount paid was an expenditure of
income. On the other hand in Regent Oil Co. v.
Strick [1966] A.C. 295, under similar facts, the
House of Lords held the amount paid to be a
capital payment. These cases differed in the
circumstances. The Usher's Wiltshire Brewery
Ltd. (supra) case was a reduction of that sum
otherwise received as income. The B. P. Aus-
tralia Ltd. (supra) case and the Regent Oil Co.
(supra) case may be regarded as outlays for
advertising.
The costs of installation in the case at Bar
should be regarded as services of the appellant
made for the purpose of gaining or producing
income within section 12(1)(a). The agreement
contains two provisions:
(1) The lease proper is contained in the open
ing clause whereby the customer "applies to
and requests the Company to lease to the
Customer ... for use in the Customer's resi
dence at 609 Coldstream Ave. The Customer
agrees to lease from the Company and the
Company to lease to the Customer said appli
ance, subject to the terms and conditions
hereinafter contained:" together with clause 3
and the following clauses. This lease is com
pleted for the appellant by delivery by the
appellant to the customer and that delivery
may be anywhere or at the residence of the
customer, but certainly without installation
and the customer is thereby restricted to use
the water heater "in the Customer's residence
at 609 Coldstream Ave."
(2) Collateral provisions for the services of
the appellant in installing and maintaining the
water heater were contained in clauses 1 and
2. The distinction between a clause forming
part of the lease and a collateral provision
was in the minds of the parties as indicated in
clause 4 which begins "as a condition prece
dent of the lease," clauses 1 and 2 do not
contain any such words as those prefacing
clause 4. Clause 3 makes the rental to begin
to run following the installation, but the
appellant could allow anyone, even the cus
tomer, to install the water heater. There is
nothing in the lease proper to prevent clause
1 from being a collateral clause.
As stated by Lord Morris of Borth-y-Gest in
Regent Oil Co. v. Strick (supra) at page 329:
... There is a difference between the profit yielding
subject and the process of operating it ....
Here, the water heater is the "profit yielding
subject" and the installation in clause 1, and the
maintenance in clause 2, are "the process of
operating it", hence are services rendered pur
suant to these collateral clauses and result in
the outlays in question. The expenses of
maintenance cannot be a capital outlay as these
are made from time to time as the need arises
and not made "once and for all" within British
Insulated and Helsby Cables Ltd. v. Atherton
[1926] A.C. 205 (Viscount Cave, L.C. at page
213). As the maintenance of the water heater
must be "for the purpose of gaining or produc
ing income" within section 12(1)(a), the installa
tion must be for the same purpose a service to
be rendered to the appellant and likewise within
section 12(1)(a).
The appeal will, therefore, be allowed with
costs and I agree with the disposition of the
learned Chief Justice.
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.