Northern and Central Gas Corp. Ltd. v. The Queen, 85 DTC 5144, [1985] 1 CTC 192 (FCTD), aff'd 87 DTC 5439, [1987] 2 CTC 241 (FCA)

Reed, J:—This is an action by the plaintiff contesting the Minister’s assessment of its taxable income for the 1972-1977 taxation years. Two aspects of the assessment are in dispute.

The first arises because the plaintiff treated certain assets for capital cost allowance purposes, as falling under class 8 of schedule B to the Income Tax Act, RSC 1952, c 148, as amended. Depreciation of twenty per cent per annum is allowed under the Act for class 8 assets. The Minister treated the assets in question as falling under class 2 of schedule B. Depreciation of five per cent per annum is allowed for class 2 assets. The assets in question comprise a natural gas liquefying and storage facility (the LNG plant). The dispute respecting the classification of these facilities relates to the 1973-1977 taxation years.

The second dispute relates only to the 1977 taxation year. In that year, as a result of increased rates the plaintiff was permitted by the Ontario Energy Board to charge its customers, the plaintiff benefitted from an inventory gain of $462,449. It received $255,340 of this gain in the 1977 taxation year. At the time of the rate increase, in August 1977 however, the plaintiff knew that it would ultimately be required by the Ontario Energy board to pass this gain on to its customers. Accordingly, the $255,340 which it received in 1977, was treated by it as a contingent liability held for the benefit of its customers; that sum was not treated as part of its taxable income. The Minister contends that it should have been so treated.

A third issue raised in the pleadings, the appropriate allocations of underwriting expenses incurred in 1972 and 1977, was settled by the parties before trial. It is agreed that the plaintiffs assessment relating to these expenses should be referred back to the Minister for reassessment.

Capital Cost Allowance — Classification of Assets

With respect to the first issue, the gist of the dispute is the appropriate interpretation of class 2(d) of schedule B:

(d) manufacturing and distributing equipment and plant (including structures) acquired primarily for the production or distribution of gas, . . .

The Minister contends that the LNG plant falls within this classification. The plaintiff contends that it does not; that it falls within class 8(d) of schedule B as being “a tangible capital asset that is not included in another class in this schedule . . .”

The LNG plant is located near Hagar, Ontario, on what is called the Sudbury lateral, a transmission line running between North Bay and Espanola. This transmission line belongs to the plaintiff and connects to that of Trans Canada Pipelines Limited at North Bay. The LNG plant is used to store natural gas purchased by the plaintiff from Trans Canada in low demand periods (April- October) for sale to the plaintiffs customers during the high demand months (November-March).

The gas is stored in a liquid form. To convert it to that form, its temperature must be lowered to around -256°. Before this can be accomplished impurities in the gas such as water and CO, must be removed. At low temperatures these would solidify creating blockages in the system. While one might classify this as “processing” it is processing only for the purposes of storage.

There is no doubt that this plant takes gas out of, and in winter months feeds the gas back into, what the natural gas industry calls a transmission system, not a distribution system. There is ample evidence that the industry draws a very specific and well defined line between a natural gas transmission system and a natural gas distribution system. A natural gas transmission system carries large quantities of gas over long distances at high pressures (eg: 500 psi g to 1,000 psig); a transmission pipeline generally has a diameter of 10 inches or more and is made of a material (metal) able to withstand high stress levels; the public is not directly served from a transmission line. A natural gas distribution system on the other hand carries gas at relatively low pressures (eg: 30 psig to 125 psig) over shorter distances; it comprises a network of small pipes sometimes made of a non-corrosive material such as plastic; and it serves the public directly. The end of a transmission system and the beginning of a distribution system is clearly ascertainable because at that point the gas is piped through a “gate station” (a regulating station) to reduce the transmission pressure to distribution pressure levels.

Since the LNG plant is more closely integrated with the plaintiffs transmission system than with its distribution system, the plaintiff argues that that plant does not fall within class 2(d) of schedule B. It is argued that that class includes only manufacturing (or production) equipment and distributing equipment, but not the intermediate transmission equipment.

This argument relies heavily on the principle of statutory interpretation that a statute addressed to a particular industry or business should be interpreted in accordance with that industry’s understanding of the terms used in the statute.* [1] Reference was made to Controlled Foods Corporation Limited v The Queen, [1980] CTC 491; 80 DTC 6373 (FCA); Consumers’ Gas Co, et al v Deputy MNR, Customs and Excise, [1972] FC 1057 (FCA), affirmed [1976] 2 SCR 640; and Royal Bank of Canada v Deputy MNR for Customs and Excise, [1982] CTC 183; 81 DTC 5301 (Sup Ct).

In the Controlled Foods Corporation case the taxpayer sought exemption from federal sales tax for certain restaurant equipment. It was argued that such equipment was used to “produce meals and drinks” and therefore should be classified as machinery used in “the manufacture or production of goods”. Reference was made to the dictionary definition of manufacture:

manufacture is the production of articles for use from raw or prepared materials by giving to these materials new forms, qualities and properties or combinations by hand or machinery.

The Court of Appeal, however, rejected this argument on the ground that the generally accepted commercial view of the nature of the restaurant business would

not be such as to consider the preparation of meals and beverages as “manufacturing or producing”.

In the Consumers' Gas case (supra) it was argued that regulators used by the company to reduce (or control) the pressure of gas delivered to its customers were exempt from sales tax since they were used “directly in the manufacture or production of goods”. This argument was rejected. In coming to this decision the Court of Appeal said at 1062:

What is “manufacture” or “production” within the ordinary sense of those words is something that varies according to the context or class of activity involved . . . it is a question, if not of fact, of characterization, to decide whether border line acts fall in one class or the other. In my view, merely changing the pressure of natural gas, when it is a reversible act such as it appears to be in this case, cannot, within the ordinary sense in which the words are used, be regarded as either “manufacture” or “production”. [Emphasis added]

See also: Regina ex rel Doughty v Manuel (1982), 38 OR (2d) 321 (Ont CA) where the words “‘public accountant” in a statute were held to refer to a person determined by the accounting profession to fulfil that role.

The defendant’s argument is that regardless of any particular meaning the natural gas industry might give to the terms “distributing equipment” or “distribution” system, those words in class 2(d) of schedule B should be interpreted in their ordinary sense, and without regard to that specialized meaning. This argument is based on the contention that the onus of proving that a meaning other than the ordinary one is applicable, rests with the plaintiff, and that this onus requires proof that the ordinary sense of the word “distribution” leads to an absurd result* [2] or at least to a disharmony.! [3] Secondly, the defendant contended that the ordinary sense of the word is that found in the Shorter Oxford Dictionary.

The action of distributing, dealing out, or bestowing in portions among a number; apportionment, allotment; the dispersal among consumers of commodities produced: opposite to production.

The reliance on the stringent absurdity test set out in Richards v McBride (supra), does not accord well with what seems to be the more flexible approach of modern statutory interpretation. In my view, the Court’s task is to decide whether, on reading the disputed provisions in the whole context of the Act and the circumstances to which they relate, it can fairly be said that a technical or “non-ordinary” meaning was intended.

Regardless of the test used, however, in this case reference to the “ordinary meaning” as found in the Shorter Oxford Dictionary is not of much assistance. It seems to me that that definition could equally describe the word “distribution” as it is used by the gas industry (as excluding the transmission phase) as it could describe the word “distribution” as it is used by the defendant (as including the transmission phase). Thus, it is to the context of the Act and the defendant’s second argument that we must turn. Class 2 of schedule B reads in general terms, as follows:

Property that is

(a) electrical generating equipment . . .

(b) a pipeline . . . unless, in the case of a pipeline for oil or natural gas, the Minister, in consultation with the Minister of Energy, Mines and Resources, is or has been satisfied that the main source of supply for the pipeline is or was likely to be exhausted within 15 years from the date on which operation of the pipeline commenced,

(c) the generating or distributing equipment and plant (including structures) of a producer or distributor of electrical energy . . .

(d) manufacturing and distributing equipment and plant (including structures) acquired primarily for the production or distribution of gas, except

(i) a property included in class 10, 13 or 14,

(ii) a property acquired for the purpose of producing or distributing gas that is normally distributed in portable containers, or

(iii) a property acquired for the purpose of processing natural gas before delivery to a distribution system,

(e) the distributing equipment and general plant (including structures) of a distributor of water . . .

(f) the production and distributing equipment and general plant (including structures) of a distributor of heat . . .

It is clear that class 2 of schedule B as a whole does not just relate to the natural gas industry. It relates to the production and distribution of electricity, heat and water as well as to the gas industry generally, not merely that involved with the production and distribution of natural gas. Subparagraph (b) is even more general, referring to pipelines without reference to the commodity they carry. Accordingly, it is difficult to conclude that the word “distribution” in subparagraph (d) was chosen with the specific usage of the natural gas industry in mind. Rather, it seems clear that the subparagraphs of class 2 were intended to encompass the whole process from the production (or manufacture) of the gas (electrical energy, water or heat) to its ultimate distribution to customers (with some specific exceptions). I think it would do violence to the word distribution as used in class 2, if one interpreted it as encompassing only the end use distribution system, as contended for by the plaintiff. Such interpretation would bring within the scope of subparagraph (d) gas production facilities and end use distribution facilities but not the intermediate transmission facilities. Such interpretation would render subparagraph (ii) meaningless or would force a reader to conclude that “distribute” in that section was being used in a sense different from the way in which it was used elsewhere in paragraph (d). Subparagraph (ii) refers to the distribution of gas in portable containers — a process radically different from the restricted meaning the plaintiff wishes to give to the word “distribute”. In my view, “distribution” in subparagraph (d) is used in a broad and general way and it was intended to encompass the transmission part of the plaintiffs overall distribution system. Thus, the LNG plant falls within class 2(d) as “plant acquired primarily for the . . . distribution of gas”. It is true that the plant is a storage facility but from the evidence led by the plaintiff it is clear that the facility is an integral part of the plaintiffs transmission system. One witness described it as an integral part of moving large quantities of gas from North Bay to Sudbury. Thus, the facility is a plant acquired primarily for the distribution of gas.

Counsel for the plaintiff also argued that the LNG plant should fall outside class 2 because it should be classified as coming within the exception set out in subparagraph (iii):

a property acquired for the purpose of processing natural gas before delivery to a distribution system,

I do not think that this argument is convincing. As noted above, it is my view that the word “distribution” as used in class 2(d) is not used in the restricted sense given to that word by the natural gas industry. It is used in a more general sense and encompasses the transmission phase of the plaintiffs enterprise. Accordingly, the plant could not be said to have been acquired for the purpose of processing gas “before delivery to a distribution system”.

Inventory Gain

The other issue still in dispute between the parties is, as noted above, the appropriate treatment of moneys received by the plaintiff during the 1977 taxation year which were attributable to an inventory gain. The rates which the plaintiff charges its customers are regulated by the Ontario Energy Board. On August 1, 1977, the Board approved a rate increase to allow the plaintiff to recoup increased costs it would incur, as of that date, in purchasing gas from Trans Canada. These increased costs resulted from a rise in gas prices allowed pursuant to federal natural gas pricing regulations under the Petroleum Administration Act, specifically PC 1977-2134 of July 28, 1977.

As a result of the increased rates which the plaintiff was allowed to charge its customers, it stood to gain an added benefit from the sale of gas it held in storage as of August 1, 1977, and which it had purchased at the lower preAugust I price. (This inventory gain was estimated to be $462,449.) It was the Ontario Energy Board policy, however, to insist that the plaintiff not benefit from any increased value its inventory acquired as a result of rate increases but that this gain be “passed-on” by the plaintiff to its customers. It had been the Board’s previous practice to accomplish this “passing-on” by delaying the date of the rate increase allowed to the plaintiff for a sufficient number of days to “wipe-out” the inventory gain. Thus, if previous practice had been followed, even though the increased cost of gas to the plaintiff became effective August 1, 1977, the Ontario Energy Board would have insisted that the rate increase the plaintiff might charge to its customers only became effective August 10, 1977. However, on this it was decided by the Board, at the request of the plaintiff, not to follow previous practice but to provide for the “passing-on” in February 1978, rather than in August 1977. (Another rate increase was expected at that time as a result of another expected federally approved rise in gas prices.) This delay was proposed by the plaintiff because a “passing-on” in February would benefit a different mix of customers from those benefitting from a delay in the summer months (ie: a larger percentage of residential as opposed to commercial and industrial customers — “heat sensitive customers” as they were referred to in the evidence). Thus in February 1978, the rate increase allowed to the plaintiff as of February 1, 1978, was allowed to become effective only as of February 13, 1978. (The delay compensated for more than just the inventory gain in issue in this case but these additional factors are irrelevant for present purposes.)

During November and December 1977, the plaintiff had sold some of its stored gas and calculated the profit thereon attributable to the inventory gain as $255,340. Knowing that in February 1978, it would be required to pass this through to its customers, the plaintiff did not treat this amount in its hands as taxable income. The amount was treated as a liability owed to the plaintiffs customers.

While I have indicated that the plaintiff “knew” it would not be allowed to keep the inventory gain, the nature of Ontario Energy Board’s decision of August 5, 1977, is particularly important. The Board, at that time did not definitively specify how the gain would be dealt with. Part of the Board’s reasons reads as follows:

There was no consistent position of the various intervenors and Board counsel with respect to whether the inventory . . . should be utilized now or in connection with the February 1, 1978 increase. What was consistent was the view that the Applicant must not be allowed to use these items to offset any lost margins as recommended by Mr Johnson.

Having regard to all the submissions, the Board has concluded that it is appropriate, as in the past, that the storage inventory at July 31, 1977, with interest, be taken into account at the time of consideration of the implementation date for the passing on of the February 1, 1978 increase. While this panel is of the view that the benefit of storage inventory ought to be reserved for those customers for whom the gas is stored, the Board considers that it would be inappropriate to stipulate now what disposition should be made by the panel of the Board that ultimately disposes of the matter.

Thus, it was left to the February 1978 Board to finally deal with the treatment to be accorded to the inventory gain. The plaintiff before that Board argued, as it had done in August, that the inventory gain should not be “passed-on” in the manner contemplated by the Board. Part of the February decision of the Board reads as follows:

The Applicant proposed that the inventory profit be used to offset a portion of the revenue deficiency rather than to delay the implementation of increased rates .. . .

The Board notes that the Applicant’s proposal to offset inventory gain against revenue deficiency results in the benefits of storage being spread across all customers, rather than to those who create the demand for storage facilities and against whom such costs are normally allocated in Phase II proceedings. The Board has consistently maintained that the inventory profit realized as a result of gas cost increases should be returned to those customers for whom the gas is stored, and finds no reason to depart from that practice.

Thus, the effective date of the February rate increase was delayed until February 13, 1978.

The plaintiff argues that the $255,340 received by it should not be considered as income in its hands because the plaintiff had no absolute right to the funds; the plaintiff knew it was going to be required to pass that gain on to its customers; it didn’t matter that the specific customers to whom it would accrue could not be identified; it was a clear liability, definite and measurable (the inventory gain (part sold) plus interest from August 1, 1977, to December 31, 1977).

The plaintiff relied on Robertson Limited v MNR, [1944] Ex CR 170; Dominion Taxicab Association v MNR, [1954] SCR 82; and MNR v Atlantic Engine Rebuilders Limited, [1967] SCR 477. In the Robertson case, an advance fee paid as a deposit was held not to be income in the hands of the recipient. The advance fee was an estimate of the amount ultimately payable; it was either retained or refunded when the amount of the earned fee was ascertained. The headnote describes the decision:

. . . where an amount is paid as a deposit by way of security for the performance of a contract and held as such, it cannot be regarded as profit or gain to the holder until the circumstances under which it may be retained by him to his own use have arisen and until such time, it is not taxable income in his hands, for it lacks the essential quality of income, namely, that the recipient should have an absolute right to it and be under no restriction, contractual or otherwise, as to its disposition, use or enjoyment.

The Dominion Taxicab case was also a deposit case. Membership fees paid to an association of taxicab owners were paid as deposits; the association used these funds to purchase capital assets and render certain services to the members. By contract the fees only became the absolute property of the association when the member left the association and if no successor to him were found. While the fees were expressed to be paid as deposits and there was a provision for the payment of interest thereon, in some circumstances, it was not clear when, if ever, a member could obtain the return of a deposit. The Court nevertheless held that the funds held by the association were not income in its hands:

. . . on the true construction of the contract and on the evidence, none of the payments of $500 became the absolute property of the Association in the year 1949; . . . as each deposit was received by the Association and became a part of its assets there arose a corresponding contingent liability equal in amount. The consideration moving from the member to the Association was not the outright payment to it of $500 but the deposit with it of that sum. While the contract fails to indicate with any precision the respective rights of the parties in regard to the sum deposited and particularly fails to make clear the circumstances, if any, under which the member may require the return of such sum, all its terms appear to me to be inconsistent with the view that the Association acquired any absolute property in such sum. The second paragraph of the contract shows that two conditions had to be fulfilled before the absolute ownership of the deposited sum could pass to the association, (i) the member must have left the Association, and (ii) the parties must have failed to agree on a satisfactory successor to the retiring member.

The Atlantic Engine case (supra) dealt with a taxpayer who required car dealers purchasing a rebuilt engine from it to pay the invoice price billed and to supply another rebuildable engine to the company. Customers who could not immediately provide the rebuildable engine were required to pay a deposit of about three times the market value of the used engine. In 96 per cent of the cases in which deposits were paid, these were subsequently redeemed by customers supplying a rebuildable engine. The Supreme Court held that these deposits were not income in the hands of the taxpayer: (at p 479-480)

The question of substance in this case appears to me to be whether in stating what its profit was for the year the respondent could truthfully have included the sum in question. To me there seems to be only one answer, that it could not. It knew that it might not be able to retain any part of that sum and that the probabilities were that 96 per cent of it must be returned to the depositors in the near future. The circumstance that the respondent became the legal owner of the moneys deposited with it and that they did not constitute a trust fund in its hands appears to me to be irrelevant; the same may be said of moneys deposited by a customer in a Bank which form part of the Bank’s assets but not of its profits. To treat these deposits as if they were ordinary trading receipts of the respondent would be to disregard all the realities of the situation.

The grounds upon which Thurlow J based his decision appear to me to be supported by the reasoning of the majority in this Court in Dominion Taxicab Association v Minister of National Revenue, supra, at p 85, where it is stated that as each deposit was received by the Association and became a part of its assets there arose a corresponding contingent liability equal in amount. . . .

The defendant argues that these cases are distinguishable, however, because the plaintiff had the legal right to the absolute use of the income in 1977. Counsel for the defendant argued that the fact situation was closer to those with which the Court has dealt in Commonwealth Construction Company Ltd v The Queen, [1984] CTC 338; 84 DTC 6420 (FCA); Harlequin Enterprises Ltd v The Queen, [1974] CTC 838; 74 DTC 6634 (FCTD) affirmed [1977] CTC 208; 77 DTC 5164 (FCA); The Queen v Burnco Industries Ltd et al, [1984] CTC 337; 84 DTC 6348 (FCA); and J L Guay Ltée v MNR, [1971] CTC 686; 71 DTC 5423 (FCTD). Counsel for the defendant argued that the sums in question could not be treated as an expense by the plaintiff since there was no legal obligation on the plaintiff to pay out these amounts as of December 31, 1977; that at most, the amount constituted a contingent liability but one that is not allowed as a deduction for tax purposes by virtue of paragraph 18( 1 )(e) of the Income Tax Act, RSC 1952, c 148, as amended.

It is clear that the sums in question cannot be brought within the scope of the deposit cases cited by the plaintiff. The plaintiff had a legal and absolute right to the use of the money when it was received. There were no restrictions in its right to the money; there were no unfulfilled conditions precedent. The money was clearly income in the hands of the plaintiff when received. Could the amount then be considered as an expense of making income because the plaintiff had a known and measurable liability to its customers at the end of 1977. The problem the taxpayer has to meet is that while the amount it expected to pay was definitely ascertainable there was no existing legal obligation at the end of 1977 requiring payment. The decision in Meteor Homes Ltd v MNR, [1960] CTC 419 at 429; 61 DTC 1001 at 1007-8 (Ex Ct) quoted with approval the following:

All the above cases serve to illustrate the principle that, in the case of a taxpayer on an accrual basis, where an expense is incurred and the amount is definitely ascertainable and legally liable or payable in the year . . . such amount may be claimed as an expense of the year.

That decision continued:

. . . A Dictionary for Accountants, second edition, p 290, defines a legal liability as —

A responsibility for some obligation, enforceable at law, as distinguished from a moral responsibility.

And quoting from Simon’s Income Tax, second edition, Vol II, pp 203 and 204:

. . . A liability, the amount of which is deductible for income tax purposes, is one which is actually existing at the time of making the deduction, and is distinct from the type of liability accruing in Peter Merchant, Ltd v Stedeford (supra), which although allowable on accountancy principles, is not deductible for the purposes of income tax.

And apart from the Harlequin Enterprises decision (supra) at 849 [6642]:

Certain as it was that the Plaintiff would, in due course, be obliged to give rebates on royalties or on returns of books, the fact is the Plaintiff’s liability to do so, under the terms of the agreements which were, in practice, observed, did not arise until the Plaintiff was presented with a demand for the credit. The Plaintiffs obligation to the distributors in respect of credits for returns was a contingent liability. . . .

And from the recent Federal Court of Appeal decision in The Queen v Burnco Industries Ltd (supra)'.

. . . An expense cannot be said to be incurred by a taxpayer who is under no obligation to pay money to anyone. . . .

The August 1977 decision of the Ontario Energy Board is therefore crucial. That Order set the rates the plaintiff might charge its customers effective August 4, 1977. Paragraph 4 of the Order provides:

This Order is subject to the following conditions:

(a) The interim rate increases hereby authorized are subject to full examination by the Board at a hearing of the Main Rate Application, and may be altered or changed as the Board may direct, and the Applicant shall refund to its customers affected thereby such amount as the Board may direct or make such other adjustments as the Board may direct with respect to amounts collected pursuant to this Order. . . .

(This is a boiler plate clause in all OEB decisions)

There is no specific requirement in that Order dealing with the inventory gain. Indeed, the reasons for decision, quoted above, expressly left that matter to the February 1978 Board. There is no doubt that the plaintiff could anticipate that it would be required to “refund” the inventory gain to its customers by virtue of a February 1978 decision. There is no doubt that an accountant would deem it necessary to reflect this fact in the books of the company but it cannot be said to be an expense for tax purposes. It was a reserve for a contingent liability. The fact that the amount of the liability was ascertainable and that the probability of it not becoming payable was very small (almost infinitesimally small) does not affect the nature of the liability (refer: Guay case, (supra)). There was no legal liability on the plaintiff at the end of 1977 to “refund” the sum to its customers.

The sum in question being properly characterized as a reserve for a contingent liability is caught by the provisions of paragraph 18( l)(e) of the Income Tax Act

(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

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

No argument was made that the reserve in question is one permitted by the Act.

A judgment will issue in accordance with these reasons.