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.