Canada: Windfalls In The Tax Court

Henco Industries Limited v. The Queen 2014 TCC 192
Last Updated: October 29 2015
Article by Andrew Stirling

A former land developer in Henco Industries Limited  v. The Queen 32 successfully argued before the Tax Court that a $15.8 million payment from the Ontario government should be characterized as a non-taxable capital receipt and a separate payment of $650,000 from the Ontario government should be characterized as a non-taxable windfall. Although the decision is noteworthy for concluding that these payments are not taxable, the decision by Miller J should also interest members of the tax community because of its analysis of various other issues discussed in the final ruling, including the distinction between eligible capital amounts and non- taxable capital receipts, the scope of paragraph 12(1)(x), the nature of inventory in the context of section 23, and the applicability of the parol evidence rule in interpreting agreements before the Tax Court.

Although legislative amendments may in part limit the relevance of the Henco decision to future cases attempting to delineate the boundary between eligible capital amounts and non-taxable capital receipts, the case raises broader structural questions about the nature of Canadian taxation and the types of payments that are subject to taxation under the Act. As noted by Miller J in his decision on costs,

[f]inding  a payment to be a non-taxable capital receipt is not something any Tax Court of Canada judge does lightly. It can have serious repercussions in our overall system of taxation as to what is a source of income that is subject to Government taxation. Circumstances are rare that a payment, perhaps shrouded in a commercial light, is non-taxable. But cases that peak under that shroud, and give both Government and taxpayers alike guidance as to what can and cannot be swept into the taxing regime, should be of keen interest.33

Facts

Henco was in the business of developing land in and around Caledonia in south- western Ontario. As of February 2006, Henco's landholdings included properties described in the decision as (1) the Douglas Creek Estates (DCE), (2) the Seneca property, and (3) the Morrison property.34

Beginning in February 2006, protests on or near the site of the DCE land by certain First Nation members and their supporters made development of the land impossible. The protesters were reported to dispute, among other things, whether the land had been properly surrendered by the First Nation during the 19th century. According to the agreed statement of facts, the protests were held "to try to stop, or at least disrupt, further development of the subdivision."35

Henco obtained certain injunctions from the Ontario Superior Court of Justice to clear the protesters from the DCE land. However, the Ontario Provincial Police declined to enforce the injunctions following a failed attempt to disperse the protest in April 2006.

After the police failed in their attempt to disperse the protest, the Ontario government offered Henco the $650,000 payment. The documentation accompanying the payment indicated that it was made "to mitigate the impact of continued occupation of DCE."36 The documentation also stated that the DCE "Funding Assistance is in respect of development, building and other related costs and expenses that have been incurred by Henco in connection with the [DCE land] because of the occupation."37  Henco's representatives indicated that the terms were not negotiated nor agreed to by Henco.  Although Henco accepted payment on May 3, 2006, it signed nothing to confirm its acceptance of the offered terms and nothing to confirm that it was to do or refrain from doing anything as consideration for the payment.

In its T2 income tax return for the taxation year that ended on April 29, 2006, Henco wrote down the value of the land inventory in respect of the DCE to $7. The Canada Revenue Agency (CRA) and Henco each had valuation reports prepared that confirmed that the DCE property had only nominal fair market value on May 1, 2006.

Representatives of the protesters, the Ontario government, and the federal government entered into a three-party agreement on May 16, 2006, agreeing to halt any development on the DCE land for an indeterminate  period of time. Provincial zoning regulations enacted on May 17, 2006 generally prohibited development of the DCE land.

Before February 2006, Henco estimated that it would earn profits of approximately $30 million in respect of the development of the DCE land on revenues of approximately $45 million.

An agreement was signed in June 2006 pursuant to which Henco sold the DCE land and certain related business assets to the government of Ontario in exchange for $15.8 million. Henco was also obliged under the terms of the agreement to stop developing the DCE land, take steps to have the injunction removed, and release Ontario from any and all claims in respect of the land. As part of the agreement, the government of Ontario agreed to reimburse  Henco for reasonable costs relating to the retention of consultants, legal advisers, appraisers, experts, advisers, or other third parties, subject to a maximum amount of $300,000.

Parol Evidence

At the beginning of the trial, the Crown brought a motion seeking to exclude, among other things, extrinsic evidence that Henco might try to admit to interpret or contextualize the agreement. The Crown brought the motion on the basis that this evidence was not admissible pursuant to the parol evidence rule. Quoting Wad- dams, the Crown described the parol evidence rule as follows:

By the general rules of the common law, if there be a contract which has been reduced into writing, verbal evidence is not allowed to be given of what passed between the parties, either before the instrument was made, or during the time that it was in a state of preparation, so as to add to, or subtract from, or in any manner to vary or qualify the written contract.38

The Crown acknowledged that there are certain exceptions to the parol evidence rule that permit courts to review extrinsic evidence to interpret a contract. In argument, it suggested that these circumstances are limited to situations in which there is either a patent or a latent ambiguity in the contract. Accordingly, the Crown took the position that evidence concerning the circumstances at the time of contracting should be admitted only when the words of the contract, viewed objectively, bore two or more reasonable interpretations.

However, the Crown acknowledged that certain courts have accepted extrinsic evidence to establish the "factual matrix" or "surrounding circumstances" that led to the formation of an agreement to assist them in determining the parties' contractual intentions as they would be determined by a reasonable person.39 A factual matrix or the surrounding circumstances can help a court to understand what the parties meant by the words that they used in a contract. Henco went further, suggesting that such an analysis was necessary to the proper interpretation of a contract, citing River Hills Ranch Ltd. v. The Queen, in which it was found that "the objective contextual scene in which the written agreement was made is an integral part of the interpretive process and is not something that is resorted to only where the words viewed in isolation suggest some ambiguity."40

In considering the parties' positions, Miller J observed that "there is no discernible bright line establishing a factual matrix (clearly admissible) and evidence of subjective attention [sic] (perhaps inadmissible)."41

The court noted the difference between the task before the civil courts, where two parties to a contract may be disputing the presence or significance of unwritten contractual rights or obligations, and the task before the Tax Court, which must assess the correctness of the characterization of the nature of a payment by a third party, the government of Canada. In the latter case, the court noted that the factual matrix is essential in determining the true nature of the payment for the purposes of assessing tax.

The court expressed concern that a contract may be drafted without due consideration of its tax implications or, more significantly, may be misleadingly drafted to affect the character of the transaction for tax purposes. A broad interpretation of the parol evidence rule in these circumstances could produce inappropriate results that are inconsistent with the object and purpose of the Act. As an example, the court cited the line of jurisprudence distinguishing employment relationships from independent contractor relationships. In these circumstances, the courts are required to look beyond the text of the contracts to the actions of the parties. Similarly, section 68 requires the courts to look beyond the stated allocation of the parties to determine a reasonable allocation in the circumstances. Such an inquiry into reasonableness would almost certainly necessitate an examination of the surrounding circumstances.

Applying the above principles to the Henco decision, the court found that a review of the factual matrix or surrounding circumstances giving rise to the signing of the agreement was imperative in interpreting the nature of the payments made under the agreement. Rather than being an ordinary commercial arrangement that was committed to writing, the agreement was drafted in "exceptional circumstances" in which market forces did not play a material role.42

Moreover, the terms of the contract itself invited the use of extrinsic evidence: the preamble stated "[w]hereas based on circumstances relating to the use and development of the property."43 The court also found that the agreement was ambiguous because it failed to allocate the payment among the assets being sold. The parties' failure to make such an allocation made the examination of extrinsic facts necessary in order to allocate these amounts for tax purposes.44

Income or Windfall: The $ 650,000Payment

The Crown argued that the $650,000 payment fell within the scope of paragraph 12(1)(x). In general terms, paragraph 12(1)(x) deems certain amounts to be included in a taxpayer's income from a business or property, including certain amounts paid by a government that are received by a taxpayer in the course of earning income from a business or property, to the extent that the payment can reasonably be considered to have been received as assistance in respect of an outlay or expense.

The court summarized the four criteria that would have to be satisfied for the $650,000 payment to be included in Henco's income pursuant to paragraph 12(1)(x):

1) The $650,000 must have been received by Henco "in the course of earning in- come from a business or property";

2) The payment must have been from a government;

3) The payment can reasonably be considered to have been received as assistance in respect of an outlay or expense;

4) The payment was not for the acquisition of Henco's business or property.45

Henco's position before the court was that the $650,000 payment did not fall within the scope of paragraph 12(1)(x) because (1) the payment had not been received in the course of earning income from a business or property, and (2) the payment could not reasonably be considered to have been received as assistance in respect of an outlay or expense. In the alternative, Henco argued that the $650,000 had been received in respect of Henco's disposition of the DCE land.

In the Course of Earning Income from a Business or Property

Henco emphasized that the first requirement could be satisfied only if the $650,000 payment were received by Henco "in the course of earning income from a business or property." This wording contrasts with the wording in paragraph 12(1)(a), which merely requires a payment to have been received "in the course of a business." Commenting on this distinction, the court observed that it would be possible that a taxpayer could receive a payment while in business yet not in the course of earning income from a business.

Henco was clearly in business and receiving revenue in the course of earning in- come from a business in 2005 and the first part of 2006 (until the protests began in February 2006). However, the court observed that the $650,000 payment was not made in respect of this period. Rather, it was made in respect of the period beginning in late February 2006 and ending on May 3, 2006, when the payment was received. The court found that it was this latter period that must be examined to determine whether the payment was made in the course of earning income from a business or property.

The court concluded that Henco was not taking steps in the course of earning income from a business during the protests. Rather, it was attempting to preserve the business itself, with an expectation that the protests would eventually cease, thereby permitting it to resume earning income in the course of a business. An example of a step taken by Henco during the protests was the seeking of the injunctions before the Superior Court of Justice.

To view this article in full, please click here.

Footnotes

32 2014 TCC 192.

33 2014 TCC 278, at paragraph 9.

34 The court also made rulings relating to (1) the fair market value of the Seneca and Morrison properties and (2) whether the Seneca property was held on income or capital account.

35 Supra note 32, at paragraph 9.

36 Ibid., at paragraph 29.

37 Ibid.

38 S.M. Waddams, The Law of Contracts, 6th ed. (Aurora, ON: Canada Law Book, 2010), at paragraph 320, note 10, quoted in Henco, supra note 32, at paragraph 82.

39 Supra note 32, at paragraph 84.

40 2013 TCC 248, at paragraph 42.

41 Supra note 33, at paragraph 88.

42 Ibid., at paragraph 92.

43 Ibid., at paragraph 95.

44 Ibid., at paragraph 98. Paragraphs 100-16 of the court's reasons considered which forms of extrinsic evidence would be admitted into evidence under one of the exceptions to the hearsay rule. The court found that certain government press releases were admissible into evidence, but it prohibited the admission of the affidavits of certain public officials. If counsel for Henco wished to have the evidence admitted, Henco would have to have called the public officials as witnesses.

45 Supra note 32, at paragraph 119.

First published by the Canadian Tax Foundation in the Current Cases feature (2015) 63:1 Canadian Tax Journal 227-39.

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2015

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions