Francon Limitée (Appellant)
v.
Minister of National Revenue (Respondent)
Court of Appeal, Jackett C.J., Thurlow J. and
Perrier D.J.—Montreal, October 10, 1973.
Income tax—Business income, computation of—Contrac-
tor obtaining early payment of holdbacks—In what year
amount assessable.
A building contractor entered into an agreement with its
customers under which the contractor received interest on
holdbacks before they became payable e.g., when the work
was certified as satisfactory. This the contractor did by
purchasing interest-bearing notes of third parties to the
contractor's customers, which became payable on the due
dates of the holdbacks. The contractor was assessed to
income tax on the assumption that this arrangement amount
ed to payment of the holdbacks in the year the notes were
purchased rather than in the later year when the holdbacks
became payable.
Held, the assessment could not stand. While the amount
of the holdbacks must be taken into account in the year in
which the contractor received payment of the amount there
of, the contractor was entitled to deduct in that year the
amount it paid out to obtain payment of the holdbacks. The
amount of the holdbacks would of course have to be
brought into income in the year the work was certified.
APPEAL.
COUNSEL:
Antoine J. Chagnon for appellant.
Alban Garon and Wilfred Lefebvre for
respondent.
SOLICITORS:
Ogilvy, Cope, Porteous, Hansard, Marler,
Montgomery and Renault, Montreal, for
appellant.
Deputy Attorney General of Canada for
respondent.
JACKETT C.J. (orally)—This is an appeal from
a judgment of the Trial Division dismissing with
costs an appeal from re-assessments of the
appellant, who is a building contractor, under
Part I of the Income Tax Act for the 1967, 1968
and 1969 taxation years.
It is common ground that whether or not the
appeal is to succeed depends upon the proper
treatment for tax purposes of certain payments
under transactions between the appellant and its
customers which, it is agreed, are typified by
the documents that evidence an arrangement
between the appellant and the Quebec Auto-
route Authority.
In the normal course of its business, amounts
payable to the contractor are withheld by its
customers (pursuant to the construction con
tracts) as "holdbacks" for a certain period of
time after completion of the work and are then
payable subject to specified conditions—e.g.,
certification of the work as satisfactory.
It is common ground that, at least for tax
purposes, holdbacks are not, in the case of the
appellant, brought into the computation of its
income for any year until they are received or
receivable.
The re-assessments in question were made on
the assumption that, although not payable until
a subsequent year, the holdbacks in question
"were nevertheless paid by the customers and
received by the contractor in the years 1968 and
1969" and on the further assumption that "for
the release or payment of the holdbacks, securi
ties were given to the customers by the Appel
lant to guaranty the work done."
The holdbacks in question apparently do not
carry adequate interest. In order to obtain ade
quate interest income on holdbacks payable to it
in the future, the appellant made the arrange
ments with its customers that give rise to the
problem in this case.
That arrangement was, in each case, to the
following effect:
(1) the appellant would purchase a term note
of a third person made payable to the custom
er in an amount equal to the holdback and
maturing on the date when it was expected
that the holdback would become payable;
(2) the term note would be placed "in
escrow" with a bank and would not be
released except on the written authority of
the customer;
(3) the customer would then "release" the
holdback to the appellant;
(4) the interest on the term note would
"accrue" for the appellant's benefit and,
when received by the customer from the
maker of the note, would be paid by the
customer to the appellant; and
(5) at the maturity date of the term note, the
face value would be paid to the customer,
who would in turn "release" the money to the
appellant "under the same terms that would
have applied" to the holdback.
The position taken by the appellant in the
Trial Division was that the holdbacks were not
in fact paid under the construction contracts in
1968 and 1969 and should not, therefore, be
included in computing the appellant's incomes
from its business for those years.
The learned trial judge rejected this conten
tion and, on my first reading of the matter, I
agree with him. I cannot think of any interpreta
tion to give to the provision in the arrangement
that the customer "will then immediately release
... the holdbacks" other than that it is a
requirement that the customer will pay the hold-
backs immediately notwithstanding that it is
otherwise entitled to hold back payment for a
period of years. However, it is not necessary to
express any firm opinion on this question as, in
my opinion, the appeal must be allowed even if
the holdbacks were paid in 1968 and 1969.
In this Court the argument of the appellant, as
set out in its Memorandum of Fact and Law,
suggests a new approach to the problem. I refer
to the following paragraphs of the Memoran
dum:
5. Upon entering into a special arrangement with a cus
tomer, the Appellant did not receive payment of the hold-
back but only received an amount equal to that of the
holdback.
6. Upon entering into a special arrangement with a cus
tomer, the respective obligations and rights deriving from
the initial construction contract of both involved parties
remained intact except that, thereafter, the holdback instead
of being held in the form of cash was held in the form of a
suitable security.
7. The substance rather than the form of the special
arrangements must be seeked in order to ascertain the tax
consequences, if any, deriving from such special
arrangements.
8. By concluding that the amount of a holdback was
received by the Appellant upon entering into a special
arrangement, one must also conclude that the Appellant
became enriched after it entered into such a special
arrangement.
9. According to the facts, the Appellant immediately after
having entered into a special arrangement was neither richer
nor poorer than it was immediately before. The Appellant
remained after entering into such special arrangements a
contingent creditor for amounts equal to that of the
holdbacks.
10. According to the facts, if the amount of the holdbacks
are held to have been paid to the Appellant at the time it
entered into special arrangements, the Appellant's cash flow
should necessarily at the same time, increased by a similar
amount whereby the Appellant would have been in a posi
tion to pay any taxes on account of such receipts of moneys.
On the contrary, according to the facts of this case, the
Appellant, in order to pay the income taxes as per the
re-assessments, would have to borrow in order to meet this
tax liability.
11. If one was to accept that the Appellant was in fact
paid the amount of the holdbacks upon entering the special
arrangements, one would also have to accept that the Appel
lant was not thereafter entitled to any further payments
from its customers. Under such an assumption, the Appel
lant's status would have changed from a contingent creditor
to a fully paid creditor.
12. Under the assumption specified in the above para
graph, how can we explain the amounts to which the Appel
lant, after having entered into special arrangements, was still
entitled to receive at the time the holdbacks become due and
payable except by accepting that the suitable securities
given constituted a deposit made by the Appellant in guaran
tee of its obligation under the initial construction contracts.
In my view the appellant has misdirected its
attempts to obtain proper tax treatment. In
order to obtain payment of a holdback in the
year when the work was completed, it entered
into an arrangement under which it had to dis
burse, in that year, an amount equal to the
holdback and obtained a right to payment of an
amount equal to the holdback at the time when,
and subject to the conditions upon which, the
holdback would have been payable if its pay
ment were not advanced under the arrangement.
Instead of claiming, in the year when the hold-
back was received as part of its income, deduc
tion of an amount disbursed in the same year to
obtain such income payment, the appellant has
been wrongly contending that it did not receive
the income payment at all.
In my view, the arrangement made by the
appellant with its customer in respect of the
holdbacks was one of the transactions of its
construction business and, as it was carried out
in the process of earning the profit of the busi
ness, it was a transaction on revenue account
and not on capital account. It follows that, not
only must the appellant take into its profit and
loss account, for the year when it was received,
the holdback immediate payment of which was
received as a result of that transaction, but it is
entitled to include, as a debit in its profit and
loss account for that year, what it had to pay
out in the year to obtain immediate payment of
the holdback. It follows, also, that it must take
into profit and loss account for some subse
quent year an amount received under such reve
nue transaction (i.e., when the holdback would
be payable under the construction contract).
The result, as I see it, is that, apart from the
special transaction, the effect of the amount
held back on the appellant's profit and loss
accounts would have been
(1) Year of completion
— nil
(2) Year of certification
— holdback payment on revenue side;
whereas, as a result of the arrangement with the
customer, the result is
(1) Year of completion
— holdback on revenue side
— amount equal to holdback on debit side
(2) Year of certification (if certified)
—amount equal to holdback on revenue side.
(Interest payments would also receive their
appropriate treatment in the accounts.)
It follows that, in my view, the appeal should
be allowed, the judgment of the Trial Division
should be set aside, and the assessments
referred to in the Notice of Appeal should be
referred back to the respondent for re-assess
ment on the basis that the amounts paid by the
appellant for the "securities" referred to in
paragraph 5 of the Notice of Appeal were dis
bursements on revenue account that should be
taken into account in computing its profits or
losses. I am of opinion that we should hear
counsel on the question of costs.
* * *
THURLOW J. and PERRIER D.J. concurred.
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.