Maurice Boisvert:— These appeals concern assessments against two corporations with respect to the 1966 and 1967 taxation years, in the case of Lagueux et Frères Inc, and 1966 only, in the case of Lagueux et Théberge Inc.
The cases were heard at Quebec City, Province of Quebec, on June 15, 1971, by the Tax Appeal Board as it was then constituted.
Both appeals involve an interpretation of contracts. The parties, who are proceeding jointly, contend that the contracts in question are for the leasing of machinery used in their logging operations, whereas the respondent contends that they are sales contracts giving entitlement to a capital cost allowance and not a deduction for rental paid for the use of the said machinery.
Lagueux et Frères Inc, now incorporated under the name of Industries Maibec Inc and hereinafter called “Lagueux”, operates a sawmill at St-Pomphile, L’islet County, P Q. Lagueux et Théberge Inc, now incorporated under the name of Opérations Forestières Maibec Inc and hereinafter called “Théberge”, carries on wood cutting operations on forest concessions in the State of Maine, USA. Its operations consist in obtaining timber cutting rights from individuals or companies, and it hauls the timber to the St-Pamphile sawmill. The evidence, which was not refuted, established that the timber supply contracts were for a one-year duration only; therefore it was more practical for the two companies to lease machinery and trucks for both the sawmill and lumbering operations.
On April 1, 1965, Lagueux leased a GMC truck from Corporate Plan Leasing Limited for a period of thirty-six months for a consideration of $3,425.76, of which $95.16 was payable in advance and the balance in consecutive monthly instalments of $95.16 each. During 1966, Lagueux paid $1,141.92 in rental. Since all the contracts are similar in substance, for purpose of the decision, only the one filed as exhibit A-1 need be reproduced:
(TRANSLATION)
1. The Lessee undertakes to lease from the Lessor, and the Lessor leases to the Lessee, the movable property described in each of the schedules herein contained, for the term and at the rental payable as indicated in the said schedules, the whole under the terms and conditions contained and set forth in this agreement and in the schedules.
2. The movable property described in any one of the schedules is hereinafter designated as “equipment”, and in the case of more than one schedule, all the movable property described in all of the schedules is hereinafter collectively designated as “equipment”, depending on the context.
3. The Lessee shall not have any real right over the equipment and cannot acquire such a right hereunder, and shall have only the right to use the equipment as Lessee in accordance with the conditions herein contained.
4. The Lessee shall, at its own expense:
(a) maintain the equipment free from any lien or encumbrance and from ali attachments, execution or legal proceedings;
(b) obtain all permits, licences and registrations required for the use of the equipment by the Lessee;
(c) pay all fees, costs, expenses and taxes relative to the equipment or its use by the Lessee;
(d) maintain the equipment in good operating condition, substantially the condition it was in at the commencement of the present lease, except for depreciation due to normal wear and tear;
(e) permit the Lessor to inspect the equipment at any convenient time;
(f) take out insurance policies on the equipment from responsible insurance companies giving the type of coverage and the amounts of coverage approved by the Lessor and with losses payable to the Lessor and to the Lessee according to their interests;
(g) promptly return the equipment at its expense to the Lessor after the expiration or termination of the term of the lease.
5. Without the prior written consent of the Lessor, the Lessee agrees
(a) not to sell, offer for sale, transfer, mortgage, pledge, sublet or lend the equipment and not to compromise it in any way;
(b) not to remove it or permit it to be transported out of Canada, and not to abandon possession of it;
(c) not to install the equipment in or secure it to a building, or immobilize it in such a way that the Lessor cannot. validly exercise its right to take over the equipment on the expiration or termination of these presents;
(d) not to change, add to or improve the equipment.
6. The Lessee undertakes to idemnify and compensate the Lessor for all losses, penalties, fines, costs, expenses and expenditures incurred by the Lessor with respect to the equipment as a result of loss, theft, destruction or damage to the equipment or of injuries suffered by a person or his death, or of loss, destruction or damage caused to any property in any way whatever by the equipment or as a result of its use, possession or operation by the Lessee or by any other person whether or not authorized by the Lessee.
7. It is expressly agreed that the Lessor offers no guarantee or representation, express or tacit, with regard to the quality, condition, performance, Suitability or capacity of the equipment, or to the effect that the said equipment complies with the laws in force at the location(s) where the Lessee may want to use the equipment.
8. The Lessor may affix on the equipment plates or other marks that the Lessor deems suitable indicating that the equipment is the property of the Lessor, and the Lessee agrees that it will not remove, obliterate, erase or cover such plates or marks, and will repair any damage to or replace the said plates or marks.
9. The parties agree that if the Lessee failed to pay any sum payable hereunder (whether or not payment had been requested), or if it failed to observe any of the terms and conditions of this agreement, or if a receiving order were issued against the Lessee, or if it called a meeting of its creditors, or if it made any assignment in favour of its creditors, or if it made an arrangement or composition with its creditors, or if the Lessee otherwise acknowledged its insolvency, or if it concluded a deed of sale or an outright sale of its assets, or if the Lessee ceased to do business, or if an attachment were or threatened to be executed on the Lessee’s assets, or if a distraint against the Lessee’s assets took place, or if the Lessee left any judgment against it unsettled for a period of ten days (without appealing it), at such time and in any such case, at the Lessor’s option, this agreement may be terminated by the Lessor (without any prior notice or request on the part of the Lessor, even if the Lessor may have allowed a similar incident previously without exercising its rights and privileges hereunder) and at such time the Lessor shall be entitled to recover and repossess the equipment (the Lessee undertaking to pay to the Lessor the cost of such re- posession) and for that purpose to enter any premises occupied by the Lessee, and the unpaid balance of the rental shall immediately become due and payable. It is agreed and understood that such termination of this agreement shall not affect or prejudice any other claim of the Lessor against the Lessee in accordance with this agreement, or the Lessor’s right to enforce such claim by action at law or otherwise.
10. This agreement as originally executed contains schedules numbers .. . . An additional schedule may be attached at any time or several schedules may be attached at any time or from time to time. Any additional schedule shall form an integral part of this agreement from the date of such schedule provided that such schedule is signed on behalf of the Lessee by the Lessee’s President, Vice-President or Secretary-Treasurer, and countersigned on behalf of the Lessor by the Lessor’s President, Vice-President or Secretary-Treasurer. When countersigned by the Lessor, the signatory for the Lessor shall, conclusively for all purposes, be presumed to be the Lessor’s Secretary.
11. In the interpretation of this agreement that word “equipment” means all the equipment described in each or all of the schedules attached hereto, and each and every one of its parts and any part replaced or substituted.
12. Time shall be of the essence of this agreement.
13. This agreement shall be subject to the laws of the Province of Quebec. 14. Should the Lessor assign this agreement or the sums payable hereunder, the Lessee undertakes to recognize such an assignment whether or not the Lessor has given notice thereof to the Lessee, and to pay all the amounts payable hereunder as indicated in writing from time to time by the assignee.
15. The Lessor and the Lessee agree that this document constitutes the complete agreement between the parties and shall benefit and bind the respective parties and their respective heirs, executors, administrators, legal representatives and successors, on the condition, however, that neither this agreement nor any right relating thereto may be transferred by the Lessee without the written consent of the Lessor. This agreement may not be modified or amended in any way other than by a written document executed by the two signatories, or in accordance with the provisions set forth in paragraph 10 of this agreement.
16. This contract shall be binding on the Lessor only when countersigned by the Lessor under its corporate seal.
On April 30, 1965 Corporate Plan Leasing Limited sent the following letter to Lagueux:
(TRANSLATION)
Re: Lease Contract No. 1342
This letter concerns Contract No. 1342 and any schedule attached thereto between the undersigned as Lessor and you as Lessee.
You may purchase the equipment specified in each individual schedule upon the expiration of the initial term of the lease for a price equivalent to 5 per cent of the original cost payable at the end of the said period, provided that you have given the undersigned not less than thirty (80) days’ and not more than sixty (60) days’ written notice of your intention to do So, and that you have duly and punctually paid the rental mentioned in the contract on the dates and in the manner specified therein, and that you have duly and punctually observed and met each and every one of the terms, requirements and conditions of the contract.
The two appellants thus leased numerous pieces of equipment and machinery. The contracts are couched in similar terms and all contain an option to purchase upon expiration of the leases.
A question of law is involved: Does this type of contract constitute a sale or a lease?
In order to rule on these appeals, the matter must be placed in the context of business as it is conducted nowadays. The leasing of machinery, trucks, vans, bulldozers, automobiles and so forth is a widespread business or industry.
Wheatcroft’s comments in The Law of Income Tax, Surtax and Profit Tax, on page 1272-1-549, describe very well what should be understood by such a contract:
Hiring and hire-purchase payments
Just as rent of business premises is a deductible expense so are hiring charges paid for hire of other capital assets. A problem, however, arises when a trader enters into a hire-purchase agreement for the use and ultimate acquisition of a capital asset such as machinery. The normal form of such an agreement today provides for (i) an advance payment, often described as consideration for the ultimate option to purchase, (ii) a series of monthly payments for hire of the article, which determine should the hirer return the article, and (iii) an option to the hirer, if and when he has paid all the monthly payments, to acquire the article for a nominal sum. It is also common to insert a clause providing for a further payment if the article is returned before the last payment and there is also usually an obligation to maintain the article in good condition during the currency of the agreement.
On such an agreement the strict view would appear to be that the advance payment and the payment ultimately paid on exercising the option are capital payments and not deductible in computing the trader’s profit, although they may entitle him to capital allowances, whilst the monthly payments, being expressed as hiring charges, are deductible and so are not eligible for capital allowances. Any other view involves disregarding the form of the transaction.
In these appeals we are confronted with the problem described above. However, we are enlightened by the decision in Darngavil Coal Co Ltd v Francis (Surveyor of Taxes), 7 TC 1. On page 11 it reads:
Here is a Company which gets its wagons under what is known as a hire- purchase agreement. It pays so much a year. It undertakes to keep the wagons in repair. It pays so much a year for a period of years and at the end of that period of years it has an option, if it likes, to make what is practically a nominal payment, and then the wagon belongs to it. It is perfectly clear, on many decided cases, that during the course of the period of years the wagon still is the property of the Wagon Company and not of the Coal Company. But the Coal Company wishes to use it, and accordingly an extra payment is made in respect of that. No discrimination is made between the two kinds of payment; it is a lump sum that is paid. Now, in that case there are two things going on concurrently—there is a sale and purchase agreement under certain terms—not a sale at the present moment, but an option on certain terms on a future date to have a sale—and on the other hand there is also concurrent with that a hiring agreement. Now, it is equally clear that so far as the Coal Company have the use of the wagon by the hiring of it during that time, that is a properly deductible expense, just as if the Coal Company had no wagons at all but simply hired their wagons from day to day, in which case it would be a certainly deductible expense. It is equally clear, I think, that they could not claim to deduct the whole of what they paid to the Wagon Company, because a large portion of what they paid is really a payment for an option at a future date to get a wagon at a sum that is far under its real value.
In Siblock v MNR, 9 Tax ABC 413, 54 DTC 38, W S Fisher, QC, then a member of the Tax Appeal Board, ruled that rental paid for leasing of various kinds of machinery was deductible.
It should be mentioned that before 1963 the Income Tax Act contained provisions affecting this type of contract. Section 18 read in part as follows:
18. (1) A lease-option agreement, a hire-purchase agreement or other contract or arrangement for the leasing or hiring of property, except immovable property used in carrying on the business of farming, by which it is agreed that the property may, on the satisfaction of a condition, vest in the lessee or other person to whom the property is leased or hired (hereinafter in this section referred to as “lessee”) or in a person with whom the lessee does not deal at arm’s length shall, for the purpose of computing the income of the lessee, be deemed to be an agreement for the sale of the property to him and rent or other consideration paid or given thereunder shall be deemed to be on account of the price of the property and not for its use; and the lessee shall, for the purpose of a deduction under paragraph (a) of subsection (1) of section 11 and for the purpose of section 20, be deemed to have acquired the property,
under the contract or arrangement on account of the rent or other consider ation.
Since this provision has been removed from the Act it would be pointless to quote it in its entirety.
By rescinding this provision the legislator certainly wanted to bring rent paid under such contracts under the application of section 12 of the Act which states that any “outlay or expense for the purpose of gaining or producing income from property or a business” is deductible provided it does not violate any other provision of the Act.
In this case it is obvious that the business depended for its existence on the leasing of pieces of equipment, machinery, trucks and so on. It was up to the appellant’s directors to decide what was the most profitable for the operation of the business. No one is obliged as the head of a business or as a taxpayer to make an enormous capital outlay for equipment if he can operate in another way, gain the same income and make the same profits which become taxable. The net profit of Lagueux amounted to $150,253 for 1966 and $80,379 for 1967. For 1966 the profits of Théberge amounted to $33,551. As one might guess, no evidence was adduced on the amount of the capital cost of the leased machinery, and once deducted, to what extent the taxable net profits would have been affected.
In his Reply to the Notice of Appeal, the respondent cites Marcotte v MNR, 25 Tax ABC 129, 60 DTC 519. The facts proved in that appeal neither closely nor vaguely resemble those proved in the present appeals. I had before be a question of the interpretation of contracts — that and only that. The contracts are clear and leave no doubt as to form or substance. Furthermore, they are all contracts between persons dealing at arm’s length. They are contrary neither to the Act nor to public order.
The conclusions I have arrived at are supported by the following comments taken from Sale of Goods by G H L Fridman, on page 8:
Contracts of sale of goods, therefore, must be differentiated from such contracts as hire and hire purchase, options to buy, and mortgages of goods. In hire purchase, for example, the ultimate intention of the parties is that property should pass from the bailor to the bailee: but something more must be done, beyond the making of the contract, before this result is achieved. Indeed, this is so true that it may be said that a person who buys on hire purchase is not in law a buyer at all, but is simply one who pays for the hire of goods plus an option to buy. He may never exercise his option to buy: there is no legal compulsion upon him to do so. It is not until such option has been exercised by him that he becomes a buyer of the goods.
For the above reasons, the appeals are allowed.
Appeals allowed.