Horton Steel Works Ltd. v. MNR, 72 DTC 1123, [1972] CTC 2147 (T.R.B.)

A J Frost:—This is an appeal from an income tax assessment in respect of the appellant’s 1968 taxation year wherein the penalty of $82,168.80 imposed under subsection (4) of section 48 of the Excise Tax Act was not allowed as a deduction from income on the ground that it was not incurred for the purpose of producing income. The Minister of National Revenue confirmed the assessment on January 14, 1971. The appeal was heard at Hamilton, Ontario, on November 22, 1971, by the Tax Appeal Board as it was then constituted.

The appellant fabricates steel plate and is a subsidiary of Chicago Bridge and Iron Company of Chicago, Illinois, United States. As the result of a sales audit, an additional federal sales tax of $666,680.25 was levied and a penalty of $82,168.80 imposed under subsection (4) of section 48 of the Excise Tax Act. The said subsection (4) reads as follows:

(4) Subject to subsection (5), upon default in payment of the tax or any portion thereof payable under Part IV, V or VI within the time prescribed by subsection (3), there shall be paid in addition to the amount of the default a penalty of two-thirds of one per cent of the amount in default in respect of each month or fraction of a month during which the default continues.

Counsel for the appellant in his argument submitted that:

(1) The amount represents an ordinary business expense of the taxpayer and was incurred by the taxpayer in the ordinary conduct of its business;

(2) The Excise Tax Act levies penalties only (rather than interest) for sales tax deficiencies; accordingly, such additional charges are a form of additional sales tax because of the manner by which the charge is imposed under the Excise Tax Act, similar to the penalty for dumping duties (ie, additional special duties) under the Customs Tariff, which penalties have traditionally been accepted by the Department as normal business expenses and deductions for corporation income tax purposes.

(3) In all of the tax cases dealing with the question of deductibility for tax purposes of fines and penalties (CCH Canadian Tax Reporter, 11-436.739), penalties were not allowed as tax deductions only in cases where such penalties were not business expenses or were unrelated to the taxpayer’s ordinary conduct of its business, which cannot be said with respect to the penalties incurred by Horton Steel Works, Limited which were related to the collection of sales tax on the sale of its products during the conduct of its ordinary business. Moreover, CCH refers only to the disallowance by the Department of penalties or interest incurred by taxpayers under the Income Tax Act, and fails to include in this reference penalties under the Excise Tax Act.

(4) The amount of $82,168.80 was disallowed by the Department under Section 12(1)(a) of the Income Tax Act as “not an outlay or expense incurred by the taxpayer for the purpose of gaining or producing income of a business”. The taxpayer submits that the penalty imposed can be identified with the federal sales tax itself which is imposed under the Excise Tax Act and is considered by the Department as a deduction for corporation tax purposes notwithstanding the “purpose of gaining or producing income” test of Section 12(1 )(a).

(5) Such additional charges under the Excise Tax Act cannot be equated with interest and penalties on a corporation’s deficient income tax liability payments which liabilities (and any accompanying charges) are determinable and payable only after the taxable income has been earned, completely unlike federal sales taxes (and related charges) which are an integral part of the corporation’s business income earning process.

In the Board’s opinion, the fine was imposed as a consequence of a breach of the law and cannot be considered an expenditure incurred in the normal course of business. The distinction between the imposition of sales tax and a penalty under the Excise Tax Act is that the penalty would not have been incurred had there been no default under the said Act. This fact severs the penalty from the tax itself. Sales tax has always been recognized as a business expense, but penalties fall into a different category being imposed only as a result of default. The respondent cannot be expected to bear any part of the burden of a sales tax penalty arising as a result of carelessness or ignorance, either directly or indirectly.

As the business of the appellant could have been carried on without any infraction of the law, the penalty is not an outlay made for the purpose of producing income under paragraph 12(1)(a) of the Income Tax Act. Reference may be had to Atomic Transfer Lid v MNR, 34 Tax ABC 451; CIR v Alexander Von Glehn & Co, Ltd (1919-20), 12 TC 232.

Appeal dismissed.