Ex. C.R.] EXCHEQUER COURT OF CANADA 527 BETWEEN: 1946 IMPERIAL OIL LIMITED, APPELLANT, Oct.30 AND 1947 MINISTER OF NATIONAL REVENUE, RESPONDENT. Oct. 31 Revenue—Income tax—Income War Tax Act, R.S.C. 1927, c. 97, es. 8, 6 (a)—Meaning of words "for the purpose of earning the income"— Payment of damages and costs for negligence deductible when liability really incidental to business. Appellant sought to deduct amount paid in settlement of damage claims arising out of a collision at sea between one of its oil tankers and another vessel, causing the latter vessel to sink, the collision- resulting from negligence on the part of the appellant's seamen. The deduction was disallowed and the amount included in the appellant's assessment, from which it appealed. The appeal was allowed. Held: That if a particular disbursement or expense is not within the express terms of the excluding provisions of section 6 (a), its deduction ought to be allowed if such deduction would otherwise be in accordance with the ordinary principles of commercial trading or well accepted principles of business and accounting practice. 2. That the words "disbursements or expenses . . . . laid out or expended for the purpose of earning the income" in section 6 (a) mean "disbursements or expenses . . . . laid out or expended as part of the process of earning the income". 3. That it is never necessary to show a causal connection between an expenditure and a receipt. 4. That where income is earned from certain operations, all the expenses wholly, exclusively and necessarily incidental to such operations must be deducted as the total cost thereof in order that the amount of the profits or gains from such operations that are to be assessed may be computed. Such cost includes not only all the ordinary operations costs but also all moneys paid in discharge of the liabilities normally incurred in the operations. When the nature of the operations is such that the risk of negligence on the part of the taxpayer's servants in the course of their duties or employment is really incidental to such operations, with its consequential liability to pay damages and costs, then the amount of such damages and costs is properly included as one of the items of the total cost of such operations and may properly be described as a disbursement or expense that is wholly, exclusively and necessarily laid out as part of the process of earning the income from such operations. APPEAL under the Income War Tax Act. The appeal was heard before the Honourable Mr. Justice Thorson, President of the Court, at Ottawa. H. C. F. Mockridge for appellant. T. N. Phelan K.C. and E. S. MacLatchy for respondent. 99298-1ia
528 EXCHEQUER COURT OF CANADA [1947 1947 The facts and questions of law raised are stated in the IMP$~IALcou reasons for judgment. LIMITED MIN . THE PRESIDENT now (October 31, 1947) delivered the OF NATIONAL following judgment: REVENUE The issue in this appeal under the Income War Tax Act, R.S.C. 1927, chap. 97, is whether in computing the amount of its profits or gains to be assessed for the year 1930 a deduction of $526,995.35 should be allowed, this being the amount which the appellant was obliged to pay in settlement of damage claims arising out of a collision at sea between its motorship Reginalite and the steamship Craster Hall owned by the United States Steel Products Company. Although the collision occurred on June 19, 1927, the total amount of the appellant's liability was not ascertained until 1930 when it was charged by it to profit and loss in that year. On the notice of assessment for 1930, dated December 24, 1942, this deduction was disallowed and the amount, together with other items, was added to the taxable income declared by the appellant on its income tax return. An appeal from the assessment, confined to this item, was taken to the Minister who affirmed the assessment on the ground that the amount paid was not an expense wholly, exclusively and necessarily laid out or expended for the purpose of earning the income within the meaning of section 6 (a) of the Act. Being dissatisfied with the Minister's decision the appellant now brings its appeal from the assessment to this Court. The appellant's business is described on its return as the manufacturing and marketing of petroleum products. In addition to producing and refining petroleum it is engaged in the transportation of petroleum and petroleum products. It has a fleet of 20 oil tankers plying on the Great Lakes and in coastal and ocean going operations. These are handled under the supervision of its marine department. This was first established in 1912 when only Great Lakes vessels were operated, but in 1921 it was expanded and ocean going tankers were acquired. The greater part of the crude oil refined in Canada by the appellant comes from South America and is carried from there to Canadian ports in oil tankers. In 1927, it had 9 ocean going oil
Ex. C.R.] EXCHEQUER COURT OF CANADA 529 tankers in operation including the Reginalite. For the 1947 most part they carried its own oil but also, on occasion, oil IMPEaIAL On. for others on voyage charters. Its marine operations were LIMITED an important and profitable part of its business. MINISTER OF NATIONAL The facts relating to the collision and the payment of REVENUE damages are not disputed. On June 19, 1927, the appel- Thorson P. lant's vessel, the motorship Reginalite had loaded a cargo of bunker fuel oil and commercial Diesel oil for the International Petroleum Company Limited and was leaving the harbour of Talara in Peru bound for a port in Chile. The steamship Craster Hall was lying at anchor at the customary anchorage for vessels outside the harbour proper and was apparently swinging at her anchor slightly out into the channel. The Reginalite was headed out to sea and as she approached the Craster Hall the men on her bridge observed that she inclined to swing towards the Craster Hall. An endeavour was made to correct this swing but it was not successful and she continued to swing. Then although the engines were reversed and the anchors dropped she collided with the Craster Hall, which later sank and became a total loss. The Reginalite suffered practically no damage. The owners of the Craster Hall took proceedings in the United States against both the appellant and the Reginalite. The damages originally claimed were estimated at $2,000,000. Negotiations for settlement continued from 1927 to 1930 when the claims were finally settled for $526,995.35, including fees, as shown by a statement of particular average (Exhibit 3) and a summary of disbursements (Exhibit 4). It is admitted that the collision was due to fault on the part of the Reginalite and that the amount paid was for damages resulting therefrom. The summary (Exhibit 4) shows some disbursements made prior to 1930. The appellant did not charge disbursements to profit and loss in the year in which they were made if the claim for damages was not settled in such year, but carried them forward in a suspense account until the claim was settled and then charged the full amount of the settlement to profit and loss in the year in which the settlement was made. The same practice was followed in the present case. While there may be some question as to the correctness of such
530 EXCHEQUER COURT OF CANADA [1947 1947 practice as a matter of law, no argument was made on it IMPERIAL om and I proceed on the assumption that the amount claimed LIMITED V. as a deduction, if deductible at all, was deductible in 1930, the year in which the total amount of the appellant's OF INISTER REVENUE liability was ascertained. Thorson P. The issue turns upon whether the amount sought to `- be deducted is excluded from deduction by section 6 (a) of the Act, which provides: 6. In computing the amount of the profits or gains to be assessed a deduction shall not be allowed in respect of (a) disbursements or expenses not wholly, exclusively and necessarily laid out or expended for the purpose of earning the income; The profits or gains to be assessed are the net profits or gains described in section 3 as being taxable income, subject to section 6 with which section 3 must be read. The principles for the computation of such profits or gains are not defined in the Act but are stated in judicial decisions. In Gresham Life Assurance Society v. Styles (1) Lord Hals bury L.C. said: Profits and gains must be ascertained on ordinary principles of commercial trading, The same view has often been expressed; for example, in Usher's Wiltshire Brewery, Limited v. Bruce (2) Earl Loreburn approved the statement that: profits and gains must be estimated on ordinary principles of commercial trading by setting against the income earned the cost of earning it, and then pointed out that this was subject to the limitations prescribed by the Act, one of which was the rule in the English Act corresponding to section 6 (a). The section is couched in negative terms. It is not primarily concerned with what disbursements or expenses may be deducted and does not define them, so that their deductibility is determinable only by inference. But it is concerned with and does define the disbursements or expenses whose deduction is not allowed. It is a specific instruction to the Minister that in his assessment operation he is not to allow the deduction of disbursements or expenses that are "not wholly, exclusively and necessarily laid out or expended for the purpose of earning the income". The section directs that such disbursements or expenses are not to be deducted, even although they might be (1) (1892) A.C. 309 at 316. (2) (1915) A.C. 433 at 444.
Ex. C.R.] EXCHEQUER COURT OF CANADA 531 deductible according to ordinary principles of commercial 1947 trading or, as it has been suggested "well accepted principles IMPERIAL OII. of business and accounting practice". The range of LIMITED deductibility according to such principles may be wider MINISTER O F NATIONAL than that which is inferentially permitted under the section. REVENIIE To that extent they must give way to the express terms Thorson J. of the section, which must, of course, prevail. The result is that the deductibility of disbursements or expenses is to be determined according to the ordinary principles of commercial trading or well accepted principles of business and accounting practice unless their deduction is prohibited by reason of their coming within the express terms of the excluding provisions of the section. These provisions were, no doubt, inserted in the interests of the revenue as a protecting safeguard against deductions which might otherwise be made but, while it is necessary to enforce the prohibitions of the section, it is not proper to go beyond its express requirements. The section ought not, in my opinion, to be read with a view to trying to bring a particular disbursement or expense within the scope of its excluding provisions. If it is not within the express terms of the exclusions its deduction ought to be allowed if such deduction would otherwise be in accordance with the ordinary principles of commercial trading or well accepted principles of business and accounting practice. Counsel for the appellant argued that the transporting of petroleum and petroleum products was part of the appellant's business, that the income from its marine operations was part of the income earned by it, that the ordinary risks and hazards of that business must be accepted as part thereof including the possibilities of loss inherent in it, that the risk of collision at sea was an ordinary hazard of a shipping company and that negligence on the part of its seamen resulting in damage to another ship was a contingency that was to be expected, and that, while the amount of damage done in the present case was large, the accident was not extraordinary or unusual. His contention was that, under the circumstances, the amount which the appellant had to pay was a proper expense wholly and exclusively incurred in the course of and for the purpose of the marine operations portion of its business
532 EXCHEQUER COURT OF CANADA [ 1947 1947 and the earning of income therefrom, and representing a IMPERIAL O m liability inherent in such business which it was obliged to LIMITED meet, that it was not a capital item but an operating one, MINISTER that it was properly deductible as a matter of accounting OF NATIONAL REVENUE practice and that it was not excluded from deduction by Thorson J. section 6 (a). I think that counsel's position was well taken, both on the facts and as a matter of law. The case is of considerable importance in view of the fact that there are no Canadian decisions on the question whether the amount of damages paid by a taxpayer on account of the negligence of his servants, such as that sought to be deducted by the appellant, is a deductible item of expenditure under section 6 (a). Counsel had, therefore, to rely Upon decisions in other jurisdictions. The leading English authority is Strong & Co., Limited v. Woodifield (1). There the appellants were .a brewery company who owned an inn and conducted it through a manager. A customer sleeping in the inn was injured by the falling of a chimney upon him, and the appellants had to pay £1490 in damages and costs because the fall of the chimney was due to the negligence of their servants, whose duty it was to see that the premises were in proper condition. The appellants sought to deduct this sum from the amount of their profits and gains assessable to income tax. The Commissioners thought that the deduction could not be allowed but stated a case for the opinion of the Court and Phillimore J. allowed it. His judgment was reversed by the Court of Appeal and an appeal from their decision was dismissed by the House of Lords. Section 100 of the Income Tax Act, 1842, (5 & 6 Vict. chap. 35), pro-, vided by Schedule D, First Case, Third Rule, as follows: In estimating the Balance of Profits and Gains chargeable . . ., no Sum shall be set against or deducted from, or allowed to be set against or deducted from, such Profits or Gains . . ., on account of Loss not connected with or arising out of such Trade, Manufacture, Adventure or Concern . . . and by Schedule D, First and Second Cases, First Rule, as follows: In estimating the Balance of the Profits or Gains to be charged . . ., no Sum shall be set against or deducted from, or allowed to be set against or deducted from such Profits or Gains, for any Disbursements or (1)) .(1905) 2 K.B. 350; (1906) AC. 448.-
Ex. C.R.] EXCHEQUER COURT OF CANADA 533 Expenses whatever, not being Money wholly and exclusively laid out or 1947 expended for the Purposes of such Trade, Manufacture, Adventure or Concern . . . IMPE$Inn OIL LIMITED In the course of his speech in the House of Lords, Lord MINTER Loreburn L.C., with whose views the majority of the other o rrONAL Lords concurred, summarized the English law on the subject, at page 452, as follows: Thorson P. In my opinion, however, it does not follow that if a loss is in any sense connected with the trade, it must always be allowed as a deduction; for it may be only remotely connected with the trade, or it may be connected with something else quite as much or even more than with the trade. I think only such losses can be deducted as are connected with in the sense that they are really incidental to the trade itself. They cannot be deducted if they are mainly incidental to some other vocation or fall on the trader in some character other than that of trader. The nature of the trade is to be considered. To give an illustration, losses sustained by a railway company in compensating passengers for accidents in travelling might be deducted. On the other hand, if a man kept a grocer's shop, for keeping which the house is necessary, and one of the window shutters fell upon and injured a man walking in the street, the loss arising thereby to the grocer ought not to be deducted. Many cases might be put near the line, and no degree of ingenuity can frame a formula so precise and comprehensive as to solve at sight all the cases that may arise. In the present case I think that the loss sustained by the appellants was not really incidental to their trade as innkeepers, and fell upon them in their character not of traders, but of householders. Accordingly I think that this appeal must be dismissed. The reason for disallowing the deduction was "that the loss sustained by the appellants was not really incidental to their trade as innkeepers, and fell upon them in their character not of traders, but of householders". The decision turned on whether the loss was or was not really incidental to the business. If it had been it seems clear beyond doubt that the deduction would have been allowed. The case is, therefore, strong authority for the statement that if a trader has to pay damages for the negligence of his servants under such circumstances that the loss is really incidental to his trade then the amount so paid is deductible. The same principle runs through the other cases cited. Two Australian cases were referred to. In Todd v. Commissioners of Taxation (1) a ferry company paid damages to passengers in respect of injuries received and claimed it as a loss incurred in the production of the company's income. Section 16 (1) (e) of the Income Tax (Management) Act, (1) (1913) N.S.W. Court of Review Decisions 6.
534 EXCHEQUER COURT OF CANADA [1947 1947 1912, of New South Wales required the Commissioners to IMPERIAL on. deduct from the income of the taxpayer the following LIMITED v. moneys and expenses, namely , , MINISTER (e) Losses, outgoings, including commission, discount, travelling OF NATIONAL expenses, and expenses actually incurred in New South Wales by the REVENUE taxpayer in the production of his income; Thorson P. The Commissioners having disallowed the deduction, an appeal was taken and Murray D. C. J. allowed it. At page 7, he said: The question is whether this is a loss incurred by the taxpayer in the production of his income. These words mean as I suggested just now, what is more fully expressed by the words "loss incurred by the taxpayer in the course of the production of his income." The course of the production in this case is partly disembarking and embarking passengers. This was a loss that happened quite accidentally. There was misconduct on the part of some employee; but so far as the company is concerned, it was purely accidental; and it did occur as a loss which might reasonably be contemplated to happen at some time or other in the course of events which were a necessary incident to the production of the income; because part of the carrying of passengers, for which they pay, is their embarkation and disembarkation. Therefore, I think that this is a loss which does come within the words of the section. The other Australian case was Herald and Weekly Times Limited v. Federal Commissioner of Taxation (1), a decision of the High 'Court of Australia. There the appellant, the proprietor and publisher of an evening newspaper, claimed to deduct from its assessable income moneys paid by way of compensation, either before or after judgment, to persons claiming damages in respect of libels published in that paper, and amounts representing the costs of contesting the claims or of obtaining advice in regard thereto. There section 23 (1) (a) of the Income Tax Assessment Act, 1922-1929, of the 'Commonwealth of Australia, provided: 23. (1.) In calculating the taxable income of a taxpayer the total assessable income derived by the taxpayer from all sources in Australia shall be taken as a basis, and from it there shall be deducted— (a) all losses and outgoings (not being in the nature of losses and outgoings of capital) including commission, discount, travelling expenses, interest and expenses actually incurred in gaining or producing the assessable income; And section 25 (e) provided: 25. A deduction shall not, in any case, be made in respect of any of the following matters:— (e) Money not wholly and exclusively laid out or expended for the production of assessable income; (1) (1932) 48 C.L.R. 113.
Ex. C.R.] EXCHEQUER COURT OF CANADA 535 The Commissioner disallowed the deduction and the 1947 Supreme Court of Victoria dismissed an appeal from his T M PERIAL OM ruling (1), Mann J. being of the opinion that although the LIMIrao expenditure was an unavoidable consequence of ' the M INISTER OF NATIONAL business of publishing the newspaper it was not in any REVEN IIE sense a productive expenditure directly or indirectly, and Thorson J. that the sums paid were not "wholly and exclusively laid — out or expended for the production of assessable income." The High Court of Australia reversed this judgment and allowed the deduction. At page 118, Gavan Duffy ,C.J. and Dixon J. said: None of the libels or supposed libels was published with any other object in view than the sale of the newspaper. The liability to damages was incurred, or the claim was encountered, because of the very act of publishing the newspaper. The thing which produced the assessable income was the thing which exposed the taxpayer to the liability or claim discharged by the expenditure. It is true that when the sums were paid the taxpayer was actuated in paying them, not by any desire to produce income, but, in the case of damages or compensation, by the necessity of satisfying a claim or liability to which it had become subject, and, in the case of law costs, by the desirability or urgency of defeating or diminishing such a claim. But this expenditure flows as a necessary or a natural consequence from the inclusion of the alleged defamatory matter in the newspaper and its publication. Counsel also relied upon a number of South African decisions. There the relevant sections of the Income Tax Act, 1925, of the Union of South Africa, being Act No. 40 of 1925, provided that certain deductions from income for the purpose of determining taxable income should be made, as follows: 11. (2) The deductions allowed shall be— (a) expenditures and losses actually incurred in the Union in the production of the income, provided such expenditure and losses are not of a capital nature. And also that certain deductions should not be made, as follows : 13. No deduction shall, as regards income derived from any trade, be made in respect of any of the following matters:— (b) any moneys not wholly or exclusively laid out or expended for the purposes of trade. The first case referred to was Income Tax Case No. 8 (2). There a tramway company in the course of its business found it necessary to pay compensation for injuries to persons and properties resulting from collisions, from (1) (1932) VZ.R. 317. (2) (1923) 1 S.A. Tax Cases 57.
536 EXCHEQUER COURT OF CANADA [1947 1947 accidents in connection with broken trolley wires and IMPERIAL om excavations made in the roadway, and from accidents due LIMITED v. to pass enger s g alig ht g in g while the trains were still in motion. MINISTER Dr The Company also incurred expenditure in obtaining legal NATIONAL REVENUE advice in respect of such claims. The Commissioner dis- Thorson J. allowed a claim to deduct these expenses but his decision was reversed. Ingram P. held, on the facts, as follows: It appeared from the evidence that in the carrying on of an undertaking of this character expenditure in compensation up to a certain amount is inevitable, and that this is so even where every precaution may be taken to guard against accident Dr the negligence of the servants of the company. It is a recurrent loss which has to be taken into consideration as a factor in the undertaking itself and having a direct bearing on the profit earning capacity. and then said, at page 58: In the case of Lockie Bros. v. Commissioner for Inland Revenue '(1), Mason J., interpreted the words "losses and outgoings actually incurred in the production of the income" as meaning "expenditures incurred in the course of and ibp reason of the ordinary operations undertaken for the purpose of conducting the business". When applying this construction each case must, of course, depend on its own merits, and in certain instances the dividing line may not be easy to demarcate; but in this particular case these items, on the evidence placed before us, certainly seem to be in the nature of such expenditure. The occurrences they represent were not extraordinary or abnormal. They were incidental and pursuant to the course of the operations which produced the profits and formed a necessary risk undertaken to earn the profits. Such being the case they were losses incurred on income account * * *. As regards the fees paid to attorneys in connection with claims arising out of such damages, such expenditure must be equally as inevitable as the actual damages and compensation to which it relates, and is also attributable to the ordinary operations of the company. A similar view was expressed in Income Tax Case No. 49 (2). There the appellant sold petrol lamps, each subject to a guarantee. One of the lamps so sold exploded and caused injuries to the purchaser for which the appellant had to pay damages and costs. His claim for the deduction of the amounts so paid was disallowed by the Commissioner but on appeal it was held that the expenditure was incurred in the course of the appellant's business and arose out of it and was, therefore, to be regarded as having been incurred in the production of income. So also in Income Tax Case No. 233 (3). There the appellants carried on business in partnership as stevedores. In the course of such business they were unloading cargo from a vessel and while a portion (1) (1922) T.P.D. 42. (3) (1932) 6 SA. Tax Cases 259. (21 (1926) 2 SA. Tax Oases 122
Ex. C.R.] EXCHEQUER COURT OF CANADA 537 of the cargo was being transferred in a net attached to a 1947 crane an article fell out of the net and killed a passer-by. IMP Om The heirs of the person killed claimed damages from the Lz imm appellants on the grounds that the accident was due to MINIsTES NA A the negligence of their servants. On the advice of counsel they settled the claim and sought to deduct the amount Thorson d. paid. It was held on an appeal from the Commissioner that damage or loss of this kind must be regarded as incidental to a business such as stevedoring and therefore as a legitimate expense in connection with the earning of the appellants' income as stevedores. Dr. Nathan P. expressed the view that the principle was that laid down by the Lord Chancellor in Strong v. Woodifield (supra), namely, that a loss can be deducted only if it is really incidental to the trade, and held that in the present case the loss was really incidental. His statement is an illuminating one. At page 260, he said: Now in this particular case we have come to the conclusion on the evidence, that damage or loss of this kind must be regarded as incidental to the business of stevedoring. It is true that there may be only isolated cases, just as it is possible that many cases of accident in the case of