Societe d'Ingenierie Cartier Limitee v. The Queen, 86 DTC 6025, [1986] 1 CTC 166 (FCTD)

Dubé, J.:—The issue to be resolved in this matter is whether the amount of $560,650 paid to the plaintiff by the United States Fire Insurance Company (“U.S. Fire’) on June 9, 1980 constituted income of the plaintiff, as assessed by the Minister of National Revenue.

The plaintiff ("Cartier") is an engineering consulting firm which was retained by Kruger Pulp and Paper Ltd. ("Kruger") in 1974 in connection with Kruger's major expansion of a manufacturing facility at Trois Rivières, P.Q. In 1975 Kruger instituted legal proceedings against Cartier (and two other companies) to recover costs for overruns and for certain other issues. Cartier was insured by U.S. Fire with respect to professional liability suits up to a maximum of $10,000,000 per claim subject to a $200,000 deductible, but not insured for non-payment of professional fees.

On December 2, 1975 Cartier launched an action against Kruger in the amount of $1,121,300 for unpaid professional fees and out-of-pocket expenses. The amount of the claim was entered by Cartier as doubtful accounts in 1977 and was ultimately written off as a bad debt. U.S. Fire pursued negotiations with both Kruger and Cartier to minimize its actual liability under Cartier’s insurance policy. On June 9, 1980 a settlement was reached whereby U.S. Fire paid Cartier $560,650 and Kruger's attorneys 100,000.

The position taken by the plaintiff is that the amount received from U.S. Fire was not in respect of unpaid fees and out-of-pocket expenses as it was not paid by Kruger, nor was the non-payment of fees and out-of-pocket expenses insured by U.S. Fire. Cartier claims that the amount was received as consideration for Cartier agreeing to discontinue its present and any future legal actions against Kruger, including its potential action against Kruger for damages to its reputation, and for giving a full and final release to U.S. Fire on all claims under its insurance policy with that company.

On the other hand, the Minister’s position is that the amount was received by the plaintiff in respect of unpaid amounts relating to professional fees and consequently income pursuant to section 9 of the Income Tax Act.* [1] Moreover, the amount was received on account of a debt in respect of which a deduction for bad debts had been made and was properly included in income by reason of paragraph 12(1)(i) of the Act. The Minister further submits that the amount is a trading receipt notwithstanding that it was not received from Kruger, because it was paid by U.S. Fire in satisfaction of Kruger's obligation towards the plaintiff in respect of professional fees and that said payment may be made by any person, although a stranger to the obligation, under article 1141 of the Civil Code of the Province of Québec which reads:

1141. Payment may be made by any person, although he be a stranger to the obligation, and the creditor may be in default by the offer of a stranger to perform the obligation on the part of the debtor, without the knowledge of the latter, but it must be for the advantage of the debtor and not merely to change the creditor that the performance of the obligation is so offered.

In his statement of defence the Minister pleaded, as an alternative, that the amount was an eligible capital receipt that ought to be included in computing the plaintiffs income in accordance with section 14 of the Act. That submission was dropped at the trial.

A basic test to determine if a sum received indirectly from another person as compensation ought to be treated as income by the taxpayer is whether he would have treated it as income if he had received it directly in the normal course of business. The test is valid whatever the source of the legal right of the taxpayer to receive the compensation. That source, however, is relevant to identify the reason for the payment of the compensation. t [2]

That basic rule was further refined by Lord Diplock in Raja’s Commercial College v. Gian Singh & Co. Ltd., [1977] A.C. 312 at 318:

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. by reference to the true character of the award.

It matters not whether the payment was voluntary, or not, on the part of the person who made it. In Henry Goldman v. M.N.R., [1953] C.T.C. 95; 53 D.T.C. 1096, the Supreme Court of Canada adopted the language of Collins, MR. in Herbert v. McQuadet [3] as follows at 99 (D.T.C. 1098):

. . . à payment may be liable to income tax although it is voluntary on the part of the persons who made it, and that the test is whether, from the standpoint of the person who receives it, it accrues to him in virtue of his office; if it does, it does not matter whether it was voluntary or whether it was compulsory on the part of the persons who paid it.

In the present case, the evidence reveals that the sum represents 50 per cent of the $1,121,300 in fees and disbursements claimed by Cartier. In a confidential memorandum, dated March 25, 1980, from the plaintiff’s inhouse counsel (for internal distribution) the matter of a settlement is discussed. The following paragraph bears reproduction:

I also confirmed, on behalf of Cartier, that we would be prepared to follow G. Emery's recommendation to accept 50% of our original claim. This I believed to be in line with your own earlier conclusion of $500,000.

A letter from the legal firm of Blain, Piché, Emery & Associates, dated June 5, 1980, forwarding the payment describes the cheque as follows:

Chèque no. 32733 de Crum & Forster du Canada Limitée, pour le compte de United States Fire Insurance Company, fait payable à l'ordre de votre Société au montant de $560,650.42, en paiement de 50% sans intérêt de la réclamation de la Société contre La Société des Pâtes et Papiers Kruger Limitée;

Again, it is to be borne in mind that the action by Cartier against Kruger that was settled was not an action for compensation for damages to Cartier's reputation as such an action was never commenced. There is no evidence that Kruger was even informed by Cartier that the latter intended to sue for damages to its reputation. Moreover, Cartier's insurance policy with U.S. Fire did not include damages to reputation.

U.S. Fire stood between two actions involving its insured client, Cartier: one by Kruger exposing U.S. Fire to a maximum payment of $10,000,000 (less $200,000 deductible) with respect to professional liability and the other action by Cartier against Kruger for unpaid professional fees. U.S. Fire played the role of the negotiator and successfully settled both matters by paying half the fees owed by Kruger to its insured client.

I now return to the basic test and answer the question as follows: the sum in question, had it been received directly by the taxpayer from Kruger, would have been treated as professional fees and taxable income. The plaintiff's action is therefore dismissed with costs.

Action dismissed.