Day & Ross v. The Queen, 76 DTC 6433, [1976] CTC 707 (FCTD)

Dubé, J:—These are appeals from reassessments made by the Minister of National Revenue for the taxation years 1966, 1967, 1968, 1969, 1970 and 1971.

The plaintiff is a New Brunswick company with head office at Hartland engaged in the trucking business in Eastern Canada. It claimed insurance premiums, amounts payable for cargo and accident damages, and fines, as expense incurred for the purpose of producing income. The Minister considered these amounts to be additions to reserve in each of the taxation years (and the deduction of fines to be contrary to public policy) and disallowed the deductions.

In the Statement of Defence, the Deputy Attorney General of Canada submitted that this Court ought to quash the appeals of the plaintiff in respect of its 1966, 1967, 1968, 1969 and 1970 taxation years on the ground that the notices issued by the Minister that no tax was payable for those years were not assessments within the meaning of subsection 46(4) of the Income Tax Act,* but only notifications.

At the outset of the trial, in view of this Court’s decision in Her Majesty the Queen v Garry Bowl Limited, [1974] CTC 457; 74 DTC 6401, counsel for plaintiff agreed that these appeals be quashed, with the result that the only assessment with respect to which this Court may grant relief is in respect of the 1971 taxation year, which assessment allows a determination of the issues for the 1966, 1968 and 1971 taxation years, as the losses incurred by the plaintiff in its 1966 and 1968 taxation years may be applied to the 1971 taxation year within the meaning of paragraph 27(1)(e) of the Income Tax Act.

Counsel for both parties agreed that the figures appearing in paragraph 8 of the Statement of Defence for the year 1971 set out the situation accurately. The paragraph also reflects the Minister’s assumptions and bears reproduction in toto:

8. With respect to paragraphs 9, 10, 12 and 13 of the Statement of Facts of the Re-Amended Statement of Claim he says that the Minister of National Revenue assessed or adjusted, as the case may be, the said returns of income referred to in paragraph 7 hereof so as to disallow as deductions from income with respect to the amounts therein set out the amounts of $11,538.46, $103,461.54, $68,560.33, and $40,995.34, for the 1968, 1969, 1970, and 1971 taxation years respectively which amounts were considered by the said Minister to be additions to reserves in each of the said taxation years determined in the following manner:

		Accident			Yearly
	Cargo Claims Claims		Premiums	Total Total	Addition
1968			$11,538.46	$ 11,538.46	$ 11,538.46
1969	$46.837.00		68,163.00	115,000.00	103,461.54
1970	$52,275.00	$32,292.60	99,992.77	183,560.53	68,560.53
1971	89,265.00	35,363.06	99,992.77	224,555.87	40,995.34
RSC 1952, c 148 and amendments thereto.

and In assessing or adjusting as he did he acted upon the following assumptions:

(i) the amounts set aside at the end of each taxation year as Insurance premiums payable were amounts in the nature of a reserve set up by the Plaintiff to meet its estimated liability to Lloyd’s of London which liability was estimated on the likely settlement of insurance claims in unascertain- able amounts at uncertain dates;

(ii) the amounts set up at the end of each taxation year as Claims Payable (Cargo or Accident) were amounts in the nature of a reserve set aside by the Plaintiff to meet the settlement of expected insuranc claims in unascer- tainable amounts at uncertain dates; and

otherwise he does not admit the said paragraphs.

I shall first address myself to the issue of insurance premiums. They were payable to Lloyd’s, London, England under a complex 3-year policy, from May 1, 1967 to May 1, 1970. The coverage included cargo claims, collision damage to tractors and trailers, and public liability and property damage. The calculation of premiums is based on a rather complex method which takes into account the total incurred losses actually paid during the year, plus an amount established by Lloyd’s as being its probable liability for claims arising during that year but unpaid. The formula is set out as follows in Endorsement No 1 to the policy:

It is further agreed that this insurance is granted in consideration of the payment of an annual deposit premium of $60,000 payable in quarterly instalments at the inception of each quarter. The final premium to be paid by the Assured shall be 100 times the total incurred losses as hereinafter defined, divided by 65, provided that in no event shall the final premium be less than that developed by the following minimum rate nor greater than that developed by the following maximum rate:

Minimum Rate	Maximum Rate
$1.20 per $100 of total	$2.40 per $100 of total
gross receipts	gross receipts

The words “total incurred losses" as used herein, shall mean actual paid losses, allocated loss expenses Including legal fees and the reserves, as estimated by the Insurers for unpaid losses, outstanding at the time of adjustment and final re-adjustment.

Adjustment of the premium as provided herein shall be made at each anniversary date.

The premium so calculated is therefore subject to a minimum rate and a maximum rate and involved the setting up by Lloyd’s of a reserve for unpaid liabilities. Relying on their own calculations, Lloyd’s claimed the maximum during each year, whereas the plaintiff contested Lloyd’s figures, established its own premiums payable in the years in question and entered the amounts in its books as accounts payable, not as a reserve.

At the end of each taxation year, the plaintiff determined that its outstanding liabilities to Lloyd’s for premiums required to be paid were as Set out in paragraph 8 of the Statement of Defence supra under the heading “Premiums”. These sums are claimed by the plaintiff as deductions in computing its income for each taxation year. The defendant says that these amounts set aside at the end of each taxation year were in the nature of a reserve to meet its estimated liability to Lloyd’s.

As it turned out, the amounts entered in plaintiff’s books as “accounts payable” for premiums were inferior to the amounts they ended up by paying Lloyd’s for each and every year. After much discussion between the plaintiff and Lloyd’s, plaintiff paid close to the maximum payable at the end of each adjustment period.

The secretary-treasurer of the plaintiff company, a chartered accountant, testified that the amounts of premiums payable were based on their judgment as to what the annual adjustments would be. He set the amounts up as accounts payable and expense, not as a reserve, because “these were accounts payable, the events had taken place”. He insisted that “you have to match expense with revenue”.

The auditor of the plaintiff company, also a chartered accountant, explained that he applied proper accounting principles in approving the entries as accounts payable, the carefully estimated premiums payable being costs of doing business, thus a proper charge.

I now turn to the claims payable. The tractor vehicles, except those used for in-town deliveries, are owned by independent contractors, whereas the trailers belong to the plaintiff. Under operating agreements, plaintiff must take out insurance for public liability and property damage, cargo damage and collision. The independent contractors are responsible to the plaintiff for the first $1,000, and the latter up to the first $5,000 to Lloyd’s, in respect of claims and damage.

On the occurrence of a liability, or loss, or damage, the amount thereof was determined immediately by the plaintiff on the basis of the facts then available. To the extent that such amount exceeded the deductible portion of $1,000 payable by the independent contractors, and up to plaintiff's $5,000 deductible, the amount was recorded as an operation expense for that year.

At the end of the taxation years 1969, 1970 and 1971 the plaintiff determined that its outstanding liabilities for claims payable to Llyod’s were as outlined above under the headings “Cargo Claims” and “Accident Claims”, and claimed these sums as deductible in computing its income for those years.

According to the president of the plaintiff company, each accident was promptly investigated and “if we felt not at fault, we set nothing up in our books. If we felt at fault, then we valued the damages and set up the liability”.

With reference to cargo claims, company officials would first examine the PRO delivery receipts to see if they were “clean” or “dirty”. Small claims were quickly processed, larger ones were investigated. No entries were made unless company officials were satisfied that the company was liable. When liability was accepted, the value of the damaged goods was duly booked as an expense. The company presi- dent added that “we were not making profits, so we were not interested in boosting expenses. Our main effort was to try to balance the books”.

On occasions, misplaced cargo would later turn up when delivered to the wrong party and returned to the company. On the other hand, claims for lost or damaged cargo would in some instances be filed many days later.

The third issue is the allowance of fines, mostly fines for violation by the plaintiff of provincial highway weight restriction laws. Fines for speeding or other traffic violations were paid by the responsible drivers themselves and are not in question here.

Various provincial motor vehicle Acts or motor carrier Acts stipulate maximum weight, and other weight restrictions, based on the number of axles of carriers, for certain provincial highways. The allowable weights include the weight of vehicle, fuel and cargo.

It appears that most of the loads carried in plaintiff’s trailers are not picked up at plaintiff’s terminals, but along the way from factories, potato farms, isolated coastal fish plants and other businesses throughout Eastern Canada. There are no scales in the trailers and plaintiff relies on the weights declared by shippers. The government scales are located at specific points, in some instances at two or three hundred mile intervals, along the highway. The driver, an independent contractor, makes up a full load from the bills of lading on the way. If the total weight at any scale exceeds the limit, then an overweight fine is levied (usually later by mail to the plaintiff) and the carrier is allowed to proceed to its destination with the overweight cargo.

Where only one shipper takes up the full load and it turns out to be overweight at the government scale, then the plaintiff pays the fine and bills his customer. Overweight permits may also be obtained in advance at the request of a shipper. In those instances, where there is but one shipper, the driver may not even get to see the cargo as the trailer may be filled and sealed in the customer’s own warehouse. Where there are more than one shipper, then the plaintiff has to bear the loss as it would prove difficult to identify which portion of the shipment was overweight.

Fines paid were booked by plaintiff as expense and fines reimbursed were entered as revenue.

This category of fines also includes some (less than 10%) fines for minor violations, such as misplaced registration documents, lost licence plates, missing mud flaps, etc. In view of their insignificance it will be more convenient to include them with the overweight fines.

Fines in the amounts of $254.65, $9,016.17, $8,703.11, $15,956, $16,733.75 and $19,490 for the taxation years 1966, 1967, 1968, 1969, 1970 and 1971 respectively, paid to various provincial authorities, were claimed by plaintiff as expense, but disallowed by the Minister as not being amounts paid for the purpose of producing income and alleged in the Statement of Defence to be against public policy.

The basic issue to be determined is whether or not these items may be deducted as expense under section 4 and paragraph 12(1)(a) of the Income Tax Act, or, in the case of insurance premiums and claims, whether they are amounts credited to a reserve and not deductible under paragraph 12(1)(e). The three relevant clauses read as follows:

4. Subject to the other provisions of this Part, income for a taxation year from a business or property is the profit therefrom for the year.

12. (1) In computing income, no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer,

(e) an amount transferred or credited to a reserve, contingent. account or sinking fund except as expressly permitted by this Part,

In order to decide whether or not an expense is incurred by the taxpayer for the purpose of gaining income within the exception provided by paragraph 12(1 )(a), it must first be determined whether the outlay was incurred in accordance with the ordinary principles of commercial trading or well accepted principles of business practice (vide The Royal Trust Company v MNR, [1957] CTC 32; 57 DTC 1055).

No expert evidence was adduced by the plaintiff, and consequently none in rebuttal by the defendant, to assist the Court in defining the accepted accounting practice to be observed in setting out the claims

in question either as accounts payable or as a reserve. Two chartered accountants testified as to the practice they followed with reference to plaintiff's books, but they could not of course be allowed to tender broad expert opinion, as plaintiff did not qualify them as experts. They were allowed however to give factual evidence of the existence of a practice of which they had personal knowledge and which they personally applied in the circumstances of this particular case (vide Robert L Fagnan v Marion Frances Ure et al, [1958] SCR 377). In any event, their expertise would not have determined the ultimate issue of the case.

It is common ground that the payment of insurance premiums as a protection against business losses is an expense made in accordance with the ordinary principles of commercial trading, or well accepted principles of business practice. It must be determined in this case if the method of recording the insurance premiums and claims payable as Calculated by the plaintiff in the books as current liabilities and expense for the year is in accordance with accepted business principles.

In Time Motors Limited v MNR, [1969] SCR 501; [1969] CTC 190’ 69 DTC 5149, the Supreme Court of Canada held that the wording of paragraph 12(1)(e) of the Act clearly refers to accounting practice in a business of the kind with which one is concerned. The evidence showed that in the appellant’s accounts credit notes outstanding (in partial payment of used cars) were treated according to standard practice as current liabilities until they were redeemed or expired. Pigeon, J said at page 506 [192, 5151):

The wording of that provision clearly refers to accounting practice. The only expression applicable to the present case is not “contingent liability” but “contingent account”. This means that the provision is to be construed by reference to proper accounting practice in a business of the kind with which one is concerned. In the present case, the only evidence of accounting practice is that of appellant’s auditor, a chartered accountant. His testimony shows that in appellant’s accounts credit notes are treated according to standard practice as current liabilities until they are redeemed or expired. They are not classed as contingent liabilities.

The terms “reserve” and ‘‘contingent account” of paragraph 12(1 )(e) connote the setting aside of an amount to meet a contingency, an unascertainable and indefinite event which may or may not occur; whereas the term “expense” in 12(1)(a) implies a liability present and certain, an amount definite and ascertainable. A standard yearly insurance premium would undoubtedly fit neatly under the generally accepted meaning of the term “expense”, and no one would think of describing it as a “contingency” or a “reserve”: the exact amount of the premium is known, ascertainable, admitted and payable.

The difficulty in the present case, of course, lies with the complex formula laid down by Lloyd’s to establish plaintiff’s yearly premiums. The amounts claimed by plaintiff as premiums payable were amounts entered in the books as liabilities in each year because they represent the cost of insurance coverage for the particular year. The amounts booked as accident and cargo claims were so entered for that year because the specific events leading to the claims had occurred in that year. The accountants did not set aside approximate amounts as “reserve” against contingencies, these amounts were booked as definitely payable because the premiums had been earned, the accidents had occurred, the claims had been filed, the investigations had taken place, the quantum of damage assessed, and the amounts entered.

In J L Guay Ltée v MNR, [1969] Tax ABC 691; 69 DTC 490; [1971] CTC 686; 71 DTC 5423; [1973] CTC 506; 73 DTC 5373; [1975] CTC 97; 75 DTC 5094, the Tax Appeal Board, the Federal Court Trial and Appeal Divisions, and the Supreme Court of Canada dismissed appeals against the Minister’s refusal to allow the appellant building contractor to deduct the 10% standard holdbacks from subcontractors. It was far from certain that the amounts of the holdbacks would be paid in full to the subcontractors. Noël, ACJ, at page 692 [5427], distinguishes deductible expenditure for a period from amounts set aside as a reserve:

In most -tax cases only amounts which can be exactly determined are accepted. This means that, ordinarily, provisional amounts or estimates are rejected, and it is not recommended that data which is conditional, contingent or uncertain be used in calculating taxable profits. If, indeed, provisional amounts or estimates are to be accepted, they must be certain. But then it is always difficult to find a procedure by which to arrive at a figure which is certain. . . .

As a general rule, if an expenditure is made which is deductible from income, it must be deducted by computing the profits for the period In which it was made, and not some other period.

The procedure adopted by appellant, of deducting from its income amounts withheld by it, which it may one day be required to pay its subcontractor, but which the latter may not claim until 35 days after the work is approved by the architect, is, as we have just seen, contrary to the rule that an expenditure may only be deducted from income for the period in which it was made, and this would suffice to dispose of the present appeal. However, as we have seen above, there is an additional reason for dismissing the appeal: this is that we are dealing with amounts withheld which are not only uncertain as to quantum if partial damages result from badly done work, but which will no longer even be due or payable if damages exceed the amounts withheld. How can it be claimed in such circumstances that a certain and current expense is involved, and that the amounts withheld, which appellant has full enjoyment of until it pays the amounts owing to the sub-contractor, or until compensation becomes due, may be deducted by appellant as it receives them from the owner.

Obviously, the holdbacks in the Guay case were “conditional, contingent or uncertain” and “should not be used in calculating taxable profits”: their very purpose was to ensure the payment of any damage which might be incurred because of faulty performance. Thus the amounts withheld were not only uncertain as to quantum if partial damages resulted, but would no longer be even due and payable if damages exceeded the amounts withheld. Such is not the situation in the case at bar where the amounts entered as expense were definitely owing and payable and were in fact paid. The judgment of Noël, ACJ was affirmed by the Federal Court of Appeal on the ground that the “appellant’s profit cannot be computed by taking, on the one hand, 90% of the value of all work done for the owner and, on the other hand, deducting the total sums paid by the appellant to the subcontractors for their work”. The Supreme Court of Canada gave no reason for dismissing the appeal.

I am of the view, therefore, that in the present case, the amounts payable, for premiums and for cargo and accident claims, constituted an outlay incurred in accordance with the ordinary principles of commercial trading, that they were properly entered as expense, and were incurred for the purpose of producing income. The Minister’s reassessment for the 1971 taxation year should therefore be varied accordingly.

And now the fines. The first determination must be as to whether or not the payment of the fines constituted an outlay made for the purpose of producing income for the plaintiff so as to meet the requirement of the exception to the prohibition of paragraph 12(1)(a). If the determination is affirmative, then the argument of public interest must be met.

In MNR v E H Pooler and Company Limited, [1962] CTC 527 at 532; 62 DTC 1321 at 1324, Thurlow, J (as he then was) of the Exchequer Court of Canada dealt with the allowance of a $2,000 fine imposed by the Toronto Stock Exchange on the respondent company for the conduct on the part of one of its vice-presidents which was considered detrimental to the interests of the Exchange. The learned judge held that there was no conceivable way in which the payment of the fine could lead to the gaining of income. The company was liable to make the payment, whether it continued to carry on the business or not, and the payment had no relation to the carrying on of the business. The vice-president was not endeavouring to earn commissions for the company but was acting for reasons of his own. Thurlow, J added:

In this view, apart from any broader principle which may or may not be applicable in the particular circumstances to exclude its deduction, the fine could not in my opinion escape the prohibition of Section 12(1)(a) unless the inducing by Mr Ramsay of other members of the Exchange to open such accounts was an act done in the course of or for the purposes of the respondent’s business.*

The “broader principle” was not defined and the payment of the fines was disallowed, not because it was tainted with impurity, but because, on the particular facts of the case, it was not incurred for the purpose of gaining income.

The English Court of Appeal in Commissioners of Inland Revenue v Alexander Von Glehn & Co, Ltd, 12 TC 232, disallowed the deduction of a compromise penalty paid by the respondent company in respect of alleged infringements of the Customs (War Powers) Act, 1915, 5 Geo V, c 31. Some comments by their Lordships are reported as follows:

Lord Sterndale, MR said at page 238:

Now what is the position here? This business could perfectly well be carried on without any infraction of the law at all.

It is perhaps a little difficult to put the distinction into very exact language, but there seems to me to be a difference between a commercial loss in trading and a penalty imposed upon a person or company for a breach of the law which they have committed in that trading.

Warrington, LJ said at pages 241-2:

Now it cannot be said that the disbursement in the present case is made in any way for the purpose of the trade or for the purpose of earning the profits of the trade. The disbursement is made, as I have already said—and the same remark applies to this Rule as to the other—because the individual who is conducting the trade has, not from any moral obliquity, but has unfortunately, been guilty of an infraction of the law.

Then, Scrutton, LJ said at page 244.:

I am inclined to think, though I do not wish finally to decide it, that the Income Tax Acts are to be confined to lawful businesses, and to businesses carried on in a lawful way.

Counsel for the defendant submitted that there is a broader principle which would exclude the deduction of a fine incurred by the taxpayer, either in the course of business, or otherwise, and made reference to some English decisions:

Fry, LJ of the English Court of Appeal said in Cleaver and Others v Mutual Reserve Fund Life Association, [1892] 1 QB 147 at 156:

The italics are mine.

It appears to me that no system of jurisprudence can with reason include amongst the rights which it enforces rights directly resulting to the person asserting them from the crime of that person.

Lord Atkin in Beresford v Royal Insurance Company, Limited, [1938] AC 586, said at pages 596-7:

The cases establishing this doctrine have been fully discussed by Lord Wright MR in his judgment in the present case. I mention some of them in order to call attention to the fact that, while in the earlier cases different reasons have been given for the rule, the principle can now be expressed in very general terms.

and at page 599:

. . . the absolute rule is that the Courts will not recognize a benefit accruing to a criminal from his crime.

In The Amicable Insurance Society v Bolland, 4 Bli NS 194, the Lord Chancellor said at page 211:

IS it not void upon the plainest principles of public policy? Would not such a contract (if available) take away one of those restraints operating on the minds of men against the commission of crimes? namely, the interest we have in the welfare and prosperity of our connexions.

Learned counsel then sought to establish that the doctrine that criminals should not benefit from their crimes should be applied under our Canadian income tax laws and would have fines disallowed as deductible expense, even if incurred for the purpose of producing income. On the other hand, counsel for plaintiff argued very effectively that the legality or illegality of the business to which the expense relates is irrelevant in interpreting the Income Tax Act.

The Exchequer Court of Canada held in Rolland Paper Company Limited v MNR, [1960] CTC 158; 60 DTC 1095, that legal expenses incurred by the appellant in defending itself against a charge of illegal trade practice under the Criminal Code were deductible, under the provisions of paragraph 12(1)(a) as expense incurred for the purpose of gaining or producing income. These expenses were incurred in accordance with sound accounting and commercial practice, they were incurred to defend and preserve the appellant’s system that produced its income. Fournier, J had this to say before he quoted Lord Haldane at page 163 [1097-8]:

That being the case, it becomes necessary to determine if unlawful acts committed in earning income from the operations of a business or trade are to be considered in computing the income of a taxpayer. The Act clearly States that the income of a taxpayer is his income from all sources. It is a sweeping and positive statement and it has been constantly held that income tax is a tax upon the person measured by his income and that the source of his income should not be looked at when computing a taxpayer’s taxable income.

In the case of Minister of Finance v Smith, [1927] AC 193; [1917-27] CTC 251, wherein it was held that upon a literal construction of the Act the profits in question, though by law of the particular province they are illicit, come within the words employed in Section 3(1), Lord Haldane in his remarks said at page 197, in fine [[1917-27] CTC 254]:

“. . . There is nothing in the act which points to any intention to curtail the statutory definition of income, and it does not appear appropriate under the circumstances to impart any assumed moral or ethical standard as controlling in a case such as this the literal interpretation of the language employed . . . .”

Four years later, the Exchequer Court held (MNR v Olva Diana Eldridge, [1964] CTC 54,5; 64 DTC 5338) that the profits of the operator of a Call girl organization was subject to tax and that she may deduct the expenses incurred for the purpose of earning income, including legal fees and commission on bail bonds. Cattanach, J stated at page 551 [5342]:

At this point I would mention it is abundantly clear from the decided cases that earnings from illegal operations or illicit businesses are subject to tax. The respondent, during her testimony, remarked that she expressed the view to the officers of the Taxation Division that it was incongruous that the government should seek to live on the avails of prostitution. However, the complete answer to such suggestion is to be found in the judgment of Rowlatt, J in Mann v Nash, 16 TC 523, where he said at p 530:

“It is said again: ‘Is the State coming forward to take a share of unlawful gains?’ It is mere rhetoric. The State is doing nothing of the kind; they are taxing the individual with reference to certain facts. They are not partners; they are not principals in the illegality, or sharers in the illegality; they are merely taxing a man in respect of those resources. I think it is only rhetoric to say that they are sharing in his profits, and a piece of rhetoric which is perfectly useless for the solution of the question which I have to decide.”

In my view, the fines paid by the plaintiff in the case before me resulted from the day-to-day operation of its transport business and were paid as a necessary expense.

In the absence of constant control by the plaintiff over the exact cargo weight carried in its trailers, and the uncontradicted evidence would suggest that such a tight control would be impractical if not impossible in a very highly competitive road transport industry, then unintentional violations of weight restrictions would seem to be inevitable. Plaintiff's method of bookkeeping, with fines paid entered as expense and fines recovered from customers booked as revenue, would also indicate that the payment of fines was very much a current item in the operation of plaintiff's business. The ready availability of advance overweight permits at the request of a shipper would also tend to show that weight restrictions can be easily overcome and that violations thereof are obviously not outrageous transgressions of public policy.

The Minister’s reassessments with reference to fines should therefore be varied accordingly.

Plaintiff's appeals in respect of its 1966, 1967, 1968, 1969 and 1970 taxation years are quashed. Plaintiff's appeal is allowed in respect of its 1971 taxation year allowing losses sustained in the five preceding taxation years under paragraph 27(1 )(e) of the Act. Costs to the plaintiff.