KEARNEY, J.:+-This action concerns a profit of $10,957.25 realized by the appellant in its taxation year 1961 on the sale, early in 1961, of a shopping centre which it had caused to be erected on a site consisting of two adjacent parcels of land situated on 97 th Street and 129B Avenue in the City of Edmonton, which it had acquired in 1959.
On June 30, 1959, Killarney Properties Limited (hereinafter called Killarney Ltd.) acquired, for the sum of $1 and other good and valuable consideration, from Kisbey Properties Limited (hereinafter called Kisbey Ltd.), with the exception of the westerly thirty-one feet throughout Lots Twenty-one (21) to Twenty- four (24), inclusive, in Block Twenty-four (24), in the City of Edmonton (Ex. 2), but, according to an affidavit of G. Edward Trott, agent for Killarney Ltd., attached to the deed, the true consideration paid by the transferee amounted to $20,000. Kisbey Ltd. had acquired the said property from the City of Edmonton.
On September 4, 1959, as appears by Exhibit 3, the City of Edmonton, in consideration of $3,500 paid to it by Kisbey Ltd. and Killarney Ltd. (the said Kisbey Ltd. having assigned its interest to the said Killarney Ltd. by assignment dated July 16, 1959), transferred to Killarney Ltd. an adjoining piece of property described as Lot 20 of Block 24. Attached to the deed is an affidavit of the aforesaid agent of Killarney Ltd. in which he declares that the present value of the land, in his opinion, amounted to $10,000: Asked how did Killarney Ltd. happen to be receiving transfer of Lot 20 from the City of Edmonton, he replied: ‘‘Lot 20 was adjacent to the other lands and so Killarney undertook to buy.’’
The witness filed as Exhibit 4 a list giving the names and occupations of his friends and associates who became shareholders of the Company, together with their respective shareholdings ; it showed 110 shares. The first name on the list is his own. He owned three shares and his loan to the Company amounted to $600. The last name on the list is Kisbey Ltd. ; the latter held twenty shares.
Kisbey Ltd. was not only the largest shareholder but. also the largest lender, and its loan amounted to $11,798.
The witness stated that before Kisbey Ltd. sold the land to Killarney Ltd. it had not taken any steps toward construction of a shopping centre, nor had it arranged for any leases, but it had consulted architects.
“Q. Who arranged for these shareholders of Killarney to put money into the company ? A. Myself.
Q. What was done with this money ? A. It was used to pay for the land.’’
The anticipated yield, based on the net return on the project before depreciation and on the cash invested, which amounted to $30,000, would rise to 56 per cent when the mortgage had been retired, which, it was estimated, would be in ten years time. In the opinion of the witness, such return was much higher than normally found in most revenue properties due, to a large extent, to the increase in the value of the land as a result of development. After selling the property in 1961 for $150,000—of which $133,000 was paid in cash and $17,000 in the form of a second mortgage—a cash balance of close to $30,000 remained in the treasury and the Company, the witness said, re-invested it in an office-and-retail-type development of a larger size, in Edmonton, being handled by the group of which Killarney was a part. Returning to the history of the shopping centre, Mr. Martenson stated that the building contract was given to the lowest bidder, Prince Construction Company Limited, for an amount of $78,000 (Ex. 5).
Construction began in September 1959 and it was anticipated that the building would be completed in six or eight weeks, which would be in late October or November, but it was near Christmas when the tenants were able to move in and the shopping centre was not completely finished until February 1960. The work was carried out much more slowly than most contracts of the same nature. The contractor, without the consent of the Company, made many changes at the request of tenants with respect to leasehold improvements. This led to difficulty in negotiating a settlement with the tenants, but, finally, under threat of legal action against them, ‘‘the contractor settled rather than face this thing in court’’. The shopping centre was completely leased in March 1960.
Messrs. Walden and Gourlay, both directors of Killarney Ltd., were in receipt of modest salaries for looking after collection of rents and dealings with the tenants.
No mortgage money had been arranged for until after the construction contract had been allotted. Unsuccessful efforts had been made to secure a loan from regular life insurance companies at interest rates of 7 to 714 per cent with no bonus, and an interim construction type of mortgage was obtained on September 11, 1959 from First Investors Corporation Limited for $90,000 at 7 per cent and a $10,000 bonus, the due date of which was November 1, 1961 (Ex. 6).
The witness stated that the following offers of purchase were reecived. On August 6, 1959, Vergil Chambers, of Edmonton, offered, through his solicitors, to purchase the shopping centre for $130,000, payable $40,000 cash and a mortgage for $90,000, amortized over ten years, with interest at 7 per cent (Ex. 7). The Company, by letter, refused the offer and informed the pur- chaser that, at the price and on the conditions mentioned, there was no possibility of a sale. The letter went on to say: ‘The only thing we could suggest is that Mr. Chambers offer to purchase all the outstanding shares in Killarney Properties Ltd. for $40,000. If all the shareholders agree to this he would then take over the company as is.’’ (Ex. 8).
Mr. Martenson stated that the property was never listed for sale with any real estate agent and added that he was interested, from an agent’s point of view, in having the property for sale and earning a commission, but that his request to obtain the listing was rejected by the directors as a whole.
On June 1, 1960, an offer was received from Nielsen Investment Ltd. for $155,000, payable $15,000 cash, plus an equity in a certain piece of property, and the balance, amounting to $98,000, payable $1,000 per month, with interest at 7 per cent (Ex. 9). The aforesaid offer was rejected.
On December 20, 1960, an offer was received from George Mah, which, the witness said, resulted in the ultimate sale of the property. The price was $137,500, payable $4,000 cash, with an additional $45,000 payable on the possession date, $84,000 by way of mortgage—to be arranged by the purchaser—and $4,500 by a second mortgage to Killarney Ltd. as vendor (Ex. 10). The offer was refused, but on January 17, 1961, Mr. Mah, through his attorneys, made a second offer (Ex. 11) amounting to $150,000, payable $133,000 in cash and $17,000 by way of second mortgages payable over a period of ten years at seven and one-half per cent interest. The offer contained the following condition :
“This offer is subject to the confirmation by North American Life that they will grant a mortgage to Mr. Mah on the above referred property in the sum of $85,000. All adjustments will be as at the date of possession and the date of possession is set at February 1st, 1961.”
The offer was accepted.
The Company paid to the agent, Melton Real Estate Co., which handled the transaction, $1,000 as commission. The regular tariff, the witness said, would amount to $6,500. Mr. Martenson stated that, at the date of purchase, the First Investors mortgage was not discharged because the Company was unable to obtain, to repay it, a conventional mortgage from another source. Mr. Mah arranged a new mortgage and retired the existing mortgage. Asked what considerations influenced the directors in deciding to sell, the witness replied :
“They were concerned by that time that they had been unable to arrange a mortgage to pay this First Investors mortgage which was due that same year. This was a large debt which .- was about to mature, and many attempts had been made to obtain a long-term mortgage through a. conventional company at conventional rates of 7 or 714 per cent, and we had been unsuccessful, so this was a consideration from the point of view of servicing this debt. There was also the consideration that the tenants still were fairly unhappy, and we had not solved all our problems with them by this time, and this was a frustrating thing for the property manager, and the directors. A third factor was also that the building was not well built and there were a series of problems, none really large in themselves, but many in number and quite irritating, things like doors not closing properly, sidewalks in front falling away from the building and that type of thing, so this was a consideration also that there might be extensive maintenance problems in the future that would not only cost money but further create tenant and landlord problems. And I think a fourth factor is that this was the first building or development ever undertaken by. this group and they were quite inexperienced, and most problems probably loomed much larger than they would appear to a developer who was experienced in this sort of thing, and this was definitely another factor in influencing the directors to accept this offer.’’
The witness stated that, in the fall of 1960, he contacted at least five mortgage companies and that other directors contacted at least another five. None of the companies showed any interest except North American Life Assurance Co. John Klink, the manager of that firm, agreed in principle to the idea but he had exhausted his quota of funds and could give no assurance that the Company would get any conventional mortgage funds in the future through his firm. The witness added that, in fact, North American Life Assurance Company eventually did grant a mortgage.
In cross-examination, counsel for the respondent elicited the following information from Mr. Martenson. This was not the first business venture that he and a number of associates had entered into. He and a number of them, in 1959, bought substantial acreage, sold enough to pay back the cost and held the balance.
About 105 shares of the Company were issued and the price paid was one cent a share. Apart from Kisbey, which was the original owner of the property, the amounts advanced as loans by the other shareholders amounted to about $17,000, and, together with the price of their. equity stock, their investment in the Company totalled $18,000. . e
The witness was asked to file a copy of minutes of a directors’ meeting of the Company dated July 6, 1959 (Ex. A), which sets out the memorandum of association; I shall comment upon it later.
The witness agreed that the construction was started in September 1959 and that prior to this the Company had already received the Vergil Chambers offer of August 9. The witness was asked to file as Exhibit B an extract from the minutes of the meeting which considered the said offer; this extract reads in part as follows:
“On motion duly made and unanimously passed it was resolved that solicitors for the company should write to solicitors for Vergil Chambers and advise him that the only offer we can consider at the present time is one to acquire all the shares in Killarney Properties Ltd. with the understanding that the leasing commissions have been paid in full and the architects fees will be paid in full. All other benefits, rights and obligations would be assumed by Mr. Chambers. (I will not I read the last two paragraphs, my Lord.) ”’
The witness was asked:
“Q. So that the directors on this 9th day of August, 1959 are . already giving consideration to under what conditions that
the property. might be sold? A. Yes.”
The witness agreed that construction was started in September 1959 and that, prior to this, the Company had already received the Vergil Chambers offer of August 9. In reference to the construction mortgage the Company received only $80,000 in mortgage money because of having to pay a $10,000 bonus. The witness agreed that the ordinary mortgage company which grants a conventional mortgage does not require a bonus of this type. The witness was asked to produce a copy of a meeting of directors of April 4, 1960, held following the completion of the building (Ex. C), an extract from which reads thus:
“2. Mr. Martenson reported that except for some minor deficiencies the building was complete. One unit remains. unleased but three applications are in hand from: prospective tenants. The building will be fully leased by May 1, 1960,
3. Mr. Walden reported that all tenants had paid their rents according to schedule and that all bills had been paid, except those relating to the balance of construction. $3,750 -has been paid on the mortgage.
4. À letter from Prince Construction Company Ltd. re final settlement was studied. The final price is to be $95,000. Alternatives of financing were discussed by the Board and it was decided to approach the mortgagor to obtain additional funds to pay the contractor. Mr. Walden to attend to the details.
5. It was decided that a sign would not be erected on the building at this time.
7. Future plans of the company in connection with the shopping centre revolved around selling the property. A price of $160,000 would be acceptable, the Board felt.’’
The witness agreed that once the leases were completed the Company planned to apply for what is called ‘‘a conventional mortgage’’, as it then would be in a position to show a mortgage company the rental income that could be obtained.
Mr. Martenson declared that, in the latter part of 1960, he contacted, among five others, Mr. Klink of North American Life Assurance Company, who informed him that the shopping centre was a development on which the insurance company conceivably would grant a mortgage but that his allotment, at that time, had been expended.
After reminding the witness that the last paragraph of Mr. Mah’s offer of January 17, 1961, states:
“This offer is subject to the confirmation by North American Life that they will grant a mortgage to Mr. Mah on the above reference to property in the sum of $85,000.”
counsel for the respondent asked the following questions and received these answers:
‘ ‘ Q. And with this offer you knew that the offer was contingent upon North American Life loaning the money? The company knew that? A. Yes.
Q. And did the company then, in looking for mortgage money, go to North American Life or Mr. Klink and say—■ Now, you have some money, will you loan it to us?’ A. No.
Q. You didn’t? A. No.
Q. Nor after January 17th, 1961, did the company approach any other mortgage institution in order to borrow money for this purpose? A. No.
Q. Now, Mr. Martenson, the offer to purchase from Mr. Mah, the first one which I think was Exhibit No. 10, that is Mah’s earlier offer dated December 20th, 1960, and this offer came to you through Melton’s Real Estate ? A. Yes.
Q. And by a man called Pat Turner? A. Yes.
Q. You were at this time the commercial manager of Imperial Realtors ? A. Yes.’’
An offer for the property in the amount of $155,000, dated June 1, 1960, whereof $42,000 was to be paid by a transfer of the purchaser’s equity in another property, was declined. The Company likewise declined an offer of $137,000, dated December 20, 1960, by George Mah who, on January 17, 1961, made a new offer of $150,000, of which $133,000 was payable in cash, and which the Company accepted.
‘“@. And Mr. Turner had a similar position with Meltons?
A. Yes.
Q. And you were close friends? A. Yes.
Q. Your office buildings were for all practical purposes next door? A. Yes.
Q. And you visited and had coffee together and you discussed various things intimately all the time we are concerned with?
A. We discussed things, yes.
Q. And the letter and the offer from Mah of December 20th came as no surprise to you. Pat Turner, the Melton man, talked to you about it prior to the offer being made, did he not? A. Yes.
Q. And in between the first offer that Mr. Mah made of December 20th, 1960 and the second offer of January 17th, 1961, you and Pat Turner negotiated further in respect of this ? A. We said merely what we wanted. We didn’t make a counter-offer.
Q. In other words you and Turner discussed this matter over quite sometime? A. We did discuss it, yes.’’
On re-examination by his own counsel, he was asked who, among the members of the Company, including the witness, were interested in land development companies prior to 1959. The witness replied:
“Some of the members were with me in Kisbey Properties Limited and some were with me in the development of a golf and country club.
Q. Who were they? A. I probably can’t tell you without referring to the shareholder list. Those that had shares in each were myself, Mr. Walden, Mr. Sawatzky, Mr. Gillmore, and I believe that is all.
Q. Was Mr. Black in Kisbey ? A. Yes.”
After indicating to the witness that the cost of the shopping centre was $95,000, which is $17,000 in excess of the contract price, counsel for the appellant put the following question : ,
“How did the company obtain the funds on which to pay the contract ? A. These funds were obtained primarily from the mortgage we received and the balance from the bank loan. ’ ’
(I might here observe that reference to the bank loan appears on Exhibit 1, where a caveat which was placed on the property by the Bank of Nova Scotia is shown.)
“Q. Now, Mr. Martenson, for the period with which we are concerned, Mr. Martenson, you were president of Killarney Properties Limited and also a real estate salesman ? A. Yes.
Q. Now, which were you during the discussions with Mr. Turner that you spoke about to my learned friend ? A. I was both. I was wearing two hats at the time in that I represented both a real estate agency and the company that owned the property.”
The following is an extract from the questions and answers given by Mr. Martenson on examination for discovery read into the record by counsel for the respondent :
117. “Q. Was the amount of the bonus partly because of the
location of the shopping centre in that perhaps it was somewhat of a speculative investment in comparison to perhaps others? <A. Partly because it is speculative, yes, in that all the leases were not acquired at that time and partly because of the shorter duration their overhead or handling costs, or what have you, have to be amortized over a shorter period of time.
273. Q. Now I notice, sir, that in the paragraph immediately
above the adjournment paragraph the last sentence read, ‘The directors felt the company is best suited to invest in real estate and that the company should try to increase its assets by fifty per cent per year.’ A. Yes.
274, Q. And the increase in assets at fifty per cent per year would
be: by carrying on business ? A. Yes.
275. Q. And I presume that this would involve buying and sell- / . ing? A. It would, it could involve buying and selling or
straight development work.
277.' Q. So that it was then the company’s view that in order to
achieve a fifty per cent increase in assets per year the best way to do it was by development of real estate? A. Yes. 278. Q. And the real estate, upon development would either be
retained by the appellant company or sold, whichever seemed more favourable? A. Yes.
279. Q. And this, I presume, has at all times been the intention,
if a company has an intention, of the appellant. A. What would be the intention ?
280. Q. Of attempting to increase its assets as fast as possible in
the way we have described ? A. Yes.’’
In support of the appellant’s claim, his counsel submitted that, in the early days of the Company, there was no intent on the part of its directors and shareholders to sell the property and that the compelling reason which led them to do so, instead of retaining it as an investment, was because they encountered what he described as a ‘‘big stumbling block’’. The said obstacle rested on the allegation that the Company, despite repeated efforts by its directors, was unable to obtain a conventional mortgage to replace the $90,000 construction mortgage negotiated with First Investors Corporation Limited and which fell due on November 1, 1961.
In my opinion, there i is to be found. in the evidence previously referred to, abundant proof that those who directed the affairs of the Company had a dual or alternative intention.
As appears by questions and answers Nos. 173, 277 and 278, supra, Martenson, on discovery, testified that the. Company, by real estate development, would try to increase its assets by 50 per cent per annum, and, thereupon, to either retain the project so developed or sell it—whichever seemed more favourable.
The Company, it may be recalled, was incorporated in June 1959 and the first offer for the property of $130,000 was made by Mr. Chambers on August 6, 1959 (Ex. 7), whereupon the Company, on August 10 (Ex. 8), while declaring that the offer was unacceptable, showed its interest in selling the property by informing the intended purchaser that, subject to ratification by the shareholders, it would be interested, if the said purchaser would make an offer, to buy all the outstanding shares I in ‘ ‘ Killarney Properties Limited for $40,000’’.
The above occurrence took place less than a month after the Company had signed the building contract (Ex. 5) and a month before any construction had commenced or the construction mortgage with First Investors Corporation Ltd. had been signed (Ex. 6). Mr. Martenson’s testimony discloses that, in February 1960, the shopping centre was nominally completed and lessees were in occupation.
The minutes of the directors’ meeting of the Company held on April 4, 1960 (Ex. D) provide another piece of revealing evidence of intent to sell. The said meeting began with a most encouraging statement made by the secretary, Mr. Walden, who reported that the one remaining vacant unit in the shopping centre would be occupied by May 1; that all tenants had paid their rents on schedule; that all bills, except those relating to the balance of construction cost, had been paid; and that the final price for construction was to be $95,000. After discussing alternative methods of financing, it was decided to approach The First Investors Corporation Ltd. to obtain additional funds to pay the contractor, and Mr. Walden was instructed to attend to the details. The evidence does not disclose whether such approach had been made.
The meeting concluded with the following declaration of intent :
“Future plans of the Company in connection with the shopping centre revolved around selling the property. A price of $160,000 would be acceptable, the Board felt.’’
The foregoing evidence, in my opinion, establishes that what might, previously, have been regarded as a secondary alternative of intent to sell the property had now become a preferred alternative. Indeed it would hardly be overstatement to say that the intent to sell had become a determination to do so.
The financial set-up of the Company, in my opinion, had the earmarks of a promotional and profit-making scheme entered into more particularly by Mr. Martenson and three or four close associates, who, through Kisbey Ltd., in which they were shareholders, held a controlling interest in Killarney Properties Ltd. The capital-stock of the Company consisted of 30,000 n.p.v. shares, which could be issued for such consideration as the directors might determine, but not to exceed $1 a share. All the issued shares of the Company were acquired by its original shareholders for 1 cent a share and they were entitled to obtain further shares, at the same price, up to some 11,000 shares, to be apportioned among the shareholders according to the amount of money they lent to the Company, which totalled approximately $30,000. In other words, the shareholders practically received their equity-holdings in the Company as a bonus for the money which they loaned to the Company.
Before passing on to consideration of the main items of defence, I might here comment on the speculative nature of the undertaking and the background of the prime movers of the venture.
The president of the Company acknowledged that because of the district in which the shopping centre was to be located, and since, at the beginning, they were not sure of obtaining tenants for the various units of the shopping centre, the project was a speculative one. We are not here dealing with a case in which it was the first time that the prime movers in the enterprise ever engaged in a similar project. They had previously organized and developed Kisbey Ltd. from which the instant property had been purchased and an unnamed golf club.
In my opinion, the acquisition, development and sale of the instant property was a further adventure in the nature of trade.
Now, with respect to the main defence, viz., that it was because it was impossible to procure a conventional mortgage that the Company was left with little or no alternative but to dispose of the shopping centre, in my opinion, the appellant has failed to adduce any convincing evidence in support of this submission and there is cogent proof in the record to the contrary. It was only in November 1960 that the president and some of his associates endeavoured, without success, to obtain a conventional mortgage, and, at this time, the president was informed that, but for the fact that North American Life Insurance Co. had used up their quota for the year, they would have been prepared to grant a mortgage. After the turn of the year, the president of the Company admitted that he had not approached the aforesaid insurance company notwithstanding that he was well aware that Mr. Mah was negotiating with the same insurance company for a $85,000 construction loan and that the latter’s offer to purchase the property in issue for $150,000, dated January 17, 1961, was made conditional upon the insurance company granting the said loan.
I consider that the only logical conclusion to be drawn from the aforesaid evidence is that the directors and the shareholders of the Company, far from intending to keep the shopping centre as an investment, were anxious to sell it and thus realize over a 33 per cent profit on their investment.
Counsel for the appellant raised other arguments, such as: trouble of an irritating nature with tenants; some evidence of defective workmanship ; doors not closing properly ; and the like. Mr. Martenson, in his evidence, said that such troubles, although they would appear large to some inexperienced shareholders, to a man like himself they did not mean much, but that they were, however, a factor in influencing the directors to accept Mr. Mah’s offer. However, I regard these irritations as being of minor importance and as having little probative value.
Mention of the fact was made that the very first object of the Company, as inscribed in its memorandum of association, was to acquire the site in issue to construct a shopping centre thereon and to lease the stores contained therein.
I place little stock in the above described point, because also included in the said objects were, inter alia:
“(c) To carry on business as investors, brokers and agents
and to undertake and carry on and execute all kinds of financial, commercial, trading and other operations which may seem to be capable of being conveniently carried on or in connection with any of these objects or calculated directly or indirectly to enhance the value of or facilitate the realization of or render profitable any of the Company’s property or rights.
(k) To establish, promote and otherwise assist any company or companies for the purpose of furthering any of the objects of this Company.
(m) To sell or dispose of the undertaking of the Company or any part thereof for such consideration as the Company may think fit and in particular for shares, debentures, or securities of any other Company wheresoever incorporated having objects altogether or in part similar to those of this Company and to distribute any of the property of the Company among the members in specie.”
It was alleged that the Company did not hire a real estate agent nor advertise the property for sale. The president was himself a real estate agent who was anxious to earn a fee upon the sale of the Company, which fee, it was said, would have amounted to over $6,000, but instead of paying anything to Martenson, the Company paid $1,000 to Mr. P. Turner, who was supposed to be the agent of the purchaser, Mr. Mah. I am unable to accept the submission of counsel for the appellant that, although, perhaps, not important in themselves, the cumulative effects of the above- mentioned occurrences are sufficient to establish that the appellant was not engaged in any adventure in the nature of trade and did not intend to turn the property to account but to retain it as an investment.
The present instance was not the first occasion that he had entered into an undertaking of a similar nature and the evidence disclosed that Mr. Martenson and three or four others, at his instigation, had joined him as associates on at least two other occasions in undertakings similar to the instant one, and there is no evidence whether or not the same can be said with regard to other shareholders of the Company.
I consider that the present case is exceptional because it is one of the very rare cases—see also the judgment of Noël, J. in M.N.R. v. Clifton Lane, [1964] C.T.C. 81 at 87—wherein there is an admission by the taxpayer of an alternative intent to sell. Such direct evidence does not appear in Regal Heights Ltd. v. M.N.R., [1960] S.C.R. 907; [1960] C.T.C. 384; nevertheless, as noted by counsel for the respondent, the taxpayer was found liable and the Court inferred from the surrounding circumstances that sensible businessmen, if they were unable to develop the property as they hoped to do, could and would re-sell it at some gain to themselves.
Counsel for the appellant placed a great deal of reliance on Dorwin Shopping Centre v. M.N.R., [1964] Ex. C.R. 234; [1963] C.T.C. 411, a judgment of Cattanach, J. in which it was held that the taxpayer was not liable for tax. In my opinion, the Dorwin case is readily distinguishable upon its particular facts. The preponderance of evidence confirmed the sworn statements (albeit self-serving) of the directors that the Company did not intend to turn the property to account by re-sale, and, unlike in the instant case, there was no admission of a preferred or alternative intention to do so.
Furthermore, in contrast to the case at bar, wherein it is clear that the directors knew where a conventional mortgage could have been had but refused or neglected to obtain it, the directors of the Dorwin Co. had reasonable expectations of obtaining from an insurance company sufficient mortgage money to complete their building project, but despite their best efforts they were unsuccessful in obtaining it, with the result that the Company’s plans were frustrated.
F'or the foregoing reasons, I consider that the present appeal must be dismissed with taxable costs in favour of the respondent. JOHNSTON TESTERS LTD. Appellant,
and
MINISTER OF NATIONAL REVENUE, Respondent.
Exchequer Court of Canada (Gibson, J.), February 26, 1965, on appeal from a decision of the Tax Appeal Board, reported Sip Tax A.B.C. !•
Income tax—Federal—Income Tax Act, R.S.C. 1952, c. 148—Section 12(1)(a); (b)—Commutation payment—Lump sum payment to obtain release from liability to make future royalty payments on annual basis —Whether deductible as commutation of revenue expenditures or nondeductible as capital expenditure.
In issue was the deductibility of a commutation payment of $146,850 made in 1958 by the appellant to obtain the release of an obligation to pay royalties for the use of certain patents, which obligation would otherwise continue on an annual basis until 1972. The appellant was the subsidiary of a U.S. corporation and carried on in Canada the business of performing specialized tests in oil wells as they were being drilled, employing for the purpose certain tools which it was licensed to use and for which it paid royalties. On January 31, 1956 all of the assets of the appellant's parent company, including the shares of the appellant, were acquired by Schlumberger Well Surveying Corp. and at the same time a new licensing agreement was executed. Under this agreement both the appellant and its parent company agreed to pay royalties to the Johnston family over a period of years ending in 1972 for the use of the said tools. Subsequently, the Johnston family sold its entire interest in these patents to Schlumberger Foundation, a charitable organization, which then released the licensees from the royalty agreement for a lump sum of which the appellant’s share was the said $146,850. The Minister evidently questioned the basis for the 1956 agreement on the grounds that it was really part of the consideration for the transaction with S. Well Surveying Corp. and that in any event the U.S. parent company and not the Johnston family owned the patent to the principal testing tool in use.
HELD :
(i) That the 1956 licensing agreement was a binding contract made at arm's length between the appellant and its parent company, as licensees, and the Johnston family, as licensors;
(ii) That there was no evidence in support of the Minister’s suggestion that the 1956 agreement was part of the consideration for the purchase of the parent company's assets and that the Minister’s objection to the basis of the 1956 agreement was of little real concern because, in any event, the appellant itself had no title to the tool in question and the royalties payable were reasonable;
(iii) That the Tax Appeal Board had erred in viewing the S. Foundation as the agent for the S. Well Surveying Corp. and in holding that the latter purchased the patents in a capital transaction for the purpose of terminating the liability of the licensees;
(iv) That the payment in question was based on good commercial practice and was clearly made “for the purpose of gaining or producing income” within the meaning of Section 12(1) (a) ;
(v) That in deciding whether a commutation payment was of a revenue nature or of a capital nature no one criterion was applicable and a correct determination depended on a careful analysis of each particular case;
(vi) That the payment in question was made to get rid of an onerous annual business expense and that as a result no advantage or benefit, either positive or negative, accrued to the capital account of the appellant but, instead, all the advantage or benefit obtained was of a revenue character and therefore the payment was not a capital outlay within the meaning of Section 12(1) (b).
(vii) That the appeal be allowed.
, ! •'
CASES REFERRED to: ,. . .
Royal Trust Co. v. M.N.R., [1957] C.T.C. 32 ;
Anglo-Persian Oil Co., Ltd. v. Dale, 16 T.C. 253;
Noble, B. W., Ltd. v. Mitchell, 11 T.C. 37 :
Mallett v. Staveley Coal & Iron Co., Ltd., 13 T. C. 772;
Dain v. Auto Speedways Ltd., 38 T.C. 525 ;
C.I.R. v. William Sharp & Son, 38 T.C. 21 ;
Bedford Overseas Freighters Ltd. v. M.N.R., [1959] C.T.C. 58;
B.C. Electric Railway Co. Ltd. V. M.N.R., [1957] Ex .C.R. 1;
[1957] C.T.C. 120;
Falaise Steamship Co. Ltd. v. M.N.R., [1959] C.T. G. 67;
Halifax Overseas Freighters Ltd. v. M. N. R., [1959] C.T. C. 71;
Stow Bardolph Gravel Co. V. Poole, 35 T.C. 459 ;
Knight V. Calder Grove Estates, 35 T. C. 447 ;
J. P. Hancock v. General Reversionary & Investment Co. Ltd.,
TT. C. 358;
Shove v. Dura Manufacturing Co. Ltd., 23 T.C. 779 ;
Green v. Cravens Railway Carriage & Wagon Co. Ltd., 32 T.C.
359 ; ye?
C. I.R. v. British Salmson Aero Engineers Ltd., 22 T. C. 29 ;
Cowcher v. Richard Mills & Co., Ltd., 13 T.C. 216;
West African Drug Co. v. Lilley, 28 T. C. 140 ;
Peters v. Smith (1963), 41 T.C. 264;
James Snook v. Blasdale, 33 T. C. 244;
Royal Insurance Co. v. Watson, [1897] A.C. 1 ;
Pyrah v. Annis, [1957] 1 All E.R. 196;
Associated Portland Cement Manufacturers Ltd. v. C.I.R., [1946]
1 All E.R. 68; . - . .
Glenboig Union Fireclay Co., Ltd. v. C.I.R., 12 T.C. 427;
Dominion Natural Gas Co. Ltd. v. M.N.R., [1941] S.C.R. 19;
[1940-41] C.T.C. 155;
Atherton v. British Insulated & Helsby Cables, Ltd., [1926] A.C.
205; 10 T.C. 155;
Van Den Berghs Ltd. v. Clark, [1935] A.C. 431:
De Souter Bros. Ltd. v. Hanger & Co. Ltd., [1936] 1 All E.R.
999 ;
Constantinesco v. The King, [1927] 11 T.C. 730;
Eagle Motors v. M.N.R., 37 Tax A.B.C. 118.
H. Howard Stikeman, Q.C., and P. N. Thorsteinsson, for the Appellant.
D. J. Wright and D. Bowman, for the Respondent.
GIBSON, J.:—This is an appeal from the decision of the Tax Appeal Board dated October 28, 1963, in respect of the income tax assessment of the appellant dated December 9, 1959, for the taxation year 1958 whereby a tax in the sum of $67,418.10 plus interest in the sum of $2,792.77 was levied for the said taxation year.
The monies which are the subject matter of this appeal were a commutation payment made by the appellant in the taxation year 1958 in the sum of $150,000 (U.S.) or $146,850.18 (Can.). The purpose of such commutation payment was to obtain the release of an obligation to pay certain royalties on patents which obligation otherwise would have continued on an annual basis until the year 1972 .
The annual royalty payments which had been made annually up to the taxation year 1958 by the appellant approximated $20,000 per year, and the appellant charged against income the said whole payment of $146,850.18 (Can.) made in the 1958 taxation year.
The Tax Appeal Board disallowed in part this expense, allowing as a charge against income only the accrued royalties up to January 31, 1958, which was the date of the release agreement under the terms of which the said commutation payment was made by the appellant. This allowance amounted to $5,872.22 (Can.). The balance of $140,997.96 the Tax Appeal Board found was an outlay of capital or a payment on account of capital the deduction of which in computing the appellant’s income for the 1958 taxation year was prohibited by reason of paragraph (b) of subsection (1) of Section 12 of the Income Tax Act.
The appellant at the material time was a wholly owned subsidiary of a United States company known as Johnston Testers Inc., of Houston, Texas, and it carried on in Canada the business of performing certain oil well tests for others and earned its income by charging such other persons, who were owners of oil wells, fees for its testing service. This service provided is called a drill stem test which the evidence discloses is a procedure whereby a sample of the hydrocarbons or other fluids from the bottom of an oil well that is in the process of being drilled are trapped in a device fixed to the end of the drilling shaft or stem and then are brought to the surface for examination and evaluation. The device in which the fluids are trapped is called a testing tool.
The drill testing tools which we are concerned about on this appeal are called firstly a main valve testing tool for which U.S. patent No. 2,126,641 was issued to one M. O. Johnston and a hydraulic valve tool for which U.S. patent No. 2,703,696 was issued to Johnston Testers Inc., of Houston, Texas. A copy of each of these patents was filed as Exhibits 1 and 2 on this appeal.
The main valve testing tool devised by the inventor M. O. Johnston in the early 1930’s, in part was assigned by him to certain members of his family and then on June 1, 1951,
M. O. Johnston and his family entered into a written contract with the appellant and the other Johnston companies including Johnston Testers Ine., whereby the latter was given the exclusive right to use the patent on this main valve tool on a royalty basis. This agreement was filed as Exhibit 3 on this appeal.
This 1951 royalty agreement was subsequently amended several times by agreements dated December 2, 1953, January 31, 1955, and August, 1955, which agreements purported to extend the terms under which the licensees would be required to pay royalty payments to the licensors. The purported reason given for these various amended agreements was that in each instance there had been an improvement to the basic patent and for each of such improvements a patent application had been made by the licensors. There was a dispute as to the precise meaning of these extension agreements in so far as the same concerned the question of whether these amending agreements in fact extended the term during which the appellant and the others were obligated to make royalty payments to the Johnston family.
In my view, however, this is not of any great significance because the important agreement in so far as this appeal is concerned is the agreement dated January 31, 1956. This agreement was entered into contemporaneously with the purchase agree- ment whereby a firm known as Schlumberger Well Surveying Corporation purchased all the assets of Johnston Testers Inc., of Houston, Texas, which assets included all the outstanding shares of the appellant company.
The said hydraulic valve tool patent which we are concerned with on this appeal was not licensed in the above-mentioned 1951 licensing agreement with the Johnston family nor was it included in any of the amending agreements to the 1951 agreement, but it was, however, included in the said agreement dated January 31, 1956.
The hydraulic valve tool, embodying the principle of the said patent for it, had in substantial measure replaced the main valve tool because it was a superior instrument and at the material time in 1956 the appellant and the other Johnston companies were in the main using the hydraulic valve tool in providing their services to their customers to earn their respective incomes. However, the main valve tool was not entirely supplanted until a year or two after the actual purchase as of the 31st of January, 1956, by Schlumberger Well Surveying Corporation.
The evidence discloses that Schlumberger Well Surveying Corporation as early as 1955 entered into negotiations for the purchase of the assets of Johnston Testers Inc., of Houston, Texas, but this early date is of no significance, and this purchase was completed as of January 31, 1956.
The relevant contract documents evidencing this transaction were filed on this appeal as Exhibits 8 and 14. In so far as this appeal is concerned, however, Exhibit 14 which is the contract amending the royalty agreement is a significant agreement. This is the January 31, 1956, licensing agreement above referred to.
By this 1956 contract the appellant and Johnston Testers Inc., of Houston, Texas, agreed to pay royalties to the Johnston family on both the main valve tool and the hydraulic tool notwithstanding the fact that by contract up to that time neither the appellant nor Johnston Testers Inc. were liable to pay royalties to the Johnston family for the use of the hydraulic tool patent. The hydraulic tool patent in fact was owned by Johnston Testers Ine. The appellant had no title to it at any time. The agreement also provided that there would be a terminal date for such obligation to pay royalties and it was fixed at December 1, 1972. The latter provision was the significant one in so far as this action is concerned.
There were many documents filed and much argument submitted for the purpose of demonstrating the reason the appellant and Johnston Testers Inc. entered into this 1956 royalty agreement with the Johnston family. Without detailing all this evidence nor referring to the submissions made, it is sufficient for the purposes of this appeal to state that in my opinion the purchase contract between Schlumberger Well Surveying Corporation and Johnston Testers Inc. by which the former acquired the shares of the appellant company would not have been completed if this licensing agreement of 1956 had not been consummated.
And I am unable to find on the evidence that the substance of this 1956 royalty agreement is anything different than the document purports to state.
I, therefore, find that this agreement was a legal and binding contract made at arm’s length between the appellant and Johnston Testers Inc. as licensees and the Johnston family as licensors to pay an annual royalty on both the main valve tool and the hydraulic valve tool until December 31, 1972.
In respect to the contract, the evidence was that after January 31, 1956, and until 1958, the appellant and Johnston Testers Inc. did pay the Johnston family royalties on these patents. The payees and payors were strangers in law and the royalties paid were allowed as an expense chargeable against the income of the appellant for the years 1956 and 1957. In 1956 such payment by the appellant amounted to $19,483.95 and in 1957 it amounted to $19,459.18. And the royalty payments from 1953 under the respective current agreement had consistently been about $19,000 or $20,000.
In 1958 the appellant and Johnston Testers Inc. entered into negotiations and did by contract commute these royalty payments. The commutation payment made by the appellant was in the sum of $150,000 (U.S.) or $146,850.18 (Can.) and by Johnston Testers Inc., $850,000 (U.S.).
At first the negotiations for the release of these royalty obligations with the Johnston family had been unsuecessful. The apparent reason for this was because the proposal first made to the Johnston family would have resulted in the payment to them being categorized as income in their hands. This was unacceptable to them because of the income tax disadvantage, and so instead different arrangements were made which caused the monies received by the Johnston family to be categorized as a capital receipt in their hands.
The Johnston family sold all their right, title and interest in these two patents (of which they only had title to one, viz., the main valve patent—any claim to the hydraulic valve patent being questionable) to a charitable organization known as Schlumberger Foundation for $950,000; and then the Schlumberger Foundation granted the release of the royalty agreements to the Johnston companies, including the appellant, for $1,000,000 and thereby the Foundation itself made a profit of $50,000.
The Schlumberger Foundation being an exempt taxpayer under United States tax laws as a charitable organization kept the $50,000 profit for its organization. (In connection with this transaction, it should be noted that the evidence disclosed that the Schlumberger Foundation at the material time was free of any control by the Schlumberger Well Surveying Corporation or any of its associate or subsidiary companies and also of the appellant or any of the other Johnston companies. )
It was argued firstly that the 1956 patent royalty agreement with the Johnston family was really part of the purchase price of the assets of Johnston Testers Inc. by Schlumberger Well Surveying Corporation, but I am unable on the evidence to find that this was so.
It was next argued that there was no necessity for the appellant to covenant in this 1956 agreement to pay any royalties in respect to the hydraulic valve tool patents because the latter in law were at that time owned by Johnston Testers Inc. In this connection there was some equivocation in the evidence of Mr. Cox, the Texas attorney of Schlumberger Well Surveying Corporation as to the reason why it was agreed to pay royalties in this 1956 agreement on the hydraulic valve tool to the Johnston family and he did not conclusively explain why this 1956 patent royalty agreement called for an undifferentiated payment of royalties, in that there was a bulked royalty payment called for, and no division was made in such payment as between the main valve tool and the hydraulic valve tool. But in so far as the appellant is concerned, this is really of no legal concern because as stated it at no time had any title to the patent for this tool, and the royalty it was called upon to pay by this 1956 agreement was reasonable according to the evidence.
The documents evidencing these transactions were filed on this appeal and in essence they demonstrate that these transactions were all made at arm’s length and they establish that the Schlumberger Foundation contracted contemporaneously with the Johnston family to pay them $950,000 for the assignment of their patent rights and with the appellant and Johnston Testers Ine. obligating them to pay it $1,000,000 for a release from the royalty agreement of 1956 in respect to these said two patents. In other words, the Schlumberger Foundation at the material time was not obligated to complete the contract with the Johnston family unless the appellant and Johnston Testers Inc. completed their contract with it for the release of the royalty agreements.
The issue on this appeal, therefore, is whether or not the appellant in these circumstances can charge as an expense against its income for the year 1958 the sum of $140,997.96 (being $146,850.18 less the sum of $5,872.22 paid in respect of royalty payments accruing to January 31, 1958).
In considering this, it should be observed that the Tax Appeal Board made one main assumption, namely, that the Schlumberger Foundation acted as agent for the Schlumberger Well Surveying Corporation, the owner of Johnston Testers Inc. and the appellant, in arranging the release agreement dated January 31, 1958, and that ‘‘the Schlumberger Well Surveying Corporation, in effect, purchased the patents in question as a capital transaction for the purpose of terminating the liability of its nominee, Johnston Testers Inc., and in turn, that of its subsidiary, Johnston Testers Ltd., the appellant herein, in respect of the royalty payments payable until December 31, 1972, under Exclusive Licensing Agreement dated June 1, 1951.
I must respectfully disagree with this assumption and, therefore, also the opinion of the Board predicated on it. Instead, I am of the opinion that Schlumberger Foundation in this particular series of transactions was a stranger in law with the parties with whom it dealt and that no relationship of agency existed in respect to any of the transactions between it and the appellant through any of the corporate convolutions which took place in completing the same.
This finding, however, does not resolve the matter.
The problem here is to determine on the facts of this case whether or not this commutation payment of $140,977.96 (Can.) was a trading or income disbursement or a capital disbursement of the appellant for the income tax year 1958 on a true application of the relevant jurisprudence.
In all cases where commutation payments are made, the application of the distinction between income disbursements and capital disbursements is difficult because such payments lie on the borderline, and the problem of assigning them to income or capital is always troublesome.
The Income Tax Act, R.S.C. 1952, does not define ‘‘income”’ or “capital”. It describes sources of income and prescribes methods of computing income. It is, therefore, necessary to find the answer in a given factual situation by reference to the decided cases; and the answer in these cases is to a question of mixed fact and law.
Counsel for the appellant referred to, mentioned or distinguished the following cases in support of their submission that the commutation payment in this case was an income disbursement: Royal Trust Co. v. M.N.R., [1957] C.T.C. 32; Anglo- Persian Oil Co., Ltd. v. Dale, 16 T.C. 253 ; Noble, B. W., Ltd. v. Mitchell, 11 T.C. 372; Mallett v. Staveley Coal and Iron Company Limited, 13 T.C. 772; Dain v. Auto Speedways Ltd., 38 T.C. 525; CLR. v. William Sharp & Son, 38 T.C. 21 ; Bedford Overseas Freighters Ltd. v. M.N.R., [1959] C.T.C. 58; B.C. Electric Railway Company Limited v. M.N.R., [1957] Ex. C.R. 1; [1957] C.T.C. 120; Falaise Steamship Company. Limited v. M.N.R., [1959] CT. C. 67 ; Halifax Overseas Freighters Ltd. v. M.N.R., [1959] C.T.C. 71; Stow Bardolph Gravel Co. v. Poole, 35 T.C. 459; Knight v. Calder Grove Estates, 35 T.C. 447 ; J. P. Hancock v. General Reversionary & Investments Co. Lid., 7 T.C. 358; Shove v. Dura Manufacturing Co. Ltd., 23 T.C. 779; Green v. Cravens Railway Carriage & Wagon Co. Lid., 32 T.C. 359 ; C.I.R. v. British Salmson Aero Engineers Ltd., 22 T.C. 29 ; Cowcher v. Richard Mills & Co. Ltd., 13 T.C. 216 ; West African Drug Co. v. Lilley, 28 T. C. 140.
Counsel for the respondent on the other hand in a similar manner referred to the following cases to support his submission that the disbursement in this case was one of capital: Peters v. Smith (1963), 41 T.C. 264; James Snook v: Blasdale, 33 T.C. 244; Royal Insurance Co. v. Watson, [1897] A.C. 1; Pyrah v. Annis, [1957] 1 All E.R. 196 affirming [1956] 2 All E.R. 858; Associated Portland Cement Manufacturers Ltd. v. C.I.R., [1946] 1 All E.R. 68; Glenboig Union Fireclay Co., Ltd. v: C.I.R., 12 T.C. 427; Dominion Natural Gas Co. Ltd. v. M.N.R., [1941] 8.C.R. 19; Atherton v. British Insulated and Helsby Cables, Ltd., [1926}. A.C. 205; Cowcher v. Richard Mills & Co., Ltd: (1927), 13 T.C. 216; Mallet v. Stavely Coal & Iron Co., Ltd., 13 T.C. 772; Van Den Berghs Ltd. v. Clark, [1935] A.C. 431 ; West African Drug Co. Ltd. v. Lilley (1947), 28 T.C. 140; B.C. Electric Railway v. MN. R., [1958] C.T.C. 21; C.I.R. v. Sharp (1959), 38 T.C. 341; Dain v. Auto Speedways (1959), 38 T.C. 525; DeSoutter Bros., Ltd. v. Hanger & Co. Ltd., [1936] 1 All E.R. 535 : Const ant inesco v. The King (1927), 11 T.C. 730; Anglo-Persian Oil Co., Ltd. v. Dale, [1932] 1 K.B. 124; Eagle Motors Ltd. v. M.N.R., 37 Tax A.B.C. 118.
In coming to a conclusion in this case, two questions have to be resolved, namely, (1) was the expenditure of $140,977.96 by the appellant in the taxation year 1958 made for the purpose of gaining or producing income within the meaning of Section 12(1) (a) of the Income Tax Act ! and (2) if it was so made, was such payment an allowable expense or was it a capital outlay within the meaning of Section 12(1) (b) of the Income Tax Act .
In this case it is clear beyond all doubt that the expenditure was made ‘‘for the purpose of gaining or producing income” within the meaning of Section 12(1) (a) of the Income Tax Act, using as a criterion for. such conclusion that it was made based on good commercial practice, and. bearing in mind that it did not have to be incurred in gaining or producing the income of the particular period in which it was expended and that no causal connection had to be established between any particular receipt of income and this expenditure, and that it was an extraneous and non-recurring item of expenditure. And it should be noted that all this is true whether this expenditure be classified as an income expense or disbursement, or as a capital outlay or disbursement.
In determining the second question of whether. this, expenditure is an income disbursement or a capital disbursement various tests or criteria are employed in the cases, as are hereinafter referred to. But probably no such determination would have had to be made in this case except for the fact that the amount sought to be charged against income is very large, and except for the fact that there is no provision for amortizing commutation payment expenditures such as this, in any category under Section 11 of the Income Tax Act, or any regulation made thereunder. However, neither comment is relevant in assisting in the solution of the problem here.
In many cases, judges have used various criteria which have assisted them in deciding this issue, based on the respective facts of such cases. For example, the criterion afforded by the economists and used by some judges in the solution of this issue is their differentiation between fixed and circulating capital. If the payment can be categorized as out of the former, the economists say it is a capital expenditure and if out of the latter it is an income expenditure.
The criterion of the accountants, which has been sometimes used in these cases, is their test as to whether such expenditure, in good and accepted commercial accounting practice, should be recorded in the books as a charge in the profit and loss account rather than a payment out of capital account.
Neither of these two above criteria, however, are of much assistance in determining the problem here.
The criterion distinguishing between a ‘‘once and for all’’ lump-sum payment made in the income account as opposed to the capital account by the House of Lords in the case of Atherton v. British Insulated and Helsby Cables, Ltd., 10 T.C. 155 was put this way by Lord Cave at p. 192, ‘‘But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.”
But Rowlett, J. in Anglo-Persian Oil Co., Ltd. v. Dale (supra), considered that this finding was inconclusive, and that there was fallacy in the use of the word ‘‘enduring’’, and stated that “What Lord Cave is quite clearly speaking of is a benefit which endures, in the way that fixed capital endures, not a benefit which endures in the sense that for a good number of years it relieves you of a revenue payment.’’ And then he held that the commutation payment made in the case before him represented the future emoluments (of the agent) which were redeemed, and that it was made in the course and for the purposes of a continuing business.
Some other criteria adopted in the cases are that if the commutation payment either (a) creates a capital asset of enduring or permanent character as, e.g., plant, machinery, etc. ; or (b) if it is a payment in respect of a capital asset in order to pro tanto go out of business, it will be categorized as a capital expenditure, but if, (c), the commutation payment does not create a capital asset even though it is made in respect to a capital asset and the business or that part of it continues after such payment, and such payment was made for the purpose of such continuing business, then the payment will be categorized as an income expenditure.
In the final analysis, however, it would appear that no one criterion can be used universally in all cases. Instead, the business purpose of a commutation payment in each case must be analyzed carefully for the object of categorization and then one or more of the various criteria may be employed to assist in determining the correct category of such payment, that is, whether the payment truly is an income disbursement or one out of capital account.
In this case by the said 1956 agreement the appellant I find acquired a capital asset, viz., the licence to use the two patents.
Such asset could have been shown on the balance sheet of the appellant as a capital asset, in which event its value would have been recorded as nominal. Its omission from the balance sheet in this case, however, was commercially acceptable accounting practice in that such omission did not affect the integrity of the balance sheet. And when it ceased to be a capital asset of the appellant in 1956, such fact did not in any significant way affect the capital account of the appellant.
The acquisition of this capital asset gave the appellant the rights to use the patents, as distinguished from the use or employment of the machines embodying such patents, which latter was the business carried on by the appellant by which it earned its income.
In respect to the latter only, the appellant paid the licensors of the patents annual royalties, calculated on actual use. For the former there was no actual dollar consideration paid.
The said release agreement in 1958 accomplished two things, namely, it got rid of the said capital asset, but the appellant paid no dollar consideration for this; and it got rid of the onerous annual payments of royalties to these licensors for use of the patents until 1972.
In other words this latter was a payment to get rid of an annual charge against revenue in the future. It was not made to get rid of a loss in business or apprehended loss in business after the income and expenditure had been put together, as was the case in all the instances when there was a pro tanto going out of business. On the contrary, the money paid in this case was not paid in order pro tanto to go out of business. The money was paid in the course of and for the purpose of a continuing business, and the appellant did in fact after this payment and still does carry on this same business.
It was argued that the appellant did pro tanto go out of business in so far as its use of the main stem valve tool was concerned because it no longer could use this machine after this release agreement was executed. And it was a fact that at that time the appellant had stopped to use the main valve tool because it had been supplanted by the superior hydraulic valve tool.
But the appellant was entitled after this release agreement in 1958 to continue the use of this hydraulic valve tool by arrangements with Johnston Testers Inc. who in fact owned the patent to it, and the appellant did continue in precisely the same business as it had been in before. What it got rid of by this commutation payment in 1958 in exchange for the release agreement was the large annual royalty charge against its revenue, payable to the Johnston family under the said 1956 agreement. And, therefore, I am unable to find that by ceasing to use the main valve testing tool in 1958 the appellant could be considered to be pro tanto going out of any part of its business.
In brief, therefore, I find that the true business purpose of this commutation payment of $140,977.96 (Can.) in 1958 by the appellant, in essence, was not to get rid of a capital asset (which was a mere incidental result), but instead it was to get rid of an onerous annual expense in respect to a business that it proposed to and did carry on, and such payment was made in the course of such continuing business; and that as a result no advantage or benefit either positive or negative accrued to the capital account of the appellant, but instead all the advantage and benefit obtained was of a revenue character and, therefore, the payment was not a capital outlay within the meaning of Section 12(1) (b) of the Income Tax Act.
‘The appeal, therefore, is allowed with costs.