The taxpayer incurred expenses in obtaining a reversal of most of the costs that the Ontario Municipal Board had awarded against it. These expenses were capital expenditures but were deductible and deducted by it under s. 20(1)(cc). The taxpayer then received a settlement amount from the law firm that had acted for the OMB in respect of its negligence in having caused the OMB to impose the costs against the taxpayer. This $400,000 receipt was income to the taxpayer on the basis of the principle that the tax treatment of the receipt was to be determined by reference to the tax treatment of the expenditures that had been made, which had been deducted in computing its income.
Ryer JA quoted (at para. 15) a commentator's statement that:
"Under the surrogatum principle, the tax consequences of a damage or settlement payment depend on the tax treatment of the item for which the payment is intended to substitute."
After then quoting (at para. 26) the statement that the "surrogatum principle should apply to maintain tax neutrality of damages," Ryer JA stated (at para. 28):
In the present circumstances, the compensatory payment was received by the appellant as a consequence of its having been required to make certain expenditures rather than its having failed to receive an expected amount. This factual distinction does not preclude the use of the surrogatum principle to characterize the compensatory payment that was received by the appellant. Thus, where the payment is intended to replace monies that have been expended by the recipient, the tax treatment to be accorded to that payment must be determined by reference to the tax treatment of the expenditures that were made. Hence, where an expenditure has been deducted in computing the income of the recipient of a compensatory payment, the amount received should be included in the income of the recipient.