The Meaning of Income in the Law of Income Tax 9781487576066

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The Meaning of Income in the Law of Income Tax

By FRANCIS EUGENE LABRIE Associate Professor in the School of Law University of Toronto

The Meaning of Income in the Law of Income Tax

Sponsored by the Canadian Tax Foundation UNIVERSITY OF TORONTO PRESS

1953

Copyright, Canada, 1953, and printed in Canada by University of Toronto Press. London: Geoffrey Cumberlege Oxford University Press Reprinted in 2018 ISBN 978-1-4875-7692-9 (paper)

TO MY PARENTS JEAN MICHEL LABRIE AND

MARGARET ANNE LABRIE

Preface A CONSIDERABLE AMOUNT has been written concerning the meaning of income for taxation purposes. The usual practice of Canadian writers has been to arrive at the meaning of income through the terms of the Canadian statute law, presenting first the relevant statutory provisions and then supplementing the law therein set forth by the cases. This approach may be justified on the view that the statute law is paramount and therefore of greater importance than the cases. On the other hand, the Canadian statute law, far from providing a code of law on the meaning of income, presents a very disjointed picture. Many matters of the utmost importance either are not dealt with at all or are dealt with only in part. Wherever the statute law is inadequate the case law remains the sole guide. Moreover, unless the approach and substance of the case law on the meaning of income is clearly understood the extent of this inadequacy cannot be readily appreciated. For this reason I have attempted to present, as far as possible, a complete picture of the case law on the meaning of income and then to superimpose on this law the text of the Canadian statutes. I have not dealt fully with all aspects of the statutory provisions since they can be found well analysed elsewhere. In addition, I have found it necessary to deal fairly extensively with the Canadian Income War Tax Act and with English income tax legislation in order to deal effectively with the case law that has arisen in England and Canada. Unfortunately, the recent English consolidation of the Income Tax Acts was not enacted until this work had gone to press. While this treatise is mainly concerned with case law, I do not purport to have dealt with every case on the subject. Many cases I have found repetitious. Others are useful only by way of illustration. Cases that I convii

PREFACE

viii

sider of minor importance I have mentioned merely by way of footnote references. This work was first published in 1949 as a University of Toronto thesis. Since then there have been a number of developments in Canadian taxation law. Yet there has been little noteworthy change in the case law on the meaning of income. In preparing this publication I have provided reference to current provisions of the Income Tax Act and have included the more recent cases. In addition I have omitted the bulk of former discussion and comparison with economics and accountancy conceptions of income. The present work remains purely a legal treatise. I wish to express my gratitude to Professor J. Finkelman and Professor J. Willis who have assisted and encouraged me throughout my task. Needless to say, responsibility for what I have written rests with me. I wish to thank Professor J. R. Westlake for agreeing to my use, particularly in chapter vm, of certain portions from our joint publication Deductions under the Income War Tax Act: A Return to Business Principles. Finally, I wish to thank the Canadian Tax Foundation for assistance in the final preparation of this volume and the University of Toronto School of Graduate Studies for consenting to its publication. I am also indebted to the editorial staff of the University of Toronto Press for their assistance in seeing this work through publication.

F. E. L. School of Law University of Toronto March 31, 1952

Contents PART ONE: INTRODUCTION I. THE INCOME TAX

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3

The Canadian Acts The English Acts The charging scheme The object of the tax Taxation at the source The "reliefs" from taxation Residence Judicial review II. THE MEANING OF INCOME

Income at Common Law Income Defined in the Income War Tax Act "Annual" "Directly or indirectly received" "The annual profit or gain from any other source" The Income Tax Act

5 7 9

13 13 16 17 18 21 21 27 28 29 49 52

PART TWO: GROSS INCOME BusJNESs Carrying on Business Defined Capital Gains Income from Trade under the English Act

III. INCOME FROM

ix

57 58 64 67

X

CONTENTS

Income from Purchases and Sales The fact of repetition The fact of alteration or transformation The nature of the commodity purchased and sold Special factors in relation to companies Other factors Income from Established Businesses Realization of assets Fixed and circulating capital Income from isolated sales Expropriation payments Insurance payments Damage payments Subsidy payments Summary of principles Income from Mutual Trading IV. INCOME FROM PROPERTY

The Conversion of Capital into Income The Conversion of Income into Capital Income from Corporeal Property Income from Patents and Copyrights Income from "Money" Income from Company Shares The receipt of income by shareholders The realization of capital from shares Special Canadian legislation V. INCOME FROM PERSONAL SERVICES

Income from Offices and Employments Capital Receipts Arising in Connection with Contracts of Service Payment for rights voluntarily surrendered Compensation for loss of office Income from Casual Services

80 81 84 85 89 94 f17

100

103 107 109 112 116 119 121 122 133 137 147 149 152 162 169 175 181 190 196 197 205 205 210 215

PART THREE: DEDUCTIONS VI. THE PROBLEM OF DEDUCTIONS

Introduction Exemptions, excepted incomes, and deductions Deductions in determining income Applying English Decisions to Canadian Acts

223

223 223 225

W

CONTENTS

VII.

VIII.

Acr Remoteness of expenditure Expenditures wholly and exclusively for the purposes of the trade Capital expenditures The necessity of expenditures Expenditure of income after it has been earned Expenditures as "owner" and not as "trader" Summary

CoMMERCIAL PRINCIPLES UNDER nm ENGLISH

THE TREND OF CANADIAN DECISIONS

The Income-Earning Process Concept Capital or Income Expenditure The "Earning" of Income Earning "the Income" Ascertained and Investment Incomes Recent Canadian Decisions The Income Tax Act

d 244 244 250 259 277 279 293 298 300 300 309 328 337 344 353 364

INDEX OF CASES

369

GENERAL INDEX

378

Part One INTRODUCTION

CHAPTER ONE

The Income Tax Acts INCOME TAX is entirely the creature of statute law. There is no suggestion at common law that persons must share their incomes with the state. While the legislatures of most parts of the British Commonwealth have imposed this tax, in no instance does their legislation provide a comprehensive code of law on the subject. In Great Britain and Canada taxes on or in respect of income have been imposed in the broadest language, leaving many matters to be determined by the courts. Foremost among the problems thus created and left unsettled is that of determining what is to be included in the profits, gains, remuneration, and other forms of payment generally referred to as "income." That concept is nowhere defined or adequately described by statute, so that its breadth of meaning has had to be gradually worked out in a long series of court decisions. The problem of distinguishing income from other forms of receipt has arisen before the courts in other connections, for example, in distinguishing income from capital for the purpose of the company law rule against the payment of dividends out of capital, in giving effect to contractual agreements wherein a consideration is expressed in terms of a division of "profits" or of "income," and in determining the right to share, as between tenants for life and remaindermen, the gains from properties settled by way of trust. However, the meaning of income has received a far more detailed consideration in cases dealing with the income tax, and in that connection the term has come to acquire very special signification. While Canadian courts have had to consider the meaning of income as used in the Canadian income tax acts, the Canadian cases are relatively few in number. United States courts, on the other hand, have 3

4

THE MEANING OF INCOME

handled a great volume of litigation on all aspects of income tax law, but the meaning of income is so much more exhaustively dealt with by the United States revenue codes that their decisions have seldom been found to be of value or assistance in resolving that problem under the broad statutory provisions of the Canadian law. Canadian courts have sought guidance and have been considerably influenced by cases decided in other parts of the British Commonwealth, and especially by those which have arisen under the English income tax acts. There is obvious danger in seeking guidance in decisions based on any statute very much diHerent from our own. Undoubtedly a number of general principles of great interpretative value have been developed by English taxation cases. But care must be exercised in order to distinguish decisions based on a legal principle of general application from those founded wholly or in part on the specific requirements of the English acts. On occasion our courts have observed such caution. In North Pacific Lumber Co., Ltd. v. Minister of National Revenue, Audette J., in dealing with the problem of whether income arising from the capital held by a company remained income when paid to that company's liquidator on winding-up, stated as follows: Some stress was laid at trial upon the state of ,the law in England of a liquidator under similar circumstances and cases cited; hut all of this must he cast aside. There is no analogy whatsoever between the English and the Canadian law with respeot to income tax under similar circumstances. In fact, a case like the present could not arise in England for the obvious reason that the tax is payable at the source. In other words when the interest on the deferred payments would oome into the hands and controls of the liquidator, the tax would have already been paid. The party who paid such interest would have been obliged to deduct therefrom the income tax and pay it to the Government. The party paying the interest must remit the tax. 1

In a more recent case which involved the problem of determining the income arising from a salaried employment, Thorson P. gave more direct warning against any offhand reliance on English cases: If -there were any provision in the Income War Tax Act similar to Rule 9 of Schedule E [of the English Act] it might he argued that the moneys paid by the appellant to the Law Society of Manitoba were not deductible in that they were not paid in the performance of his duties as a lawyer, hut there is no such provision. Sec. 6 (a) is quite different. In interpreting the terms of a statute it is always dangerous to apply decisions in other jurisdictions upon other statutes that are not in pari materia; and nowhere is it more dangerous than in the case of such an Act as the Income War Tax Act. In my view, cases decided in the United Kingdom under Schedule E, Rule 9, of the Income Tax Act, 1918, have no application to the proper interpre1(1917-27] C.T.C. 336, at p. 341.

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THE INCOME TAX ACTS

tation of Sec. 6 (a) of the Income War Tax Act, or to the determination of what disbursements or expenses are deductible under such Aot. 2

There is reason to believe that in spite of such warnings the Canadian courts have tended to rely on English cases without sufficient regard to English legislation. In any event, there can be no question but that a proper understanding and reasonable application of English cases in solving Canadian income tax problems must be based on a sound appreciation of the English scheme of taxation in relation to the Canadian legislation. · THE CANADIAN

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The Canadian Income War Tax Aot3 enacted that "there shall be assessed, levied and paid upon the income during the preceding year of every person, other than a corporation or joint stock company • . . residing or ordinarily resident in Canada at any time in such year; or ... who is employed in Canada at any time in such year; or . . . is carrying on business in Canada at any time in such year . . . a tax computed at the rates set forth in ... this Act" and that "corporations and joint stock companies resident or carrying on business in Canada . . • shall pay a tax upon income at the rate applicable thereto set forth in ... this Act."4 These constituted the main charging provisions. This Act also imposed, by way of added taxation, an income tax of 5 per cent on all persons ( including corporations) resident in Canada in respect of interest and dividends paid to them in currency which is at a premium in excess of 5 per cent in terms of Canadian funds; 5 an income tax of 15 per cent on non-resident persons ( including corporations) in respect of dividends, certain specified interest and copyright payments, rents, salaries, wages, trust income, and other forms of income received from Canadian sources; 6 an income tax of 15 per cent on non-resident persons ( including corporations) in respect of the gross amount of all rents, royalties, or similar payments 2Bond v. M.N.R., [1946) C.T.C. 281, at p. 286. Note also in this connection, Montreal Light, Heat & Power Consolidated v. M.N.R. [1940-41) C.T.C. 217, Maclean J., at p. 222. 3"An Act to authorize the Levying of a War Tax upon Certain Incomes," R.S.C., 1927, c. 97, as amended. The original act (The Income War Tax Act, 1917, 7 Geo. 5 (Can.), c. 28) was intended as a temporary measure to provide extra revenue to defray the heavy expenditures due to World War I. The tax was retained throughout the period between world wars and, in view of the heavy expenditure and added indebtedness resulting from the second war, has now come to be regarded on all sides as a permanent part of Canada's fiscal system. 4Jbid., s. 9 (1), (2). "Ibid., ss. 9B (1), 2 (1) (h) . 6fbid., s. 9B (2).

6

THE MEANING OF INCOME

for the use in Canada of real or personal property, patents, or for anything used or sold in Canada; 7 and a graduated gift tax upon the transfer by gift of any property by persons residing or ordinarily resident in Canada. 8 With the exception of the gift tax, these added taxes were correlative to the main scheme of income taxation, so that it may generally be said that the Act imposed a tax on persons and corporations residing or carrying 01;1 business in Canada in respect of all their income, and on other persons and corporations in respect of their income derived from Canadian sources. From an economics standpoint it is usual to regard that Act as imposing taxation on the wealth produced annually by the nation. From the standpoint of law the Act was held to impose an annual tax on persons, measured with reference to the amount of income received by each person.9 11bid., s. 27 (1). s. 88. 9Waterous v. M.N.R., [1928-34) C.T.C. 168 (S.C. Can.); Smith v. A.-G. of Can., [1917-27) C.T.C. 240, Audette J., at p. 242, affirmed sub nom. Smith v. Minister of Finance, [1917-27) C.T.C. 251 ( P.C. ). Income tax has been held to be a tax on the person, measured with reference to income, in cases dealing with provincial statutes ahnost identical with the Canadian Act; as, for example, in Forbes v. A.-G. of Man., [1935-37) C.T.C. 237 (P.C.) (Manitoba Special Income Tax Act); Judges v. A.-G. of Sask., [1935-37) C.T.C. 277 (P.C. ) (Saskatchewan Income Tax Act); Kerr v. Superintendent of Income Tax, [1943) C.T.C. 97 (S.C. Can.) (Alberta Income Tax Act). Vide: "From all this it is apparent that the tax to be levied in any year is not a part of the income, as such, of the inhabitant, but a sum of money to be measured by, or in proportion to the amount of his income during the preceding year. It is the inhabitant who is taxed for his fair and reasonable share of the expenses incurred by the municipality on his behalf, and on behalf of all the other inhabitants, and his income for the preceding year is referred to solely for the purpose of ascertaining what it is just and reasonable that he should be required to pay. No attempt is made to seize or appropriate the income itself, or to anticipate its payment. He receives it, and applies it as he thinks fit." Abbutti v. City of St. John [1908) 40 Can. S.C.R. 597, per Maclennan J., at p. 616 (Income Tax Ordinance of St. John). Again, "All this is in accord with the general policy of the [Income War Tax] Act which imposes the income tax on the person and not on the property. In other words, it is the person who is assessed in respect of his income." McLeod v. Minister of Customs & Excise (1917-27) C.T.C. 290 (S.C. Can. ), per Mignault J., at p. 296. But compare with these statements the view adopted by the Exchequer Court of Canada ( on the authority of statements appearing in English cases) while considering the problem of whether a payment for income tax ought to be deducted in determining income: "This tax is not an expenditure for the purpose of earning income; but it is an expenditure which is made necessary by statute, and chargeable upon and out of profits earned without it. The profits must be made before the tax can come into existence and the tax is the Crown's share of the profits which have been made." Roenisch v. M.N .R., [1928-34) C.T.C. 69, per Audette J., at p. 72. See also McLeod v. M.N.R., [1928-34) C.T.C. 88, Audette J., at p. 91. The Judicial Committee of the Privy Council has recently held in British Columbia Electric Railway Co., Ltd. v. The King, [1946) C.T.C. 224, that the tax imposed on nonresidents bys. 9B (2) of the Income War Tax Act was also a tax on persons and was, therefore, extra-territorial in its operation. 81bid.,

THE INCOME TAX ACTS

7

The Canadian Income Tax Act10 which replaces the Income War Tax Act from January 1, 1949, imposes the same graduated taxation on persons resident and non-resident but in somewhat different terms. S-s. 1 of s. 2 states that "an income tax shall be paid as hereinafter required upon the taxable income for each taxation year of every person resident in Canada at any time in the year" and s-s. 2 provides that "where a person who is not taxable under s-s. 1 for a taxation year (a) was employed in Canada at any time in the year, or ( b) carried on business in Canada at any time in the year, an income tax shall be paid as hereinafter required upon his taxable income earned in Canada for the year determined in accordance with Division D." The word "person" is defined by s. 127 ( 1) (ab) of the Act as including corporations; and "resident" is also defined by s. 127 ( 3) and ( 4) so as to include all persons who would be taxed under s. 9 of the former Act. "Taxation year" is by s. 127 ( 2) defined as meaning, in the case of companies, the fiscal period ending in that year, and in the case of individuals, the calendar year, so that, under either Act, the tax is imposed on the income of the fiscal or calendar year preceding the April 30th deadline for filing returns. "Division D," above referred to, when considered in conjunction with s. 127 ( 6) ( which extends the ordinary meaning of "carrying on business in Canada") in effect limits the taxation of non-residents to their income earned in Canada, determined in like manner as under ss. 24 to 26 of the Income War Tax Act. The added 15 per cent taxes imposed by the latter Act on non-resident persons and corporations with respect to certain incomes from Canadian sources have been retained together with the gift tax. 11 The added 5 per cent tax on persons entitled to receive payment of dividends in any currency at a premium in Canadian funds has been abandoned under the new Act. A return to a parity of exchange between Canadian and United States currency had made the former provision of no further practical operation. THE ENGLISH ACTS

In England, income tax is an annual tax, being imposed each year by a Finance Act which charges the tax at a standard rate, together with an annual surtax, the latter being but an added income tax on higher incomes. This annual imposition of income tax is regulated by more permanent statutes-the income tax acts. The annual Finance Act provides that all enactments relating to income tax which had effect for the previous year shall continue in force for the year in 1011-12 Geo. 6 (Can.), c. 52. HBy ss. 96-9 ands. 100 respectively.

8

THE MEANING OF INCOME

question. Any desired alterations in income tax legislation for that year are also contained in the Finance Act. 12 The main enactment relating to income tax is the Income Tax Act, 1918.13 The law laid down therein has been altered in a number of respects by later income tax acts passed in 1943,14 1944,15 and 1946.16 These acts, with the amendments affected by the annual Finance Act, together comprise 12To illustrate, the Finance Act, 1950 ( 14 Geo. 6 ( U .K.), c. 15) imposes ( Part II) income tax and surtax for that year as follows: "22. ( 1) Income tax for the year 1950-51 shall be charged at the standard rate of nine shillings in the pound, and, in the case of an individual whose total income exceeds two thousand pounds, at such higher rates in respect of the excess over two thousand pounds as Parliament may hereafter determine. " ( 2) All such enactments as had effect with respect to the income tax charged for the year 1949-50 shall have effect with respect to the income tax charged for the year 1950-51." S. 50 further provides that "Part II of this Act shall be construed as one with the Income Tax Acts." 138-9 Geo. 5 (U.K.), c. 40. This simply re-enacted the provisions of the Income Tax Act, 1842 (5-6 Viet. (U.K.), c. 35) as su~equently altered by the annual finance acts from 1842 to 1918. Income tax was first imposed in England in 1799 (39 Geo. 3 (U.K.), c. 13) to help finance the war with France. It was repealed in 1802 ( 42 Geo. 3 ( U .K.), c. 42) but revived again in 1803 ( 43 Geo. 3 ( U .K.), c. 122). A new act was passed in 1805 ( 45 Geo. 3 ( U .K.), c. 49) and again in 1806 ( 46 Geo. 3 ( U .K.), c. 65). In 1815, on the close of the war with France, the tax was repealed. It was revived again in 1842 and has remained in effeot ever since. The wording of the Income Tax Act, 1842, was the same as that of the Act of 1806, so that the scheme of the income tax legislation in England remains today as it was in 1806. In 1920 a Royal Commission on the Income Tax was appointed "to inquire ... and to report what alterations of law and practice are necessary or desirable..••" The Commissioners reported that: "Our recommendations, though numerous and far-reaching, do not amount to a suggestion for any fundamental change in the nature of the tax. As it was in 1842 so in its essential features it should remain. . . . We recognize, and we think the public will recognize, that an old-fashioned system that has entered into the thoughts and the business of the people of this country for several generations should be judged, not by a theoretical standard of excellence, but by the results it has achieved. . . . We have made many recommendations for the alteration of the tax and, as we hope, for its improvement; but we have made no attempt whatever to overturn the whole framework of the tax and set up in its place something else bearing the same name." ( Cmd. 615 of 1920, p. 3.) Nevertheless, in 1927 the Chancellor of the Exchequer appointed a committee "to prepare a draft of a Bill or Bills to codify the law relating to Income Tax, with the special aim of making the law as intelligible to the taxpayer as the nature of the legislation admits, and with the power for that purpose to suggest any alterations which, while leaving substantially unaffected the liability of the taxpayer, the general system of administration and the powers and the duties of the various authorities concerned therein, would promote uniformity and simplicity." The committee reported in 1936 ( Cmd. 5131 of 1936) and submitted the draft of a new income tax bill ( Cmd. 5132 of 1936). No action has been taken to date to implement the proposed legislation. 14Income Tax (Employments) Act, 1943, 6-7 Geo. 6 (U.K.), c. 45. 15Income Tax (Offices and Employments) Act, 1944, 7-8 Geo. 6 (U.K.), c. 12. 16Income Tax Act, 1945, 8-9 Geo. 6 (U.K.), c. 32.

THE INCOME TAX ACTS

9

the English legislation governing the imposition of income tax. The law enacted by them is extremely complicated in detail and few general provisions are not qualified or altered by some form of exception. Nevertheless, their general outline follows a fairly definite pattern set forth in the Act of 1918.

The charging scheme The ascertainment of income is governed by the first schedule of the 1918 Act, which divides income into five main divisions ( schedules A to E) roughly according to the source or sources from which the income arises. Each of these schedules contains its own separate body of rules for determining the income from the sources indicated, while there are also general rules which govern the computation of income under all schedules. This multiform method for determining the income to be taxed is indicated in the first section of the Act, which states: . . . where any Act enacts that income tax shall be charged for any year at any rate, the tax at that rate shall be charged for that year in respect of all property, profits, or gains respectively described or comprised in the schedules marked A, B, C, D and E, contained in the First Schedule to this Act and in accordance with the Rules respectively applicable to those Schedules. Schedule A governs the charge of tax in respect of the income arising from the ownership of property in land. It reads in part: Tax under Schedule A shall be charged in respect of the property in all lands, tenements, hereditaments, and heritages in .the United Kingdom, for every twenty shillings of the annual value thereof. The rules of this schedule subject to tax all lands capable of occupation, without regard to their actual use or occupation; "annual value" is described as being the actual or estimated rack-rent. Schedule B provides for the income tax in respect of the income arising from the occupation of the lands referred to in schedule A, as follows: Tax under Schedule B shall be charged in respect of -the occupation of all lands, tenements, hereditaments, and heritages in the United Kingdom for every twenty shillings of the assessable value thereof estimated in accordance with the rules of this Schedule.17 17The apparent breadth of this schedule is cut down considerably by rule 1 applying thereto which exempts from tax all dwelling-houses, and all buildings occupied for carrying on a trade or profession. Further, by the Finance Act, 1941 (4-5 Geo. 5 (U.K.), c. 30, ss. 10, 11) nearly all the income from farm land and market garden land is now taxed on the profits and gains as governed by schedule D.

10

THE MEANING OF INCOME

By "assessable value" is meant, according to the rules of this schedule, an amount usually equal to three runes the annual value referred to in schedule A. Schedule C, along with the rules thereto, provides for income tax on profits derived from any public revenue ( in the United Kingdom or elsewhere) and payable in the United Kingdom. It reads: True under Schedule C shall be charged in respect of all profits arising from interest, annuities, dividends, and shares of annuities payable out of any public revenue, for every twenty shillings of the annual amount thereof. Schedule Dis more general in its scope. It taxes certain of the profits and gains from numerous sources, including sources outside the United Kingdom. S. 1 thereof provides: 1.-Tax under this Schedule shall be charged in respect of( a) The annual profits or gains arising or accruing(i) to any person residing in the United Kingdom from any kind of property whatever, whether situate in the United Kingdom or elsewhere; and (ii) to any person residing in the United Kingdom from any trade, profession, employment, or vocation, whether the same be respectively carried on in the United Kingdom or elsewhere; and (iii) to any person, whether a British subject or not, although not resident in the United Kingdom, from any property whatever in the United Kingdom, or from any trade, profession, employment, or vocation exercised wi!)hin the United Kingdom; and ( b) All interest of money, annuities, and other annual profits or gains not charged under Schedule A, B, C, or E, and not specially exempted from tax.... By s. 2 of this schedule it is subdivided into six cases, this division also being made according to the source from which the income is derived: 2. Tax under this Schedule shall be charged under the following cases respectively; that is to say,Case I -Tax in respect of any trade not contained in any other Schedule; Case II -Tax in respect of any profession, employment, or vocation not contained in any other Schedule; Case III-Tax in respect of profits of an uncertain value and of other income described in the rules applicable to this Case; Case IV-Tax in respect of income arising from securities out of the United Kingdom, except such income as is charged under SoheduleC; Case V -Tax in respect of income arising from possessions out of the United Kingdom;

THE INCOME TAX ACTS

11

Case VI-Tax in respect of any annual profits or gains not falling under any of the foregoing Cases, and not charged by virtue of any other Schedule; and subject to and in accordance with the rules applicable to ,the said Cases respectively. Finally, schedule E imposes the tax on the income from offices, employments, and public pensions: Tax under Schedule E shall be charged in respect of every public office or employment of profit, and in respect of every annuity, pension, or stipend payable by the Crown or out of the public revenue of the United Kingdom other than annuities charged under Schedule C, for every twenty shillings of the annual amount thereof. The language imposing tax under these schedules will be seen to be by no means uniform and, further, as not always suggesting a tax on income in the commonly accepted meaning of that term. Schedule A and its rules speak only of "annual value," meaning the full rental value, of certain lands, while "assessable value" in schedule ,B also bears no relation to the annual gain actually derived from the source there indicated. Schedule C refers to "profits" and schedule D to "profits or gains" while the rules to schedule E also mention "profits" as arising under that schedule. Consideration of these differences gave rise to a widely held belief that the tax imposed under schedule A was in the nature of a property tax and, further, that a different type of tax was imposed under each schedule. 18 This view was definitely overruled by the House of Lords in London County Council v. AttorneyGeneral.19 The question there raised was whether the appellant's actual profits and gains derived from the ownership of lands and taxed under schedule A but not taxed under schedule D, might be considered "profits or gains brought into charge to such [income] tax." The argument advanced by the Crown and accepted by the Divisional Court and Court of Appeal was to the effect that an income tax was imposed by schedule D but was not imposed under schedule A. The House of Lords rejected this contention. The following statement from Lord Macnaghten's judgment, holding the tax to be the same under all schedules, has become the classic description of the English Income Tax Act: l8"The intention of the Act, it is abundantly clear, was in Schedule A to tax 'property'," Coltness Iron Co. Ltd. v. Black ( 1881) 6 App. Cas. 315, per Lord Penzance, at p. 325. And: "By the Income Tax Acts the legislature thought fit to impose upon the subjects of this country an income tax, and it is plain from the enactments that they meant to include every species of property and profits whatever." A .-G. v. Black, ( 1871) 40 L.J. Ex. 89, per Martin B., at p. 95. 19[1901] A.C. 26.

12

THE MEANING OF INCOME

Income tax, if I may be pardoned for saying so, is a tax on income. It is not meant to be a tax on anything else. It is one tax, not a collection of taxes essentially distinct. There is no difference in kind between the duties of income tax assessed under Sched. D and those assessed under Sched. A or any of the other schedules of charge. One man has fixed property, another lives by his wits; each contributes to the tax if his income is above the prescribed limit. The standard of assessment varies according to the nature of the source from which taxable income is derived. That is all. Sched. ·A contains the duties chargeable for and in respect of the property in all lands, tenements, and hereditaments capable of actual occupation. There the standard is annual value. It is difficult to see what other standard could have been adopted as a general rule. But there again, if .t he subject of charge be lands let at rack-rent, the annual value is ",understood to be the rent by the year at which the same are let." In every case the tax is a tax on inoome, whatever may be the standard by which the income is measured. It is a tax on "profits or gains" in the case of duties chargeable under Sched. A and everything coming under that schedule-the annual value of lands capable of actual occupation as well as the earnings of railway companies and other concerns connected with land-just as much as it is in the case of the other schedules of charge. 20

Lord Davey adopted the same view, which he expressed in similar terms: The truth is that the income tax is intended to be a tax upon a person's income or annual profits, and although (for conceivable and no doubt good reasons) it is imposed in respect of the annual value of land, that arrangement is but the means or machinery devised by the Legislature for getting at the profits. . . . I am, therefore, of opinion that the words "profits or gains" are apt words, and the words chosen by the Legislature for describing not only the taxable subjects under Sched. D, but also those comprised in Scheds. A and B and the other schedules..•.21

The various schedules must therefore be taken as outlining sources of income and the income tax as but one tax. Accordingly, it has been held that the schedules are to be construed as mutually exclusive so that ( assuming always that there is no express contrary provision in the Act) the revenue authorities have no power to elect as between one schedule and another in imposing tax on any income.22 Neither can income already dealt with under one schedule be taxed again under a different schedule, since it has been held that income from one source cannot be taxed twice. Thus, where a taxpayer carrying on 20Ibid., at p. 35. This passage is often and erroneously understood by Canadian authorities as meaning that income tax does not charge capital gains. The passage has no bearing on the problem of whether capital gains are to be regarded as income. 21 Ibid., at p. 45. ?. 2Fry v. Salisbury House Estate, Ltd., [1930] A.C. 432.

THE INCOME TAX ACTS

13

trade derives profits from the ownership of land connected therewith, such profits cannot be included in his income from trade and taxed under schedule D but must be dealt with only under schedule A; 23 neither can profits arising from the occupation of land and taxable under schedule B be included in the income arising from trade and taxed under the provisions of schedule D; 24 and, again, if interest payable from public revenues is exempt from tax under the provisions of schedule C, it is not proper to include it as. profits and gains and so tax it under schedule D. 25 The same rule does not apply as between the different cases in the schedules, however, so that though income may still be taxed only once, it may be taxed under any of the cas~s to schedule D at the option of the revenue authorities. 26 The ob;ect of the tax It must be noted that, in contrast with judicial pronouncements that the Canadian tax is a tax on persons, the English Act is described as imposing a tax on incomes. Lord Macnaghten in the passage quoted above refers to the tax as "a tax on income ... not meant to be a tax on anything else," while Lord Davey says that "income tax is intended to be a tax upon a person's income or annual profits." Their view is supported in other cases which refer to the amount of tax as being part of the income or the Crown's share of the income.27 Such statements do not properly describe a personal contribution to the state measured with reference to the income received; and they ought not to be applied in reasoning on the Canadian income tax. 28 Taxation at the source One of the most distinctive features of the English income tax as compared with the Canadian tax is the provision for taxing a large measure of income at its source. Under this plan, the person assessed, charged, and made primarily liable for paying the tax does not in any way correspond to the person intended ultimately to bear the 23Jbid.; Hoare and Co., Ltd. v. Collyer, [1932) A.C. 407. 24 Back v. Daniels, [1925) 1 K.B. 526. The occupiers have in certain cases an election between schedules B and D ( schedule B, rules 5, 7). Also, the profits from farming are now charged under schedule D (Finance Act, 1941, s. 10; Finance Act, 1942, s. 28). 20 Hughes v. Bank af New Zealand, [1938) A.C. 366. 26Liverpool and London and Globe Insurance Co. v. Bennett, [1913) A.C. 610. 27Ashton Gas ,Co. v. A.-G., [1906) A.C. 10; Smith v. Lion Brewery Co., Ltd., [1909) 2 K.B. 912, at p. 922; Allen v. Farquharson Bros. & Co., [1932) 17 T.C. 59, at p. 63. 28Yet Canadian courts, quoting from the English cases, have been known to refer to the Canadian tax in :exactly the same terms. See Roemsch v. M .N.R., [1928-34) C.T.C. 69, at p. 72.

14

THE MEANING OF INCOME

burden. Under schedule A, for example, the income from the ownership of land is normally assessed and charged at the uniform rate on the occupier, or person using the land. 29 Where the occupier is not the owner, he is entitled to deduct the amount of the tax from his rent and his liability to pay rent is pro tanto discharged upon his paying tax to the Crown;30 but he must not be viewed as having paid the tax for and on behalf of the landlord as the latter's agent. 31 Thus, the fact that the landlord may be entitled to certain reliefs, exemptions, or abatements under the Act does not affect the amount of tax payable by the tenant occupier or impair his right to deduct from the rent the full amount of tax paid. 32 The landlord must make special claim for such reliefs, recovering them as a debt due him from the Crown. 33 There is no requirement that the tax be deducted from the rent paid. Should the occupier fail to do so his right of recovery may be lost; 34 and if through other circumstances he is unable to claim against the landlord he must bear the tax himself as if imposed on his own income. 35 Similar provision for taxation at the source of the income is contained in the general rules applying to all schedules. Companies are taxed as legal entities at the standard rate with no allowance for the dividends paid to shareholders and without regard to the share29The Income Tax Act, 1918, schedule A, no. VII, rules 1 and 2 provided: "1.-Save as in this Act provided in any particular case, tax under this Schedule shall be charged on and paid by the occupier for the time being. "2.-Every person having the use of any lands or tenements shall be deemed to be the occupier thereof." soschedule A, no. VIII, rules l, 2. 31 Duke of Beaufort. v. I.R.C., (1913) 3 K.B. 48; Dru.ghom v. Moore, (1924) A.C. 53, Viscount Cave L.C., at p. 57. szswatman v. Ambler, ( 1854) 24 L.J. Ex. 185. 33 The situation has been described as follows: "The effect of the statute is that the property tax is a portion of the rent ( which is profits of the lessor) which is intercepted by the State as its share of those profits with the result that the lessee is by virtue of the statute in a position to discharge himself of the whole of hi~ debt of 150l. to his lessor by payment of only, say, 140l. In case the lessor be a person who is exempt from income tax, or entitled to abatement of income tax, the sums of which he obtains payment under the Act of Parliament are recovered as a statutory debt owing to him by the Crown. The rent paid by the lessee remains the less sum which he has paid to the lessor, but under the Act of Parliament the latter is entitled to have in addition to his rent a satisfaction of the statutory liability of the Crown to pay him that by which notwithstanding that he was exempt his rent was in fact reduced. It results that in my judgment the rent paid in this case is not the contractual rent, but the difference between the contractual rent or so much of it as the tenant affects to pay and the property tax which the tenant has deducted." Duke of Beaufort v. I.R.C. (see note 31), Buckley L.J. per curiam, at p. 59. 34Denby v. Moore, ( 1817) 1 B. & Aid. 123. 35Miller v. C.I.R., (1930) A.C. 222.

THE INCOME TAX ACTS

15

holders' individual liabilities for tax. On declaring and paying the dividend, companies may deduct the tax appropriate thereto. 36 Where any yearly interest of money, any annuity or other annual payment, or any royalty or other sum paid for the use of a patent is wholly payable by any taxpayer out of profits and gains "brought into charge to tax," such taxpayer is entitled to deduct and retain the amount of tax when making these payments. 37 Here again, this right to deduct tax is a mere form of relief to the taxpayer. If he omits to do so his right of deduction is lost,38 and if circumstances have prevented the payer from deducting tax, that fact will not entitle him to avoid the tax by excluding these expenditures from his profits and gains.39 On the other hand, where any of the above types of payment· are not made wholly out of profits and gains charged to tax, as, for example, where the person making the payment has been entitled to deduct their amount in computing his profits and gains, that person is separately assessed and made liable to account to the Crown for the tax payable and is obliged to deduct the tax in making the payment. 40 The remaining forms of income receipt are taxed either by assessing and collecting the tax at the source of payment or from persons through whose hands they pass, or by direct charge on the person beneficially entitled. 41 Thus, the tax on the income from public 36Rules to all schedules, r. 20. The companies in paying and deducting tax do not act as agents or representatives of the shareholders. "Some time was occupied in the discussion of the question, whether in paying income tax on its profits the company acted as agent for its shareholders, and some cases were cited where this expression had been used.... Plainly, a company paying income tax on its profits does not pay it as agent for its shareholders. It pays as a taxpayer, and if no dividend is declared the shareholders have no direct concern in the payment. If a dividend is declared, the company is entitled to deduct from such dividend a proportionate part of the amount of the tax previously paid by the company; and in that case the payment by the company operates in relief of the shareholder. But no agency, properly so called, is involved." I.R.C. v. Blott, [1921] 2 A.C. 171, per Viscount Cave, at p. 201. 37Rules to all schedules, r. 19. This rule now governs certain payments of rent etc. respecting land (Finance Act, 1934, 24-25 Geo. 5 (U.K.) s. 21; Finance Act, 1940, 3--4 Geo. 6 (U.K.), s. 17). It follows, of course, that the taxpayer cannot also deduct any of these payments in computing his profits and gains since they would then be no longer paid out of profits and gains "brought into charge to tax." See also, rule 3 ( l) applicable to cases I and II, schedule D, and ss. 17, 209 (1) (b ).

SBTaylor v. Taylor, [1937] 3 All E.R. 571; Hatch v. Hatch, [1919] 1 Ch. 351. 39Boyd (James) & Sons v. Havelock, ( 1918) 7 T.C. 321; Alexandria Water Co. v. Musgrave, (1883) 11 Q.B.D. 174. 40Rules to all schedules, r. 21, as amended by Finance Act, 1927, 17-18 Geo. 5 (U.K.), s. 26 following the case of Re Long Propeller, Ltd., [1927] 1 Ch. 120. This rule has since been expanded to cover other types of payments than those originally mentioned therein. 411ncome Tax Act, 1918, s. 100 requires direct returns from all persons.

16

THE MEANING OF INCOME

revenues, imposed under schedule C, is deducted and paid to the Crown by the paying agent on behalf of those to whom payments are made; 42 trustees or agents are required to collect the tax on amounts received for beneficiaries and principals; 43 trustees, guardians, tutors, etc. pay the tax on behalf of persons who are generally classed as incapacitated; 44 and factors, agents, managers, etc. pay it for persons not resident. 4 r; A similar rule applies to receivers, liquidators,46 executors, and administrators. 47 The incomes from offices, employments, and pensions ( schedule E) were at one time taxed by direct assessment on the recipients; but in nearly all cases the tax is now collected at the time of payment by the employer, acting as agent for the Crown.48

The "reliefs' from taxation As thus far described the English system of charging tax on all income at a standard rate does not make the necessary allowance for ·differences arising out of the individual circumstances of taxpayers. Such allowances are provided by the granting of "reliefs," the benefits of which must in most cases be specially applied for by each taxpayer. Included in these reliefs are claims for exemption from tax, deductions from the amount of assessment, reductions in the amount of tax, and other like concessions which the taxpayer is entitled to claim under the Act. Any excess tax shown to have been paid may be claimed as a debt due from the Crown. The main reliefs are in respect of exemptions for small total incomes, certain allowances for "earned" ( as distinct from business or investment) incomes, for dependents, for persons over sixty-five years of age, for superannuation payments, for life insurance premiums, and for double taxation by different countries. Many particular items of relief, such as the relief for business losses and management expenses, are specially provided under the various 42 Ibid.,

schedule C, rule 1 ( c), and the rules for paying agents. 43Ibid., s. 101. These and the following like provisions do not impose taxation but are concerned merely with tax collection. "They are really machinery for enabling the Crown, in common cases, to get the income tax which is properly payable." Rex v. Newmarket Income Tax Commissioners. Ex parte Huxley, (1916) 1 K.B. 788, per Lord Cozens-Hardy M.R., at p. 797. See also Drummond v. Collins, [1915) A.C. 1011, Lord Parker, at p. 1019. 44 Income Tax Act, 1918, general rules to all schedules, rr. 4, 13, 14; s. 161; s. 237. 45Jbid., general rules to all schedules, rr. 5- 12. 46[bid., general rules to all schedules, r. 15. 41Ibid., s. 161. 4 8Under what is known as the "Pay As You Earn" {P.A.Y.E.) system; introduced by the Income Tax (Employments) Act, 1943 (6-7 Geo. 6 (U.K.), c. 45) and the Income Tax (Offices & Employments) Act, 1944 {7-8 Geo. 6 (U.K. ), c. 12).

THE INCOME TAX ACTS

17

schedules. Further discrimination in the amount of tax payable by different persons is effected by the imposition of additional income tax, called super-tax or surtax, at a graduated rate. It has already been pointed out, that the "total income from all sources" provides the basis for taxation under the Canadian law. That aggregate is required to be ascertained under the English Act only for the limited purposes of determining the extent of the taxpayer's right to certain reliefs and the amount of his liability for surtax. Residence

The concept of "residence" we have seen as providing the main test of chargeability under the Canadian Act both as regards individuals and companies. Under the English Act that concept as governing liability for tax is important for quite different reasons and serves various purposes. Most of them concern the extent to which the taxpayer may claim reliefs. They have been ably summarized as follows: The question whether a person is "residing" or "resident" or "ordinarily resident" in the United Kingdom may be of importance for various purposes. For instance, with certain exceptions, a person not resident in this country cannot obtain any relief in respect of earned income or deduction of tax on assessable income, or relief in respect of insurance premiums and similar payments. A person "residing" in the United Kingdom is liable to tax in respect of profits from any kind of property and of the profits of a trade, etc., carried on by him in this country or elsewhere; and although the profits of a trade carried on in this country are chargeable whether it is carried on by a resident or not, the question whether an individual, a partnership or a company is residing in this country often has an intimate connection with the question whether the trade is carried on here. In regard to some "foreign possessions" a person residing here is taxable on the profits only so far as they are received in this country, but in respect of foreign securities and other possessions, such as stocks, shares and interests in land, the extent to which he is to be charged may depend OD whether he is or is not "ordinarily resident in ,the United Kmgdom." Liability to tax in respect of interest on the securities of a foreign State or British possession, and on the stocks of foreign companies, if payable in this country, as well as Indian annuities, if so payable, depends on "residence"; liability in respect of War Loan interest, etc., on "ordinary residence." The provisions of the Act of 1936 for "preventing the avoiding of liability by means of transfers of assets" abroad are applicable only to cases of "individuals ordinarily resident in the United Kingdom." ... The provisions and arrangements for double taxation relief ... depend for their application upon the question whether the person affected is or is not resident in .the United Kingdom or the other territory concerned; as do the regulations for consequent credit against United Kingdom tax. A person "who is in the United Kingdom for a temporary purpose only and not with any view or intent of establishing his residence therein," and has not resided

18

THE MEANING OF INCOME

here for six months in any year, is not taxable in respect of any foreign possessions or securities. Provisions for the assessment of non-resident persons through resident agent, trustees and so on apply to almost all forms of the tax. And a person whose ordinary residence is in the United Kingdom does not esoape liability because he has left the country for the purpose only of occasional residence abroad; that is "residence [abroad] taken up or happening as passing opportunity requires or admits."49 Yet the over-all result attained is very much the same under bath the English and Canadian Acts in that, generally speaking, persons who are resident must pay tax on or with respect to their income from all sources and non-residents are required to pay tax on or with respect to their income from sources within the country. It has been said of the English Act: The policy of the Act is to tax the person resident in ·the United Kingdom upon all his income whencesoever derived and to tax the person not resident in the United Kingdom upon all income derived from property in the United Kingdom. The former is taxed because (whether he be a British subject or not) he enjoys the benefit of our \aws for the protection of his person and his proper,ty. The latter is taxed because in respect of his property in the United Kingdom he enjoys the benefit of our laws for the protection of that property.110 Accordingly, it will be seen that the Canadian and English income tax acts have the same ultimate objective; but that in seeking to attain that objective they proceed along very dissimilar lines.

Judicial review There remains one further important point of difference between English and Canadian law, and it concerns the position of the courts in the plan of income taxation. In Canada appeals may be taken to Canadian courts on any question arising out of an assessment. 61 In M. Konstam, The Law af Income Tax (London, 1950), p. 350. 50Whitney v. I. R. C. [1926) A.C. 37, per Lord Wrenbury, at p. 54. Cf. Colquhoun v. Brooks, ( 1889) 14 App. Cas. 493, Lord Herschell, at p. 504; Simon's Income Tax (London, 1948), p. 46; A. Farnsworth, Income Tax Case Law (London, 1947), p. 2; F. E. Koch, The Double Taxation Conventions (London, 1947), p. 30. 111 An appeal on any matter of dissatisfaction arising out of an assessment may be taken directly from the final determination of the Minister of National Revenue to the Exchequer Court of Canada by s. 60 of the Income War Tax Act and by s. 55 of the Income Tax Act. That court had, bys. 66 of the Income War Tax Act, exclusive jurisdiction to hear and determine all questions that might arise in connection with an assessment and to make any order it might have considered proper. In 1946 an intermediate appeal from the Minister's determination to an Income Tax Appeal Board was provided by Part VIII A, added to the Income War Tax Act, and it is continued by s. 54 and Division I of the Income Tax Act. From the Exchequer Court an appeal may be taken to the Supreme Court of Canada. This appeal is now final, since by amendment to the Supreme Court Act passed in 1949 ( 13 Geo. 6 ( 2nd session) (Can.), c. 37) appeals to the Judicial Committee of the Privy Council are abolished. 49E .

THE INCOME TAX ACTS

19

England appeals are taken by way of case stated from the commissioners of income tax and are confined to questions of law only. On all questions of fact the commissioners' determination is final. 112 This restriction on their power to review has led the English courts to distinguish between questions of fact and law in a manner which has never troubled Canadian courts. It is questionable whether or not this restriction on the power of the English courts to review really limits them to the extent commonly supposed. They have the power to decide the meaning of the terms used throughout the English Act, to decide whether any question arising before them is one of fact or of law, and to reverse the coinmissioners' finding on all questions of fact where they are of opinion that there was no evidence before the commissioners to support that finding. Where the courts have chosen to give any term used in the English Act an "ordinary meaning" they thereby permit any ruling of the commissioners thereon to stand as being a question of fact. But they may at any time attribute a special connotation to a word or phrase of the Act; and, having done so, they can hold there to have been no evidence before the commissioners .to support their finding, in the light of the extended or altered meaning placed on the phraseology in question. In other words, in construing a concept such as "residence," which would ordinarily involve the drawing by the commissioners of an inference or "ultimate" finding of fact from the evidence or "primary" facts, the courts are free to give residence a special meaning for purposes of the Income Tax Act and force the commissioners to conform to that meaning by the exercise of the power to review for lack of evidence. 113 Thus, the English and Cana52S. 149 ( 1) of the English Income Tax Act, 1918, provides: "149.- ( 1) (a) Immediately after the determination by the general commissioners, or by the special commissioners, of an appeal under this Act, the appellant or the surveyor, if dissatisfied with the determination as being erroneous in point of law, may declare his dissatisfaction to the commissioners who heard the appeal. " ( b) Having declared his dissatisfaction, he may . . . require the commissioners to state and sign a case for the opinion of the High Court thereon . . .. "(d) The case shall set forth the facts and the determination of the commissioners. . . . " ( 2) (a) The High Court shall hear and determine any question or questions of law arising on the case. . . . " ( 3) An appeal shall lie from the decision of the High Court or of any judge thereof to the Court of Appeal and thence to the House of Lords, and in Scotland, from the decision of the Court of Session, as the Court of Exchequer in Scotland, to the House of Lords." 113"Jnferences from facts stated by the commissioners are matters of law, and can be questioned on appeal. The same remark is true as to the construction of

20

THE MEANING OF INCOME

dian courts are not usually found to be far apart in the meaning given to concepts such as "residence" and "trade" which are common to both acts. However, the more limited jurisdiction of the English courts is a matter to be borne in mind when seeking to determine or evaluate the exact law laid down by any English case. 6' documents. H the commissioners state the evidence and hold upon that evidence that certain results follow, it is open to the court to differ from such a holding." Cameron v. Prendergast, [1940] 2 All E.R. 35, per Viscount Maugham, at p. 40. The exercise of control over the commissioners by reviewal for lack of evidence is strikingly illustrated by the judgments of the House of Lords in Famier v. Cotton's Trustees, [1915) A.C. 922, esp. at pp. 930 ff. See also Bomford v. Osborne, [1941] 2 All E.R. 426; Fattorini, Ltd. v. I.R.C., [1942] 1 All E.R. 619, 631; and chap. VI, note 23, infra. Gi"This appeal, which is taken under sec. 29 of the said [Manitoba] Act, is on both law and fact. In this respect our appellate provisions differ from those of the English Act, which confines appeals strictly to matters of law. This distinction must be borne in mind when dealing with English cases." In re Income Ta:c Act (Manitoba), ( 1933) 41 M.R. 621, per Dysart J., at p. 623. See also: "It is important to bear in mind the differing r81es of the Court under the two systems [Victoria State and British systems]. It is, for instance, only by doing so that the limits of applicability can definitely be assigned to many of the judicial decisions under the British statute bearing upon questions analogous to those now again in issue." Commissioner of Taxes v. Britµh-Australian Wool Realization Association, Ltd., [1931] A.C. 224, per Lord Blanesburgh, at p. 230. See also Brown v. M.N.R., [1949] C.T.C. 77, at p. 85; and McDonough v. M.N.R., [1949] C.T.C. 213, at pp. 217-18.

CHAPTER

TWO

The Meaning of Income INCOME AT COMMON LAW INCOME means literally "incoming" or "what comes in" considered in relation to money or money's worth. But such a broad literal meaning of that term does not satisfy even the normal requirements for day-today expression. It is usual to speak more specifically of "gross income," "net income," "total income," or to single out certain income with reference to its source as in "earned income" or "investment income." Dictionary and other definitions of income usually refer to it as the "profit," "gain," or "economic advantage" accruing from designated sources; but such synonymous terms are inadequate to evince the true meaning of that concept for a purpose as technical as the law of income taxation. From that standpoint the usual definitions of income merely provide alternative expression of a concept which requires to be explained more accurately and more fundamentally. "Income" does not, for the purpose of income tax law, include all the realizable wealth which, in a physical sense, "comes in." Its meaning is limited by two cardinal principles, either or both of which are involved in every decided case on the subject. The first of these principles is that income includes only amounts arising or resulting from the pursuit of gain. Alternatively, this proposition may be viewed and stated as being that income does not include the realized value of a source of income. The general application of this principle is not always too clearly understood. The majority of the cases actually resting upon it concern the problem of distinguishing income from amounts received on the realization of some form of capital asset that has been acquired previously. It is therefore commonly said in the cases on the meaning of income that income tax

21

22

THE MEANING OF INCOME

does not tax capital gains, meaning the gain made on realizing the value of a capital asset. Perhaps the most famous statement in this connection is that of Justice Pitney in delivering the opinion of the Supreme Court of the United States that a stock dividend was not "income" to shareholders within the meaning of that term in the Sixteenth Amendment to the Constitution of the United States. Having accepted the definition of income as "the gain derived from capital, from labour, or from both combined," he states: Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a oorrect solution of the present controversy. The Government, although basing its argument upon the definition as quoted, placed chief emphasis upon the word "gain," which was extended to include a variety of meanings; while the significance of the next three words was either overlooked or misoonceived. "Derived-from-capitar'; "the gainderived-from-capital," etc. Here we have .the essential matter; not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being "derived," .that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposa,l;-that is income derived from property. Nothing else answers the description. 1 While still attending to the distinction between income and capital, property, or assets, he adds: The fundamental relation of "capital" to "income" has been much discussed by economists, the former being likened to the ,tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time.2 The rule that income does not include the realized value of capital ( which is a source of income8 ) is a well-recognized principle of tax law both in England and in Canada. In the case of Spooner v. Minister of National Revenue the Judicial Committee confirmed the application to the Canadian Act of the presumption, previously expressed by Lord 1 Eisner v. Macomber, ( 1919) 252 U.S. 189, at p. 207; approved in I.R.C. v. Blott, [1921] 2 A.C. 171, Viscount Findlay, at p. 195, and Pool v. Guardian Investment Trust Co., Ltd., [1922] 1 K.B. 347, Sankey J., at p. 359. The italics are Justice Pitney's. 2 (1919) 252 U.S. 189, at p. 206. We see this 6gure of speech adopted by English courts in Pool v. Guardian Investment Trust Co., Ltd., [1922] 1 K.B. 347; R11all v. Hoare, [1923] 2 K.B. 447, 454; Haig's (Earl) Trustees v. I.R.C., (1939) 22 T.C. 725; LoW1'y v. Field, [1936] 2 All E.R. 735, 739; Leader v. Counsell [1942] 1 All E.R. 435, 436; Williams v. Davies, [1945] 1 All E.R. 304, 307; Barry v. Cordy, [1946] 2 All E.R. 396, 400. 3"1t is, I think, inherent in the idea of capital, whether of a company or of an individual, that there is an asset in the form of money or a fund or other property capable of being or becoming a source of income to its owner." Baymond Co., Ltd. v. M.N.R., [1945] C.T.C. 4, per Thorson J., at p. 9.

THE MEANING OF INCOME

23

Hanworth M.R., that "it cannot be taken that the Legislature meant to impose a duty on that which is not profit derived from property, but the price of it."4 This rule that income does not include capital receipts or gains is perfectly sound law, but should be recognized and regarded as simply part of the more general proposition, first stated above, that income includes only amounts arising from the pursuit of gain. If otherwise understood it is misleading. A great deal of income does in fact represent a gain from capital as, for example, where a merchant purchases and resells stock-in-trade at a profit. But in such instances the resulting income is the product of the merchant's trading activity in which his capital is but one of many factors. The distinction between a receipt of income from trading activity and a receipt of capital gain from the purchase and sale of an asset rests, in the ultimate analysis, on the motive underlying the entire transaction in each case and not on any matter of real, intrinsic difference between them. We have the distinction most clearly and admirably explained by Mr. Justice Rowlatt in an English case as follows: But then there is no doubt that if you set on foot an organized seeking after

emoluments which are not in themselves profits, you may create, by way of a trade, or an adventure, or a vocation, a subject matter which does bear fruit in the shape of profits or gains. A different conception arises, a conception of a trade or vocation which differs in its nature, in my judgment, from the individual acts which go to build it up, just as a bundle differs from odd sticks. You may say, I think, without an abuse of language, that there is something organic about the whole which does not exist in its separate parts. . . . there is no doubt that one might create a trade by making an organized effort to obtain emoluments which are not in themselves taxable as profits, and the most familiar instance of all, of course, is a trade which has for its object the securing of capital increment. A person who buys an objeot which subsequently turns out to be worth m-0re than he gave for it, and which he sells, does not thereby make a profit or gain for income tax purposes. But he can organize himself to do that in a commercial and mercantile way, and the profits which emerge are taxable profits, not of the transaction, but of the trade. . . . Test it in this way. A person may organize an effort to find things. He may start a salvage or exploring undertaking and he may make pr-0fits. The profits are not the profits of the findings, they are the profits of the adventure as a whole. Again he may make a loss. One cannot say that the 1-0ss was due to the failure to find. The loss is due to the trade. That is a good test, because it shows the difference between the trade as an organism and the individual acts.5

It will be noted that his lordship speaks of "an organized seeking after emoluments," "an organized effort to obtain emoluments" which 4(1921h'34] C.T.C. 184, per Lord Macmillan, at p. 187, quoting Lord Hanworth M. R. in Perrin v. Dickson, [1930] 1 K.B. 107, at p. 119. llGraham v. Green, [1925) 2 K.B. 37, at p. 40.

24

THE MEANING OF INCOME

may, of course, be manifested in trading, or in any other vocation. In another case his lordship has again expressed this difference between a gain in realizing an investment and an income earned through trading: Now income tax is not attracted by the mere circumstance that there is a profit, because the profit may be a mere accretion of the value of the article, and the profit may not accrue in the oourse of any trade at all. On the other hand, the circumstance that the profit is due to an accretion in value of the article does not negative the application of the income tax, because the accretion of value to the article may have been the very thing that a trader [sic], within Case I., was established to secure. 6 It may be seen, therefore, that the problem of distinguishing income involves careful consideration with a view to ascertaining the true nature of the source from which the gain is derived; which may in tum involve the problem of whether a business is being carried on and whether the transaction giving rise to any gain in question forms a part of such business. In this connection there have come into use such legal concepts as "fixed capital," "circulating capital," "casual profits," many of them borrowed by the courts from the language of economists to lend support to their conclusions on a problem requiring ultimately to be solved on the basis of sound economic considerations. Even where it has been finally determined that a business is being carried on, the rule that income must result from the pursuit of income through that business, or that income does not represent a source of income, still applies. Where all or even part of a trade or business, including stock-in-trade, is sold outright, no part of the selling price constitutes income. Again, where income results from personal services, a payment received for an employee's release of rights under his contract of service is not income; and, on the same principle, the payments received by an employee under independent contracts of sickness, accident, or disability insurance are not income. The problem of distinguishing income from its various sources we shall leave for more detailed consideration in later chapters. The second underlying principle governing a determination of income is that income means net income, or "incoming" less certain

"outgoing" or expenditure, to be determined according to ordinary commercial principles. The first rule, above, concerns the problem of whether what comes in is of the nature of income. The second rule, just mentioned, concerns the problem of what deductions must be made in ascertaining the income from amounts received which are admittedly of such a nature.

6 Rees Roturbo Development Syndicate, Ltd. v. Ducker, (1928) 138 L.T.R. 143, at p . 147.

THE MEANING OF INCOME

25

The rule that income means what is commonly referred to as net income was early established in English taxation law in cases arising under the rules to case I of schedule D of the English Income Tax Act which impose tax on the "full amount of the profits or gains from any trade."7 It is nowhere more clearly laid down than in Russell v. Town and County Bank where we find stated by Lord Herschell that: The duty is to be charged upon "a sum not less than the full ,amount of the balance of the profits or gains of the trade manufacture, adventure, or concern"; and it appears ,to me that that language implies that for the purpose of arriving at the balance of profits all that expenditure which is necessary for the purpose of earning the receipts must be deducted, otherwise you do not arrive at •the balance of profits, indeed, you do not ascertain, and cannot ascertain, whether there is such a thing as profit or not. The profit of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts. That seems to me to be the meaning of the word "profits" in relation to any trade or business. Unless and until you have ascertained that there is such a balance, nothing exists ,to which the name "profits" can properly be applied. 8

Much the same view was expressed by Lord Parker in Usher's Wiltshire Brewery, Ltd. v. Bruce : The expression "balance of profits and gains" implies, as has been often pointed out, something in the nature of a credit and debit account, in which the receipts appear on the one side and the costs and expenditure necessary for earning those receipts appear on the other side. Indeed, without such account it would be impossible to ascertain whether there were really any profits on which the tax could be assessed. 9

The fact that income, whether described as income or as profit or gain, means net income is equally well established in Canadian law. In upholding a recent appeal against the imposition of a provincial tax on gross revenue, the Judicial Committee carefully pointed out that ".. . there are marked distinctions between a tax on gross revenue and a tax on income, which for taxation purposes means gains and profits. There may be considerable gross revenues, but no income taxable by an 7A.-G. v. Scott, ( 1873) 28 L.T.R. 302; Mersey Docks and Harbour Board v. Lucas, (1883) 8 App. Cas. 891, at pp. 903, 912; Last v. London Assurance Corporation, (1885) 10 App. Cas. 438, at pp. 446, 448, 450. For more recent cases proceeding on the same view see British Sugar Manufacturers, Ltd. v. Harris, [1938] 1 All E.R. 149 and Lowry v. Consolidated African Selection Trust, Ltd., [1940] 2 All E.R. 545, esp. at pp. 549, 573, 579. Income has also been held to mean net income in interpreting testamentary dispositions of income: In re Redding, [1897] 1 Ch. 876. Useful reference may also be made to the discussion on the ordinary meaning of "income" in the recent House of Lords decision in F. P. H. Finance Trust, Ltd. v. C.I.R. [1944] 1 All E.R. 653. 8 (1888) 13 App. Cas. 418, at p. 424; see also Lord FitzGerald at p. 429. 9 [1915] A.C. 448, at p . 458.

26

THE MEANING OF INCOME

income tax in the accepted sense."'10 In the case of Lawless v. Sullivan a statute of the province of New Brunswick imposed a tax on "the amount of income" and "the whole amount of income" received annually in the city of Saint John by agents carrying on business there on behalf of persons having their principal place of business elsewhere. The Saint John branch of the Bank of British North America claimed the right to deduct its losses from its gains on business carried on in the city of Saint John over the period of the year in question. It was held on appeal to the Judicial Committee, reversing the view of both the Supreme Court of Canada and the Supreme Court of New Brunswick, that the appellant was entitled to set the full amount of their annual outgoings against the amounts received. In their lordships' judgment, delivered by Sir Montague Smith, "income" is regarded in the same light as profits and gains in the English cases under schedule D. He says: It must always be borne in mind that the tax is imposed on the income received during the fiscal year, and what therefure has to be ascertained fur the purpose of assessment is the income for the entire year. There can be no doubt that, in the natural and ordinary meaning of language, the income of a bank or trade for any given year would be understood to be the gain, if any, resulting from the balance of the profits and losses of the business in that year. That alone is the income which a commercial business produces, and the proprietor can receive from it. The question is, whether the word "income" in the enactment to be construed is to be understood in a different, and what, for the purpose of taxation, would be a more onerous sense.... The intention of the Legislature should be very clearly shewn to justify an interpretation of the word "income" which would require that, in the account for the year, the items of profit only should be included, and the losses excluded, although, but for the operations which occasioned the losses, the apparent profits could not have been made.... Their Lordships have come to the conclusion, upon consideration of the Act in question, that there is nothing in the enactment imposing the tax, nor in the context, which should induce them to construe the word "income," when applied to the income of a commercial business for a year, otherwise -than in its natural and commonly accepted sense, as the balance of gain over loss, and consequently they are of the opinion that where no such gain has been made in the fiscal year, there is no income or fund which is capable of being assessed. 11 Similarly, in the case of Roenisch v. Minister of National Revenue, which arose under the Canadian Income War Tax Act, we find it stated by Audette J.: 10The King v. Caledonian Collieries Ltµ., [1928) A.C. 358, per Lord Warrington of Clyffe, at p. 363. 11 ( 1881) 6 App. Cas. 373, at pp. 378, 379, 383.

27

THE MEANING OF INCOME

The profit of a trade is the surplus by which the receipts from the trade exceed the expenditure necessary for the purpose of earning those receipts. . . . In the ordinary sense and meaning ''profit" would be what could be properly described as "profit of the concern" and that surely would be all the net proceeds of the concern after deducting the necessary outgoings without which those proceeds could not be earned or received. 12

In general, the question of what items of outgoing may be deducted is determined according to sound commercial and accounting principles, but their operation is of course subject to any express provisions contained in the income tax statutes. The operation of these principles in the light of the Canadian statutes comprises the whole broad problem of deductions in computing income for Canadian income tax. This problem we shall leave for later discussion. INCOME DEFINED IN THE INCOME WAR TAX

Acr

Uoder the heading "taxable income defined" the Canadian Income War Tax Act defined income, for the purposes of that Act, as follows : 3. (I) For the purposes of this Act, "income" means the annual net profit or gain or gratuity, whether ascertained and capable of computation as being wages, salary, or other fixed amount, or unascertained as being fees or emoluments, or as being profits from a trade or commercial or financial or other business or calling, directly or indirectly received by a person from any office or employment, or from any profession or calling, or from any trade, manufacture or business, as the case may be whether derived from sources within Canada or elsewhere; and shall include the interest, dividends or profits directly or indirectly received from money at interest upon any security or without security, or from stocks, or from any other investment, and, whether such gains or profits are divided or distributed or not, and also the annual profit or gain from any other source including. . • .

There then followed sub-headings (a) to ( h) which itemized certain payments and receipts as being included. The word "net" in this statutory definition stands out as affirming the plain ordinary meaning of profits and gains established by the English and Canadian courts. 12(1928-34] C.T.C. 69, at p. 72. For similar expressions adopting this view of the English law on the meaning of income, see Webb v. Australian Deposit and Mortgage Bank, Ltd., (1910) 11 C.L.R. 223 (Aust.). See also: "Nor can the meaning of the word 'income' or the words 'profits or gains,' be affected by the fact that the one is used in an Imperial Act for providing a revenue for the Imperial government, while the other occurs in a provincial assessment Act for providing one for domestic or municipal purposes only." In re Canada Life Assurance Co. and City of Hamilton, ( 1898) 25 O.A.R. 312, at p. 318. Or again : "Capital must not be confused with income which is equivalent to the expression of 'balance of gains and profits.' " Saskatchewan Co-operative Wheat Producers, Ltd. v. M.N.R., (1928--34] C.T.C. 41, at p. 46.

28

THE MEANING OF INCOME

The balance of the above section does not truly define but merely mentions various forms of incoming and sources of income. It therefore offers no assistance in distinguishing an income payment from one representing a realization of capital or of any other source of income. This fact was noted by Maclean J. in Kellogg Company of Canada, Ltd. v. Minister of National Revenue where he says: Again, while the Act describes the sources of income, it nowhere defines "income" and nowhere does it define "capital." Inasmuch as there is no statutory definition of "income" or "capital" it is to the decided cases that one must return for light, and, as was said by Lord Macmillan in Van den Berghs Ltd. v. Clark . . . "while each case is found to turn upon its own facts, and no infallible criterion emerges, nevertheless the decisions are useful as illustrations and •as affording indications of the kind of considerations which may relevantly be borne in mind in approaching the problem" of discriminating between an income receipt and a capital receipt and between an income disbursement and a capital disbursement. 13

"Annuar The above section also refers to income as being the "annual" profit or gain. In so far as the word "annual" suggests that any computation of income must relate to the full period of one year it merely confirms a meaning implicit in s. 9 of the Act which charged tax with respect to "the income during the preceding year."14 Question arose as to whether this word excludes from the scope of the definition an income profit or gain which is not received annually. Schedule D, case VI, of the English Act charges tax in respect of any "annual profits or gains" and the argument that this language implied the idea of recurrency of income from year to year was first rejected by Rowlatt J., who discusses the function of the word "annual" as follows : Assuming then that these commissions constitute "profits or gains," the further question for consideration is whether they are ",annual" profits or gains. The word "annual" may mean "annually recurring," as applied to the seasons of the year, or "recurring over a long period of years": or it may mean '1asting only for one year," as we speak of certain flowers as annuals which must be sown afresh every year: or, as in the case of interest on a sum of money, it may mean "calculated with reference to a year." In the present case the transaction did last for a year and was renewed for another year, 13(1942] C.T.C. 51, at p. 56. 14"1t must always be borne in mind that the tax is imposed on the income received during the fiscal year, and what therefore has to be ascertained for the purpose of assessment is the income for an entire year." Lawless v. Sullivan, ( 1881) 6 App. Cas. 373, at p. 378. "By sec. 3 of our Act, the word 'income' is defined and means the annual net profit or gain or gratuity of a person; the word annual is used to mean all profits during the year and to be consistent with sec. 4 [s. 9] which says that the income is to be assessed and levied upon the income of the preceding year." Morrison v. M .N.R., [1917-27] C.T.C. 343, per Audette J., at p. 349.

THE MEANING OF INCOME

29

although it did not so continue of its own accord, but by agreement between the parties. I do not think that any of those meanings are applicable to the word "annual" as used in Case 6. . . . The word "annual" here can only mean "calculated in any one year," and "annual profits or gains" mean "profits or gains in any one year or in any year as the succession of years comes round."111

This rejection of any idea of recurrency in the word "annual" was followed by Canadian judges when considering s. 3 of the Canadian Act.ts "Directly or indirectly received" The provision that income must be received confirms what is already implicit in the term "income" 01 "incoming" and, accordingly, Justice Pitney in Eisner v. Macomber speaks of income as "coming in, being 'derived; that is, received or drawn by the recipient ( the taxpayer) for his separate use, benefit and disposal," while the Judicial Committee has said, "There must be a coming in to satisfy the word 'income.' "17 Notwithstanding these statements and similar expressions of the same view, the computation of income on an accrual basis has been allowed in both England and the United States in recognition of sound accountancy principles whereby the accrual method is regarded in certain circumstances as the only proper and accurate means of determining income. This departure from the literal in favour of the recognized commercial meaning of the term "income" is proper only when expressly or impliedly permitted by statute.18 It has been held that by providing that income shall be "directly or indirectly received" s. 3 of the Income War Tax Act excluded the application 15 Ryall v. Hoare, [1923) 2 K.B. 447, at pp. 454, 455; expressly affirmed by the House of Lords in Mart;n v. Lowry, [1927) A.C. 312, and Jones v. Leeming, [1930) A.C. 415, at pp. 422, 427. 16Morrison v. M.N.R., [1917-27) C.T.C. 343, Audette J., at p. 349; Consolidated Textiles, Ltd. v. M .N.R., [1947) C.T.C. 63, Thorson P., at p. 67. A contrary view has been suggested by an outstanding Canadian authority: "The reason this interpretation was adopted was due to the fact that the English Income Tax Act is enacted for one year only, while the Canadian Statute provides for continuous taxation of income and will be in force until repealed. It is quite possible that if it is necessary for the Courts to interpret this word in Canada a different view might be taken and profits which occur once and will not recur might escape taxation." M. Gordon, "How to Study Income Tax Law" in Law Society of Upper Canada, Special Lectures on Taxation, 1944 (Toronto, 1944), p. 195. It is necessary to point out that though income tax is charged annually by the Finance Act the English income tax acts governing the imposition of the tax are not annual statutes. 17St. Lucia Usines and Estates, Ltd. v. Colonial Treasurer, [1924) A.C. 508, per Lord Wrenbury, at p. 512. 18The English Act, schedule D, provides that tax shall be charged in respect of "the annual profits or gains arising or accruing...." The United States code directs that income shall be computed by whatever method "does clearly reflect the income." Thus, these statutes allow considerable latitude.

30

THE MEANING OF INCOME

of this accountancy principle and required that income be determined only on a cash receipts basis. The leading case in this regard is Capital Trust Co., Ltd. v. Minister of National Revenue. 19 In that case a testator directed that an executor of his estate be paid $500 per month for his services. The testator died in 1923 but nothing was paid the executor until 1927 when he was paid $19,500, representing thirty-nine back payments. It was held that the executor was not entitled to spread the payments over the intervening years. The judgment of the Supreme Court of Canada rests squarely on the provisions of s. 3: The statute here by sec. 3 defines income as "income received" and by sec. 9 imposes the tax upon "the income during the preceding year." Unfortunately in this case the taxpayer is bound to pay a larger amount than could have been levied and collected upon the same income had it been paid in instalments month by month as it became due and payable, but that cannot affect the liability plainly imposed by the statute. 20

It has been suggested, on the authority of certain obiter dicta appearing in the case of Robertson, Ltd. v. Minister of National Revenue,21 that income may be taxed when received though it is not yet earned. We submit that this view is incorrect in that it overlooks the plain fact that "income" received but not yet earned is not income. In the Robertson Case the appellant, as agent for certain underwriters, effected policies of industrial liability insurance for which it was paid a commission on the premiums paid thereunder. These premiums in19(1935-37] C.T.C. 267. 20Ibid., Davis J. per curiam, at p. 270. See also Robertson, Ltd. v. M .N.R., [1944] C.T.C. 75, Thorson J., at p. 89; and Trapp v. M.N.R., [1946] C.T.C. 30, Thorson P., at pp. 37, 41. In the Trapp Case it was also held that the words "not ... laid out or expended ..." in s. 6 ( 1) (a) of the Act prevented the making of deductions of sums not actually paid out and that the entire scheme of the Act thus appeared clearly to exclude the computation of income on an accrual basis. The Income Tax Act provides more general latitude in the method of computing income from business and property, as follows : "14. ( 1) When a taxpayer has adopted a method for computing income from a business or property for a taxation year and that method has been accepted for the purposes of this Part, income from the business or property for a sul>sequent year shall, subject to the other provisions of this Part, be computed according to that method unless the taxpayer has, with the concurrence of the Minister, adopted a different method." The taxing authorities in Canada have always accepted the computation of income by corporations on an accrual basis even though this practice would appear to be illegal under the Income War Tax Act. 21 "It seems equally clear that if income is received in any one year it is taxable in that year, even though it has not yet been earned, and it follows that the appellant was not entitled to make any deduction from income received by it in any year on the ground that it was not earned in such year." Robertson, Ltd. v. M.N.R., [1944] C.T.C. 75, per Thorson J., at p. 90.

THE MEANING OF INCOME

31

eluded "advance premiums," part of which was subject to repayment by the underwriters in the event of cancellation of the policies or adjustments of premiums on terms and conditions provided for in the contracts, and "minimum premiums" which were in no event to be repaid. The appellant was under obligation to refund to or on behalf of its principals, the underwriters, the commissions it had retained from any premiums which later became repayable. The appellant claimed the right to deduct an amount set aside annually as a reserve for unearned commissions to take care of commissions which would in future be refunded. It was held that this deduction to meet a contingent liability was prohibited both expressly by s. 6 ( 1) ( d) of the Income War Tax Act and by common law, and that any refunds of commissions due to cancellations and adjustments would have to be deducted from the receipts of the year in which they were made. However, from the standpoint of determining what is income received, the court drew a distinction between the commissions received on "minimum premiums," which would be in no event repayable, and commissions received on the balance of the premiums, which would or might be repayable, and held that only the former possessed the quality of income since they were the only payments beneficially received by the appellant. But it is difficult to see how the income payments thus received can have been considered unearned. The underwriters had assumed the obligation of insurers under the contracts in question; the appellant had concluded these contracts as their agents and had thereby earned a commission on not only the "minimum premiums" but on a certain undetermined portion of the "advance premiums" as well. For these reasons it is submitted that the decision cannot be said to support the proposition that income which is received is taxable even though not yet earned. The above case does, however, support and illustrate the rule that the mere receipt of a payment does not give it the character of income. This proposition is self-evident in most instances. Gifts of money do not when received normally fall within the category of income; and the same observation applies to loans of money, and to the gross receipts from a trade or business. But there is a stronger tendency towards confusion where, as in the present case, the payment in question possesses the attributes of an income payment when regard is had to its source. The judgment of Thorson J. brings out the necessary added requirement that income must be beneficially received by the taxpayer. On the basis of a test for the receipt of income once laid down by Justice Brandeis-whether the taxpayer's right to the amounts received is absolute and under no restriction, contractual or otherwise,

32

THE MEANING OF INCOME

as to its disposition, use, or enjoyment-Thorson various fees actually received by the appellant:

J.

distinguished the

Applying this test, I think a distinction must be drawn between the minimum and additional fees, on the one hand, and the advance fees, on the other, received from employers by the ap.pellant on behalf of -t he underwriters. The minimum fee on each contract, as has been seen, could be retained by the underwriters, regardless of what the earned fee, developed after the audit of the payroll, might be. There were, therefore, no restrictions upon the right of the underwriters to keep the minimum fees; their right to them was absolute. The same applies to the additional fees, for they were paid as the result of ascertained facts. The right of the appellant to its percentages of such minimum and additional fees was equally absolute and unrestricted. . • • They were clearly items of profit or gain to the appellant from its business and properly taxable in the year of their receipt. The "advance fee" paid ·b y the employer to the underwriters and received by the appellant on their behalf had, in my judgment, a different quality, for under the contract between the underwriters -and the employer, as shown by the indemnification certificate, it was stipulated that the advance fee should be "held as a deposit," and dealt with in a specified manner.... The difference in the stipulations with regard to the minimum fee and the advance fee indicates a difference in the nature of the payments made and received and in the rights of the recipient to their disposition, use and enjoyment. The underwriters could keep the minimum fee immediately upon its receipt on their behalf by the appellant; they could not do the same with the advance fee-they had to hold it as a deposit, with a right to retain it to their own use only under specified circumstances, which might or might not arise. Until the right of retention -arose, the amount of the deposit could not be profit or gain to the underwriters. If the amounts of the advance fees did not have the quality of income in the hands of the underwriters, neither did any percentages of them have such quality in the hands of the appellant. 22

In the above case there was a clear, contractual limitation on the appellant's retention of amounts it had received. In England, where the

courts follow the same doctrine of beneficial receipt, 23 it has been held that the payment of a profit to another pursuant to a mere moral obligation, unenforceable at law, is insufficient to preclude beneficial receipt by the payor.24 In a recent decision of the Exchequer Court in Biggar v. Minister of National Revenue25 the facts were that one Smart was a partner in each of two law firms and that under an arrangement with his partners in the second firm he agreed to share with them his net 221bid., at pp. 91, 92. 2asee, for example, Morley v. Tattersall, [1938] 3 All E.R. 296, and, more recently, l.R.C. v. Duncanson, [1949] 2 All E.R. 846. 24Hutchinson & Co. (Publishers), Ltd. v. Turner, [1950] 2 All E.R. 633. 25(1948] C.T.C. 43.

THE MEANING OF INCOME

33

profits from the first firm. He later acquired, by what amounted to a purchase, the share of one of his partners who retired from the first firm. The total net profits of the first firm were paid into the bank account of the second firm and from that account Smart paid the annual instahnents of purchase price and share of profits payable to the retired partner and remaining partner respectively of the first firm. These deposits and withdrawals by Smart were carried out with the knowledge and consent of all partners in the second firm. It was argued that these amounts were taxable as income received by the second partnership on which the partners were individually liable for income tax.26 Cameron J. rejected this contention, pointing out that there was no beneficial receipt of money such as was necessary to constitute income: Not all money in the bank account of a partnership is "income of the partnership." Many deductions may be made before the income of the partnership is ascertained. In the case of a furn of solicitors, substantial amounts of trust monies may pass through the :firm's accounts, but such trust funds could not be considered as "income of the partnership." The mere fact that all of the monies paid to J.E.M. Fetherstonhaugh, and part of the monies paid to F. B. Fetherstonhaugh, passed through the bank account of Smart and Biggar does not by itself establish that the sums represented by these payments were "inoome of the partnership." It would be necessary, I think, to establish that under the agreement ... they were sums which represented Smart's "net share from time to time" in the partnership of Fetherstonhaugh and Company, and to which the :firm of Smart and Biggar was entitled, and which had been received by that firm. . .. there is no evidence to indicate that the appellant benefited in any way by the payments to J. E. M. Fetherstonhaugh and F. B. Fetherstonhaugh. At no time did he consider that he was entitled personally to any part of such payments. So far as the evidence goes, the only person who benefited by the payment was Smart, who thereby acquired the ownership of the shares of his former partners in Fetherstonhaugh and Company.27

The above extract concludes with the suggestion that the moneys paid into the bank account of the second firm were income of Smart. The principle that income may be received through the agency of another without having been brought into the physical possession of the person so receiving it is well recognized and was retained in force by the words "directly or indirectly received" in s. 3 of the Income War Tax Act. Thus, it was held in a later appeal arising out of the facts jus•t reviewed that the amounts paid into the bank account of the second firm were income of Smart since they were in fact com2say s. 30 of the Income War Tax Act ( vide ss. 6 ( c) and 15 of the Income Tax Act) which taxed the shares of the partners in the income of a partnership, whether withdrawn or not during the taxation year, as income of the partners. 27[1948] C.T.C. 43, at pp. 50, 51.

34

THE MEANING OF INCOME

pletely under his control and disposition. In his judgment Cameron states:

J.

Nor can it be said Smart did not "receive" these sums. They were unquestionably under his control at all times. By paragraph 11 of the Statement of Claim it is alleged that he deposited all the profits from Fetherstonhaugh and Company in the bank account of Smart and Biggar, thus indicating that even if he did not directly receive the income he did have such control over it as to come within the words ",directly or indirectly received" in sec. 3 of the Act. And by sec. 30 it is provided that the shares of the partners in the income of the partnership, whether withdrawn or not during the taxation year, shall, in addition to all other income, be income of the partners and taxed accordingly. 28

On the same reasoning, that full control over a payment is the equivalent of actual receipt, income paid into the hands of an agent is indirectly received by the principal. Income may also be received by a beneficiary through the intermediary of a trustee. Thus, income paid into the hands of a trust company to be applied toward the redemption of another company's bonds is received by the latter company.29 However, a payment thus received must have retained its character as income in the hands of the beneficiary or his trustee. In Burns' Executors v. Minister of National Revenue3° the executors of an estate were directed to hold the residue of the estate in trust to pay out 60 per cent of the net annual income therefrom on certain annuities, to allow the balance of the income to accumulate as part of the capital of the estate until the death of the last annuitant and then to pay 33 per cent of this entire accumulated residue to the Royal Trust Company in trust to pay the net annual income therefrom to five named charitable objects. The accumulated income of the estate, while destined for ultimate payment to the charities, was held not to be their income since it was received by the trust company on their behalf as a capital payment by gift under a will. Indirect receipt will also result where income is directed to be paid into the hands of persons designated to receive payment. In such event the entire transaction may be properly viewed as an indirect receipt and an expenditure of the same amount by the person directing payment. This form of receipt has sometimes been termed "constructive receipt" and is expressly confirmed by s. 16 of the present Income Tax Act. That section may be interpreted as proceeding even further, for it covers the situation where payments are made to an28Royal Trust Co. & Stevens v. M.N.R., [1948] C.T.C. 21, at p. 31. 29Dominion Telegraph Securities, Ltd. v. M.N.R., [1946] C.T.C. 1. 30(1950] C.T.C. 393 (P.C.).

THE MEANING OF INCOME

35

other with the mere "concurrence" of a taxpayer. On any view, however, the amounts so paid over must possess the quality of income to the alleged recipient. In B. & B. Royalties v. Minister of National, Revenue81 the appellant company owned a leasehold interest in certain oil lands on which it drilled and later operated an oil well. By agreement with a trust company, the appellant made an absolute conveyance to ,that company of 80 per cent of all the oil to be produced from its property, the trust company agreeing to divide this oil among the appellant company and various other persons entitled as prior holders of royalty interests in the production of the well. The oil was sold, with the consent of all the persons interested under this trust, to various oil companies and payment was made by them direct to the trust company. The Minister of National Revenue sought to tax the appellant company on the full 80 per cent of the proceeds as being income indirectly received. It was held that the trust agreement operated to divest the appellant company of all ownership of the oil and not merely to impose on the appellant an obligation to pay over in a certain manner the proceeds of the well for the benefit of ,the holders of royalty interests. Therefore the appellant company could be truced only on the share of the well's production ultimately received by it on a distribution by the trustee. 32 Another Canadian case on the question of indirect receipt by expenditure through another but which presented somewhat more difficulty in arriving at a proper interpretation of the many facts and 81(1940-41] C.T.C. 65. this agreement operate to divest the Company of its beneficial interest in the percentage of production therein mentioned, or in the proceeds of that production, or, is the agreement in substance but a contractual obligation assumed by the Company to pay to those who purchased royalty interests a certain proportion of the net income realized from the sale of oil receovered from a specified oil well? ... The substance of the transaction was, I think, the irrevocable alienation, for a consideration paid, of a stated percentage of any production recovered, or the proceeds of that production when sold, less certain deductions. I think the agreement sought to put the ownership of a percentage of the oil produced in the Trustee on behalf of the purchasers of royalty interests, and the moment the oil was pumped to the surface the legal interest therein passed to the Trustee. . . . The production in question may have been under the direction of the Company as operator of the undertaking, on behalf of those holding royalty interests, but not as owner. The Company could not, I think, successfully assert that the proceeds derived from the sale of the production in question belonged to it, or that it was a profit or gain to which it was entitled." Ibid., per Maclean J., at pp. 76, 77. The effect of this decision in avoiding double taxation was later barred by the enactment of s. 3 ( 3) of the Income War Tax Act which taxed the proceeds coming into the hands of the trustees as if such trustee were a corporation. This provision was continued bys. 73 of the Income Tax Act but was repealed in 1950 (14 Geo. 6 (Can.), c. 40, s. 28). 32 "Did

36

THE MEANING OF INCOME

negotiations involved in it, was Snyder v. Minister of National Revenue. 83 The facts were essentially as follows. The appellants, Snyder and his associates, acquired the right to drill for and remove oil from certain lands under a lease the terms of which bound them to drill a well. They formed a company, and sold it their rights under the lease in return for shares of the company. The company further agreed to secure the drilling of a well pursuant to the requirements of the lease, to divide the production of the well into 100 units of production and sell to the public enough units of production to meet part of the cost of the well, and to divide the remaining units of production (less certain royalties payable to prior owners of the oil rights) among the appellants, after subtracting therefrom a part of the cost of drilling -the well which, it was agreed, the appellants would assume. The well came into production. The appellants' share of the cost of drilling amounted to $16,333.50. A portion of this amount was deducted by the company from the units of production distributable to the appellants and the balance was paid to them. The Minister of National Revenue contended that the amount so deducted was income which had been received by the appellants through the agency of the company and expended by them through that agency as capital expenditure in drilling the well. The appellants maintained that this amount did not represent income directly or indirectly received in that the company, in making payment to the driller, was discharging its own obligation. The whole problem can be seen to turn on the interpretation to be placed on the agreement between the appellants and the company. In the Exchequer Court, Maclean J. gave judgment for the Crown on the view that the appellants had received a stipulated share of the well's production out of which they had been bound to discharge the agreed upon share of the drilling expenses: The point for determination is not free entirely from difficulties, but the contention of the Crown must, I think, prevail. The appellants were the holders of the remaining units of production, and having undertaken that their units of production should bear the "costs and charges" in question they agreed that there should be taken from the proceeds of their pooled production units sufficient to pay the claim of Head, which was, I think, a payment made at the request of the appellants out of the income coming to them as the holders of their units of production. Tirls was merely saying: "You, Sterling Royalties Ld., pay out of any proceeds coming to us from our pooled units of production sufficient to pay the balance of Head's contract price for drilling the well." ... It was part of the consideration for the assignment of the lease to Sterling Royalties Ld. that the units of pro88[1938--39) C.T.C. 151 (Ex.); reversed [1939) S.C.R. 384.

THE MEANING OF INCOME

37

duction transferred to the appellants should be charged with the payment of the second instahnent of Head's contract price, if the well came into production. The source of the payment to Head was in the nature of a dividend, or a profit or gain, earned and distributable to the appellants from their production units in the proportion in which each held shares in Sterling Royalties Ld. 34

On appeal to the Supreme Court of Canada, the majority of that court held that the company had assumed the full obligation and cost of drilling the well and that the appellants had sold their lease to the company in return for certain agreed units of production less a portion of the drilling costs. After full consideration of all negotiations and contracts ancillary to the main agreement, Duff C.J.C. concludes: Further •.. nowhere in these instruments is there to be found any evidence of an obligation on the part of the vendors to pay moneys agreed to be paid by the Company to Head for the construction of the well. The vendors [appellants] were under an obligation to the licensors [licensors to the vendors] to construct the well and work it. If they failed to perform that obligation they would expose themselves to an action for damages; but, on the other hand, the Company agreed with the vendors to perform that obligation and also, as we shall see, convenanted directly with the licensors to perform it. ... Obviously, the effect of article 2 of the ,agreement between the Company and the licensors was to make the Company directly responsible to the licensors for the performance of these stipulations; that is to say, the Company agreed to observe, carry out and perform the obligations of the vendors, to commence the work of drilling a well within five weeks of the 1st of June, and to carry on such drilling operations continuously and diligently as just mentioned. . . . As between the Company and the vendors, the sum of $15,000 now in question was, by force of the original vendors' agreement with the Company, to be charged on the vendors' units...• From all this it results, in my opinion, that the sum in question was never, directly or indirectly, received by the appellant and his associates within the meaning of the statute. 36

The judgment of Davis J. (Rinfret J.) was to the same effect, while Crocket J. and Hudson J. dissented in adopting the same view of the transactions as Maclean J. had done in the lower court. Closely associated with the question of indirect receipt is that of receipt in money's worth. While, as we have seen, a payment according to the directions of another may constitute an indirect receipt of income by that other, there must nevertheless be some form of payment for there to be either a direct or an indirect receipt. Such payment may be made in money or money's worth. Where goods, services, securities, and other forms of valuable property are beneficially received and 34[1938-39] C.T.C., at p. 158. 85[1939] S.C.R., at pp. 387, 391, 393, 395.

38

THE MEANING OF INCOME

accepted in discharge of an obligation ,the situation is the same as if that obligation had to that extent been discharged in money. 36 On the other hand, the mere existence of an obligation to pay does not constitute payment. Thus, the right of persons other than partners to demand the payment of a share of partnership profits is not income. 37 Neither can the receipt by a creditor of a mere acknowledgment of indebtedness or promise to pay of his debtor be regarded as a receipt of income. The obligation must somehow have been actually met for there to have been payment in either money or money's worth. This principle was clearly laid down by the Judicial Committee in Income Tax Commissioner v. Darbhanga. 38 In that case money was owed in the form of principal and interest on a debt. By arrangement between the debtor and creditor the latter agreed to take in satisfaction of the principal and interest due him certain assets and certain promissory notes. Some of these notes were given in satisfaction of the interest due. It was held that the receipt of these notes could not be regarded as a receipt of income. Lord Macmillan, while acknowledging that an obligation to pay money may be discharged by the payment of money's worth, says: "A debtor who gives his creditor a promissory note for the sum he owes can in no sense be said to pay his creditor; he merely gives him a document or voucher of debt possessing certain legal attributes.''39 In another appeal from India of about the same date, it was held that where the holders of a mortgage, under which interest was due and payable in money, accepted in extinction of that mortgage a new mortgage for an amount including the interest on the former mortgage, the former interest due and payable in money could not be said to have been paid by the substitution of the new obligation and security. 40 The latter case goes further in this regard since the grantors of the new mortgage were not identical with the grantors of the old mortgage and the property mortgaged by the new mortgage was greater in extent. The English House of Lords has recently held that where interest owing under a mortgage is "capitalized" by adding the 36For example, Canada victory loan bonds, Waterous v. M.N.R., [1928-34] C.T.C. 163 (Ex. ), [1928-34] C.T.C. 168 (S.C. Can.); or shares in a corporation, Sal11Wn v. Weight, (1935) 153 L.T.R. 55, Pool v. Guardian Investment Trust Co., Ltd., [1922] 1 K.B. 347, Californian Copper Syndicate, Ltd. v. Harris, ( 1904) 5 T.C. 159; or debentures of a company, Scottish & Canadian General Investment Co., Ltd. v. Easson, [1922] S.C. 242; or real estate, Ruskin Investments, Ltd. v. Copeman, [1943] 1 All E.R. 378; or "ground annuals," Emery (John) & Sons v. C.I.R., [1937] A.C. 91. a1c.I.R. v. Lebus, [1946] 1 All E .R. 476. 38( 1933) L.R. 60 Ind. App. 146. 39Jbid., at p. 161. 40Jncome Tax Commissioner v. Raghunanden, ( 1933) L.R. 60 Ind. App. 133.

THE MEANING OF INCOME

39

amount thereof to the principal sum due, such interest cannot be regarded as paid.41 The rule has also been applied in the case of such capitalization of interest due on a bank loan. 42 The situation with respect to receipt in money's worth would appear then to be as follows: If you have an original obligation to pay in cash it must, for there to be receipt of payment, be paid in cash, or, if there is agreement to substitute payment in kind, it may, under that agreement, be paid in kind. In the same way an obligation to pay in kind may, by agreement, be paid in cash. But there can be no payment by an arrangement between the parties to make and receive payment, in any form, at a future date, even though the terms of promise of payment may be varied. While, from the strict standpoint of the law of contract, there may have been "accord" between the parties relative to the discharge of the original obligation and "satisfaction" in the form of executory consideration for that discharge, 43 there has been no execution of either the original undertaking to pay or of any substituted undertaking to pay. It is implicit in the word "income" or "incoming" and in ·t he requirement that income be "directly or indirectly received" that the undertaking to pay income, in whatever form, be performed and not merely discharged. "The tree has produced no fruit, to use a well-worn simile. The owner of the tree has refused to allow it to be picked, and has merely given a voucher entitling the holder to pick it at a future date."44 It has also been said: "It is quite true that income may arise by the receipt of money's worth as well as by the receipt of money, and· it is equally true that a debtor may pay his debt by giving the promise of a third party to pay. Indeed the best form of payment in the world, Bank of England notes, if subjected to the unusual treatment of being read, will be found to be promises by a third party to pay.''45 The 41 1.R.C. v. Oswald, [1945] 1 All E.R. 641 (H.L.), overruling I.R.C. v. Lawrence, Graham & Co., [1937] 2 All E.R. 1 (C.A.); and compare Toronto General Trust Co. v. The King, [1942] C.T.C. 65. 42Paton v. I.R.C. [1938] 1 All E.R. 786 (H.L.). 4 3See British Russian Gazette and Trade Outlook v. Associated Newspapers, Ltd., [1933] 2 K.B. 616. 44Cross v. London & Provincial Trust, Ltd., [1938] 1 All E.R. 428, per Sir Wilfrid Greene M.R., at p. 433. The same principle was recently discussed and followed in the Canadian Exchequer Court decision in Flinn v. M.N.R., [1948] C.T.C. 90. Its operation appears to have since been overborne, with respect to payments of interest, declared dividends, and debts, by amendment to the Income War Tax Act in 1947 adding ss. 11 to s. 3, and, with respect to patronage dividends, by the addition in that year of ss. 12 to s. 3. Income Tax Act, ss. 24 ( 1), 68(6). 4°Cross v. London & Provincial Trust, Ltd., [1938] 1 All E.R. 428, per MacKinnon L. J., at p. 435.

40

THE MEANING OF INCOME

example here given is not a good one. Bank of England notes are probably money, and, if not, would probably, by express or implied understanding of the parties, be a sufficient means of discharging the obligation to pay contained in their original agreement. Thus, if money were lent to the Bank of England, the payment of interest to the lender in Bank of England notes would also be a valid payment. But would the promissory note of a third person, if given by the Bank of England in discharge of their interest obligation, be income to the lender? It is submitted, on principle, that it would not be, unless it were originally agreed, expressly or by implication, that payment could or would be made in this form. It is further suggested that, for the same reason, the substitution, by mutual agreement, of a debtor's promise to pay in kind for his original promise to pay in cash or in different kind would not be a receipt of income in money's worth. But if the original undertaking of a debtor were discharged by a creditor, not in consideration of his promissory note promising to pay, but in consideration for his promise to give his promissory note promising to pay, then it might conceivably be argued that, on receipt of the notes, the creditor had received income in the form of money's worth. 46 The situation from the standpoint of receipt is in no way affected by the fact that the substituted promise is of any or great value. The original unfulfilled promise might also have been of great value. To allow such considerations to govern would render meaningless the statement that income must be received. All accrued incomes and expenditures might then be looked on as income received and expended in money's worth. Furthermore, a receipt of money's worth is subject always to the general rule that the amount received must represent income. "It is one thing to say that income is none the less income because it is received in the shape of money's worth instead of money: this proposition is true. It is a totally different thing to say that the receipt of money's worth is necessarily a receipt of income; this proposition is 46The fact that a debtor's promise to pay can, when received, be income in money's worth to the creditor is in fact acknowledged by Scott L. J. in Associated Insulation Products, Ltd. v. Gokler, [1944] 2 All E.R. 203, at p. 203 where, in considering the situation on the distribution by a company of certificates of indebtedness to shareholders, he says: "If those resolutions provided in reality for a distribution by way of dividend not of money but of money's worth, the income tax due in respect of it under case V would be not on the money figure of interest payable on each share, but on the market value of the certificates on the date of their distribution multiplied by the number of shares held. If, on the other hand, the reality of the transaction was the declaration of a money dividend payable not presently, but only on a future date, namely, Jan. 1, 1940, then it follows that till the due date arrived and payment was in fact received by the respondent company as shareholder, no income arose from its foreign possessions."

THE MEANING OF INCOME

41

not true."47 Thus, while a profit or gain may have been received in money's worth it must be income and not a capital realization or gain. 48 A share in a company is undoubtedly money's worth; 49 but where a stock dividend has been declared and paid by a company and received by the shareholders, the shares thus received are not income of those shareholders. r;o There are occasions when an indirect receipt of income and a receipt of income in the form of money's worth so resemble one another as to be difficult to distinguish. However, it is doubtful that they can ever be properly regarded as being the same. It is of interest, from this standpoint, to examine and compare three fairly recent cases. In the case of Re Gillespie Estate/' 1 which arose under the Alberta Income Tax Act, the deceased, John Gillespie, insured his life, making the Gillespie Grain Company, Ltd. the beneficiary under the policy, and the company thereafter paid all premiums. Later, the proceeds of the policy were directed to the payment of Gillespie's succession duties and the company released all its policy rights. It was held that the premiums paid by the company were income to the insured and, further, that they had been indirectly received by the insured. "The situation was the same in effect as if the payments had been made direct to the insured and by him paid over to the insurance Company.''52 The decision was affirmed by the Alberta Court of Appeal, their lordships' views being briefly expressed by Ford J.A. as follows : There can, I think, be no doubt that the payment by Gillespie Grain Company Limited of the premiums in each of the years in question was made for John Gillespie's benefit in consideration of the services as recited in Exhibit 7, and the amounts thereof must ibe treated as if paid to him, and to be income received by him as much as if he had been paid a salary as president and manager of the company. The fact that they were paid not to him but to the Insurance Company makes no difference. They were profit or gain indirectly received during each of the years in which the premiums were paid, and were income within the meaning of the Income Tax Act, Statutes of Alberta, 1932, ch. 5. 53

On this view the Court of Appeal denied the appellant's contention that the income payments were not received when the premiums were 41 Cross v. London & Provincial Trost, Ltd., [1938] 1 All E.R. 428, per Sir Willrid Greene M.R., at p. 433. 48 Spooner v. M.N.R., [1928-34] C.T.C. 184, 188. 49Note 36, supra. 50I.R.C. v. Blott, [1921] 2 A.C. 171; and see pp. 188 ff. infra. This result has of course been altered by the income tax acts. 51(1942] C.T.C. 249; affirmed [1943] C.T.C. 127. 52[1942] C.T.C. 249, per Macdonald J., at p. 253. 53[1943] C.T.C. 127. at p. 129.

42

THE MEANING OF INCOME

paid but were received at the later date when the company released all its claims under the policy to Gillespie. The following from among the added observations by the Court of Appeal on the facts of the case is significant: "By the first admission of fact, it is admitted that John Gillespie insured his life. ltis not a case of a corporation insuring the life of its president and manager in which it had an insurable interest."54 This case seems clearly to have been decided on a basis of indirect receipt by Gillespie through the discharge of his premium obligations. On the other hand, consider the English House of Lords case of Hartland v. Diggines. 55 A shipping company voluntarily paid the income tax of the appellant, its employee, over a series of years but without receiving any request or direction from him to do so. The main argument of the appellant in denying his liability for tax on these amounts was that they were not paid to him or at his request and were therefore not received as emoluments from his office within schedule E of the English Act. The House of Lords held that he had received money's worth in each of the years in question. 56 Their lordships' reasoning did not suggest that the money payments had ever been received by the appellant. We may compare the reasoning in the above two cases with the recent judgment of the Exchequer Court of Canada in Salter v. Minister of National Revenue. 51 The appellant was an employee of the Sun Publishing Company, Ltd. of Vancouver over a period of twenty-eight years, ending in his withdrawal from the office of president and general manager of the company in 1942. In 1938 the company had decided to provide annuities for some of its employees including the appellant. Individual annuity policies on each employee were negotiated by the company with the Monarch Life Assurance Company under which the company was to pay the premiums. In the appellant's case the policy provided for a life annuity, to commence in 1944, with ten years of annuity certain, his wife to receive payment during the balance of the guaranteed period in the event of his early death. In the event of the appellant leaving the company before the maturity date all benefits of the appellant and his wife were to cease, and the insurance company was only bound to pay the appellant in one sum the amount of all premiums paid by the company or the cash 5 4 Ibid.,

at p. 128. 55(1926] A.C. 289. 56"It is true that the appellant did not receive cash in his hands, but he received money's worth year after year. This being so, I cannot resist the conclusion that the payment was in fact a part of his profits and emoluments as an officer of the company for which he has been properly assessed to tax." Ibid., per Viscount Cave L.C., at p. 292. 57[1947] C.T.C. 29.

THE MEANING OF INCOME

43

surrender value of the policy, whichever should be the greater. The appellant left the company's employ in 1942, receiving from it an assignment of all its control and interest in the policy. It was arranged with the insurer that the appellant should pay the remaining premiums, that there should be slight changes in the beneficiaries, and that the aforementioned provision governing settlement in the event of the annuitant leaving the company should be cancelled. In each of the prior years the company had paid the annual premium on the policy and, in addition, had paid to the Department of National Revenue the added tax alleged to be due from the appellant on this annual insurance premium. The revenue authorities had credited the appellant with the annual payments of tax. They now claimed income tax on the amount of income tax paid by the company and thus credited to the appellant's tax account. The appellant claimed, inter alia, on appeal that neither the annuity premiums nor the income tax paid on them by the company were directly or indirectly received by him. Cameron J. held that these amounts were personal and living expenses forming part of the profit, gain, or remuneration of the taxpayer and also forming part of the gain, benefit, or advantage accruing to the taxpayer under any contract, within the meaning of ss. 3 ( 1) ( e) and 2 (r) (ii) of the Income War Tax Act. He apparently did not consider it necessary under those sections that such expenses should be received. He does state, in what might appear to be an observation concerning receipt: The annuity contract was entirely for the benefit of the appellant, for although in certain particulars the appellant did not have absolute control as to options, loans and assignments, I cannot recall any provisions in the policy under which the Company could at any time receive any benefits thereunder without, at least, the voluntary approval and direction of the appellant.118

But it is to be observed that the appellant appears to have had no claim whatever under the terms of the annuity until the condition that he continue in the employ of the company to the maturity date of the policy was fulfilled. In any event, his lordship went on to hold that the annuity premiums ( and of course the income tax) paid by the company were income in the form of a gratuity ·from the employment within the meaning of the main definition of income in s. 3 ( 1). In this connection he dealt more fully with the problem of receipt. He says: I am also of the opinion that in •addition to being taxable •as personal and living expenses under sec. 3 ( 1) ( e) the premiums so paid by the Company are taxable in the hands of the appellant as a gratuity indirectly received

11s1bid., at p. 43.

44

THE MEANING OF INCOME

by the appellant from his employment with the Company.••• The whole scheme, therefore, related to his employment or office, and being gratuitous on the part of the Company and the premiums being paid to the insurer for the sole benefit of the appellant, the amount thereof was a gratuity indirectly received by him. 59

His lordship relied in support of this conclusion on both the Gillespie Case and Hartland v. Diggines. But it is to be noted that, in the former case, the indirect receipt arose as a result of premiums paid under a contract of insurance which had been entered into by the taxpayer, and that, in the latter case, there was a receipt, not of money, but of money's worth. Against this objection to identical use being made of both cases it may be said that the distinction drawn is inconsequential in that the result arrived at in the present case is the same under either view. But the choice of view may have a direct bearing on the time when the income can be said to have been received. If indirectly received it was received when the premiums were paid to the insurance company. If received in money's worth it could not have been received until the appellant acquired more than a mere contingent benefit under the policy contract, which, in the circumstances, would seem to have been when it was assigned to him on his retirement. The latter view does not appear to have been urged by counsel for the revenue and, as has already been observed, the judgment is based on alternative grounds. Without more detailed information on the various contracts and negotiations than is provided in the judgment it is not possible to enter further into this question. However, even as it stands, the case serves to illustrate that the principles of indirect receipt and receipt in money's worth are not to be confused. It has been said that for any acquired advantage to be money's worth it must be capable of being disposed of by the person receiving it. The origin of this suggestion is directly attributable to the English House of Lords decision in Tennant v. Smith. 60 The decision in that case concerned the free occupation of bank premises by the servant of a bank; and we find it stated by various of the learned law lords, in referring to the English Act: "... the thing sought to be taxed is not income unless it can be turned into money" (Lord Halsbury L.C.); "I do not think it comes within the category of profits, because that word, in its ordinary acceptation, appears to me to denote something acquired which the acquirer becomes possessed of, and can dispose of to his advantage-in other words, money-or that which can be turned to pecuniary account" (Lord Watson); "On examining the 59Jbid., p. 43-44. 60(1892] A.C. 150.

THE MEANING OF INCOME

45

schedule it became obvious that it extends only to money payment or payments convertible into money" (Lord Macnaghten); "... it appears to me that the residence of the appellant upon the bank premises, which although rent free could not in any way be converted by him into money or money's worth, cannot be held to be either a gain, profit, perquisite, or emolument, within the meaning of the statutes" (Lord Field). 61 These statements are pure obiter dicta and are misleading. Attempts to escape taxation on the strength of that doctrine have failed. In the recent case of Ede v. Wilson, 62 which, like Tennant v. Smith, arose under schedule E of the English Act, the appellants, who were senior officials in the employ of a company, were issued shares of the company at a value far below the market value in payment for their services. Ordinarily, in these circumstances, they would have received payment in money's worth to the extent of the difference between the true value of the shares and the price paid for them. But the appellants had bound themselves not to part with the shares without the permission of the company directors for as long as they remained the servants of the company. Wrottesley J. held that the full value of the shares was income, though not without some difficulty in surmounting the above dicta in Tennant v. Smith. 63 It is submitted that the proper meaning to be taken from the judgments in Tennant v. Smith is that income must be beneficially received. We have already examined this proposition in connection with the receipt of income in the form of money. It applies with equal force to a receipt of income in money's worth. But the case of Tennant v. Smith has so frequently been understood otherwise that it now requires more detailed examination than it would ordinarily merit. 6tlbid., at pp. 157, 159, 163, 164. 62(1945] 1 All E.R. 361. 63As it stands, his judgment proceeds on the somewhat questionable reasoning that the shares were salable in spite of the prohibition since it merely operated as a clog on salability and might have been avoided by the appellants obtaining the directors' consent to any sale or resigning from the employ of the company. He describes the shares as being, in terms of another dictum of Lord Halsbury L.C. in Tennant v. Smith, "capable of being turned into money from their own nature" (italics added). In Gold Coast Trust, Ltd. v. Humphrey, [1946] 2 All E.R. 742, at p. 747, Sommervell L.J. uses the phrase"... asset ... marketable in its nature and not some merely personal advantage which by its nature cannot be turned into money...." The latter case brings out the fact that restrictions on marketability will no doubt affect the amount of the "money's worth" received. " . . . if an asset is capable of valuation, it should be valued and brought into the account, even though that value may not be presently realizable in the accounting year.... The fact that it cannot be realized in the accounting year is no doubt an element which the commissioners should take into account in estimating the value. . . ." Per Scott L.J., at p. 749. This view was expressly affirmed by the House of Lords, [1948] 2 All E.R. 379.

46

THE MEANING OF INCOME

The appellant was agent at a branch of the Bank of Scotland and, as part of his duty, was required to occupy the bank house in order to care for the premises and to be on hand for the conduct of any special business after bank hours. He was not allowed to sublet or use any part of the premises for other than bank business and was obliged to leave in the event of his ceasing to hold office. On his application for an abatement or "relief' from taxation, question arose as to whether the value of the premises was part of the income from his office or employment, so as to constitute a part of his "total income from all sources." It had been held in a previous judgment that the bank was the sole occupier of the entire premises64 and it is in the light of this circumstance that their lordships' observations that the benefit acquired was not convertible into money are to be construed. Their finding was, in effect, that since the appellant's occupation formed part of his duties it was undertaken for and on behalf of the bank. Thus regarded, the judgments in that case go no further than to confirm the accepted principle that income must be beneficially received, in its application to income in the form of money's worth. On the same principle, the supplying to employees of uniforms which it is in their line of duty to wear would not be income. Similarly, where cash is supplied to an employee who is under a duty to apply it according to his employer's needs and objects it is not income of the employee. There is no difference in principle where an employee is required to spend his own money in this manner and is reimbursed at a later date. In the recent Canadian case of Samson v. Minister of National, Revenue65 the appellant was hired by the Government of Canada as wartime Hides and Leather Administrator and it was by order-incouncil directed that he be paid a salary of $1 per year, his actual transportation expenses, and a living allowance of $20 per day while absent from his place of residence in connection with his duties. The Department of Na•tional Revenue does not appear to have sought to call the transportation expenses an income received by the appellant, but sought to tax him merely on the $20 per day living allowance, although there would seem to have been every indication that the government intended to provide regular support, as well as transportation, for its employee. The Department was probably induced to distinguish the living allowance as income because it was fixed at an 64 Russell v. Town and County Bank, ( 1888) 13 App. Cas. 418. Lord Herschell said, at p. 427: "It is contended on behalf of the appellant that the whole of this building is a dwelling-house. My Lords, I cannot agree in that conclusion. I do not think that the word 'dwelling-house' is here used in any such sense, and that a bank or manufactory or a warehouse becomes a dwelling-house because some servant of the trader resides in that building for the purposes of the trade." 65[1943] C.T.C. 47.

THE MEANING OF INCOME

47

amount certain per day without surrender of vouchers and was called '1iving allowance," and s. 3 (1) of the Income War Tax Act seemed specifically to include it as income in stating that: . . • "income" means . . . also the annual profit or gain from any other source including ••• ( d) the salaries, indemnities or other remuneration of ... (v) all persons whatsoever, whether . . . paid • • . out of the revenue of His Majesty . . . or by any person, except as herein otherwise provided; ( e) personal and living expenses when such form part of the profit, gain or remuneration of the taxpayer or the payment of suoh constitutes part of the gain, benefit or advantage accruing to the taxpayer under any . . . contract, arrangement . . . irrespective of when created. • . .

Thorson J. held that the living allowance was not income or, which amounts to the same thing, that it was not beneficially received by the taxpayer. The following extracts from his judgment show clearly his reasoning in that regard: An analysis of the terms of the Order-in-Council under which the appellant was appointed and careful consideration of the duties he was called upon to perform together with all the attendant circumstances including the financial conditions attached to the appointment lead me to the conclusion that no remuneration to the appellant other than the purely nominal salary of one dollar per year was involved in the appointment or contemplated by the Order-in~Council and that the per diem living allowances in this case were not taxable income at all within the meaning of the Income War Tax Act but were intended to be reimbursement to the appellant for the additional living expenses to which he would he put by reason of his necessary absences from his place of residence in connection with his duties. . . . It is obvious that the reimbursement which the appellant received for his actual transportation expenses cannot be considered as taxable income to him. The other reimbursement which he received, namely, the per diem living allowances, are also reimbursement to him of additional living expense, and do not cease to have the character of reimbursement merely because their amount is set at a fixed amount per diem. All that is meant thereby is that a top limit of reimbursement of additional living expense has been fixed by the Order-in-Council. . . . The assessability for income tax purposes of any particular amount does not depend upon what it is called, but rather upon what it really is .... Nothing, therefore, turns on the fact that the payments made to the appellant in this case are called allowances nor does the fact that the word "allowance" does not appear in section 3 of the taxing statute have any signHicance. The word is used in a number of statutes with different meanings. Its use is not conclusive for the purpose of determining whether a receipt of money in the hands of a taxpayer is really in the nature of remuneration to him resulting in net gain or profit or gratuity or is really reimbursement to him of expenses.66 66Jbid., at pp. 67, 68.

48

THE MEANING OF INCOME

His lordship proceeded further to uphold the view that if legislation directing a payment to be made indicated clearly that it was being made for the purpose of reimbursement and not as remuneration for services rendered, a court might not question the good faith of this legislative averment, as it might do in the case of a private contractual arrangement between an employer and employee. He therefore declined to question the substance of the so-called reimbursement under the present terms of hiring on the ground that it was fixed at a definite sum per day without regard to actual out-of-pocket expenditure. After referring, by way of illustration in this connection, to certain of the payment and reimbursement provisions in the Canadian Senate and House of Commons Act, he concludes that the real intendment of the legislation must govern and that in the legislation before him the intention was that the money in question be paid as reimbursement: The fact that statutory payments of allowances are stated in a fixed amount does not change their character. In each case the true intendment of the statute must he ascertained. li a statutory enactment or its equivalent makes it clear that a payment authorized by it is not by way of remuneration but only by way of reimbursement of expenses, then the amount of such payment is not taxable income in the hands of the recipient unless the Inoome War Tax Act has clearly made it so, either in express terms or by necessary implication. li there is any reasonable doubt in the matter it should be resolved in favour of the taxpayer, for Parliament by appropriate legislation can easily put the matter beyond dispute. The same observations will apply to other statutory allowances made for specific purposes, where the statute has made it clear that the payments are not made or received by way of remuneration. Where such allowances, according to the real intendment of the statute, are made for purposes other than those of gain or profit or gratuity to the recipient, they are not taxable income and do not become such because the amount of the allowance is fixed. Where the allowance is authorized for expenses, the fixed amount is to be regarded as the amount of expenses beyond which no reimbursement is authorized.•.• As I interpret the Order-in-Council, I have come to the conclusion, having regard to all the circumstances of the case, that the per diem living allowances authorized by it involved no element of remuneration or net gain or profit or gratuity to the appellant, and did not result in any gain or profit to him. They were paid and received only as reimbursement of living expenses over and above ordinary personal and living expenses up to the fixed amount per day. They were not in any sense "income" as defined by the Income W•ar Tax Act and the appellant should not have been assessed for income tax purposes in respect of them. 67

It may be noted that this judgment proceeds throughout on the assumption that payments named in the enumerated subsections of s. 3 (I) of the Income War Tax Act are not by that fact alone constituted 6TJbld., at

pp. 71, 73.

THE MEANING OF INCOME

49

income, but that they must satisfy further prerequisites in that regard. Following this decision, the Income War Tax Act was amended by adding s. 3 ( 4) which taxed as income any payment made to any person in connection with a duty, office, or employment, but which specifically excluded from its operation travelling expenses and living allowances paid to certain categories of persons employed by the government. Similar provision, with slightly enlarged exceptions, is now contained in s. 5 of the Income Tax Act. There is the suggestion in the introductory clause of s. 3 ( 1) of the Income War Tax Act that certain types of investment income need not be received, in that income "shall include the interest, dividends or profits directly or indirectly received from money at interest upon any security or without security, or from stocks, or from any other investment, and, whether such gains or profits are divided or distributed or not.. . ." It does not appear ever to have been argued before the courts that this provision made dividends taxable where they had not yet been paid over to shareholders. The meaning and operation of the clause remained uncertain, but it would appear to have been somewhat at variance with s. 12 ( 1) of the Act which provides that "dividends or shareholders' bonuses shall be taxable income of the taxpayer in the year in which they are paid or distributed."

'The annual profit or gain from any other source" The balance of s. ( 1) gave rise to an important problem in that it enumerated a number of payments in sub-heads (a) to ( h) but left open the question whether these payments are enumerated as incomes by definition or as further sources of income. The language of the section, strictly read, would seem to indicate that the items enumerated are named as sources of income. Having stated that "income means the annual net profit or gain" from designated sources and that it "shall include" certain types of payment directly or indirectly received, the introduction to s. 3 ( 1) concludes: "and also the annual profit or gain from any other source including. . . ." Then follow the enumerations of payments (a) to ( h). The view that these enumerations were not meant to extend the meaning of income is supported by the contrasting language of the remaining sub-sections ( 2) to ( 12) of s. 3 which provide that certain payments or amounts "shall be deemed to be income" or "shall be taxable as income" to the extent and at the times indicated. The courts have in one instance suggested that the legislation introducing one of these presently enumerated items, namely, s. 3 ( 1) ( d) which mentions the remuneration of salaried persons, was unnecessary and declaratory. 68 It is obvious, 68 Caron

v. The King, [1917-27] C.T.C. 117 (P.C.), at pp. 121, 122.

50

THE MEANING OF INCOME

however, that some of them were presented to Parliament in the expectation and belief that they would overrule previous decisions on the meaning of income.69 The argument thats. 3 (1) enumerated sources of income has been raised in a number of cases and some earlier statements indicate that it was received with favour. The tendency of the courts has been to interpret s. 3 very strictly and literally. In Shaw v. Minister of National Revenue, Duff C.J.C. stated: It is no part of our duty in construing and applying a taxing statute to ask ourselves what might have been in the draughtsman's mind or to accept the impression received from a casual inspection of the enactment to be applied. It is our duty to analyse such enactments with strictness and, in the case of a definition such as this, to apply it only to those cases which plainly and indubitably fall within it when strictly read.10

Davis J. said: It is income that is being .taxed and not capital. The governing words of sec. 3, in so far as life insurance policies are concerned, are "and also the annual profit or gain from any other source including." I am unable to read the provision as bringing into charge something which, when its true nature is looked at, is of a capital nature which otherwise would not have been chargeable. 71 It is also noteworthy that in Lumbers v. Minister of National Revenue, Hudson J. paraphrases s. 3 (1) in the following manner: "3. For the purposes of this Act, 'income' means the annual net profit or gain or gratuity . . . received by a person from . . . ( b) annuities or other annual payments received under the provisions of any contract, except as in this Act otherwise provided."72 The judgment of the Exchequer Court in Samson v. Minister of National Revenue73 is premised on the view that a payment coming within the enumerated payments of s. 3 ( 1) is not, therefore, an income payment. It will be recalled that the appellant was directed by order-in-council to be paid $20 per day "living allowance" while absent from his residence in connection with his duties; and that it was argued that these payments were within the enumerative sub-head ( d) of s. 3 ( 1) as being ". . . indemnities or other remuneration of ... all persons whatsoever, whether ... paid 69For example, s. 3 (1) (f), introduced following the appeal in Spooner v. M.N.R., [1928--34) C.T.C. 184 (P.C.); and s. 3 (1) (e) amended following Malkin v. M .N .R., [1938--39) C.T.C. 128 (Ex.). The latter amendment did not succeed in its apparent objective: "It is quite manifest that it was one of the purposes of the amending statute to capture the tax assessed in this case, but I think the draftsman has not succeeded in doing so." Per Maclean J. in Malkin v. M.N.R. [1942) C.T.C. 135 (Ex.), at p. 142. 70[1938--39) C.T.C. 346, at p. 348. nJbid., at p. 352. 72[1944) C.T.C. 67, at p. 70. 73[1943) C.T.C. 47.

THE MEANING OF INCOME

51

out of the revenue of His Majesty . .. or by any person ..." and within sub-head ( e) thereof as being "personal and living expenses when . .. such constitutes part of the gain, benefit or advantage accruing to the taxpayer under any ... contract, arrangement. ..." Thorson J. entered into an examination of the payments and the authority under which they were made in order to determine their "true nature" and came ultimately to the conclusion that they were not paid and received as income, but as reimbursement of living expenses. The judgment reveals that his lordship's only other concern was with the meaning of the term "income" in s. 3. On deciding that the payments were not within the meaning of that term, he did not proceed to discuss whether they were within the language of the enumerative sub-sections argued before him. Notwithstanding this earlier trend it was recently held by Thorson P. in Wilder v. Minister of National Revenue74 that the enumerated paragraphs of s. 3 ( 1) are not statements of sources of income from which only the annual profit or gain is taxable but that the subject matter of each of them is included as an item of taxable income in the definition provided by the section. The facts of that case were simply that the appellant sold his assets to a corporation in consideration of the corporation's undertaking to pay him an annuity of $1000 per month for his life. The appellant contended that clause ( b) of s. 3 ( 1) included "annuities or other annual payments received under the provisions of any contract" only as a source of income and that only the income portion of the $12,000 he received annually was taxable. While Thorson P. referred to the previous cases, he preferred to base his interpretation of s. 3 on other considerations. His first reason for judgment was that prior to the 1927 revision of the Canadian statutes the section was unambiguous and that "if an ambiguity appears in the Revised Statutes which did not exist in the Act repealed thereby it should be resolved by adopting the meaning that is consistent with that of the repealed Act." His second reason was that all the enumerations of s. 3 (1), and in particular the first enumeration of "the income from but not the value of property acquired by gift, bequest, devise or descent," could not be sensibly construed as stating a source of income. These reasons are open to criticism. His first consideration disregarded the fact that the enumeration under review did not antedate the 1927 revision. Of his second line of reasoning it may be said that the rule of uniform construction that he adopted was equally lacking in sense when applied to other clauses, notably clauses ( b) and ( g) 14(1949] C.T.C. 302.

52

THE MEANING OF INCOME

whereby the full amount of annuities payments would be taxed as income. In another annuities case arising under the same section, O'Connor v. Minister of National Revenue,76 the task of bringing about a more equitable solution of the problem of taxing annuities received under the terms of a will would have been made easier by a less rigid and uniform interpretation of the s. 3 enumerations. Moreover, a more flexible attitude might have avoided the need for later statutory amendments instituted to remedy injustices arising under these enumerations in the taxation of annuities. On appeal to the Supreme Court of Canada, the judgment of Thorson P. in Wilder v. Minister of National Revenue was reversed. 76 Rinfret C.J.C. was clearly of the opinion that clause ( b) of s. 3 ( 1) enumerated a source of annual profit and gain. Taschereau and Fauteux JJ. adopted the view that annual payments received in exchange for a sale of assets did not come within the meaning of "annuities or other annual payments" in clause ( b). The reasoning of the majority is clearly founded on the fundamental assumption that the Act was not intended to tax capital payments. Rand and Kellock JJ. dissented on other grounds, though Kellock J. concurred in the conclusion of Thorson P. that s. 3 ( 1) ( b) enumerated an income payment. THE INCOME TAX Acr

Unlike the Income War Tax Act the Canadian Income Tax Act contains no definition or purported definition of income. S. 3 sets forth, simply and concisely, the income included within the scope of the Act: 3. The income of a taxpayer for a taxation year for the purposes of this Part is his income for the year from all sources inside or outside Oanada and, without restricting the generality of the foregoing, includes income for the year from all (a) :businesses, (b) property, and ( c) offices and employments.

This section, it will be noted, does not require that income be "received" either directly or indirectly. The general rule that income must be beneficially received will no doubt continue to apply, since that rule is virtually part and parcel of the meaning of income. But the courts are not barred by this section from giving due recognition to the commercial principle sanctioning the accrual system for determining income in certain circumstances. This liberty in computing the income from a business or property is confirmed by s. 14 ( 1) which 71>(1943) C.T.C. 255.

76(1951) C.T.C. 304.

THE MEANING OF INCOME

53

allows any method adopted by the taxpayer and accepted by the Minister of National Revenue. The requirement that income is to be computed on an annual basis is explicit both in s. 3, above quoted, and in s. 4, which in general terms provides that "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." I,t is doubtful that this section makes any further alteration of or addition to the meaning of income. The common law principle that income means net income is nowhere generally afBrmed in the Act, but it is expressly excluded from operation in determining income from an office or employment by s. 5 which states that "income for a taxation year from an office or employment is the salary, wages and other remuneration, including gratuities, received by a taxpayer in the year" plus certain enumerated benefits, and minus certain specified deductions, "but without any other deductions whatsoever." It will be noted that this section requires that the income from these sources be received. S. 6 of the Act, which deals with certain non-income gains, avoids a policy of the Income War Tax Act of "deeming" these gains to be "income" for the purposes of the entire enactment, by merely providing that "without restricting the generality of section 3, there shall be included in computing the income of a taxpayer for a taxation year" the amounts thereinafter specified. This method of handling these payments leaves the meaning of income free from confusion and does not give "income" a meaning in other parts of the Act which the legislature might not have foreseen and intended. Consider, for example, the difference in these alternative methods in their effect on the extent of the prohibition, in s. 12 ( 1 ) (a) of the Act, that "in computing income, no deduction shall be made in respect of . • . 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" ( italics added). The concept of "taxable income" is introduced very artfully and logically into the scheme of this Act. It is stated by s. 2 ( 3) as meaning the income of the taxpayer minus certain deductions permitted by Division C. All such deductions are in the nature of "reliefs," to use the terminology of the English jurisprudence, accorded to the taxpayer on the basis of personal status and income expenditure. They are not in any way related to the manner or method by which the income arose or was earned. In this way the concepts of "net income" and "taxable income" are not confused by failure to distinguish between deductions relating to a computation of income and those relating to

54

THE MEANING OF INCOME

a computation of the amount of income tax payable. Contrast, in this connection, the provisions of s. 5 of the Income War Tax Act making " 'income' as hereinbefore defined" subject to many and diverse types of "deductions and exemptions" ranging from allowances for depletion and interest on borrowed capital, on the one hand, to deductions for single and marital status, dependents, charitable donations, etc., on the other.

Part Two GROSS INCOME

CHAPTER

THREE

Income from Business IN the preceding chapter, we have seen "income" defined as "the gain derived from capital, from labour, or from both combined." 1 This is the ordinary form of dictionary definitions for that term, and such definition may be seen to suggest three sources of income-capital, labour, and a combination of both. It is at once apparent that it is extremely difficult to recognize any clear line of demarcation between them, as sources. From the standpoint of economics, labour and capital are a source of gain only when they are brought together as factors in production. What the authors of this definition probably had in mind was the fact that there are three methods of acquiring the form of gain known as income. There is, in the first place, the situation in which income is derived by a pure labour contribution carried out under the control and direction of another person. This method of earning income was envisaged in s. 3 of the Income War Tax Act, where it was stated that "•. • 'income' means the annual net profit or gain or gratuity . . . as being wages, salary, or other fixed amount ..• directly or indirectly received by a person from any office or employment . . . ," and ins. 3 of the Canadian Income Tax Act, which states that".... income . .. includes income for ·t he year from all ... offices and employments." There is, secondly, the situation where income is obtained purely through the ownership of capital, in the form either of money or of other tangible property, which has been surrendered to the use and 1 Supra, P'. 22. "The general principle of the property and income tax . . . is, that everything of the nature of income shall be assessed, from what source soev.ir it may be derived, whether from invested capital, or from skill and labour, or from a combination of both.. . ." Coltness Iron Co., Ltd. v. Black, ( 1881) 1 T.C. 287, per Lord President Inglis, at p. 307.

57

58

THE MEANING OF INCOME

control of someone else in consideration of an agreed compensation. This type of income is also specifically mentioned in both Canadian income tax acts. S. 3 of the Income War Tax Act proceeded, in defining income, to include ".. . the interest, dividends or profits directly or indirectly received from money at interest upon any security or without security, or from stocks or from any other investment . .."; the Income Tax Act includes ".. . income for the year from all property...." Finally, income may be obtained through the self-employment and self-utilization of both labour and capital in the pursuit of gain. It is apparent that this method covers a very wide range of activity since it includes every combination of these two factors. In the case of the professional man, the labour factor is clearly dominant. On the other hand, there are cases where the capital factor is as clearly dominant, for example, where a person derives income from leasing and administering housing accommodation which he owns, or where he carries on the business of a private investor in securities. Between the two extremes just illustrated there may exist an endless variety of enterprises, each showing a different application of labour and capital by its sponsor. This wide range of activity in the pursuit of gain can best be described as coming within the one category of carrying on business. Where a man has entered upon the free use and direction of his labour and capital he is, from a practical standpoint, in business. Where, on the other hand, his labour or capital is hired to another he cannot reasonably be considered to be carrying on business. It is in relation to business in this broad sense that the meaning of income is to be considered in this chapter. CARRYING ON BUSINESS DEFINED

If we turn to the judgments of English and Canadian courts of law

for a definition of carrying on business we find considerable inconsistency of expression on the meaning of that term. The broadest expressions of the meaning of the term "business" merely describe it as being duty, as opposed to pleasure. In an early case considering the meaning of the term as used in a covenant of a lease, Lindley L.J. said, "The word means almost anything which is an occupation, as distinguished from a pleasure-anything which is an occupation or duty which requires attention is a business. . . ."2 A similar definition is also to be found in Halsbury's Laws of England.3 2 Rolls v. Miller, ( 1884) 3 " 'Business' is a wider

27 Ch. D. 71, at p. 88. term not synonymous with trade and means practically anything which is an occupation distinguished from a pleasure." Halsbury, Laws of England (2nd ed. ), XXXII, p. 306; and adopted by Cameron D.J. in Mahaffy v. M.N.R., [1945) C.T.C. 408, at p. 414.

INCOME FROM BUSINESS

59

This behaviouristic conception of "business" is obviously too general to be of any value in matters of taxation. It was rejected by Rowlatt J. in an English excess profits tax case in which, also, he attempted to explain the commercial meaning of that term. He says: It has been said on behalf of the appellants that the word "business" is a very wide word. That word, in whatever sense it be understood, JS undoubtedly an elastic word capable of wide extension; but it must be borne in mind that it is also a word which has two virtually distinct meanings. lt may mean any particular matter or affair of serious importance.... The word "business," however, is also used in another and a very different sense, as meaning an active occupation or profession continuously carried on, and it is in this sense that the word is used in the Act with which we are here concerned.4

While Rowlatt J. would include a profession or occupation within the meaning of business, he would seem to have had in mind that business implied an "active'' and "continuous" course of conduct. The view that business implies activity was soon afterwards rejected by the Court of Appeal as being too narrow in that there might be what Atkin L.J. described as a "passive" carrying on of business. He says, referring to the activi•ty of an appellant company: It is true that it might be called, if you please, a passive carrying on of a business as opposed to an active carrying on of a business; but I for my part think with regard to the definition of "business" given by Rowlatt J.. . . if it was really intended for a precise definition, that the form in which it was expressed would be too narrow. . . . Personally if any emphasis is attached to the word "active," I think it would narrow the meaning of the word "business"; for I see nothing to prevent a holding company-holding being a well-known method of carrying on business in these days-from carrying on a business. 5

In that case it was held, reversing Rowlatt J., that where a company obtained a mineral concession which it later leased to another concern for exploitation in return for a royalty based on profits, it was engaged in carrying on business, since it was incorporated for the object, expressed in its memorandum, of acquiring and working concessions and turning the same to account. In having regard to the memorandum and articles of association of the company the Court of Appeal introduced a new element into the question of carrying on business, namely, the object with which transactions are being carried out. The decision of the Court of Appeal was later approved in this respect by the House of Lords in a case where a company that had constructed a railway and then relinquished it to the government to operate in return for a 4C.I.R. v. Marine Steam Turbine Co., Ltd., [1920] 1 K.B. 193, at p. 202. 5C.I.R. v. Korean Syndicate, Ltd., [1921] 3 K.B. 258, at p. 276.

60

THE MEANING OF INCOME

fixed annual payment was held to be s•till carrying on business. Lord Sumner expressly denied that activity and continuity of action are essential for carrying on business. He says: To ascertain the business of a limited liability company one must look first at its memorandum and see for what business that provides and whether its objects are still being pursued. . . . there would seem rto be a presumption that a company continues to carry on business as long as it is engaged in collecting debts periodically falling due to it in the course of its former business. Business is not confined to being busy; in many businesses long intervals of inactivity occur. In the present case, at any rate, I think that no change has occurred to enable your Lordships to say that the company's carrying on of business is a thing of the past, or that the Commissioners could properly find that it is so.6

The element of purpose, which Rowlatt J. omitted to consider, had been stressed in an early statement of Jessel M.R. in considering the meaning of carrying on business in the English Companies Act. He concludes, after an extensive reference to dictionary definitions of the term: "... anything which occupies the time and attention and labour of a man for the purpose of profit is business. It is a word of extensive use and indefinite signification.''7 But he did not consider a profit motive, by itself, as sufficient since he later adds: "... in the ordinary case of investments, a man who has money to invest, invests his money and he may occasionally sell the investments and buy others, but he is not carrying on a business."8 Lord Justice Cotton may be seen to have combined the elements of habitual activity and pursuit of profit in considering the meaning of "trade or business" in the English Income Tax Act. He says:"... in my opinion when a person habitually does and contracts to do a thing capable of producing profit, and for the purpose of producing profit, he carries on a trade or business."9 In a recent Canadian case Thorson J. adopted a similar view: "In my view, the term, 'trade or business' . . . contemplates an activity in which the prospect of gain or profit is involved and 'tlie pursuit of a trade or business' involves the pursuit of gain or profit.''10 The difficulty with these statements defining business with reference to the earning of profits is that they do not indicate the meaning of profits. "Pursuit of profit" cannot be taken here to mean all gainful, profitable, or remunerative activity, otherwise the above statements are not borne out by the decisions excluding capital gains from business profits in many of the cases in which they appear. If profits be taken in its 6 South 1 Smith

Behar Railway Co., Ltd. v. C.l.R., [1925) A.C. 476, at pp. 485, 488. v. Anderson, ( 1880) 15 Ch.D. 247, at p. 258. Bibid., at p. 261. 9 Erichsen v. Last, ( 1881) 8 Q.B.D. 414, at p. 420. tOSamson v. M.N.R., [1943) C.T.C. 47, at p. 66.

INCOME FROM BUSINESS

61

commonly understood sense, as meaning the income from business, the above statements are of course of no assistance. All in all, the judicial definitions of business are not very helpful. But if regard be had to the English and Canadian decisions in taxation cases there is authority to support the view that carrying on business signifies independent enterprise, involving the element of entrepreneurship, adventure, or commercial risk. In Robbins v. Commissioners of Inland Revenue,1 1 an excess profits tax case, it was held by Rowlatt J. that, where a person was bound under contract with a company to give all his time to selling goods manufactured by that company and all the sales offices and equipment were supplied by it, such person did not own or carry on a business, even though he was paid by commission. It would appear that the undertaking lacked the requisite qualities of adventure and independence.12 It has been recently held by the Exchequer Court of Canada that an administrative officer of the Crown appointed under the Wartime Prices and Trades Board was not "in the pursuit of a trade or business,"13 and, in another case, that a member of the legislative assembly of a province was not within that category.14 The Supreme Court of Canada recently decided that the salaried general agent and manager of a loan company did not carry on a business. 15 In the same case it was also held that the investment 11(1920] I K.B. 51. 12"The question here is whether these words include the occupation of a wholetime servant, which is not an independent occupation but simply that of working for one isolated employer. It may be observed that the business referred to in the section is a business owned or carried on. It seems to me that prima facie a wholetime servant does not own or carry on a business. A business which is capable of being owned or carried on is in the ordinary sense of the word a business which i.'i the adventure of the persons who owns it or carries it on.... "The fact that in s. 45 a trade or business owned or carried on is treated as a continuous occupation capable of being transferred from hand to hand and owned by several persons in succession seems to show that the expression "trade or business" as used in the Act cannot refer to the occupation of a mere whole-time servant, but must refer to the occupation of a man wno carries on some business which is his own independent business, although it may include some office or employment involving a payment by commission in respect of transactions or services rendered." Ibkl., per Rowlatt J., at pp. 66, 70. 13"His duties . . . for the . . . Board were in connection with the policies of price control which were entrusted to that body for administration and had no relation to trade or business with the prospect of gain or profit." Samson v. M.N.R., [1943] C.T.C. 47, per Thorson J., at p. 66. 14 Mahaffy v. M.N.R., [1945] C.T.C. 408, affirmed [1946] C.T.C. 135 (S.C. Can.). ·.. ··:" '-'°' '! "'! 15Argue v. M.N.R., [1948] C.T.C. 235. "The services rendered by the appellant to the company were, in my opinion, rendered qua servant and the remuneration received by him was for services rendered in that capacity. The business carried on was the company's business and not his and the rendering of services of this nature in the capacity of a paid servant or employee of a company is not carrying on business." Locke J., per curiam, at p. 240.

62

THE MEANING OF INCOME

of money by a private investor did not constitute a business within the meaning of that term in the Excess Profits Tax Act. The mere receipt of royalties based on the production of oil wells has been held not to constitute the carrying on of business. 16 On the other hand, it was recently held in Blackwell v. Minister of National Revenue that a commercial traveller who represented a number of commercial houses in travelling about his territory in his own car with samples of merchandise to solicit orders from customers, for which he was paid entirely by commission on goods sold and paid for, was earning profits from carrying on business within the meaning of the Canadian Excess Profits Tax Act. 17 Thorson P. there says: He had his own car, as his claims for deduction of expenses show, and he paid his expenses himself. He operated from his own house and selected his own customers. His remuneration depended on his own efforts and their results. He was not subject to the direction or control of any one of the mills or business houses but was independent of them. He was his own master. The facts are inconsistent with his being merely an employee and consistent with his carrying on a business. I find that that is what he was doing. 18

In Commissioners of Inland Revenue v. Sangster19 an inventor who was gifted with considerable business ability entered into an arrangement with a company, of which he was managing director, providing for his continued employment with the company and granting it the privilege of electing to share in the inventions he might make while in its employment. He transferred licences to use the patents in which this company showed no interest to another company, of which he was the main shareholder, a director, and the manager, in return for a royalty on every article manufactured and sold under these licences. It was held by Rowlatt J. that each type of income received by him must be considered separately and that it could not be said that in his over-all position of employee, shareholder, and owner of patents he carried on a business. 20 While Rowlatt J. speaks, in that case, of the 16 Spooner v. M.N.R., [1928--34) C.T.C. 178 (S.C. Can.); affirmed [1928--34) C.T.C. 184 (P.C.). 17(1949) C.T.C. 362; affirmed [1951) C.T.C. 1 (S.C. Can.). 18(1949) C.T.C. 362, at p. 366.

19(1920) 1 K.B. 587.

20"The respondent is managing director of a company: that is not, nor is being a shareholder carrying on a business. He is also an owner of royalties. That again is not carrying on business. But those are the whole sources of his income. It is true that he is adding to his royalties, and he is performing his duties of managing director of the company and it may be very advantageous that he has those positions-that he has that particular form of property and is creating more, but I do not think those matters can be added together and that it can be said, in what I cannot help describing as a loose way, 'Look at the general position.' I think the respondent's position must be dissected and what his income is really derived

INCOME FROM BUSINESS

63

inventor's income as having been derived from three distinct "sources" -his managing directorship, his shares, and his patents-it would seem preferable to regard the income as having been earned by three distinct methods. The source of his income was the business of manufacturing and selling under his patents. But such business was carried on by the companies. He, as managing director, was vitally concerned with it, but nevertheless he did not carry it on. Within the category of "business" there exists the narrower concept of "trade." It has been judicially recognized that "business" is a word of more extensive meaning than "-t rade,'' 21 the latter term referring to the type of business in which there is the prime element of purchase and sale of commodities. In Grainger and Son v. Gough, Lord Davey says: "Now, what does one mean by~ trade, or the exercise of a trade? Trade in its largest sense is the business of selling, with a view to profit, goods which the trader has either manufactured or himself purchased."22 That case arose in connection with the English Income Tax Act; and under that Act the meaning of trade, as distinct from the meaning of business, is of paramount importance in that, while the provisions of schedule D ·thereof charge a tax on the annual profits or gains from any "trade, profession, employment, or vocation," the income from "business" is not mentioned. Accepting the view that trading is but one form of business, we may in turn distinguish between different forms of trading. A trader who purchases commodities for resale may direct his attention and effort, in whole or in part, to their improvement or transformation with a view to selling a finished product at a profit In such case there would arise a processing or manufacturing profit. A trader may transport and handle the commodity purchased, and would then realize a marketing profit or distribution profit; or he may simply retain his ownership of the commodity purchased until such time as it has increased in demand and price, and then sell it at a gain which might properly be termed a profit through speculation. On its face, s. 3 of the Canadian Income War Tax Act appears to warrant that no distinction need be made between business and trade for determining the meaning of income for the purpose of that Act. In from must be ascertained. In my judgment it is derived from those three distinct sources, and he is not, in respect of each or all of them put together deriving this royalty income from a business." Ibid., at p. 595. 21 "The word 'business' is not defined in the statute. It has, of course, a more extensive meaning than that which is given to the word 'trade.' " Thorson J. in Samson v. M.N.R., [1943) C.T.C. 47, at p. 65. See also Mahaffy v. M.N.R., [1945] C.T.C. 408, Cameron D.J., at p. 414. Compare the definition of "business" in s. 127 ( I) ( e) of the Canadian Income Tax Act. 22(1896) A.C. 325, at p. 345.

64

THE MEANING OF INCOME

the broadest terms, s. 3 provides that "••• 'income' means the annual net profit or gain or gratuity . . . as being profits from a trade or commercial or financial or other business or calling, directly or indirectly received by a person . . . from any trade, manufacture or business . •. ." S. 3 of the Canadian Income Tax Act is equally broad in providing that the income of a taxpayer for a taxation year includes income from all businesses. "Business" is defined by s. 127 ( I ) ( e) to include "a profession, calling, trade, manufacture or undertaking of any kind whatsoever and includes an adventure or concern in the nature of trade but does not include an office or employment." But there is nevertheless some advantage in recognizing the distinction between "trade" and other forms of business. The English income tax case law on which much Canadian law is based places considerable emphasis on trade as distinct from business owing to use of the former term in schedule D of the English Income Tax Act. Moreover, it is principally in this buying and selling form of business enterprise that we meet with the difficulty of distinguishing income from capital gains. CAPITAL GAINS

There is a type of incoming in money or money's worth that is recognized in law as being clearly different in its nature from the amounts received by any of the methods heretofore discussed. To this category belong amounts received by way of gift, or through inheritance. Also, where the owner of property acquires added wealth through an increase in the value of that property his gain is not in the same category as that of a dealer who purchases and resells similar property. The fact that this owner's gain may be converted into money through sale of property once purchased or inherited does not alter its nature; and neither would the fact that the property has undergone repair, improvement, or alteration indicate conclusively that a new and different situation has arisen. English courts of law have always recognized the difference between a capital gain made on a sale as owner and an income gain made on a sale as business man, or more specifically, as trader; the difference between the case, on the one hand, where a man purchases property as an investment and later disposes of it, and the case, on the other hand, where a man sets out deliberately to realize a gain through purchase and resale. The former has always been excluded from the category of income for the purpose of the income tax. We have a clear expression of this view in the following words of Rowlatt J.:

INCOME FROM BUSINESS

65

Two kinds of emolument may be excluded from Case 6. First, anything in the nature of capital accretion is excluded as being outside the scope and meaning of these Acts confirmed by the usage of a century. For this reason, a casual profit made on an isolated purchase and sale, unless merged with similar transactions in the carrying on of a trade or business is not liable to tax. "Profits or gains" in Case 6 refer to the interest or fruit as opposed to the principal or root of the tree. The second class of cases to be excluded consists of gifts and receipts, whether the emolument is from a gift inter vivos, or by will, or from finding an article of value, or from winning a bet. All these cases must be ruled out because they are not profits or gains at all. 28

On considering, apart from the judicial decisions, this matter of difference between what Rowlatt J. described as a casual profit on purchase and resale and a profit made in carrying on a business it would appear that the feature which distinguishes them is essentially one of difference in the attitude with which each form of gain is acquired. In the one case there has been set in motion, according to design, a plan calculated to bring about a gain while in the other case the element of pursuit of gain is entirely lacking. The one gain is the direct reward of labour and capital. The other gain may be regarded as of the nature of an unearned increment resulting from any rise in the money value of an asset. Other differences may justify distinguishing capital and income gains for taxation purposes. With respect to total availability for expenditure on consumption, capital accretions and income do not normally rest equal. Finally, in the absence of a very complete and, of necessity, complicated system of averaging, the imposition of income tax on capital accretions would result in unfairness in taxing in one year the gain which might have been acquired over a long period of years. It would not be unreasonable, therefore, to expect that English and Canadian law would have approached the problem and evolved a test for income somewhat along the lines above suggested, i.e. the difference in the attitude with which each form of gain is acquired. The main development has, however, been in an entirely different direction, although in some of the earlier statements handed down by the courts a certain degree of subjectivity of approach is apparent. We have earlier quoted Rowlatt J. as saying, in distinguishing a capital gain from an income gain, ". .. there is no doubt that one might create a trade by making an organized effort to obtain emoluments which are not in themselves taxable as profits, and the most familiar instance of all, of course, is a trade which has for its object 28Ryall v. Hoare, [1923] 2 K.B. 447, at p. 454.

66

THE MEANING OF INCOME

the securing of capital increment. ... In that case you have a trade which is going to be in articles with a view to securing the accretion in value to these articles, and the accretion of value does not negative the incidence of income tax."24 There is also an element of subjectivity present in statements, already referred to, which purport to define carrying on business as the doing of a thing "habitually ... and for the purpose of producing profit," "for the purpose of profit," "with a prospect of gain or profit," ana where "the prospect of gain or profit is involved." But the general trend has been to consider the meaning of income from an objective point of view, in which that question has become overshadowed by what would appear normally to be the lesser question of the meaning of trade or business. The development of English law in this direction can be attributed to the wording of the English Income Tax Act. The Canadian law has followed the same trend although without similar justification. In the result, no meaning for income has been developed beyond the purely negative proposition that it does not include capital gains. The following statement from a learned Canadian authority adequately summarizes the law as at present supported by the decisions: The tax imposed by the British and Dominion Acts is essentially a tax upon income and not capital except in so far as there are specific provisions to the contrary. A profit or gain derived from the realization of a capital asset with a view to substituting some other form of investment should be distinguished, therefore, from a profit or gain realized in the course of carrying on a trade or business. If the profit or gain is merely the result of realizing the enhancement of value of an asset, it is a capital accretion and not subject to tax while if it is a profit or gain made in an operation of business in carrying out a scheme for profit-making it is income and subject to tax. The line which separates the two classes is difficult to define and each case must be considered according to its facts; the decisive question being whether QT not a trade

QT

business is carried on. 211

It has already been noted that the Canadian income tax acts tax all income. In Morrison v. Minister of National Revenue, Audette J. expresses the generally accepted view of s. 3 of the Income War Tax Act when he says: Now the controlling and paramount·enactment of sec. 3 defining the income

is "the annual net profit or gain or gratuity." Having said so much the

statute proceeding by way of illustration, but not by way of limiting the foregoing words, mentions seven -different classes of subjects which cannot be taken as exhaustive since it provides, by what has been called the 24Supra, p. 23. 2off. A. W. Flaxton, The Law Relating to Income Tax and Excess Profits Tax of the Dominion of Canada (2nd ed., Toronto, 1947), at p. 222. The italics are added.

67

INCOME FROM BUSINESS

omnibus clause, a very material addition reading "and also the annual profit or gain from any other sources." The words "and also" and "other sources" make the above illustration absolutely refractory to any possibility of applying the doctrine of e;usdem generis set up at the hearing. The balance of the paragraph is added only ex ma;ori cauteld. . . . The net is thrown with all conceivable wideness to include all bona fide profits or gain made by the subject. 26

S. 3 of the Income Tax Act includes the income for the year "from all sources." The basic problem under the Canadian Acts is simply that of establishing a meaning for income. INCOME FROM TRADE UNDER THE ENGLISH

Acr

The English Act imposes a tax on income but directs, in a manner discussed above in chapter 1, that the tax shall be levied under five separate schedules according to the source from which such income is derived. Income from a source designated in any schedule can be taxed only under that schedule, while income from a source which is not specifically named, will be taxed, if at all, under the so-called "sweeping-up" provisions of schedule D, which impose tax "in respect of any trade [case I] ... profession, employment or vocation [case II] not contained in any other schedule ..." and, finally, "in respect of any annual profits or gains not falling under any of the foregoing Cases, and not charged by virtue of any other Schedule .. ." [case VI]. Any receipt which does not arise from an indicated source is not taxed, or, as we often find this result expressed, it is not income within the meaning of that term in the English Act. Moreover, while the language of the "sweeping-up" provisions of case VI may seem broad in its scope, it has been narrowed through adherence to the rule that that case must be read ejusdem generis with the preceding cases of schedule D. Thus, it may readily be seen that two problems arise for determination under the English Act: 1. The problem whether a profit or gain is of an income nature; 2. The problem whether a profit or gain is derived from a source indicated in the schedules to the English Act. These problems are distinct; and, it should be noted, the latter is not raised by the Canadian Act. The English courts have, on occasion, shown a tendency to regard them separately where any other approach would tend to absurd results. Thus, in Cooper v. Stubb~ 1 it was held by a majority of the Court of Appeal that while the appellant 26 (1917-27) C.T.C. 343, at p. 350. See also Blackwell v. M.N.R., [1951) C.T.C. 1, Cartwright J., at p. 7. 27[1925] 2 K.B. 753.

68

THE MEANING OF INCOME

in tha,t case was not in fact, as found by the commissioners, engaged in a trade, his gains through private speculations on the cotton exchange were nevertheless, in point of law, "profits and gains" assessable to income tax under schedule D. Warrington L.J. states: The question ... is simply this, were these dealings and transactions entered into with a view to producing, in the result, income or revenue for the person who entered into them? If they were, then in my opinion profits arising from them were annual gains or profits within the meaning of para. l (b) of Sch. D. On the findings of the Commissioners themselves they were contracts entered into with •a view to making a profit on a rise or fall, as the case might be, in the market price of the contracts. They extended over a considerable number of years. There were large numbers of transactions in each of those years, from which in some years the appellant derived considerable revenue; and for myself I cannot see what there is to exclude that revenue from the tax which is charged under Sch. D. It seems to me, therefore, that, in this case, whatever may be the case under different facts, at all events the profits made by these transactions are annual profits and gains, and must be assessable to income tax. 28 Atkin L.J. also accepts the commissioners' finding, but then proceeds, apart from the question of "trade," to hold that the gains in question were not made on a realization of capital invested: In this case you have to look at the facts, and when you do so you find that the appellant has been making these profits or gains, not by investing his capital, because he never invested any money in the matter, but by making executory contracts. He invested no money as such in the matter at all. But we have figures in the schedule to the case which show that the appellant has been entering into these transactions every year from 1915 to 1922; that is, for eight years running he has been in receipt of money from these transactions; I was going to say in receipt of revenue, but that ,perhaps begs the question, but it appears to me to be really expressive of the true facts. He has had an annual revenue from these transactions throughout the whole of this period.29 This approach was soon afterwards rejected and the problem of the meaning of income again subordinated to the problem of the meaning of trade in the House of Lords decision in Jones v. Leeming.80 In that case the person assessed had joined with a limited company, a business firm, and a solicitor in acquiring two options to purchase certain rubber estates in Malay. The commissioners found, as a fact, "that the appellant acquired the property or interest in property in question with the sole object of turning it over again at a profit, and that the appellant at no time had any intention of holding the property or interest in property as an investment." A company was later promoted 28Ibid., at p. 769. 201bid., at p. 775. 30[1930] A.C. 415.

INCOME FROM BUSINESS

69

by the solicitor and the property was sold to it at a profit. The commissioners also found that the taxpayer had not carried on trade or any concern in the nature of trade. It was held by the members of the House of Lords who heard the appeal, including Lord Warrington who, as a member of the Court of Appeal, had decided the case of Cooper v. Stubbs, that the gain was not income. Cooper v. Stubbs was distinguished on the ground that there the transactions had not been isolated. Viscount Dunedin, in considering the scope of case VI of the English Act, states: The limitations of the words "profits and gains" were pointed out by Blackburn J. long ago in the case of Attorney-General v. Black • •. when he said that profits and gains in Case VI must mean profits and gains ejusdem generis with the profits and gains specified in the preceding five Cases. . . • The fact that a man does not mean to hold an investment may be an item of evidence tending to show whether he is carrying on a ,t rade or concern in the nature of ,trade in respect of his investments, but per se it leads to no conclusion whatever. 31

There is here an evident tendency to rest the whole decision on the question whether there was trading. Lord Thankerton says, ''This was a simple case of purchase and resale, once the Commissioners had decided that the transaction was not a concern in the nature of trade"; 32 and Lord Macmillan: "The difficulty which here confronts the Crown is that the profit made by the respondent was the result of an isolated transaction of sale but not of a transaction of sale by way of trade and it is not easy to see how the profit on an isolated sale which is not a trading transaction can be other than a capital accretion and so outside the category of annual profits or gains.''33 Finally, all of their lordships except Lord Macmillan expressly affirmed the expressions of Lawrence L.J., in the Court of Appeal, who had proceeded clearly on the ground that there was no source of income, in the form of trade or an adventure in the nature of trade, from which an income might be said to have arisen. The passage of his judgment approved by the House of Lords reads as follows: ... I have the greatest difficulty in seeing how an isolated transaction of this kind, if it be not an adventure in the nature of trade, can be a transaction

ejusdem generis with such an adventure and therefore fall within Case VI. All the elements which would go to make such a transaction an adventure in the nature of trade, in my opinion, would be required to make it a transaction ejusdem generis with such an adventure. It seems to me that in the case of an isolated transaction of purchase and re-sale of property there is s11bid., at pp. 422, 423. a21bid., at p. 427. SS[bid., at p. 430.

70

THE MEANING OF INCOME

really no middle course open. It is either an adventure in the nature of trade, or else it is simply a case of sale and re-sale of property.34 The same view of "profits or gains" in case VI of schedule D is apparent in the judgment of Rowlatt J. in Graham v. Green, 35 but is made even more evident in that case by the fact that no question of distinguishing income from capital gains was involved. There the appellant had earned his livelihood for many years by placing bets on horse races at the odds offered regularly by bookmakers. It was sought to charge him under case VI but Rowlatt J. dismissed the assessment for the reason that the appellant's activities could not be described as a vocation or trade: These are mere bets. Each time he puts on his money at whatever may be the starting price. I do not think he could be said to organize his effort in the same way as a bookmaker organizes his, for I do not think the subject matter from his point of view is susceptible of it. In effect all he is doing is just what a man does who is a skilful player at cards, who plays every day. He plays to-day, and he plays to-morrow, and he plays the next day, and he is skilful on each of the three days, more skilful on the whole ,than the people with whom he plays and he wins. But it does not seem that one can find, in that case, any conception arising in which his individual operations can be said to be merged in the conception of a trade. I think all you can say of that man, in the fair use of the English language, is that he is addicted to betting. It is extremely difficult to express, but it seems to me that people would say he is addicted to betting, and could not say that his vocation is betting. The subject is involved in great difficulty of language, which I think represents great difficulty of thought. There is no tax on a habit. I do not think "habitual" or even "systematic" fully describes what is essential in the phrase "trade, adventure, employment, or vocation." All I can say is that in my judgment the income which this gentleman succeeded in making is not profits or gains, and that the appeal must be allowed, with costs. 36 Obviously, the approach to the English Act thus adopted by the English courts allows no true and unrestricted inquiry into the problem of the meaning of income. It is therefore not surprising to find that English law has progressed no further in this regard than the purely negative statement that income gains do not include capital gains and the distinguishing of both concepts according to a number of objective tests for carrying on trade or business. The now classic statement on the problem of seeking out income is that of the Lord Justice-Clerk 34 (1930] 1 K.B. at p. 301-2. "Had there been only one transaction it is clear from Leeming's case . . . per Lord Buckmaster and Lord Dunedin, quoting with approval Lawrence, L. J., that if trading is negatived in the case of purchase and sale of land at a profit, it must be capital accretion: there is no halfway house." Williams v. Davies, (1945] 1 All E.R. 304, per Wrottesley J., at p. 308. 35(1925] 2 K.B. 37. 36Jbid., at p. 42.

INCOME FROM BUSINESS

71

(Macdonald) in the Scottish case of Californian Copper Syndicate, Ltd. v. Harris, where he says: It is quite a well settled principle in dealing with questions of assessment of Income Tax, that where the owner of an ordinary investment chooses to realise it, and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit in the sense of Schedule D of the Income Tax Act of 1842 assessable to Income Tax. But it is equally well established that enhanced values obtained from realisation or conversion of securities may be so assessable, where what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business. . . . What is the line which separates the two classes of cases may he difficult to define, and each case must be considered according to its facts; ,the question to be determined being-Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?37

In the Canadian courts, no independent attempt has been made to develop a meaning for income. The test of the Lord Justice-Clerk Macdonald has been approved not only by the House of Lords38 but by the Judicial Committee of the Privy Council on appeals from the Dominions39 and is freely quoted by the Canadian courts in considering the Canadian Income War Tax Act, 40 notwithstanding that there is seemingly no justification in the terms of that Act for the view that income can only result from trade, or business, or other named sources. 41 However, it is noteworthy that in the recent case of McDonough v. Minister of National Revenue42 Cameron J. is careful to explain and emphasize that the House of Lords decision in Leeming v. Jones was rendered having regard to the finding of fact by the commissioners that the transaction was not a concern in the nature of trade. Moreover, he regarded that decision as distinguishable where 5 T.C. 159, at pp. 165, 166. 38Ducker v. Rees Roturbo Development Syndicate, Ltd., [1928] A.C. 132, at 37( 1904)

p. 140. 39Commissioner of Taxes v. Melbourne Trust, Ltd., [1914] A.C. 1001, at p. 1010; Anderson Logging Co., Ltd. v. The King, [1917-27] C.T.C. 210, at p. 212; Commissioner of Taxes v. British-Australian Wool Realization Association, Ltd., [1931] A.C. 224, at pp. 250, 251. 40Anderson Logging Co., Ltd. v. The King, [1917-27] C.T.C. 198, at p. 200 (S.C. Can.); Saskatchewan Co-operative Wheat Producers, Ltd. v. M.N.R., [1928--34] C.T.C. 47, at p. 55 ( S.C. Can.) ; Merritt Realty Co., Ltd. v. Brown, [1932] S.C.R. 187, at p. 188; Highwood-Sarcee Oils, Ltd. v. M.N.R., [1942] C.T.C. 101, at p. 114; Economic Trust Co. v. M.N.R., [1946] C.T.C. 142, at p. 154; Atlantic Sugar Refineries, Ltd. v. M.N.R., [1948] C.T.C. 326, at p. 334. 41There is such justification, however, in connection with the Canadian Excess Profits .Tax Act. See Martin v. M.N.R., [1948] C.T.C. 189; Argue v. M.N.R., [1948] C.T.C. 235. 42(1949] C.T.C. 213, esp. at p. 217.

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THE MEANING OF INCOME

the court was free to make all findings of fact. This caution, while long overdue, does not emancipate the meaning of income under the Canadian Acts from the restrictiveness of the trading test. 43 In spite of the fact that the principle that income does not include capital gains can only be of assistance in determining the meaning of income in the limited class of cases wherein gain results from selling activity, the English courts have managed to adhere generally to that test and avoid separate investigation into the meaning of income without at the same time producing decisions too far out of line with the dictates of common sense ( though it is not meant to suggest that the test has not enabled a great deal of gain to be sought and won without the payment of income tax) . The courts' success has been due in large part to the fact that in cases where income has resulted from the pursuit of gain purely through labour or purely through capital ownership, the "carrying on business" test has been so obviously not in point as to be seldom argued. Wherever absurd results might be seen to arise in the "in-between" type of case they have been fairly well avoided through an extension of the meaning of trading. Considerable latitude of meaning is given by s. 237 of the English Act which states: " 'Trade' includes every trade, manufacture, adventure or concern in the nature of trade." Further flexibility has resulted from the courts' attitude that trading is a question of fact for the commissioners on which the courts need only find that there was some evidence of trading in order to uphold a finding of the commissioners to that effect. Jessel M.R. is reported as saying, in an early case: "There is not, I think, any principle of law which lays down what carrying on trade is. There are a multitude of things which together make up the carrying on of trade, but I know no one distinguishing incident, for it is a compound fact made up of a variety of things."44 The commissioners are, of course, subject to the "no evidence" rule, as explained in chapter 1 above, but the general reluctance of the courts to interfere with their findings on the question of "trading" still leaves them considerable freedom, as is evident from the attitude shown by Warrington L.J.: 43Even more recently, in "N" v. M.N.R., [1951] C.T.C. 297, Hyndman D.J., while citing the test evolved in the Californian Copper Syndicate Case, emphasized his finding that property was purchased with the object of its resale at a profit in deciding that that profit was income. Also, in Walker v. M.N.R., [1951] C.T.C. 334, Hyndman D.J. stressed the importance of whether a racetrack better carried on his activities with an intention to make profit in deciding whether these profits arose from a "business" or, in the language of s. 3 ( 1) of the Income War Tax Act, a "profession or calling." 44 Erichsen v. Last, (1881) 8 Q.B.D. 414, at p. 416. The parallel problem of carrying on business has been held by Canadian courts to be one of fact. McLeod v. M.N.R., [1917-27] C.T.C. 282, at p. 288; Highwood-Sarcee Oils, Ltd. v. M.N.R., [1942] C.T.C. 101, at p. 114.

INCOME FROM BUSINESS

73

The Commissioners are the judges of fact, and this Court, and every Court on appeal from the Commissioners, which has jurisdiction in questions of law only, is very much tempted, when it feels that it cannot agree with the Commissioners in their finding of fact, to find some reason in law by which that finding may he reversed. In my opinion the Court of Appeal ought to be very careful not to yield to that temptation, or to interfere with the decision of the Commissioners on a question of fact except in a very clear case, where either the Commissioners have come to their conclusion without evidence which should support it, that is to say, have come to a conclusion which on the evidence no reasonable person could arrive at, or have misdirected themselves in point of law..•. It must be home in mind that the Commissioners are men of business, who are for that reason selected to deal with these questions relating .to income tax, and, as a tribunal, particularly well qualified to decide such questions of fact, and we ought not, nor ought the King's Bench, lightly to set aside their findings on such subjects. 45

But the commissioners are nevertheless bound to confine themselves within the legal meaning of trade46 so that in arriving at a proper and reasonable conclusion on the meaning of income it has been necessary for the courts to expand the legal meaning of trade and, more recently •to escape the restrictiveness of that concept by abandoning entirely the trading test. It is of interest to trace the English legal development in this connection. The earlier descriptions of trade stress the element of "repetition," "habit," or "system" in selling and purchasing. In Grainger v. Gough Lord Morris regarded "carrying on trade" as being, in its ordinary and popular meaning, almost as broad as "carrying on business." He says: There can be no definition of the words "exercising a trade." It is only another mode of expressing "carrying on a business"; but it certainly carries with it the meaning that the business or trade must be habitually or systematically exercised, and that it cannot apply to isolated transactions. There is no special legal meaning to the words "exercising a trade," and it must be considered with regard to what would be its ordinary or popular meaning, and that must in each case depend on the facts of -t hat particular case; and we are not to canvass what might be a logical outcome from any decision when it is the facts of the particular case that are solely decided on. 45 Cooper v. Stubbs, [1925) 2 K.B. 753, at p. 768. A similar view is expressed by Scrutton L.J. in Rees Roturbo Development Syndicate, Ltd. v. Ducker [1928) 1 K.B. 506, at p. 517. 46Thus, in South Behar Railway Co., Ltd. v. I.R.C., [1925] A.C. 476, at p. 483, Viscount Cave expresses his agreement with the Court of Appeal " . . . in holding that the finding of the Commissioners is not a finding of pure fact, but is an inference of law founded upon the specific facts found in the case, and accordingly that the decision was open to review...." The commissioners have been reversed on their finding as to the existence of trade in a number of income tax cases, among them: Tebrau (Johore) Rubber Syndicate v. Farmer, (1910) 5 T.C. 658; C.I.R. v. Livingston, (1927) 11 T.C. 538; C.I.R. v. Fraser, ( 1942) 24 T.C. 498.

74

THE MEANING OF INCOME

I have heard no suggestion of any plainer or more intelligible meaning for the words "exercise his trade" than the words themselves convey. 47

Similarly it has been held that "carrying on trade" requires some degree of "organization," and that therefore the gains from continuous gambling activity could not be regarded as income. 48 But in Cooper v. Stubbs, where the appellant made gains on a series of gambling transactions in the purchase and sale of cotton futures, it was the view of Pollock M.R. that habit and system were not necessary characteristics of trading and that the commissioners' finding that there was no trade should be reversed. 49 It will be recalled that Warrington L.J. and Atkin L.J. accepted the commissioners' finding but decided independently of the question of trading that, as a question of law, the gains were of the nature of income. In view of later observations of the House of Lords in Jones v. Leeming50 the opinion of Pollock M.R. seems the more correct. In some cases the presence of the element of repetition has likewise been held unnecessary. In those cases the fact that there was a pursuit of gain was clearly revealed by the circumstances attending an isolated purchase and resale. This is the situation where, for example, an item is purchased and then processed before its resale. In a case involving the isolated purchase, repair, and resale of a ship a new test was laid down by Lord President Clyde as follows: I think the test, which must be used to determine whether a venture such as we are now considering is, or is not, "in the nature of trade," is whether the operations involved in it are of the same kind, and carried on in the same way, as those which are characteristic of ordinary trading in the line of business in which the venture was made. If they are, I do not see why the venture should not be regarded as "in the nature of trade," merely because it was a single venture which took only three months to complete. 51

But even this test affords no guidance in cases where gain is pursued by a novel method which offers no parallel. A number of cases of this 47(1896] A.C. 325, at p. 343. v. Green, [1925] 2 K.B. 37; Down v. Compston, [1937] 2 All E.R. 475. 49 "It does not appear to me that a habit or system were characteristics necessary to finding that there was a trade in this case. . . . to my mind when rightly tested the contracts which were made by the appellant over these years in successive series of contracts do constitute a business, and it is not a right test in law to try and apply the touchstone of habit or system in order to ascertain whether or not a trade was carried on." [1925] 2 K.B. 753, at p. 765. 50(1930] A.C. 415, discussed supra, p. 68. 51 C.I.R. v. Livingston, [1927] 11 T.C. 538, at p. 542. This test was approved by Rowlatt J. in Leeming v. Jones, [1930] 1 K.B. 279, at p. 283; and a very similar view was expressed more recently by Wrottesley J. in Williams v. Davies, [1945] 1 All E.R. 304, at p. 307, where he points out: "It has been laid down that the transaction must be judged by ascertaining how far it consists of and is governed by the ordinary incidents of trading." 48 Graham

INCOME FROM BUSINESS

75

description have arisen, especially in recent years, which indicate and illustrate the difficulties encountered by the English courts in linking their approach to the problem of income with the concept of carrying on trade or business. In Ryall v. Hoare, 52 the directors of a limited company gave a guarantee of an overdraft at the company's bank in return for a commission. The transaction was an isolated one and there was no intention that similar guarantees would ever again be undertaken. It was not suggested that any trade or business was being carried on. The Crown sought to tax this commission as "profits or gains" to the directors under case VI of the English Act. Rowlatt J. upheld the assessment on the ground, simply, that, "... we may say that where an emolument accrues by virtue of service rendered whether by way of action or permission, such emoluments are included in 'Profits or gains.' "53 Yet, in dealing with the argument of the appellant that "casual profits" were not included within case VI, he says: This case raises the whole question of the meaning of the expression "casual profits." I have already referred to the case of letting a furnished house, and other illustrations were referred to in the course of argument. I need only mention the case of casual authorship, as where a person who is neither a journalist nor an author by profession is called in by a firm of publishers to write a single book or a single article for reward. There again the amount which it is sought to tax is an instance of casual profits, but yet is liable to tax under Case 6 in the same way as •the rent received in the letting of a furnished house, or oas the commissions paid to the directors who gave the guarantee in the present case. 54

These examples of "profits or gains" would appear obvious except for the fact that in Martin v. Lowry55 both Lord Sumner and Lord Carson questioned their validity. Lord Carson said: . . . I should like to limit the decision as regards Ryall v. Hoare ... to what is necessary to be decided in this case. The learned judge who decided ,that case introduced instances, where he thought income tax would be payable, where there was in reality no trade being carried on and where it could hardly be alleged that trade was being carried on, they being isolated transactions. My Lords, I desire, like my noble friend who has preceded me, to reserve my opinion upon that subject if it ever becomes necessary to decide it. 56 52(1923] 2 K.B. 447. 5 3Ibid., at p. 454. Rowlatt J. again followed this reasoning in the case of Sherwin v. Barnes, ( 1931) 16 T.C. 278. 54(1923] 2 K.B. 447, at p. 455. 55(1927] A.C. 312. 56 Ibid., at p. 317. "The observations of Lord Sumner and of Lord Carson upon Ryall v. Hoare in that case [Martin v. Lowry] have reference to Case I, which was the case with which their Lordships were dealing...." Wilson v. Mannooch, [1937] 3 All E.R. 120, per Lawrence J., at p. 123.

76

THE MEANING OF INCOME

At about the same time the Court of Appeal decided in Cooper v. Stubbs 51 that where a member of a firm of cotton brokers and cotton merchants made a gain from buying and selling cotton futures it was a taxable "profit or gain" within case VI of the English Act notwithstanding that, in the view of the majority of the court, the appellant was not carrying on trade. But, as already noted, the House of Lords in Jones v. Leeming58 again disapproved of approaching separately the problems of trading and "profit or gain." The modem trend of English law has been to ignore the artificial limitations on the meaning of income imposed by the House of Lords. In Wilson v. Mannooch, 59 a partner in a firm of solicitors agreed with certain builders, who were in need of money to purchase certain property, that he would personally lend or arrange for the lending by others of the purchase price in consideration of one-third of the resulting profit on resale of the property, but not more than £500. The land was resold at a profit entitling him to the full £500 maximum. On one other occasion it had been agreed between him and the same builders that he would lend the full purchase price of certain property in return for £300 bonus on its resale in addition to 6 per cent on his loan. The commissioners held that he was not assessable on the sums of £500 and £300 on the ground "that the respondent had engaged in a venture not in the nature of trade." On appeal by the Crown, the respondent argued, relying mainly on the case of Jones v. Leeming, that the gain was in the nature of capital gain since it did not result from trading. Lawrence J. followed Ryall v. Hoare and allowed the appeal. He limited the decision in Jones v. Leeming to cases where there has been profit on the purchase and resale of an article, thus again separating the problem of "profit or gain" from the problem of "trading": In my judgment, the sums received in the present case are not analogous to the appreciation of capital upon the sale of an article, but are in reality payments to the respondent for the finding of money, and have the character of income, and not capital. The finding of the majority of the Commissioners, that it was an adventure not in the nature of trade, is not really, I think, the true point, although it may be that they had in mind the true question, which is whether it is an annual profit of a capital or of an income nature. In my judgment, the sums were annual profits of an income nature, and I think, therefore, that the appeal must be allowed with costs. 60 57(1925] 2 K.B. 753. 58(1930] A.C. 415. 59(1937] 3 All E .R. 120. 60Ibid., at p. 124. For similar expressions of the same view, see the recent case of Hobbs v. Hussey, [1942] I All E.R. 445.

INCOME FROM BUSINESS

77

The principle laid down in Jones v. Leeming was similarly confined in the case of Leader v. Counsell. 61 There the appellants and other persons pooled their capital, in order to purchase a famous racehorse, under an agreement whereby each subscriber was to be entitled to send mares to be serviced free of charge in proportion to the number of shares held. They were also entitled to sell their free nominations to others. The question was whether the appellants were taxable under case VI on their receipts from 1934 to 1940 from the sale of their nominations. The commissioners found that they were not carrying on a trade. The appellants argued, again on the authority of Jones v. Leeming, that the profit on the purchase and sale of the nominations could not therefore be "profits or gains" within case VI. Lawrence J. denied the contention and allowed the assessment, on the view that Jones v. Leeming was confined to a purchase and sale of property and that the profits here in question were from the use of the horse and not from the sale of property. In other words, he confined the subject matter of the purchase to the horse. He refers repeatedly to the statement of Lawrence L.J. in the Court of Appeal in Jones v. Leeming, and later affirmed by nearly all members of the House of Lords, to the effect that in an isolated transaction there is no middle course open between trading and a simple resale of property, as obiter dicta. In addition, he again sanctioned separate consideration being given to the problems of "profit or gain" and of "trade." He says: In my opinion, the argument of the Crown is correct, and I think it appears from all the cases which have been cited, that, where the commissioners have found that there is no trade, the true question to be considered is whether the profits in question are of an income or revenue nature. That was indicated in the first case that was cited, Ryall v. Hoare• •• • If the dictum of Lawrence, L.J., could be pushed to the extent which counsel for the appellants seeks to push it in this case, it would be impossible for the Court of Appeal to have reached ,t he decision which it did in Cooper v. Stubbs • • • which was approved by the House of Lords in Leeming v. Jones . .•• As I say, the true principle, in my opinion, is that laid down in Cooper v. Stubbs . • • that where there is no trade it must be seen whether the profits are "of an income or revenue nature," and, if they are, they can be taxed under Case VI, notwithstanding the faot that they may be said, from some aspects, to be the purchase and resale of property. In the present case, in my opinion, the transactions in question were not the purchase and resale of property, but were merely realizing the reproductive faculties of Solario. There was no purchase of the nomination which was sold. The only purchase in which the appellants engaged was in the purchase of the horse itself. 62

Finally, in the recent case of Ba"y v. Cordy,63 the English Court of 61(1942] 1 All E.R. 435. at p. 436. 63 (1945] 1 All E.R. 695; affirmed [1946] 2 All E.R. 396 (C.A.).

62Ibid.,

78

THE MEANING OF INCOME

Appeal avoided the limitations inherent in the decision in Jones v. Leeming by what amounted, in effect, to complete abandonment of the trading test. The respondent in that case was a mathematician who devised a plan to provide himself with £7,000 a year for life from an original capital of about £100,000. He purchased at a London auction, over a period of eighteen months, endowment policies on the lives of others which were there being purchased and resold on a sort of insurance policies exchange. His policies were chosen in accordance with a plan whereby each year policies of the face value of £7,000 would come to maturity. After enjoying £ 7,000 returns annually for the period 1937 to 1943 he abandoned his plan and sold all of the remaining policies in order to retire in India, where the climate was more suited to his health. He was assessed for income tax on the amount of gain realized from the policies matured or sold. The commissioners found: On consideration of the particular facts of this case and the evidence before us, having in mind especially the number of purchase transactions over a period of about 18 months together with the manner in which the policies were selected and purchased in pursuance of an organized scheme, we hold that the appellant engaged in a concern in .the nature of trade, resulting in profits-the fruit of the capital laid out-which are assessable to income tax under Case I of Sched. D.

They assessed him accordingly. On appeal Macnaghten J. reversed the commissioners and discharged the assessment on the ground that there was no dealing in the life insurance policies as they were purchased in order to be retained until their maturity, that there was therefore no "trade" or "adventure or concern in the nature of trade," and that there were therefore no "profits or gains." "Trade" he regarded as a word which must "be construed in the Income Tax Acts in its ordinary and accepted sense." Both Macnaghten J. and the commissioners may be seen to have followed the traditional approach to the problem of income through the concept of trade. On appeal the respondent argued that his gains were not income but were capital gains and that, if they were income, they were not income from an "adventure or concern in the nature of trade" within the meaning of s. 237. The Court of Appeal held, on a very wide construction of s. 237, that the commissioners' finding ought to be upheld. In answer to the respondent's first contention the court intimated that the decision of the commissioners on the nature of the receipt was final, as on a matter of fact. However they did not allow their decision to rest there: But the respondent's submission that the question of income versus capital should be considered and decided as a self-contained issue apart from the

INCOME FROM BUSINESS

79

question whether the operations of the respondent were commercial ("a concern in the way of trade") is fallacious, because the commercial characteristic may of itself change a capital realization into an income receipt. 64 Their lordships do not go on to consider, more fundamentally, why the commercial character of a receipt transforms it into an income receipt, but, having made the observation, they then consider the problem of whether trade is being carried on, just as if income might only arise from trading. However, they give to the definition of "trade" in s. 2:37 an interpretation more broad by far than that adopted in any previous case; and with such expansion in the meaning of trade the meaning of income is, of course, correspondingly enlarged. In their judgment they suggest that the words "manufacture, adventure or concern in the nature of trade" in s. 237 were intended to enlarge the ordinary meaning of "trade,'' and that the words "manufacture" and "adventure" are to be read as independent of the qualifying phrase "in the nature of trade." They refer for the meaning of "adventure" and "trade" to the Oxford English Dictionary, to the writings of the English scholars, and to the meaning of "trade" in the Industrial Courts Act; and they find "trade" to be "a word of very wide import." They further support this finding by an alleged trend in judicial decisions: The history of judicial decisions has been similar-showing a strong tendency not to restrict the scope of Sched. D, a .tendency which was, we think, in sympathy with the general social and economic outlook of the country. There is hardly any activity for gaining a livelihood and not covered by the other schedules, which does not seem to us to be swept into the fiscal net by Sched. D. . .. and the trend of decisions in this direction-of enlargement rather than restriction-has certainly been no less marked since than before 1889.65 Their lordships therefore conclude: That a single transaction may fall within Case I is clear; but, to bring it within, the ,transaction must bear clear indicia of "trade." . . . Unless ex facie the single transaction is obviously commercial, the profit from it is more likely to be an accretion of capital and not a yield of income. But that question is almost necessarily one of faot. On the other hand, to bring a source of profits within the meaning of "trade" in Case I, it is not necessary to show the presence of a regular business of buying and selling as Macnaghten, J., seems ,to have .thought. That would exclude banking; insurance, finance, bookmaking . . . or stallion-keeping; all of which concerns or businesses have been held to fall within Case I. 66 Finally, in support of the commissioners' conclusion that there had been a "trade" within the defin~tion in s. 237, their lordships relied on the following facts: 6 4 [1946) 2 All E.R. 396, Scott L.J., per curiam, at p. 398. 65Jbid., at p. 399. 661bid., at p. 400.

80

THE MEANING OF INCOME

The case is conclusive that he made up his mind to utilize the commercial market in endowment life policies for the express purpose of getting a means of livelihood at ,the average rate of £7,000 a year over a long period of years. He showed great mathematical skill-an element in the business of an average adjuster, an underwriter, a banker or a financier. He continued to make his purchases in the commercial market over a period of 18 months-i.e., until he had planted enough trees to yield him ,the fruit he wanted over the series of seasons for which he was making his purchases.67

This case would appear to give to the word "trade" as defined in the English Income Tax Act a meaning sufficiently broad to include all things "commercial" in their nature and to bring within the scope of that term all means of seeking gain through a combination of labour and capital. The word "commercial" is in fact used no less than five times throughout their lordships' judgment and is, in one instance, used interchangeably for "concern in the way of trade." The editor of the All England Law Reports has noted, in connection with this case, that, ". . . the whole trend of modern decisions is to regard Sched. D as embracing almost every method of gaining a livelihood not included in any other schedule." Should this trend be confirmed and continued by the House of Lords and the need to characterize and identify the source of income within the English schedules be thereby relaxed, a true, positive analysis of the meaning of income might ,t hen be worked out by the English courts. At present, even in this latest development, they may be seen to have progressed no further in this direction than to paraphrase the example of Justice Pitney, and call it the "fruit" rather than the "tree." INCOME FROM PURCHASES AND SALES

It has already been suggested that income arises from the pursuit of gain and that this subjective element is the feature which distinguishes income from the other forms of incoming, among them capital gains, which are regarded as being outside the scope of the income tax acts. Where the pursuit of gain is carried out through means other than purchase and resale the question of capital gain does not normally arise. But where there is purchase and resale, the question in distinguishing income from capital gain should be, not whether there is a trade being carried on, but whether there is an intention to pursue gain through that method. In other words, the question should concern the intention with which the transaction was undertaken. The approach of the English and Canadian courts to the problem of income 67Jbid., at p. 400.

INCOME FROM BUSINESS

81

or capital gain, by which they proceed indirectly, giving primary consideration to the question of trade, overlooks the true nature of the problem but has nevertheless the obvious advantage of objectivity. The common law has always avoided dependence on matters of intention. To quote a well-known statement of Brian C.J. in an early case on the question of consensus ad idem in the formation of contract, "it is trite learning that the thought of man is not triable, for the devil himseH knows not the thought of man."68 But just as the common law has developed objective standards of offer and acceptance in the formation of contract, so the question of whether a purchase and sale has been undertaken in order to realize a gain can be as easily judged from what has been said and done. The English and Canadian cases on the question of carrying on trade and business can be regarded in this light. The result is revealing. Not only do they lend themselves easily to such an analysis but that analysis shows several factors to be paramount in determining this all-important question of intention.

The fact of repetition The single purchase and resale of an article at a profit may be undertaken without any intention of securing that profit. But when the same transaction is repeated many times over the inference that purchases are being made for the purpose of resale and that there is an intention to profit by such transactions is fairly conclusive. It is not surprising, therefore, that the element of repetition has been stressed in cases dealing with the question whether trade or business is being carried on. The leading English case stressing the importance of repetition is Pickford v. Quirke. 69 There the appellant joined with four other persons in forming a syndicate for the purpose of "turning over" a cotton-mill at a profit during the spinning-mill boom following World War I. This process consisted in buying up all the shares in an existing mill, liquidating the company, forming a new company, and selling the concern to the new company at a profit. The revenue authorities attempted to tax the five associates on their profit but the commissioners held that they were not carrying on trade or business and, accordingly, dismissed the assessment. However, the appellant Pickford took part, over a fairly short period, in three other "turning-over" transactions of the same nature, each time with different associates. The commissioners upheld an assessment on his profit on the series of transactions on their finding that, "although each one transaction considered separately might not have constituted a trade under Case I., yet taken together they showed that the appellant had entered habitu68Year

Book, 17 Ed. 4, 1. 138 L.T.R. 500.

69( 1928)

82

THE MEANING OF INCOME

ally into profitable contracts of the kind and had in fact made a business of 'turning over' cotton mill companies." On appeal their finding was upheld by Rowlatt J., whose judgment brings out clearly that repetition alone might place a new slant on the nature of the appellant's gains. The matter is, of course, discussed by him solely from the standpoint of trading. He says: It was held that the individual transactions were not adventures in the nature of ,t rade and not taxable. So be it. But consistently with that, and consistently with every element in that view, it can be held that, as a whole, these transactions so far as he took part in them were a trade, adventure or concern on his part 70

The Court of Appeal affirmed Rowlatt

J., Lord

Hanworth stating:

You may hav~ an isolated transaction so independent and separate that it does not give you any indication of carrying on a trade.... When, however, you come to look at four successive transactions you may hold that what was considered separately and apart, a transaction to which the words "trade or concern in the nature of trade" could not be applied, yet when you have that transaction repeated, not once nor twice but three times, at least, you may draw a completely different inference from those incidents taken together.71

The importance of repetition is also brought out in the judgment of the Canadian Exchequer Court in Morrison v. Minister of National, Revenue. 72 The appellant, a member of a firm of grain commission merchants, bought and sold grain through the firm on his own account. In 1922 he realized a gain from 260 such transactions and was assessed for income tax. Audette J. held that the appellant's gain was income from a trade or business. He says: An individual in his personal exertions may also carry on two or more isolated such transactions on the exchange; but when it comes to a person, like in the present case, using his skill and knowledge in his trade acquired through experiences in trading in the same commodity in partnership, and who in this one year, as appears by exhibit No. 6, has gone into 260 such separate transactions or ventures, the necessary conclusion is that he makes a particular business or trade of it with the object of making profits, and he thereby becomes a dealer in stocks, a trader who carries on business in such commodity.... I find that the appellant became liable to taxation upon his profits and gains realized in this particular and continuous course of business or pursuit, as a standing commercial practice, in buying and selling this commodity for profit.73 101bid., at p. 501. 11Ibid., at p. 504. 72[1917-27] C.T.C. 343. 73[bid., at pp. 347, 350. The importance of repetition has been stressed in recent cases before Canadian courts. In Campbell v. M.N.R., [1951] C.T.C. 258, a police officer erected a building in 1939 which he sold at a profit in 1943. In that

INCOME FROM BUSINESS

83

But repetition has not been regarded as conclusive evidence of trading, a fact which lends support to the view that the intention with which a purchase and sale is made is the more fundamental consideration. It has been held that for there to be trading the repeated acts must somehow be closely related so as to show a system. In the words of Atkin L.J.: "It may very well be that transactions may be so carried out as to be nothing but in the nature of temporary investments repeated several times over, and resulting in something in the nature of capital accretions which could not be brought within the title or meaning of 'annual profit or gain'...." 74 On the other hand, it has been held that an isolated transaction of purchase and sale might well amount to trade when other circumstances show such to be the intention. It was said by Lord Esher M.R., in a bankruptcy case: In my opinion, to say that if only one or two transactions can be proved, then as a matter of law it cannot be said ,t hat they are transactions in a business is too drastic a statement. I think that whether one or two transactions make a business depends upon ,the circumstances of each .case. I take the test to be this, if an isolated transaction, which if repeated would be a transaction in a business, is proved to have been undertaken with the in.tent that it should be the first of several transactions, that is, with the intent of carrying on business, then it is a first transaction in an existing business. 75

We find a similar view expressed by Thorson P. in a recent Canadian income tax case: While it is recognized that as a general rule an isolated transaction of purchase and sale outside the course of the taxpayer's ordinary business does not constitute the carrying on of a trade or business so as to render the year he bought and sold a house and purchased another house which he sold in 1944. In 1944 he built a house which he sold in 1945. In 1945 he purchased land and built thereon an apartment house which he sold in 1947. He immediately purchased more land and commenced building an apartment block which he sold at a profit before it was completed. He was held to be "carrying on a trade, business or calling for the purpose of making a profit." In "N" v. M.N.R., [1951] C.T.C. 297, the appellant had, since 1930, engaged in a series of loans and invest.. ments with her savings. In 1937 she first purchased a house which she soon afterwards sold. She continued that practice and made seven purchases and sales of houses a year in 1939, 1940, and 1941. In 1942 she made three such transactions. She entered into twenty-six real estate transactions in 1943, thirteen in 1944, and ten in 1945. It was held her idea in purchasing involved the intention of selling with the object of profit and not for investment purposes only, and assessment on her profits for the years 1943, 1944, and 1945 was upheld. See also Cragg v. M.N.R., [1951] C.T.C. 322 where the appellant was held to have earned income from a business in the sale in 1946 of three properties. In the prior period from May 1, 1943, to January 1, 1946, he had purchased ten properties and sold nine of them. 74Cooper v. Stubbs, [1925] 2 K.B. 753, at p. 775. 75In re Griffin, ( 1891) 60 L.J.Q.B. 235, at p. 237.

84

THE MEANING OF INCOME

profit therefrom liable to income tax .. . it is also established that the faot that a transaction is an isolated one does not exclude it from the category of trading or business ,transactions of such a nature as to attract income tax to the profit therefrom,78

The fact of alteration or transformation A finding of income from an isolated transaction will ordinarily result where the purchase and sale is combined with a further application of labour and capital to the article purchased, thus giving the whole undertaking an obvious appearance of profit-seeking. That an isolated purchase and sale may, when combined with an alteration of the article purchased, come within the meaning of trading in the English Income Tax Act is evident from the leading case of Commissioners of Inland Revenue v. Livingston. 77 A ship repairer, a blacksmith, and a salesman combined their resources to purchase a cargo steamship for £1,000 and they then spent more than that amount in converting the vessel into a steam-drifter. It was sold at a profit which the Scottish Court of Session held to be income from a trade in spite of the isolated nature of the transaction. Lord President Clyde expressed the view that non-repetition only prevented the undertaking from being considered a "dealer's trade" and that this limitation did not prevent it from being "in the nature of trade" where "the operations involved in it are of the same kind, and carried on in the same way, as those which are characteristic of ordinary trading in the line of business in which the venture was made." The opinion expressed by Lord Sands is very much the same: That purchase and transmogrification of the thing purchased by manufactudng or industrial process and resale (the transaction being one of such magnitude that it might in ordinary course be the whole business for the time_being of a person regularly engaged in the trade) is carrying on a trade within the meaning of the Statute for the time being, although the transaction be isolated, is a legal interpretation of the Statute. 78 The case of Cape Brandy Syndicate v. Commissioners of Inland Revenue79 is similar in principle. Three persons, members of separate firms, formed a syndicate to purchase all the surplus brandy offered for sale by the government, and amounting in all to 3,100 casks. It was purchased in three lots or instalments. Some of it was shipped to the East and sold there; but most of it was shipped to London and MAtlantic Sugar Refineries, Ltd. v. M.N.R., [1948] C.T.C. 326, at p. 333; approved by Kerwin J. in delivering the majority judgment on appeal to the Supreme Court of Canada, [1949] C.T.C. 196, at p. 199; and by Cameron J. in McDonough v. M .N.R., [1949] C.T.C. 213, at p. 226. 77(1926) 11 T.C. 538. 78Jb£d., at p. 545. 79[1921) 1 K.B. 64.

INCOME FROM BUSINESS

85

blended with French brandy purchased for that purpose and then resold through commission agents in about one hundred transactions extending over a period of one year. While the members of the syndicate had at no time undertaken any similar transaction it was admitted that they had purchased the brandy for no purpose or intention other than to resell it. Rowlatt J. upheld the commissioners' finding that the appellants were engaged in trade or business. The nature of the commodity purchased and sold But the circumstances may be such as to make an isolated purchase and resale a plain "dealer's trade" wi•thin the language of Lord President Clyde in the Livingston Case. In Martin v. Lowry80 a wholesale agricultural machinery merchant purchased from the government in June, 1919, some 45,000,000 yards of surplus aircraft linen of World War I. He was required by the terms of purchase to take delivery in full within six months. Being unable to dispose of it in one bulk sale, he rented an office, set up a large and skilful sales organization, and from July, 1919, to March, 1920, sold 35,000,000 yards to 55 wholesale firms, 5,000,000 yards to 208 exporting firms, and the balance to 1,017 retail firms. The commissioners found that his profit was income from a trade and that he purchased a large quantity of linen "with the sole intention of selling it again at a profit, and he proceeded to sell it piecemeal by an extensive series of transactions spread over a period of seven months, using for the purpose an organization and methods such as are ordinarily adopted by traders in selling the articles in which they deal." On final appeal to the House of Lords it was held that there was evidence on which the commissioners could find that there was trade. Little attention was paid to their finding that the purchase was made for the sole purpose of resale at a profit. But in Rutledge v. Commissioners of Inland Revenue81 no system of sales was established, and we find that the judgments there give consideration to the question of purpose or intention. In that case a business man, whose prior interests included money-lending, transactions in real estate, and some connection with the film industry, happened, while on a visit to Germany, to meet with the opportunity of purchasing a large quantity of toilet paper from a bankrupt German firm for £1,000. He sold the entire purchase in one transaction to one buyer for £12,000 and was assessed for income tax on his gain. Lord President Clyde held that there was an "adventure ... in the nature of trade" though he did not consider that there was any actual trade 80(1927] A.C. 312. 81(1929) 14 T.C. 490.

86

THE MEANING OF INCOME

since the transaction was isolated. His conclusion that the gain was income seems, in the circumstances, both justified and reasonable; but his finding that appellant was taxable on this income for having engaged in trade must be viewed as doubtful in the light of the later House of Lords decision in Jones v. Leeming; 82 unless we accept the recent qualifications placed on that case in the afore-mentioned case of Barry v. Cordy. 83 Lord Clyde says: The question in the case is whether the profits thus assessed are, or are not, profits of an "adventure . . . in the nature of trade". . . . An adventure it certainly was; for the Appellant made himself liable for the purchase of this vast quantity of toilet paper obviously for no other conceivable purpose than that of re-selling it at a profit; and that is just what he did. . .. The question remains whether the adventure was one "in the nature of trade." The Appellant's contention is that it could not be such, because it is essential to the idea of trade that there should be a continuous series of trading operations. . . . It is no doubt true that the question whether a particular adventure is "in the nature of trade" or not must depend on its character and circumstances, but if-as in the present case-the purchase is made for no purpose except that of re-sale at a profit, there seems little difficulty in arriving at the conclusion that the deal was "in the nature of trade," though it may be wholly insufficient to constitute by itself a trade. 84 As already mentioned, it was decided in the Cape Brandy Syndicate Case that a purchase, blending, and later resale of brandy over a period of months was carrying on a trade. But in a more recent case, the purchase of whisky through an agent for £407 and its later resale in one transaction was held to result in income from an advenhrre in the nature of trade even though the taxpayer had no special knowledge of the trade, had entered into only the one transaction, and did not blend or advertise the product for sale. 811 In the decisions in the above cases there seems little doubt that the nature of the commodity purchased was the important factor since from that factor alone the inference that the purchase was made with a view to resale is conclusive. In such circumstances there was unquestionably a pursuit of gain through purchase and resale. The question whether there were physical transactions amounting to trade is clearly a subordinate issue and the importance it assumed can be justified only on ,t he peculiar division of the English Act according to the source of income. The essential element of purpose is more openly recognized in cases arising under the Australian Income Tax Assessment Act. In Blockey v. Federal Commissioner of Taxation 86 three 82Discussed supra, p. 68.

14 T.C. 490, at p. 496. 851.R.C. v. Fraser, (1942) 24 T.C. 498. 86( 1923) 31 C.L.R. 503. 84( 1929)

88Supra, p. 77.

INCOME FROM BUSINESS

87

hardware merchants agreed together to purchase wheat scrip to the value of £5,000 with a view to reselling it and sharing equally all resulting gains or losses. They purchased scrip through brokers over a period of two months and sold it over a period of one month. This was held by the Supreme Court of Australia to be income, notwithstanding the isolated nature of their venture, on the ground that the transaction was not entered into as an investment. Knox C.J. deals with the problem apart from the narrow concept of trade and business: The agreement between them was that they should buy from time to time wheat scrip for the sole purpose of reselling such scrip as opportunity offered at a profit. The transactions of purchase and sale extended over a considerable period, and the intention of the appellant and his co-adventurers clearly was not to hold the scrip as an investment but if possible to realize a profi.t by selling it at a higher price than they gave for it. 87 The other members of the court delivered judgments to the like effect. Isaacs J. says: It is not ,the case of a man buying land or goods to keep or use, and then finding it desirable or advantageous to sell.... The all-impor,tant fact is that there were a series of transactions connected by a common purpose, that of dealing in wheat scrip, and consisting of all the characteristic operations found in a business of that nature, buying and selling; the scrip itseH being treated, not as an investment, but as stock-in-trade, a mere medium for successfully carrying through the profit-making scheme. 88 In the recent Canadian case of Atlantic Sugar Refineries, Ltd. v. Minister of National Revenue89 the appellant corporation was already engaged in the business of buying raw sugar, refining it, and selling the refined product. In 1937 and again in 1939 it engaged in transactions in raw sugar fuhues and made $212.10 and $71,183.09 profit in those respective years. The Exchequer Court judgment holding these gains to be profits from the company's business reveals that the nature of the product was an important factor in reaching what was considered to be a proper decision, although the conclusion is phrased in terms of the standard tests for business and trading worked out by the English courts and dealt with above. At one point in his judgment Thorson P. observes:

It was not a case of idle capital being temporarily invested in sugar. I think it is fanciful to say that the appellant was making a temporary investment in raw sugar and that such investment stood in the same position as if it had purchased shares of a mining or industrial concern or foreign exchange for a purpose unconnected with its business. There was, in my view, nothing of a capital or investment nature in the appeHant's transactions. 90 B7Jbid., at p. 506.

BBJbid., at p. 507. C.T.C. 326; affirmed [1949) C.T.C. 196 (S.C. Can.). 90[1948) C.T.C. 326, at p. 333. 89[1948)

88

THE MEANING OF INCOME

But in Economic Trust Co. v. Minister of National Revenue91 a trust company, with considerable funds to invest, made thirty-three purchases and ,twenty-three sales, over a period of seventeen years, in shares of stock of a revenue-bearing variety in large and established corporations. In spite of the evidence of the senior officers that the company intended to purchase and resell the stock for gain, and the fact that the company's statute of incorporation provided that it should have the power to do so, the Exchequer Court was considerably hesitant in finding that the purchases and sales were part of a business. The full co-operation of the company's officials in giving such evidence is explained by the fact that the question there concerned the deduction, as trading losses, of losses incurred in the stock transactions. Returning now to the more numerous English decisions, we may see that investments that are generally regarded as permanent can be more readily turned over without producing income, or, to revert to the terminology under the orthodox English approach, without carrying on trade or business. That land, as a commodity, enjoys favourable regard in this connection is apparent from a number of cases, of which Hudsons Bay Company v. Stevens92 is the best-known example.93 The appellant was incorporated in 1670 by royal charter which also granted to it an enormous tract of land in North America together with certain rights to trade and govern in its territory. In 1868 the company surrendered all its right to this land to the Crown, receiving in return a large cash payment from the Government of Canada and the option to lay claim from time to time within a period of fifty years to one-twentieth of the land in that part of the fertile areas being surveyed and opened up for settlement. Acting under this arrangement the company acquired large tracts of land in western Canada. It advertised and sold these lands through a land sales department established for that purpose and all land department accounts were kept separate from its fur-trading and retail-trading activities. The company's directors gave evidence before the commissioners that there was no trading in land, that all lands were being disposed of in the interest of colonization and not with a view to trading profits, and that, moreover, the land acquired in 1868 could not be separated from 91(1946] C.T.C. 142. 92(1909) 101 L.T.R. 96. 9 3But within this general commodity category there is room for further refinement. All forms of landed property are not equally appropriate as an investment. We may readily distinguish a purchase of undeveloped land from a purchase of an apartment block. It will be noted that in the recent Canadian case of Cragg v. M .N.R., [1951] C.T.C. 322, Thorson P., in discussing whether the gain on a purchase and sale of landed properties was income, laid proper stress on the revenue-producing nature of the various properties turned over.

INCOME FROM BUSINESS

89

that originally received from the Crown in 1670 and that there could not therefore be any accurate estimate of the cost price of the land sold on which to estimate the gain or profit. The company's selling activities appear to have been even more extensive than those carried on in selling the Air Force linen in Martin v. Lowry; but the commissioners held in this case that there was no trading in land. Their decision was reversed by Channell J., but was restored by the Court of Appeal. Cozens-Hardy M.R. says: The company are doing no more than an ordinary landowner who is minded to sell from time to time, as purchasers offer, portions suitable for building of an estate which has devolved upon him from his ancestors. I am unable to attach any weight to the circumstance that large sales are made every year. This is not a case where land is from time to time purchased with a view to resale. The company are only getting rid by sale, as fast as they reasonably can, of land which they acquired as part of the consideration for the surrender of their charter.94

Farwell L.J., while he was of opinion that the drawing of an inference of no trade was a question of law on which the commissioners might be reviewed, considered that inference drawn by the commissioners to be correct: It is just as if an ordinary landowner had sold his estate in consideration of

a sum down and a covenant to convey certain portions ,to be selected by him within a term of years. On such conveyances being executed, the owner would simply be a landowner again, whether the land so conveyed had been improved or laid out by the other or not. And his future sales in lots of such lands at various times would be by virtue of his ownership and not in respect of any trade. 96

It may also be recalled that in Jones v. Leeming96 the purchase and later sale of a rubber estate at a profit was held not to be a trade or concern in the nature of trade. The fact that the subject-matter of purchase and sale was land had undoubtedly some bearing on that decision. But it is submitted that, in view of the commissioners' finding the purchase was made for the sole purpose and intention of resale, the decision must either be explained on the narrow view of "trade" in schedule D laid down therein or be regarded as inconsistent in principle with the tenor of the English decisions on this subject. Special factors in relation to companies The cases show that even an isolated transaction in a commodity which is as stable a form of investment as land will still give rise to income where other circumstances show that the intention throughout is clearly to purchase and resell for gain. In Thew v. South-West 94(1909) 101 L.T.R. 96, at p. 97. 95Jbid., at p. 98. 96[1930] A.C. 415.

94

THE MEANING OF INCOME

The cases show that other company documents may be equally relevant in disclosing purpose. In Tebrau (Johore) Rubber Syndicate, Ltd. v. Farmer110 a company was incorporated for the primary, named object of acquiring, cultivating, and developing a certain rubber estate mentioned in the memorandum of association, and any other estates found suitable for rubber cultivation. The company was empowered to buy any property and to sell any part of its holdings. It acquired the estate named and one other estate and sold them both at a profit. In finding that the profit was not income the Scottish Court of Session placed considerable emphasis on the company's prospectus, the wording of which indicated that it was being launched as a rubber production company. In another case, the fact that the articles of association of a company directed the payment of dividends out of income was regarded as evidence that gains applied to the payment of dividends were income. 111 This fact does show that the company officers and directors regarded such gains as income; but since their views pertain to the way in which the money should be applied or expended after its receipt, the better view would seem to be that this fact ought not to have been considered. 112 Finally, in HighwoodSarcee Oils, Ltd. v. Minister of National Revenue118 Maclean J. referred to a company's balance sheet and the reports of directors to shareholders for assistance in determining the extent of the business from which it earned income.

Other factors On the hypothesis that there is no peculiar characteristic which distinguishes a purchase and sale by way of trade from an ordinary purchase and sale, and that the distinction between an income from purchase and sale and a capital gain from purchase and sale rests on the intention with which they are carried out, there can be no exhaustive list of factors to be considered in identifying either type of situation. While those items already mentioned are more frequently encountered, others can be of equal importance in this connection. In Cooper v. Stubbs, 114 for example, while the judgments proceed 110( 1910) 5 T.C. 111 Commissioner

658. of Taxes v. Melbourne Trust, Ltd., (1914] A.C. 1001, at

p. 1011. 112See Hudson's Bay Company v. Stevens, ( 1909) 101 L.T.R. 96. The distinction drawn by Duff J. in Anderson Logging Co., Ltd. v. The King, (1917-27] C.T.C. 198, at p. 204, between capital, meaning funds not available for distribution among shareholders, and capital, meaning capital assets, should also be recognized in this connection. 113 (1942] C.T.C. 101, (Ex. ). See also, in the same connection, Ducker v. Rees Roturbo Development Syndicate, Ltd., [1928] A.C. 132, at p. 141. 114(1925] 2 K.B. 753.

INCOME FROM BUSINESS

91

and turning them to account, then that is a matter to be considered when you come to decide whether doing that is carrying on a business or not. 99

This view was approved by the House of Lords in South Behar Railway Co., Ltd. v. Inland Revenue Commissioners. Lord Sumner there states: "To ascertain the business of a limited liability company one must look first at its memorandum and see for what business that provides and whether its objects are still being pursued. ..."100 The leading Canadian case considering the relation in regard to trade of the memorandum of association of a company is Anderson Logging Company, Ltd. v. The King. 101 The appellant was incorporated under the British Columbia Companies Act, having among its stated objects, "to acquire by purchase or otherwise timber licenses, timber leases and timber lands, and to sell and deal in these," in addition to carrying on a logging business. The company purchased timber limits in 1910 which it resold at a profit in 1920. The Supreme Court of Canada held that this profit was income. Duff J., in delivering judgment for the entire court, says: The appellant company was incorporated for the purpose of making a profit by carrying on business in various ways including, as already mentioned, by buying timber lands and dealing in them. J.t is difficult to discover any reason derived from the history of the operations of the company for thinking that in buying these timber limits the company did not envisage the course it actually pursued for turning ·these limits to account for its profit as at least a possible contingency; and, assuming that the correct inference from the true facts is that the limits were purchased with the intention of turning them ,to account for profit in any way which might present itself as the most convenient, including the sale of them, the proper conclusion seems to be that the assessor was right in treating this profit as income.. .. 102 .

Further on he adds:

The sole raison aetre of a public company is to have a business and to carry it on. If the transaction in question belongs to a class of profit-making operations contemplated by the memorandum of association, prima facie, at all events, the profit derived from it is a profit derived from the business of the company.1oa 99 (1921) 3 K.B. 258, at p. 273. The same distinction between an individual and a company is expressed by Edwards J. in Commissioner of Taxes v. Miramar Land Co., Ltd., (1905) 26 N.Z.L.R. 723, where he says, (at p. 734): "A person who buys one piece of land, subdivides it, and sells it in allotments, is not carrying on business. Why? Because it is not the ordinary business of his life, or any part of the ordinary business of his life. A company which is incorporated for the purpose of buying lands and selling them at a profit buys one piece of land, and sells it again at a profit. It is carrying on business. Why? Because the object of the corporate existence of the company is to buy lands and sell them at a profit." 100(1925] A.C. 476, at p. 485. 101(1917-27) C.T.C. 198 (S.C. Can.); affirmed [1917-27) C.T.C. 210 (P.C.). 1 oa1bid., at p. 207. 102[1917-27) C.T.C. 198, at p. 201.

92

THE MEANING OF INCOME

It is to be noted that Duff J. gave primary consideration to the purpose with which the purchase was made, treating the declared objects in the memorandum of association as evidence of that purpose. Other matters of evidence considered by him were that the company had never in fact engaged in any logging operations, that there had been a minor transaction of purchase and sale of limits at an earlier date, and that the company had invested in shares of other lumber companies. If the memorandum of association is thus taken to be of evidential value only it follows that a corporation will not be precluded by a declared object of incorporation for purchase and resale from realizing capital gains on the sale of assets which were not acquired for such declared object. It has in fact been held that losses on the purchase of oil leases which it was within the declared powers of a company to purchase were not deductible in computing its trading profits where "the money invested by the appellant in oil leases was not made primarily with a view to a resale of its interest in the well or wells to be developed, but to something that would produce a revenue to the appellant...."104 Conversely, circumstances might be such as to indicate that a company was earning income in an ultra vires pursuit of gain. The position of a company's memorandum in considering the question of trade or business was oonsidered by Lord President Clyde in Balgownie Land Trust, Ltd. v. Commissioners of Inland Revenue where he concludes: The objects and powers defined in the Memorandum are of the wide and general character which is appropriate to, and characteristic of, an ordinary company trading in real estate. The objects and powers are to acquire, to let, to improve, and to sell land. One is not, however, entitled to infer from the circumstance that a company is professedly formed with trading purposes in view and for trading objects that the transactions in which it engages necessarily constitute a trade or ·business; because it does not follow horn the fact that it has objects and powers such as I have indicated that it actually uses them for the purpose of conducting the usual business of a company trading in real estate. But the professed objects of the company are not, for that reason, to be left out of account; on the contrary, they must be kept in view when considering the transactions in which the company is proved to have been engaged.105

The High Court of Australia has adopted a similar view: In our opinion the authorities show that the objects and powers of the Company contained in its memorandum and articles of association are not decisive of the question whether the sale was an operation of business in carrying out a scheme of profit-making, but that a consideration of all the 104Highwood-Sarcee

Oils, Ltd. v. M.N.R., [1942] C.T.C. 101, per Maclean

at p. 118; affirmed [1944) C.T.C. 57. 105( 1929) 14 T.C. 684, at p. 692.

J.,

INCOME FROM BUSINESS

93

matters advanced by the Company was relevant to a determination of that question..••106

The memorandum of association or letters-patent of incorporation have been considered in a number of Canadian cases and regarded in each of them as but one material circumstance for consideration. 107 In one of these cases it is said by Maclean J.: In considering such cases it is not sufficient to consider merely what are the powers and objects of the company concerned, though that is of importance, hut rather what in fact the company was doing in the ,taxation period in question.... Where a limited company comes into existence for some particular objects or purposes, and if in fact it becomes engaged in some or all of such objects or purposes, then that is a matter to be considered when you come to decide whether doing that is carrying on an ordinary trading business or not. 108

A distinction should be recognized between the objects expressed in a company's memorandum and the powers enabling it to pursue those objects. Obviously, the fact that a power held by a company has been duly exercised is of no evidential value in regard to the purpose for which it was exercised. 109 106Ruhamah Property Co., Ltd. v. Commissioner of Taxation, ( 1928) 41 C.L.R. 148, per Knox C.J., Gavan Duffy, Powers, and Starke JJ., at p. 151. 1011n re Hastings Street Properties, Ltd., [1928--34] C.T.C. 60 (B.C. C. of A. ); Merritt Realty Co., Ltd. v. Brown, [1932] S.C.R. 187, affirming (1932] 1 W.W.R. 234; Highwood-Sarcee Oils, Ltd. v. M.N.R. [1944)] C.T.C. 57 (S.C. Can.), affirming [1942] C.T.C. 101 (Ex. ); Economic Trust Co., Ltd. v. M.N.R. [1946] C.T.C. 142 (Ex.); Atlantic Sugar Refineries, Ltd. v. M.N.R., [1949] C.T.C. 196 (S.C. Can.) . 108Highwood-Sarcee Oils, Ltd. v. M.N.R. [1942] C.T.C. 101 (Ex.), at pp. 115, 118. I09"The mere fact that a company has power to sell a particular asset, or all its assets, does not in the least imply that it is part of the business of the company to sell that particular asset or its assets. Most people of sound mind and understanding have power to dispose of their property. It does not follow from that that they carry on the business of buying and re-selling property such as that which they possess. Indeed, looking at the memorandum of association of Wilson Box ( Foreign Rights), Ltd., I think if Wilson Box ( Foreign Rights), Ltd., as a going concern had sold these foreign rights which it had acquired, that any shareholder in that company might well have come to the court and asked for a winding up order on the ground that the substratum of the company had gone. He obviously could not put such a contention as that before the court if the company which he had joined was formed for the purpose of carrying on the business of buying and re-selling these foreign rights." Wilson Box (Foreign Rights), Ltd. v. Brice, [1936] 3 All E.R. 728, per Romer L.J., at p. 737. And see I.R.C. v. Hyndland Investment Co., (1929) 14 T.C. 694. For a different view of the relevancy of a company charter, founded on the orthodox approach that income must arise from carrying on trade or business, see Frears R.I., Charter Powers and Liability to Income Tax, ( 1945) 23 C.B. Rev. 480. Any distinction between a company's objects and powers appears to have been ignored by Angers J. in Economic Trust Co. v. M.N.R., [1946] C.T.C. 142, where he gave considerable weight to the fact that the company had the power to purchase and sell revenuebearing securities in finding that such purcliases and sales formed part of the company's business.

94

THE MEANING OF INCOME

The cases show that other company documents may be equally relevant in disclosing purpose. In Tebrau (Johore) Rubber Syndicate, Ltd. v. Farmer110 a company was incorporated for the primary, named object of acquiring, cultivating, and developing a certain rubber estate mentioned in the memorandum of association, and any other estates found suitable for rubber cultivation. The company was empowered to buy any property and to sell any part of its holdings. It acquired the estate named and one other estate and sold them both at a profit. In finding that the profit was not income the Scottish Court of Session placed considerable emphasis on the company's prospectus, the wording of which indicated that it was being launched as a rubber production company. In another case, the fact that the articles of association of a company directed the payment of dividends out of income was regarded as evidence that gains applied to the payment of dividends were income. 111 This fact does show that the company officers and directors regarded such gains as income; but since their views pertain to the way in which the money should be applied or expended after its receipt, the better view would seem to be that this fact ought not to have been considered. 112 Finally, in HighwoodSarcee Oils, Ltd. v. Minister of National Revenue113 Maclean J. referred to a company's balance sheet and the reports of directors to shareholders for assistance in determining the extent of the business from which it earned income.

Other factors On the hypothesis that there is no peculiar characteristic which distinguishes a purchase and sale by way of trade from an ordinary purchase and sale, and that the distinction between an income from purchase and sale and a capital gain from purchase and sale rests on the intention with which they are carried out, there can be no exhaustive list of factors to be considered in identifying either type of situation. While those items already mentioned are more frequently encountered, others can be of equal importance in this connection. In Cooper v. Stubbs, 114 for example, while the judgments proceed 110( 1910) 5 T.C. 658. of Taxes v. Melbourne Trust, Ltd., (1914] A.C. 1001, at p.1011. 112See Hudson's Bay Company v. Stevens, ( 1909) 101 L.T.R. 96. The distinction drawn by Duff J. in Anderson Logging Co., Ltd. v. The King, (1917-27] C.T.C. 198, at p. 204, between capital, meaning funds not available for distribution among shareholders, and capital, meaning capital assets, should also be recognized in this connection. 11 3[1942) C.T.C. 101, (Ex.) . See also, in the same connection, Ducker v. Rees Roturbo Development Syndicate, Ltd., (1928) A.C. 132, at p. 141. 114(1925] 2 K.B. 753. 111 Commissioner

INCOME FROM BUSINESS

95

on the basis that the appellant was not carrying on a concern in the nature of trade in cotton futures, the fact that he was selling for future delivery a commodity which he had not yet bought would, of itself, seem to establish conclusively that there was an intention to purchase and sell for gain. We have seen that in the case of Californian Copper Syndicate, Ltd. v. Harris the fact that the company was formed for the express object of acquiring and selling mining properties was looked to in finding that an isolated purchase and sale of certain property resulted in income; but the court also took note of the fact that the paid-up capital of the company was almost exhausted in purchasing the land, as showing that exploitation of the minerals was not among the objects contemplated at the time of purchase. m; So too, the manner in which property is acquired, whether by devise or by grant or by purchase or by the application of one's own labour, is undoubtedly of importance. We have seen that that factor, as well as the great length of time land was held prior to its sale, provided the basis for explaining and justifying the decision in Hudson's Bay Company v. Stevens in a number of the later sale of land cases. 116 McLeod v. Minister of Customs and Excise 117 shows similar emphasis. A banker devised and bequeathed all his property to trustees ,to convert it into money and distribute the proceeds as directed by his will. He owned large tracts of land near Detroit, Michigan, which he had subdivided and part of which he had sold as lots from an office in Detroit which he had established prior to his death. The trustees were directed to sell these lands as they deemed prudent in the best interests of the estate and to improve or alter the lands or buildings in order to dispose of it. They continued to maintain the office, collected purchase money from the sale of lots and sold further lots, and even built houses and constructed sewers and sidewalks in order to facilitate sales. Maclean J. held that the trustees were merely realizing the estate and that the profits were not assessable. The fact that they were selling lands acquired by bequest and 1111" • • • I feel compelled to hold that this Company was in its inception a Company endeavouring to make profit by a trade or business, and that the profitable sale of its property was not truly a substitution of one form of investment for another." ( 1904) 5 T.C. 159, per Lord Justice-Clerk Macdonald at p. 166. "I am satisfied that the Appellant Company was formed in order to acquire certain mineral fields or workings-not to work the same themselves for the benefit of the Company, but solely with the view and purpose of reselling the same at a profit. The facts before us all point to this." Ibid., per Traynor J., at p. 167. 116Cf. Alabama Coal, Iron, Land and Colonization Co., Ltd. v. Mylam, (1926) 11 T.C. 232, at p. 253. 117[1917-27] C.T.C. 282.

96

THE MEANING OF INCOME

were acting under the insbuctions of the will was undoubtedly an important consideration. But in a case where the executors of a will failed to dispose of devised real estate and then formed the beneficiaries into a company to take over the estate, the company was held taxable on its profits from improving, developing, and selling portions of the estate as well as from the purchase and sale of other lands. 118 Finally, there have been cases in which the direct evidence of persons connected with a transaction has been scrutinized in order to explain the purpose with which it was undertaken. 119 In the recent Canadian case of McDonough v. Minister of National Revenue120 the appellant is reported to have admitted that when he acquired shares he intended to resell them at a profit. Moreover, as in Cooper v. Stubbs, discussed supra, he had arranged to resell the shares before becoming bound to purchase them. More particularly the facts in the case were that the appellant, McDonough, conceived the idea of amalgamating a number of mining properties. He had formerly been engaged in exploring and prospecting for mines, having had no experience in promoting companies or raising capital for mining development. He expended considerable effort in obtaining options covering the properties in question and in devising a means to raise money to exercise them. The appellant promoted a new company to bring about the desired amalgamation, provision being made for the appellant to acquire shares of the company by purchase and option. The appellant was able to interest others in financing the company and disposed of his rights at a profit on which he was assessed for income tax. The Exchequer Court decided that the appellant's gain had been made in an "operation of business in carrying out a scheme of profit making." Leeming v. Jones, relied on to establish that the gains from an isolated transaction were not income, was distinguished on the ground that there was in that case a finding of fact by the commissioners that no trade was carried on. The appellant's own admission regarding his intentions to resell at a profit, the fact that he had no money of his own with which to finance the amalgamation, and the added fact that over a considerable period he had devoted his time and efforts exclusively toward the reorganization scheme, made the court's conclusion that there was a scheme for profit making almost unavoidable. Applying the test evolved in the Livingston Case, 118 Balgownie Land Trust, Ltd. v. C.I.R., ( 1929) 14 119E.g. Economic Trust Co. v. M.N.R., [1946] C.T.C.

T.C. 684. 142, at pp. 148 ff. Atlantic Sugar Refineries, Ltd. v. M.N.R., [1949] C.T.C. 196, at p. 202. See also the recent Canadian cases, "N" v. M.N.R., [1951] C.T.C. 297; Cragg v. M.N.R., [1951] C.T.C. 322. 120(1949] C.T.C. 213.

INCOME FROM BUSINESS

97

Cameron J. concluded that the share purchase and sale operations "were of the same kind and carried on in the same way as those which are characteristic of a mining promoter and underwriter." There is no limit to the factors that may be of value in showing an intention to purchase with a view to resale, or, as the question is approached by the courts, that go together to constitute trading. When it is fully appreciated that the problem is one of intention, there is little advantage in pursuing the instances further. INCOME FROM ESTABLISHED BUSINESSES

Authoritative statements on the meaning of income usually adhere to the principle that income does not include capital gains. This principle they then qualify with the further rule that income arises from trade or business. But it has also been recognized that any trader may, in his capacity as owner of trading assets, realize an increase in their value which is a true capital gain. Thus, not every profit on the sale of assets by a trader is taxable trading profit. There is, then, in English and Canadian law, a line of cases which concerns the problem of determining capital gains from a business income in circumstances where the fact of the existence of that trade or business is not in question. If we leave aside, for the moment, the idea that income is the gain from trading, in favour of a more general view that income is the monetary ( or equivalent) return received from a combination of labour and capital in the pursuit of gain, it is at once apparent that there is no distinction between the principles involved in deciding the problem we have discussed of whether a gain has resulted from trade, and the problem of whether a gain has resulted from a particular trade. As far as gains made through purchases and sales of assets are concerned, if we accept the view that the difference between a resulting income gain and capital gain is founded on the different purpose or attitude with which an asset is acquired, the fact that the vendor is engaged in a trade or business is simply one among the many factors which may disclose that purpose. For example, the question whether income has resulted from the purchase and resale of real property will no doubt be affected by the fact that the vendor has been engaged all along in the building construction business; again, the fact that a person carries on the business of a trustee or of an insurer necessitating large investments will be relevant to the question whether his purchase and resale of government securities has given rise to income gain; and, similarly, the fact that a purchase and resale of wheat was

98

THE MEANING OF INCOME

undertaken by someone engaged in the business of flour-milling will assist in showing the intention with which that transaction was undertaken. Under the accepted approach ( or carrying on trade or business approach) to the meaning of income, as first adopted under the English Act, the fact that the person assessed is already in a business or trade has a somewhat different significance because the trading test and the necessary requirement, laid down in cases such as Jones v. Leeming, that the gain be derived from a source indicated in that Act, can often and conveniently be met by ascribing the gain to that trade. It is obvious that a person engaged in one trade or business may enter upon an additional and entirely separate trade or business. Such person may even become engaged in a separate pursuit of gain without carrying on another trade or business within the legal meaning of that term. Any difficulty which might arise in determining income with respect to non-traders in such circumstances can often be avoided by treating the added activity and the ensuing gain arising therefrom as an adjunct of the established trade. There are English and Canadian cases in which this reasoning is evident, although it is not meant to suggest that there is any conscious departure by the judges from the accepted view of income as meaning the gains from trading. In Benyon and Co., Ltd. v. Ogg, 121 for example, the appellant company carried on the business of acting as agents for certain colliery companies in purchasing supplies for them. In 1914 it purchased two lots of 250 wagons each for two colliery companies. Foreseeing a rise in the cost of materials and wages, the company decided to purchase a third lot of 250 wagons on its own account from the same suppliers. The following year it sold this lot at a profit. It was found that the company had purchased the wagons as a speculation and with a view to their resale at a profit. The company had never before purchased and resold such supplies and did not contemplate doing so again, so that, on appeal from the commissioners, it was argued that the isolated transaction thus entered into did not constitute a trade or business. In upholding the commissioners' decision that the profits were income, Sankey J. neatly avoided the problem of deciding whether the profit arose from a trade in wagons and discussed the transaction as if it formed part of the appellant's regular agency business. He says, referring to the third lot of wagons : They were no part of the capital, bought for the purpose of the Appellant

Company's trade, and I do not .think that the purchase price of the wagons 121 (

1918) 7 T.C. 125.

INCOME FROM BUSINESS

99

when sold ever formed part of the capital of the business.... Although it is perfectly true that the transaction began with one purchase and ended with one sale, that, I think, is only a coincidence. ... It seems to me, that it was a profit made in the operation of the Appellant Company's business. 122 The same approach is apparent in the recent decision of the Canadian Exchequer Court in Atlantic Sugar Refineries, Ltd. v. Minister of National Revenue. 123 The appellant company was incorporated with wide powers, including the power to purchase and resell raw sugar, but carried on the business of buying raw sugar, refining it, and selling the refined product. In 1937 the company entered into minor transactions in the raw sugar futures market and made a small profit. In 1939 it entered more extensively into that market and maintained separate accounts for those transactions. It made large profits on which it was assessed for the payment of income tax. The evidence established that the futures transactions were undertaken with a view to offsetting an anticipated loss from the company's manufactures due to the rising cost of raw sugar and that they were undertaken as pure speculation independently of the company's regular business. The company contended, pointing to the added fact that its supplies of raw sugar had never before been secured through the raw sugar futures market but had always been purchased directly from suppliers, that its gain was a capital gain from the employment of its capital outside normal business operations. It further argued, in line with the English authorities, that the gain did not come within the meaning of income ins. 3 of the Income War Tax Act because it did not arise from a trade or business. In answer to the first contention, Thorson P. found that the purchase of sugar futures was not undertaken as a capital investment in raw sugar. While this finding might appear sufficient to have disposed of the appeal, he apparently considered it necessary to deal also with the second contention. After an exhaustive reference to the leading English cases on the meaning of trade or business he concluded that because the venture into the futures market was to offset anticipated loses in the refining business it constituted a part of such business. "It was the abnormal situation in the appellant's business in its ordinary course that took it into the raw sugar futures market." He then added: Moreover, quite apart from their cause, they were transactions in the same commodity as that which i,t had to purchase for its ordinary purposes. In my view, they were of the same character and nature as trading and business operations as those of its business in its ordinary course, even although they 1221bid., at p. 133.

123(1948) C.T.C. 326.

100

THE MEANING OF INCOME

involved a departure from such course. The appellant made such departure an operation of its business. 124

His final conclusions are phrased in the familiar language of the tests for income laid down in the leading English cases : In my judgment, the profit of the appellant from its sales and purchases in

the raw sugar futures market may fairly be regarded as "a gain made in an operation of business in carrying out a scheme for profit making," or "a profit made in the operation of ,t he appellant company's business." The operations involved in the transactions were also "of the same kind, and carried on in the same way, as those which are characteristic of ordinary trading in the line of business in which the venture was made."125

While there seems to be no doubt that this case was correctly decided, it is to be regretted that, the purchase of sugar futures having been found not to represent a capital investment, it was considered necessary thus to bring the facts within the English view of trading or business in order to find the profit from such an obvious undertaking in pursuit of gain to be inoome within the meaning of the Canadian Income War Tax Act. Realization of assets It has never been questioned in English law that a trader should be allowed the same opportunity as other persons to dispose of his assets without incurring an income gain. The reasoning in cases which consider whether a trader has earned an income or capital gain proceeds from the oft-commended statement of the Lord Justice-Clerk Macdonald in Californian Copper Syndicate, Ltd. v. Harris that a capital accretion can only be included in the computation of profits if "what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business."126 Accordingly, it has been recognized that a capital profit in the hands of a trader is not necessarily a taxable trading profit; that it must be profit arising or accruing from a trade, not just a profit arising or accruing to a trader, and that it must be profit from the exercise of trading activity, not the profit from capital as such. Mere realization, it has been decided, is not trading.127 There remains the problem of distinguishing acts in realization from acts in trading and, 124Ibid., at p. 337. Similar emphasis is apparent in the judgments delivered on appeal to the Supreme Court of Canada, [1949] C.T.C. 196, esp. at pp. 201, 202. 125(1948] C.T.C. 326, at p. 337. 126( 1904) 5 T.C. 159, at p. 166. 121commissioner of Taxes v. British-Australian Wool Realization Association, Ltd., [1931] A.C. 224, where it was held by the Privy Council, following the English authorities, that the transactions of an organization set up by the Australian and British governments to dispose of surplus wool from World War I did not give rise to "income" within the meaning of the income tax act of the state of Victoria.

INCOME FROM BUSINESS

101

since they both include an act of selling and usually of purchasing prior to such sale, any satisfactory, objective distinction between them has been difficult to establish. Where the trade or business involves a process such as growing or manufacturing, the distinction between the carrying on and a sale in realization of the assets of such business has been easy to identify owing to the physical changes of conduct that accompany the different attitude in each case. But where the business involves mere purchase and resale there is more difficulty. We find this difficulty expressly recognized by Lord Phillimore in delivering judgment for the Judicial Committee in Doughty v. Commissioner of Taxes, where he says: Income tax being a tax upon income, it is well established that the sale of a whole concern which can be shown to be a sale at a profit as compared with the price given for the business, or at which it stands in the books, does not give rise to a profit taxable to income tax. It is easy enough to follow out this doctrine where the business is one wholly or largely of production. In a dairy farming business or a sheep rearing business, where the principal objects are the production of milk and calves or wool and lambs, though there are also sales from time to time of the parent stock, a clearance or realization sale of all the stock in connection with the sale and winding up of the business gives no indication of the ixofit (if any) arising from income; and the same might be said of a manufacturing business which was sold with the leaseholds and plant, even if there were added to the sale the piece goods in stock, and even if those piece goods formed a very substantial part of the aggregate sold. Where, however, a business consists, as in the present case, entirely in buying and selling, it is more difficult to distinguish between an ordinary and a realization sale, the object in either case being to dispose of goods at a higher price than that given for them, and thus to make a profit out of the business. The fact that large blocks of stock are sold does not render the profit obtained anything different in ·kind from the profit obtained by a series of gradual and smaller sales. This might even be the case if the whole stock was sold out in one sale. Even in the case of a realization sale, if there were an item which could be traced as representing the stock sold, the profit obtained by that sale, though made in conjunction with a sale of the whole concern, might conceivably be ,treated as taxable income. 128

While their lordships' judgment may here be seen to suggest that an out-and-out sale of a business might give rise to an income gain as regards the stock-in-trade, the English courts have not been thus strict, and they have allowed the question of realization or trading to remain largely in the hands of the commissioners to be decided as a question of fact with regard to all the circumstances. These would include such matters as whether the stock was sold in one sale or a number of sales, whether sales were made over a long or a short period of time, and whether sales were continued through the usual channels and were 128[1927) A.C. 327, at p. 331.

102

THE MEANING OF INCOME

effected by ordinary means. The distinction to be drawn is well presented by Lord Atkinson in / . and R. O'Kane and Co. v. Commissioners of Inland Revenue where he says: A trader who wishes to retire from business may wind up his business in several ways; he may sell his concern as a going concern, or he may auction off his stock. But there is another way quite as effectual, and that is by continuing to carry on his business in the ordinary way, but not replenishing his stock which he has accumulated as it is sold. 129

In that case the appellant company carried on business as wine and spirits merchants in Belfast for a number of years. In 1916 it decided to retire from business and the company's customers were notified by circular of that decision and of the quantity and type of the remaining stock on hand. The company entered into no new contracts for the purchase of stock but it completed certain unexpired running contracts with distillers for the purchase of liquor. It had sold nearly all this new stock and its old stock by the end of the year 1917, and it was contended that the company should be taxed only on the profit on the new stock acquired after ,t he decision to retire from business. The commissioners found as a fact that all the sale transactions were transactions in carrying on a trade and the House of Lords, in upholding this finding, affirmed their assessment on the profits from all sales. On the other hand, in Commissioners of Inland Revenue v. Nelson 130 the commissioners were upheld in arriving at the opposite conclusion from slightly different circumstances. A whisky broker decided to retire from business and, after having notified his creditors and customers of his intention, he sold his entire business assets, including the stock-in-trade, trade name, and office furniture to one of his customers in one transaction. The commissioners found that this sale was a realization of assets other than in the course of trade which had been entered into after trading had ceased. The Scottish Court of Session upheld their decision, the Lord President observing: .. . sale of a stock-in--trade such as whisky or grain on realization may be either a sale in the course of trade or a sale not in the course of trade according to circumstances, and the Special Commissioners here had, in the facts admitted or proved, evidence on which they were entitled to hold that the sale was not a sale in the course of trade.131

There was some suggestion in the recent decision in Wilson Box, Ltd. v. Brice132 that formal liquidation or winding-up will, as a matter of law, transform a trading situation to one of realization. The company 129( 1922) 126 L.T.R. 707, at p. 710. 1aO(l939) 22 T.C. 716. 132[1936] 3 All E.R. 728 (C.A.).

1311bid.,

at p. 723.

INCOME FROM BUSINESS

103

in question was formed in 1933 to acquire and manage, but with the power to sell, the foreign rights in a certain patent. The company acquired the pateq.t for £2,500 and paid for it through the issue of paid-up shares. The shareholders then sold their shares in the company for £50,000 but the purchaser defaulted on the agreement. It was finally agreed between the shareholders and the purchaser in default that the company should go into voluntary liquidation and that the liquidator would be authorized to sell the patent rights to the same purchaser for £20,000. This arrangement was carried out and the £20,000 distributed among the shareholders. The commissioners found that the company's trade was dealing in patent rights and inventions and that the proceeds of the sale were trading receipts and taxable as income. Lawrence J. held that there was no evidence on which the commissioners might find that the profit resulted from a trading transaction in that it was clearly a profit on the realization of the company's assets. 133 He took the view that the same transaction, carried out by the company, would have been a trading transaction, and in excluding the gains from the category of income he placed full reliance on the fact that the company was in the hands of a liquidator whose duties were confined to the beneficial winding-up and distribution of the assets under the Companies Act. The Court of Appeal, while dissociating themselves from the view that the sale of patents was part of the company's business, gave emphasis to the fact that the transaction was carried out by the liquidator at a time when by statute the company had ceased to carry on business except in so far as necessary for beneficial winding-up. However, it was soon afterwards decided in Baker v. Cook134 that a liquidator might in fact be found to have carried on the business being liquidated, either by himself or through an agent. The situation in English law would, then, appear to be that a trader may realize the value of his assets at any time without attracting tax on the same basis as another person; that he may do so either with or without entering into formal liquidation proceedings; and that in either event the question whether he is realizing or trading remains primarily one of fact for the commissioners on which they are allowed considerable freedom. The Canadian law would, presumably, be the same, though the question whether trade was being carried on would be completely in the hands of the Canadian courts. Fixed and circulating capital Apart from the question of complete realization by winding-up of business, it is obvious that many of the assets owned by trading con133(1936] 2 All E.R. 452. 134(1937] 3 All E.R. 509.

104

THE MEANING OF INCOME

cems are not purchased for resale, such as, for example, the business premises, office furniture, plant and equipment, and investments, and that the profit from the sale of such assets is not an income profit or, in the language of the courts, that their sale does not cons·t itute part of the trade with which they are connected. In adhering once again to the test for income set out in the Californian Copper Syndicate Casethat the enhanced value on a sale of assets can only be included in trading profits "where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business"-a sale of assets with which a trader carries on business, as distinct from those in which he carries on business, has been described by the courts as a partial realization, partial liquidation, or partial going out of business. However, in this type of case the trading test has ip large part been displaced by a distinction, taken over by the courts from the writings of economists, between sales of "fixed" and of "circulating" or "floating" capital assets. This distinction, which may be seen to relate directly to the purpose or intention with which an asset is acquired, appears to have been first adopted in cases dealing with the company law rule against the payment of dividends out of capital. 135 These concepts we see first used in determining the meaning of income for taxation purposes in the case of John Smith and Son v. Moore136 where two members of the House of Lords classified short-term coal contracts with colliery owners as fixed capital in the business of a coal and shipping agent. Lord 135For example, we have the distinction between fixed and circulating capital reviewed in the judgment of Swinfen Eady L.J. in Ammonia Soda Co., Ltd. v. Chamberlain, [1918] 1 Ch. 266, at p. 286, where he says: "What is fixed capital? That which a company retains, in the shape of assets upon which the subscribed capital has been expended, and which assets either themselves produce income, independent of any further action by the company, or being retained by the company are made use of to produce income or gain profits. A trust company formed to acquire and hold stocks, shares, and securities, and from time to time to divide the dividends and income arising therefrom, is an instance of the former. A manufacturing company acquiring or erecting works with machinery and plant is an instance of the latter. In these cases tlie capital is fixed in the sense of being invested in assets intended to be retained by the company more or less permanently and used in producing an income. What is circulating capital? It is a portion of the subscribed capital of the company intended to be used by being temporarily parted with and circulated in business, in the form of money, goods or other assets, and which, or thejroceeds of which, are intended to return to the company with an increment, an are intended to be used again and again, and to always return with some accretion. Thus the capital with which a trader buys goods circulates; he parts with it, and with the goods bought by it, intending to receive it back again with profit arising from the resale of the goods. A banker lending money to a customer parts with his money, and thus circulates it, hoping and intending to receive it back with interest. He retains, more or less permanently, bank premises in which the money invested becomes fixed capital." 136(1921] 2 A.C. 13.

INCOME FROM BUSINESS

105

Haldane there observes, in explaining the difference between these concepts: My Lords, it is not necessary to draw an exact line of demarcation between fixed and circulating capital. Since Adam Smith drew the distinction in the Second Book of his Wealth of Nations, which appears in the chapter on the Division of Stock, a distinction which has since become classical, economists have never been able to define much more precisely what the line of demarcation is. Adam Smith described fixed capital as what the owner turns to profit by keeping it in his own possession, circulating capital as what he makes profit of by parting with it and letting it change masters. The latter capital circulates in this sense. 187

The distinction between "fixed" and "circulating" capital has been drawn by the English courts on a number of occasions in distinguishing capital from the income receipts of a trade,138 and has been acknowledged in that connection in judgments of the Judicial Committee139 and of the Canadian Exchequer Court. 140 In the recent judgment of the Judicial Committee delivered by Viscount Simon in British South Africa Co. v. Commissioner of Income Tax he interrelates the "fixedcirculating capital assets" and the "carrying on business" tests for income as follows: For the purpose of assessment to income tax • . . the proceeds of sale of an asset are brought into account if the sale is in the course of the ,taxpayer's trade or business. Thus, if it is his trade or business to make and to sell, or to acquire and to sell, shoe-making machinery, then the proceeds of sale of such machinery are brought into account: if it is his trade to make and sell shoes, and for that purpose he owns or uses shoe-making machinery, then if he sells such machinery, the proceeds of such sale are not ,brought into account. In the former case the machinery is sometimes called "floating" or "circulating" capital, in the latter "fixed" capital. 141

It is evident that the question whether a particular asset falls into either category will depend upon the individual circumstances in every case, and particularly on the nature of the trade in which the asset is employed. Furthermore, it would appear that an item of capital may change from the one form to the other form as the circumstances of a 1s11bid., at p. 19.

for example, in Rees Roturbo Development Syndicate, Ltd. v. C.I.R. [1928] 1 K.B. 506; Collins v. Firth-Brearley Stainless Steel Syndicate, Ltd., ( 1925) 133 L.T.R. 616; C.I.R. v. Newcastle Breweries, Ltd., (1926) 135 L.T.R. 618, at pp. 621, 624; Van den Berghs, Ltd. v. Clark, 104 L.J.K.B. 345 (C.A. ), [1935] A.C. 431, at p. 443. 139Commissioner of Taxes v. British-Australian Wool Realization Association, Ltd., [1931] A.C. 224, at p. 229; British South Africa Co. v. Commissioner of Income Tax, [1946] A.C. 62, at p. 80. 140See Economic Trust Co. v . M.N.R. [1946] C.T.C. 142. t4I[l946] A.C. 62, at p. 80. 188As,

106

THE MEANING OF INCOME

particular business become altered. A change in an asset from circulating to fixed capital would appear to have taken place in the facts leading up to the decision in Beams v. W eardale Steel, Coal and Coke Co.142 The company originally owned and operated a colliery and also carried on business as iron and steel manufacturers. It accumulated large slag heaps in the course of its steel business. Later, it discontinued the steel business, confining its operations to the collieries. The slag heaps were eventually sold for road-making purposes and it was held that the profit on their sale was not income. While this particular asset, the slag, would appear to have been circulating capital and to give rise to an income gain if sold at a profit by a steel manufacturer, the discontinuance of that aspect of the company's business enabled the slag to be sold at a capital gain since it was not the product of the business remaining at the time of its sale. The converse case is illustrated by Gloucester Railway Carriage and Wagon Co., Ltd. v. Commissioners of Inland Revenue.143 There the appellant company manufactured and purchased railway wagons which it dealt with by outright or hire-purchase sales to railway companies or by letting them on hire to such companies. The bookkeeping accounts of the sales and hiring branches of the company's business were kept separately. The wagons let on hire were treated as capital assets in the accounts of that branch of the business and depreciation was charged from their value each year. The company later decided, in view of prevailing high prices, to sell all the wagons used for hiring purposes and to confine its future activity to the sale of wagons. The company was assessed for corporation profits tax on the profit from these sales, profit being defined in the same terms as in the English Income Tax Act. The assessment was upheld by the commissioners, whose finding, it may be noted, places particular emphasis on the purpose for which the wagons were originally manufactured or purchased. They say: In our opinion we must have regard to the main object of the company, which is to make a profit in one way or another out of making wagons and rolling stock. We are unable to draw the very sharp line which we are asked to draw between wagons sold, wagons let on mre purchase and wagons let on simple hire, nor do we consider that this very sharp division in fact exists. We do not regard ourselves as precluded by the fact that as long as the wagons were let, they were treated "as plant and machinery" subject to wear and ,tear, from deciding that they are stock in trade when they are sold, even though let under tenancy agreements, for they seem to us to have in fact the one or other aspect according as they are regarded from the point of view of the users or the company. In our view shortly it 142( 1937) 21 T.C. 204. 143(1925) A.C. 469.

INCOME FROM BUSINESS

107

makes no difference that one way of making a profit out of the wagons was given up, for the very giving up itself involved the making of a profit in another way out of the same wagons, and the purpose of the company's trade is to make a profit out of wagons. 144

On appeal to the House of Lords the commissioners' finding was upheld. Lord Dunedin, in a judgment concurred in by all members of the court, says: The appellants are a company who dealt in wagons. It acquired wagons

generally by construction in its own works, but also on many occasions by purchase. The wagons so acquired it dealt with in two ways. Either it sold .•. or it hired them out. ... The Commissioners have found-and I think it is the fact-that there was here one business. A wagon is none the less sold as an incident of the business of buying and selling because in the meantime before sold it has been utilized by being hired out. There is no 9llllilarity whatever between these wagons and plant in the proper sense, e.g., machinery, or between them and investments the sale of which plant or investments at a price greater than that at which they had been acquired would be a capital increment and not an item of income. 145

The decisions in the last two cases can be fairly satisfactorily explained apart from the fixed-circulating capital distinction on a basis of the trade carried on. It may be reasoned that in the former case the company was not in the trade or business of buying and selling slag while in the latter case the company remained throughout in the business of buying or manufacturing and selling wagons. However, in cases where persons or corporations already engaged in trade or business realize a gain through an unusual or isolated sale, or through means other than selling, the fixed-circulating capital test remains somewhat more satisfactory than the carrying on business test in distinguishing income from capital gains.

Income from isolated sales :In George Thompson and Co., Ltd. v. Commissioners of Inland Revenue146 the appellant carried on business as a shipowning and water transportation company. In the year 1916 the government of Australia requisitioned a number of its ships. The company had previously purchased large supplies of coal for future delivery, for which it now had no further need. It sold these deliveries of coal to another company at a profit. The company maintained that this profit did not arise from its business of shipowners and carriers in that it did not deal in coal and that the purchase and sale of coal had at no other time been undertaken and could not be regarded as a normal incident of 144Ibid., at p. 472. at pp. 474-5. 146 ( 1927) 12 T.C. 1091.

145 Ibid.,

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THE MEANING OF INCOME

its shipping business. However, Rowlatt J. affirmed an assessment for excess profits tax on this gain, profits having for the purpose of that tax the same meaning as under the English Income Tax Act. He says: Here this coal was agreed to be purchased, there can be no doubt, on revenue account. These Appellants were providing ,themselves with the coal with which to run their ships, and it was provided with that intention. They did not buy it on capital account; they did not buy it as a thing to hold and enjoy the fruits of; they bought it as a thing which they required to buy and use and consume as consumable stores . . . . On the facts I think this is simply a c-ase of a person who is bound to buy a certain amount of consumable stores, who over-buys and is lucky enough to dispose of those consumable stores which he has got in the way of his business in relief of his business at a profit, or whatever way in which you like to put it. He has simply got out of it, and not only escaped the expense, but there is something put in his pocket for it in the way of his business. 147 The appellant's contention that it was not in the business of buying and selling coal seems unquestionable, but the decision can be explained on the view that the coal formed part of the circulating capital, "a thing which they required to buy and use and consume as consumable stores," and not part of the fixed capital, "a thing to hold and enjoy the fruits of'; or, again in the words of Rowlatt J., that the coal was purchased "on revenue account" and not "on capital account." The decision in the case of Imperial Tobacco Co., Ltd. v. Kelly 148 can be justified on the same basis. An English tobacco manufacturer purchased a large supply of United States currency with a view to buying tobacco leaf in the United States of America. Following the outbreak of World War II the purchase of tobacco leaf in the United States was prohibited by government regulation and a further regulation requisitioned the United States currency on hand with the company at a price that exceeded the price at which it had been purchased. The company opposed an assessment for income tax on this profit on the ground that the purchase and resale of American 14 7lbid., at pp. 1100, 1102. Rowlatt J. was in this case faced with his own previous decision in McKinlay v. Jenkins, ( 1926) 10 T.C. 372, where he held that a gain made by a building construction company on the sale of Italian lire, which had been secured in order to pay for marble being purchased in Italy, was not income. In distinguishing that case Rowlatt observes, significantly, that it was never appealed, and he explains the decision y saying that he had there regarded the purchase of lire as a speculation or temporary investment. McKinlay v. Jenkins was further questioned by the English Court of Appeal in Imperial Tobacco Co., Ltd. v. Kelly, [1943] 2 All E.R. 119, a case which appears to be quite the opposite. "My reading of the decision in the Imperial Tobacco Co. case .. . leads me to think that neither Macnaghten, J., nor Lord Greene, M.R., considered the Marble case . .. wholly free from doubt." Atlantic Sugar Refineries, Ltd. v. M .N.R., [1948) C.T.C. 326, per Thorson P., at p. 333. 148(1943) 2 All E.R. 119.

l·

INCOME FROM BUSINESS

109

dollars did not form part of its business. Again, there would seem to be no doubt as to the correctness of this contention, yet Macnaghten J. and the Court of Appeal held that the gain made was part of the income from the business. If, however, the currency in hand be regarded as a commodity, such profit does then appear to have been realized from circulating capital. Lord Greene M.R. says, in delivering judgment for the court: A manufacturer has provided himself with a commodity, namely, dollars. I call dollars a commodity not for the reason that they are not currency in this country, but because they have a characteristic which is common to other commodities, and is not shared by sterling, namely, that their value from day to day varies in terms of sterling, just in the same way as coal, or bricks, or anything else may do. The appellant company having provided themselves with this particular commodity, which they proposed to exchange for leaf tobacco, their contemplated transactions became impossible of performance, or were not in fact performed. They then realized the commodity which had become surplus to their requirements. 149

There is the further suggestion in his judgment that the purpose for which the dollars were purchased was a governing factor, and that this purpose characterized their purchase and sale as a revenue transaction. He says: We have here a finding of fact as to the purpose for which the dollars were bought. The purchase of .the dollars was the first step in carrying out an intended commercial transaction, namely, the purchase of tobacco leaf. The dollars were bought in contemplation of that and nothing else. The purchase, on the facts found, was, as I say, a first step in ,the carrying out of a commercial transaction, which would be completed by the purchase and delivery of ,the leaf and payment of the dollar purchase price for it. We must decide this case having regard to the facts as found. In ,t he light of those facts, the acquisition of these dollars cannot be !regarded as colourless. They were an essential part of a contemplated commercial operation . . . . To reduce the matter to its simplest elements, the appellant company has sold a surplus stock of dollars which it had acquired for the purpose of effecting a transaction on revenue account, 150

This reasoning again illustrates that the income arising from purchases and resales is clearly dependent on the underlying gainful intention with which they are undertaken. Expropriation payments An expropriation of trading assets cannot very well be regarded as an aspect of a trading or business activity. Yet the reasoning in the English cases has gone this far in viewing expropriation as a form of forced sale. In Commissioners of Inland Revenue v. Newcastle 149Ibid., at p. 121. 1 GOibid., at p. 121.

110

THE MEANING OF INCOME

Breweries, Ltd. 151 a company carried on the business of brewers and wine and spirit merchants, in which they imported raw rum, reduced and blended it, and then sold it either through the company's own retail outlets or wholesale. In 1917 the British Admiralty, acting under the Defence of the Realm Act, expropriated a large amount of the raw rum held in storage by the company, paying it ,a price which allowed for a profit, on which the company was assessed for excess profits tax. The commissioners discharged the assessment, but they were reversed by Rowlatt J. who held that the profit arose from the trade. This decision was upheld by the Court of Appeal and the House of Lords. The argument advanced on behalf of the company was that it did not carry on trade in raw rum, and that an isolated and compulsory transaction in such a large quantity of raw rum could not be considered part of its trade, but was an interference with and partial destruction of that trade. This argument was not accepted. Rowlatt J. treated the expropriation as a sale, and says: The subject that was dealt with was rwn. The respondent company bought the rwn to keep it for a bit, to deal with it a little and then to sell iii: again at a profit. Before they had finished dealing with it, ibefore its maiturity was complete, and before it was blended, and so on, the Admiralty took it and paid, as I have said, a price .for it. . . . Now what is that except a compulsory sale of the rwn? It seems to me, when you really look at the substance of the thing, it is in a very small compass. That is all it is: a compulsory sale of the rwn.1112

On appeal, Lord Hanworth also regarded the expropriation as a trading transaction, though his judgment suggests the view that in any event the profit arose from a circulating capital asset. After referring to the cases deciding that an isolated transaction may be in the nature of trade and give rise to taxable profit, he says: It is difficult, therefore, to accept any distinction in favour of the appellants,

based upon the faot that the rwn actually taken by the Admiralty was not in a condition in which rwn was sold in their business by the appellants. If it is to be held a transaction of trade or business of any description, whether continuously carried on or not, it is covered by the charge. Nor is it easy to accept the argwnent that as the transaction was carried out under a compulsory requisition, it cannot be treated as falling within trade or business.... The rwn-even if in a different strength-was intended to be sold at some time in the carrying on of the appellants' business. Its requisition caused it to be dealt with sooner than later; but along the same channel down which it was always intended that it should pass from the appellants' possession, namely, by sale. Their trade was not stopped altogether, and 1 5 1 (1926) 134 L.T.R. 506, Rowlatt J.; (1926) 135 L.T.R. 618 (C.A.); (1927) 137 L.T.R. 426 (H.L.). 152( 1926) 134 L.T.R. 506, at p. 510.

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the rum was in time replaced. Both the rum and the sum paid for it were of the nature of circulating capital. ... u;a The judgment of Warrington L. J. suggests the same distinction: The rum in question was a commercial asset capable of being put to a use by which gain might be acquired. It has been put to such a use and gain has been so acquired, and it seems to me . . . the fact that the appellants were not free agents in the matter is irrelevant. It was, no doubt, an unusual mode of deriving gain from the particular asset, but as I have already pointed out this fact Is not enough to prevent that gain from entering into the account of profits arising from the business of which it was an asset. 154 The House of Lords affirmed the decision on substantially the same reasoning. The judgments in all three courts distinguished an earlier expropriation case, Glenboig Union Fiteclay Co., Ltd. v. Commissioners of Inland Revenue,155 on the ground that it involved a partial destruction or interference with a business. The company in question carried on the business of processing fireclay, deriving this raw material from land which it owned. During the war a portion of the fireclay lands were expropriated and removed. Compensation was paid on the basis that the quantity taken represented raw material for two and one-half years of operation. The House of Lords held that the gain realized through the expropriation was not income in that it was compensation for the destruction or deprivation of a capital asset which prevented a realization, through trading, of the full value of that capital asset. The trading and non-trading distinction thus drawn between these two cases is difficult to follow. It seems more reasonable to distinguish between the land expropriated in the latter case as a fixed capital asset, and the rum expropriated in the former as a circulating capital asset. In the case of Sutherland v. Commissioners of Inland Revenue, 156 also referred to in the Newcastle Breweries Case, the appellant owned a steam drifter with which he carried on the business of fishing. During the war his ship was taken over by the Admiralty and he was paid compensation for its use. He argued, in appeal from his assessment for excess profits duty, that his fishing business had been brought to an end and the payment had been received as compensation for the stoppage of his trade. While the ship was no doubt a fixed capital asset in his trade, it was pointed out that the compensation was not paid for the ship but for its use. Since income may be received for the 153(1926) 135 L.T.R. 618, at pp. 620, 621. HH[bid., at p. 623. 155(1922) 12 T.C. 427. 156( 1918) 12 T.C. 63.

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THE MEANING OF INCOME

use of assets, any decision that the compensation received was income would seem quite justified. However, this reasoning of the Scottish Court of Session that the income arose from the taxpayer's business and was therefore assessable for excess profits tax is harder to justify. It appears to have been arrived at by regarding the taxpayer's business very broadly, as "that of the employment of a ship for gain in ordinary ship-owning business."151

Insurance payments In the cases discussed so far in connection with established businesses, a gain has resulted from a sale of assets, or from an expropriation of assets, which the courts may regard as a compulsory sale, and the transaction has been classified as part of the trade or business being carried on. This classification is rendered more difficult where, as in the case of insurance proceeds, money is received both involuntarily and in the absence of any form of sale. Where insurance money is received to compensate for the destruction of property connected with a trade, a distinction between capital receipts and income can be much more readily drawn from the distinction between fixed and circulating capital. In the leading English case of Gliksten and Son, Ltd. v. Green, ir;s a quantity of stored timber owned by a company carrying on the business of a timber merchant was destroyed by fire. The compensation received from insurance on the timber represented a considerable profit to the company, on which it was assessed for income tax. It was argued on behalf of the company that, under schedule D, "the tax is to apply to a trade and it is to be computed on the amount of the profits and gains of the trade and . . . that whatever was received in relation to this fire was not a profit or gain of the trade, but that it was something received from the insurance, that the real business that they were carrying on was not that of insuring the timber, but its purchase and its sale."159 The House of Lords decided, affirming the Court of Appeal and Rowlatt J., that the gain was income. Lord Buckmaster's judgment adheres closely to the trading test: It is quite ,true it [the timber] has been converted into cash through the operation of the fire, which is no part of their trade, but loss due to it is protected through the usual trade insurances, and the timber has ,thus been realized. It is now represented by money, whereas formerly it was repret57Jbid., p. 70. The case of Ensign Shipping Co. v. C.I.R., (1928) 139 L.T.R. Ill is decided on similar reasoning. The government paid the appellant compensation for the detention in port during a coal strike of two of its ships loaded with coal. This was held to be a temporary chartering of the vessels by the government and within the company's ordinary business as "shipowners." 158(1929) A.C. 381. t59Jbid., per Lord Buckmaster, at p. 383.

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113

sented by wood. If this results in a gain, as it has done, it appears to me to be an ordinary gain-a gain which has taken place in the course of their trade-none the less because, as Mr. Macmillan put it, and as I think Sir John Simon before him appears to have put it, it is no part of a timber merchant's business to trade in fires.160 Lord Dunedin also seeks to bring the transaction within the meaning of the appellant's trade or business, and does so through reasoning which appears self-contradictory: The whole point is that the business of the company is to buy timber and to sell timber, and when they sell timber they turn it into money. This particular timber was turned into money, not ,because it was sold, but because it was burned and they had an insurance policy over it. The whole question comes to be whether that is a turnover in the ordinary course of their business. I think it was. They had that amount of timber, which they got rid of and for which they got a certain price, and then they could begin again.161 The Canadian case of B.C. Fir and Cedar Lumber Co., Ltd. v. Minister of National Revenue162 gave rise to a slightly different problem since in that case insurance payments were not received for the loss of any asset. The appellant, a lumber dealer, insured its plant and property against fire. It also insured against losses sustained by a suspension of business due to fire under two types of policy: one compensating it for "fixed charges," meaning all standing charges and expenses which would necessarily continue during the time the business was inoperative through fire; and the other compensating it for "loss of net profits," meaning profits that would have been earned in the normal uninterrupted course of business operations. It does not appear to have been doubted that the insurance payments received for the destruction of plant and equipment were capital receipts. However, it was contended on appeal to the Exchequer Court of Canada that the compensation received in respect of "fixed charges" and "loss of net profits" was also not within the meaning of income in the Income War Tax Act. Maclean J. dismissed the appeal, following a decision of the United States Board of Tax Appeals to the effect that such receipts were taxable under the United States Revenue Act. He gave considerable emphasis to the fact that the insurance premiums had been charged to the revenue account of the company. He then adds: The moneys in question were, I think, a gain or profit connected with and arising from the business of the appellant. I cannot conceive of it being anything else. If the same were transferred to a reserve or contingent t60ibid., at p. 384. t6tibid., at p. 385. 162(1928-34] C.T.C. 36.

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THE MEANING OF INCOME

account no deduction could he allowed upon the ground that it was there so placed. It was not a receipt or revenue on account of loss or replacement of capital. 16 3

The same question, arising out of the same facts, was later argued before the Judicial Committee on an appeal under the British Columbia Income Tax Act. 164 The judgment there given is more interesting. The Supreme Court of Canada had held, unanimously, in reversing the British Columbia Court of Appeal, that the receipts for the '1oss of net profits" were not profits earned in the business but an indemnity for profits lost through the absence of the business. 165 The Judicial Committee held that these receipts were income. Portions from the reasoning in the judgment delivered by Lord Blanesburgh are considerably more revealing as to the true nature of income than the majority of the judicial statements considered so far. In distinguishing the receipts from the insurance of business premises from the receipts from the insurance of net profits he would appear to differentiate between insurance for the purpose of protecting business capital and insurance for the maintenance of business income: The main purpose of the respondents, as it is of all similar industrial units, is the acquisition of gain, such acquisition in the case of each unit being effected by the exercise of such of the powers conferred upon it by its constitution as it may determine to exercise. In the case of the respondents acquisition of gain was primarily to result from their carrying on of the business of manufacturers of and dealers in lumber and lumber products. In the conduct of that business they were exposed to ,the grave risk of fire, and the insurance of their premises and plant was an insurance against a possible capital loss dictated by every consideration of prudence. If the risk were not so guarded against, then by a fire sufficiently disastrous the whole operations of the respondents might definitely be brought to a close and acquisition of gain for them definitely ended. But such a fire, even if so far insured against, might still prove a hindrance more or less prolonged to the unbroken acquisition of gain from ,their business by reason of the fact that its continuance might not be possible during the period of reinstatement. This insurance receipt therefore was the product of a revenue payment prudently made by the respondents to secure that the gains which might have been expected to accrue to them had there been no fire should not be lost, but should be replaced by a sum equivalent to their estimated amount. 166

He also acknowledges that the income of the taxpayer need not be profits of the business, though he adopts the reasoning in the Newcastle Breweries Case and Gliksten and Son, Ltd. v. Green in deciding 1aa1bid., at p. 39. 164B.C. Fir and Cedar Lumber Co., Ltd. v. The King, [1932] A.C. 441. 1611(1931] S.C.R. 435. 166(1932] A.C. 441, at p. 446.

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that, in this case, the income arose from the business of lumber merchant. This decision was expressly approved by the English Court of Appeal in Executors of Williams v. Commissioners of Inland Revenue167 where, again, insurance payments were not received in respect of any of the company's assets. In that case a private company insured one of its directors, whose special knowledge in the line of the company's business was of special value to it, against injury or death by accident. The question was whether £15,000 received on his death by accident was income of the company. The director was not bound to the company by any contract of service so that neither he nor his services could be regarded as a company asset. It was held that this insurance was taken out to secure the company against loss of profits and that the proceeds, as representing profits otherwise obtainable, should be brought into the profit and loss account. It is to be noted that in the judgment of the Court of Appeal, delivered by Lord Greene M.R., no attempt is made to bring the insurance payments within the category of receipts from the trade. He simply says: The sole question ... we have to consider is whether or not this sum was in the hands of the company a receipt on capital account. •.. What we have to consider is whether that sum of money received in the circumstances which I have stated and being of the nature which I have stated, is to be treated for income tax purposes as capital or income. 168

The court found that the nature of the receipts was to place the company in income and, in this connection, the important matter to be considered is said to be the "object of the insurance" or the "purpose of the policy." That object or purpose the court found as being "to give the company something to make up for the loss which the company would sustain if it were to be deprived of Crawford's services." Returns from the realization of goods and services fall into revenue account, and, therefore, payments made to replace them fall into the same category. On the same reasoning, an insurance payment in compensation for revenue expenditure such as employees' wages and standing charges during periods of business inactivity is to be regarded as an income or revenue receipt. 169 The above cases ought not to be explained on the basis that the insurance premiums were in fact charged to revenue account by the taxpayer, since that event is obviously not conclusive on the question 167 [1943] 1 All E.R. 318; affirmed by the House of Lords, [1944] 1 All E.R. 381. 1as1bid., at pp. 318, 319. 169B.C. Fir and Cedar Lumber Co., Ltd. v. M.N.R., [1928--34] C.T.C. 36; Murphy v. Gray and Co., Ltd., [1940] 3 All E.R. 214.

116

THE MEANING OF INCOME

of law whether payments received are capital or income. These cases do show that the narrower concepts of trading or business have not operated to restrict the meaning of income in regard to insurance receipts. It is of interest to note the different conclusion that may be reached under the "carrying on of trade or business" test, illustrated by the case of Thomas Merthyr Colliery Co., Ltd. v. Davis,17° in which some doubt is expressed by Slesser L.J. as to the validity of The King v. B.C. Fir and Cedar Lumber Co., Ltd. in English law. 171 It was there held, following Rhymney Iron Co., Ltd. v. Fowler172 that payments made to a colliery association under a scheme for indemnity in the event of deficiency or stoppage of output due to strikes were not deductible as a revenue expenditure in computing profits and gains because not made "wholly and exclusively for the purposes of the trade" within the English Act, which words had been said in the House of Lords in Strong and Co., Ltd. v. Woodifield to mean "for the purpose of enabling a person to carry on and earn profits in the trade."173 However, more will be said herein as to the validity of this dictum when dealing with the problem of deductions. Damage payments Damages comprise another form of receipt which, like insurance receipts, does not arise in the normal but in the interrupted course of a trade or business and for which, therefore, the carrying on business test for income is hardly adequate. Where damages are paid for injury or impairment of capital assets the distinction between fixed and circulating capital may be usefully employed in determining income. But there are difficult cases where the differentiation between an income and a capital receipt by way of damages is more obscure. In Burmah Steam Ship Co., Ltd. v. Commissioners of Inland Revenue174 a shipowner placed a ship in the hands of a firm of ship repairmen under a contract for repairs. The ship was detained beyond the stipulated period and £, 1,500 damages was paid to the owner for the delay. While the ship would appear to have been part of the fixed capital assets in the trade, the damage payment was held to be income in that it was not paid for a reduction in the value of the asset but for injury to the trade through loss of the services of the ship and was a profit or gain of the trade. Lord President Clyde states: In the present case ... when .the Appellant entered into the contraot with the repairers, the consequences of a failure by the latter to deliver punctu170(1933] I K.B. 349. 171Ibid., at p. 372. 172(1896] 2 Q.B. 79. 173(1906] A.C. 448, per Lord Davey, at p. 453. 1 74( 1931) 16 T.C. 67

INCOME FROM BUSINESS

117

ally, which were in the contemplation of both parties at the time, were that the Appellant would be deprived of the opportunity of putting the vessel .to immediate profitable use in his business. It was in respect of this deprivation that the damages were recovered. The contemplated "hole" in the Appellant's profits was unfortunately made, and in my opinion the damages recovered must go, as a matter of 6ound commercial accounting, to fill that ''hole," and therefore constitute a proper item of profit in the Appellant's profit and loss account. t 76 On the same principle, payments as damages for the breach of all ordinary business contracts of the payee are held to belong to the revenue account since they represent an alternative form of realizing gain under contracts entered into for that purpose. Thus, payment to a shipbuilder by a shipping company as compensation for cancellation of a contract for the construction of ships bas been held to be income. 178 Payment ro a firm of manufacturers' agents for cancellation of their agency agreements was also held to be income,177 as was payment to chemical merchants for cancellation of a contract granting them the exclusive right to sell the agricultural chemicals produced by a certain manufacturer. 178 A company carrying on business as steel polishers agreed to introduce a valve manufacturing company to Rolls-Royce, Ltd. in return for a commission on all valves sold by it to Rolls-Royce, Ltd. The contract was later cancelled on payment of a lump sum, and it was held to be income notwithstanding that the company's business was and remained the polishing of steel. 179 In another case a company which carried on business as worsted spinners received lump sum payments by way of compromise, for cancellation, and by way of damages, for breach, in respect of contracts for the sale of yam. These payments were held to be income.180 In all the above cases it was contended that the payments were not received in the ordinary course of the appellant's business. In each case the decision that the payment was income seems none the less reasonable. The evident approach of the courts in each instance is to regard all contracts connected with business as having been undertaken for the purpose of acquiring a gain, and to regard the payments resulting from such contracts as income, unless it can be established that the payment somehow represents the realized value of a capital asset. Contracts relating to assets such as the more permanent machinery and plant connected with a business deal obviously with capital. But t76Jbid., at p. 72. 116Short Bros., Ltd. v. C.l.R., ( 1927) 136 L.T.R. 689. t77Kelsall Parsons and Co., Ltd. v. C.l.R., (1938) 21 T.C. 608. 178Bush, Beach and Gent, Ltd. v. Road, [1939] 3 All E.R. 302. 1 79Shove v. Dura Manufacturing Co., Ltd., [1941] T.R. 5, (1941) 23 T.C. 779. tSORobinson and Sons v. C.l.R., (1929) 12 T.C. 1241.

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THE MEANING OF INCOME

where a contract is large in importance and duration in relation to a trade or business, so as to form substantially the foundation for that business, it may relate to capital notwithstanding that it does not concern a fixed capital asset and confers no proprietary rights. Where ,these contracts are not related to any form of business property the fixed-circulating capital test can be of no value for the purpose of distinguishing capital and income. 181 The decisions disclose that the courts are very reluctant to give contracts this capital classification. A well-known case, and what appears to be the only case, in which a contract has been thus regarded is Van den Berghs, Ltd. v. Clark. 182 In 1908 the appellant company entered into a pooling arrangement with a rival manufacturer of margarine by which both companies undertook to share their profits according to a fixed ratio and to share the use of certain patent rights essential to their business. The agreement was carried out until 1913 when it was extended to 1940. Later on it was terminated by the parties and large payments were agreed to be paid the appellant. It was held that these payments were capital receipts. The unusual importance of the agreements relative to the entire business undertaking is apparent from the judgment of Lord Macmillan: These agreements are called in the stated case "pooling agreements," but that is a very inadequate description of them, for they did much more than merely embody a system of pooling and sharing profits. . . . the cancelled agreements related to the whole structure of the appellants' profit-making apparatus. They regulated the appellants' activities, defined what they might ·and what they might not do, and affected the whole conduct of their business. I have difficulty in seeing how money laid out to secure, or money 181Thus, we have it stated by Lord Macmillan in the case of Van den Berghs, Ltd. v. Clark, [1935] A.C. 431: "I have not overlooked the criterion afforded by the economists' differentiation between fixed and circulating capital which Lord Haldane invoked in John Smith & Son v. Moore ... and on which the Court of Appeal relied in the present case, but I confess that I have not found it very helpful." In John Smith & Son v. Moore, [1921] 2 A.C. 13 two members of the House of Lords held that short-term coal contracts with colliery owners valued at £30,000 were fixed capital assets in the business of shipping and coal merchants. In view of the short duration and frequency of these contracts in the trade the validity of the decision is doubtful. Cases such as Greyhound Racing Association v. Cooper, [1936] 2 All E.R. 742; Bush, Beach and Gent, Ltd. v. Road, [1939] 3 All E.R. 302; Kelsall Parsons and Co., Ltd. v. C.I.R., ( 1938) 21 T.C. 608, show that circulating capital must be viewed more broadly than as capital which is to he turned over and change hands during the course of business. It may be observed that John Smith & Son v. Moore concerned the different problem of deducting expenditures to secure a contract. The decision may also be justified on the view that the purchase price of the contracts represented part of the capital expenditure in the purchase of a business; see City of London Contract Corporation v. Styles, ( 1887) 3 L.T.R. 512 and London Bank of Mexico and South America, Ltd. v. Apthorpe, [1891] 1 Q.B. 383. 182(1935] A.C. 431.

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received for the cancellation of, so fundamental an organization of a ,trader's activities can be regarded as an income disbursement or an income receipt. 183

While this case has often been cited in appeals against the assessment of the proceeds of voluntary and .involuntary cancellations of contracts, this decision appears to be the only one of its kind. Subsidy payments Subsidy payments are classified as income or capital receipts according to the purpose for which these subsidies are paid. If the payment is made to reimburse a trader for his expenditure on capital account it will be regarded as a capital receipt. Otherwise it will be held to be an income receipt. The purpose of the payment is to be judged by reference to the authority under which it was paid. There has been no attempt by the courts to determine the nature of such payments according to whether they fall within or without the trading activities of the taxpayer since, by their nature as voluntary payments, all subsidies would be capital receipts according to such a test. In the recent English case of Higgs v. Wrightson 184 it was held that a government payment to a dairy farmer by way of ploughing grant for each acre of pasture land brought under cultivation was an income receipt. Although it was argued that the cost of breaking land was capital expenditure to the farmer, the court held, having regard only to the statute under which the payment was made, that the payments were income. The statute in question required further acts, after ploughing, with a view to cleaning and preparing the land and making it capable of bearing crops, and it directed payment to the person at whose expense the land had been ploughed up, whether or not he owned the land. The conclusion of Macnaghten J. was that "it [the payment] would seem to be a grant towards the expense of the ploughing and the subsequent operations mentioned" and, accordingly, he affirmed the commissioners' decision that the amount received must be brought into the revenue account of the farming operations. On the other hand, in the recent Canadian Exchequer Court decision in St. John Dry Dock and Shipbuilding Co., Ltd. v. Minister 183Ibid., at p. 442. Each case, it would seem, must be decided on its own facts. "And where you have a payment for the loss of the contract upon which the whole trade of the company has been built, where the expected profits of the contract are used to measure the loss of them for a period of future years, and where in consquence of the loss the company's structure and character are $featly affected, the payment seems to me to be beyond doubt a capital payment. Ba", Crombie and Co. v. I.R.C., [1945] S.C. 271. 184(1944] I All E.R. 488.

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THE MEANING OF INCOME

of National Revenue185 a governmental subsidy was held to be a capital receipt where it was shown to have been made for the purpose of reimbursement for capital expenditures. The appellant company entered into the construction and operation of a dry dock under an agreement with the Government of Canada pursuant to a statute authorizing the payment of subsidies "as an aid to the construction of any dry dock" needed in the public interest and of sufficient size to meet the public requirements. The subsidy payments were in large part expended by the company on revenue expenditures. The conclusion that the payments were not income receipts was arrived at having sole regard to the purpose of the expenditure as disclosed by the act of Parliament and orders-incouncil authorizing its payment. The purpose of the statute the court found to be to secure the construction of a dock in the national interest and security, which finding, of course, does not assist in determining the question whether the legislature intended to fulfil this purpose by subsidizing its construction or by supplementing the income of any firm willing to undertake the project. Further consideration of the statute and documents led the court to conclude that the former was intended. Thorson J. states, in this regard: The subsidy was paid as an aid to its construction, was payable, as section 9 shows, in respect of its construction and its amount was calculated on the ·cost of its construction. That Parliament was concerned with the construction of the dock, rather than with its maintenance or operation, is shown by the fact that no forfeiture of the subsidy payments ,took place if the dock was not, after its construction, kept in repair and working order. In such event the Government: had the remedy of taking possession of the dock and operating it. Parliament also clearly showed that the subsidy was intended exclusively for dock construction purposes by ,the provisions of the Act relating to the issue of bonds. . . . Complete control over everything relating to the issue of bonds was vested in the Government and no consent was given for the issue of bonds that would be a charge on the dock unless the subsidy payments were assigned to the trustee for the bondholders as security for such bonds. Parliament intended by these provisions to make sure that the dock would be constructed and be available in the public interest without any risk that it would ever pass into the hands of the bondholders through any default in payment of the bonds. 186

While, it is submitted, the above considerations form the true ground for the decision, it is of interest that his lordship elsewhere expresses his conclusion in terms of the trade and business test of income. Moreover, the conclusion reached by the approach at185(1944) C.T.C. 106. 186Ibid.,

at p. 125.

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tempted, that the appellant did not engage in the business of dry dock construction, seems somewhat unrealistic. He says: The appellant was not entitled to receive nor did it receive the subsidy in the course of its trade or business operations or because of them. The subsidy was not a trade or business receipt or revenue or an item of trade or business profit or gain. There was no guarantee of trade or business profits or earnings nor was the subsidy given to supplement or increase the operational revenues of the appellant. Indeed, the subsidy payments had nothing to do with the trade or business operations of the appellant at all. It became entitled to them immediately upon construction of the dry dock pursuant to the agreement authorized by the Act. At that time, it was not in the business of dry dock construction and was not yet engaged in the business of operating the dry dock. The appellant, moreover, would continue to be entitled to the subsidy payments even if it never operated the dry dock at all. 187

Summary of principles In conclusion it is to be observed that the concept of income has been liberally interpreted in determining the income of a person who ,is already established in trade or business. The whole approach to finding whether a receipt is an income or capital receipt proceeds by a study of the existing business. The income is described in all the cases as the income of the business, is regarded as belonging to the revenue account of the business and is said to have resulted through the business having been expanded, developed, or carried out in the direction of the source from which the payment has emerged. In this way, gains from isolated transactions of sale and purchase, unusual and accidental bargains, payments in the event of trade stoppage, damage or subsidy payments dependent on the behaviour or will of other persons, are all included in the category of income from the business. The courts would appear to approach the problem by regarding all gains made by a business man as income except to the extent to which they may be shown to represent capital. The trade or business in question is not regarded narrowly, as comprising a fixed process, but is looked upon broadly, as a pursuit of gain through undefined activity in an unlimited sphere. Neither are capital gains identified as being every gain realized by a process which falls outside any pre-identified concept of trade or business. The problem is simply one of deciding whether, on commercial principles, the receipt ought to be entered as revenue or capital in the trading account. These observations are not intended by way of criticism of this approach, which approach, it is submitted, is in conformity with 1 s11bid.,

at p. 121.

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THE MEANING OF INCOME

reason in that it recognizes that a trader, in pursuit of gain, will not necessarily follow out his object by a fixed procedure. In other words, these cases establish that carrying on trade or business does not exist as a concept which may be identified along objective lines. However, in contrast with this approach, where the problem is whether income has arisen from an isolated transaction of purchase and sale by a non-trader, a strict concept of carrying on trade or business is constantly being invoked and applied. INCOME FROM MUTUAL TRADING

Much difference of opinion has existed as to whether income accrues to concerns organized and operating according to the wellknown form of mutuals or co-operatives, by which all gains through their activities are repaid to the membership in proportion to patronage. The income tax position of these organizations has been investigated under the authority of parliament both in England and in Canada; and there would appear to be no doubt that, from the standpoint of the economist, these organizations engage in trade and business and, furthermore, that they do so to considerable financial advantage to themselves and their membership. The Canadian Royal Commission on Co-operatives, appointed, inter alia, to inquire into "the present position of co-operatives in the matter of the application thereto of the Income War Tax Act and the Excess Profits Tax Act, 1940'' and to report "all facts which appear .. . to be pertinent for determining what would, in the public interest, constitute a just, fair and equitable basis for the application of the Income War Tax Act and the Excess Profits Tax Act, 1940 to cooperatives and to persons other than co-operatives in respect of methods of doing business analogous to co-operative methods, such as the making of payments commonly called patronage dividends," reported, in response to the argument that mutual organizations did not earn income: If we consider a marketing or supply association and its members as one group of individuals, then the whole of the incomings of this group from the sale of produce is the gross income of the association and its members taken together..•• A cooperative store which sells consumers goods is perhaps in a slightly different position. In this case, the expenses of the •association and its members incurred to outsiders is clear and determinate. However, the goods are not resold by the members; Jbid., at p. 381.

126(1943]

2 All E.R. 255.

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THE MEANING OF INCOME

the risk undertaken. The court looked upon payment by way of compensation for the risk of failure to repay as representing compensation for a depreciation in capital and as an item to be included on capital account. Particular reliance was placed on the fact that payment of a reasonable rate of interest was also provided for under the agreement and that this long-term loan was actually associated with considerable risk. In view of the fact that the securities received were never disposed of in a sale by the appellant the decision may be seen as proceeding far in the separation of the income and capital elements of a lending transaction; and it would appear to lend some remote support to the view ( discussed above) that, in ordinary circumstances, payments in addition to rent to the lessor of wasting assets might not be considered income. In the judgment of Lord Greene M.R. it is admitted that the compensation for risk of capital loss is income where it takes the form of a higher interest rate, and that, where the lender is in the moneylending business, compensation for the assumption of risk will be income: "So long as the moneylender is carrying on his business this is immaterial since he will be assessed under Sched. D, case 1. It is part of his business to take capital risks." In Brown v. National Provident Institution 121 the House of Lords held that the difference between the amount paid for a Treasury Bill purchased at a discount and the amount received where such bill was retained until maturity was taxable within "profit . . . on all discounts." Viscount Cave there observes: "If it were decided otherwise, an easy way would be opened to moneylenders of evading the payment of tax on their interest on short loans"; 128 and, in rejecting the appellant's argument that the profit should be divided between the element of income received for the use of money and the element of capital gain, Lord Sumner states: ".. . there is nothing to show that under this section profits on discounts have to be analysed into a return for the use of money by way of income and a possible accretion to capital.'°129 In Lomax v. Peter Dixon and Co., Ltd. the Court of Appeal distinguished the latter case on the ground that the risk of loss through failure of repayment of Treasury Bills is negligible. This distinction further emphasizes the importance of the facts in deciding each particular case. The English law, pending further consideration of the problem by the House of Lords, can perhaps best be summed up in the words of Lord Greene who assembles his conclusions in the Lomax Case as follows: (i) Where a loan is made at or above such a reasonable commercial rate of int.erest as is applicable to a reasonably sound security there is no pre127[1921] 2 A.C. 222. 12s1bid., p. 238. t29Ibid., p. 255.

169

INCOME FROM PROPERTY

sumption that a "discount" at which the loan is made or a premium at which it is payable is in the nature of interest. (ii) The true nature of the "discount" or the premium (as the case may be) is to be ascertained from all the circumstances of the case and apart from any matter of law which may bear upon the question (such as the interpretation of the contract) will fall to be determined as a matter of fact by the Commissioners. (iii) In deciding •the true nature of the "discount" or premium, in so far as it is not conclusively determined by the contract, the following matters together with any other relevant circumstances are important to be considered, viz., the term of the loan, the rate of interest expressly stipulated for, the nature of the capital risk, the extent to which, if at all, the parties expressly took or may reasonably be supposed to have taken the capital risk into account in fixing the terms of the contract. 130

The separation of income from capital in cases where payment for the use of money is arranged in capital form is expressly provided for in the Canadian income tax acts. S. 3 (2) of the Income War Tax Act provided that where under any existing or future contract or arrangement for the payment of money, the Minister was of opinion that payments of principal money and interest were blended, or payment was made pursuant to a plan which involved an allowance of interest, whether or not there was any provision for payment of interest at a nominal rate or at all, the Minister should have the power to determine what part of any such payment was interest and such part was thereupon deemed to be income for the purposes of the Act. The Income Tax Act contains similar provisions except that the power to determine whether there is any payment of interest is no longer vested in the Minister but is placed in the determination of the courts on the basis of what is reasonable.131 Under this provision, questions of reasonableness, when they arise, they have to be solved on considerations similar to those prevailing in English law. INCOME FROM

Co:MPANY

SHARES

Company shares are well known as a form of personal property and the income arising from their ownership is received in the form of dividends declared and paid by the company. Share ownership comprises membership in a company, conferring on the owner the important right of participating in the control of the company's affairs; and the incorporation of companies with share capital constitutes a well-known method of carrying on business with the benefit of a limited liability. From a practical standpoint the corporation exists as a form of business organization and, from the point of view of 130(1943] 2 All E.R. 255, at p. 262. 131Jncome Tax Act, s. 7.

170

THE MEANING OF INCOME

economics, the income of the corporation and of the shareholders arises from the same source. Shareholding involves the direct ( though limited) assumption of business risk and the control and practical ownership of the corporate business. The declaration of a corporate dividend may be viewed as an act of distribution by the shareholders of income earned through the intermediary of the corporate organization. But the question of ascertaining the income derived from shares is decided with strict regard to the legal fiction of separate corporate entity. In law the corporation is more than a device for the safe conduct of business. It exists as a separate person or entity and the property and income of corporation and shareholder are separate. The shareholder owns only the shares which alone constitute the source of his income. This legal view may appear more or less artificial and unrealistic, depending on whether we have in mind a closely held corporation of four or five persons or a corporation which comprises many thousand unrelated shareholders. In English law, the double taxation of income, in an economics sense, does not normally occur. Tax is imposed on income at a standard rate and at the source of income. According to the general rules 19 to 21 applicable to all schedules of the English Income Tax Act, where interest, annuities, dividends, or patent royalties are paid out of profits or gains brought into charge to tax, the payer is entitled to deduct and retain the amount of tax at the standard rate, thus recovering the amount of tax he has already paid. Where like payments are not made out of profits or gains, e.g. where they have been allowed as a deduction in computing profits or gains of the payer, the tax on such payments must be collected by the payer and remitted to the Crown. Share dividends are not allowed as a deduction and the company must therefore deduct the tax when paying them. Rule 20, applying in particular to the taxation of share dividends, reads as follows : 20. The profits or gains to be charged on any body of persons shall be computed in accordance with the provisions of this Act on rthe full amount of the same ,before any dividend thereof is made in respeot of any share, right or title thereto, and the body of persons paying such dividend shall be entitled to deducrt the tax appropriate thereto.

The view of the English courts on the situation prevailing under this rule is well described in a recent judgment of Lord Atkin where he states: My Lords, irt is now clearly established that in the case of a limited company the company itself is chargeable to tax on its profits and that it pays tax in discharge of its own liability and not as agent for Its shareholders. The latter are not chargeable wirth income tax on dividends, and they are

INCOME FROM PROPERTY

171

not assessed in respect of them. The reason presumably is that the amount which is available to be •distributed as dividend has already been diminished by tax on the company, and that it is thought inequitable to charge it again. At one time it was thought that the company, in paying tax, paid on behaH of the shareholder; hut this theory is now exploded by decisions in this House; and the position of the shareholders as to tax is as I have stated it. 132

However, English common law would unquestionably require that the income from shares be regarded separately from the company profits or fund out of which such income is paid. Thus, for purposes of super-tax, imposed in England on all persons with reference to income from all sources, the dividends from shares are to be taxed in the hands of the shareholder. 133 Again, the general rules mentioned above have no application to the receipt of dividends from foreign companies, and the House of Lords has recently decided that the dividends received in the United Kingdom from a foreign company are subject to income tax notwithstanding that the company profits from which ,t he dividends were paid were received from the United Kingdom and have already borne United Kingdom income tax through either taxation or deduction at the source. 134 Their lordships are careful to point out that, in law, this practice does not involve the double taxation of income since the income of a corporation and the income of a shareholder are separate incomes arising from different sources. Upon examining the problem in the light of the common law rule of interpretation against the double taxation of income under the English Act Lord Russell states his conclusions thus: I am unable to state, or justify, any principle ( to be implied from the Acts

or existing at common low) to support the view that it is illegal for the

Crown to levy and retain the tax on the full amount of its profits distributed in dividends declared by a foreign company in favour of a shareholder resident here, because some part of the income out of which those dividends have been declared can be traced back to a source in which it has been taxed in the United Kingdom. . . . This theory about double taxation in the circumstances mentioned has no doubt arisen from the fact that in the legislation relating to income tax a departure has been made in one respect from the consequences which should logically have followed from the fact thait a limited company is a legal entity separate and distinct from the individuals who are the owners of its share capital. Logically there would be no answer to the view that a company's income is one taxable income and that the profits which it distributes to its shareholders out of its taxed 132Cull v. I.R.C., [1939] 3 All 133J.R.C. v. Neumann, [1934]

E.R. 761, at p. 763. A.C. 215. 184Canadian Eagle Oil Co., Ltd. v. The King, [1945] 2 All E.R. 499, overruling Gilbertson v. Fergusson ( 1881) 7 Q.B.D. 562. See also Barnes v. Hely Hutchinson, [1939] 3 All E.R. 803 (H.L.) .

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THE MEANING OF INCOME

income in dividends is another and new income, taxable again in the shareholder's hands. But, as was said by Lord Phillimore in Bradbury v. English Sewing Cotton Co. •.• "Their [i.e. the shareholders] taxa,tion would seem to be logical, but it would be destructive of joint stock company enterprise...."135

The same principle was affirmed and again applied by the House of Lords in their very recent decision in Inland Revenue Commissioners v. Reid's Trustees.136 The question there in issue was whether dividends declared and paid by a foreign company out of capital gains were taxable in the hands of the appellant shareholders as "income arising from possessions out of the United Kingdom" within case 5 of schedule D of the English Act. It was held, reversing the Scottish Court of Session, that the income of the shareholders was derived from the shares and not from the capital assets of the company. The shares, being the source of income, had been in no way diminished and the amount received from them could not properly be regarded as a return of capital. "The tree owned by the trustees, whereof this sum was the fruit, was their holding of 3,433 shares ... ."137 The views expressed by Lord Macdermott are representative of the opinions held by all their lordships. He approaches the problem according to what he terms the "true income" rule, meaning the common law rule, apart from the special provisions of the English Act applicable to English company dividends. He concludes: This dividend, then, was income arising from the trustees' shareholding, and the question, accordingly, reduces itself to this: Is it permissible, in order to determine the liability of the dividend to tax in the hands of the respondent shareholders, to look beyond the immediate source, the shareholding, and to examine the make-up of the profits out of which the dividend has been declared. In my opinion, the answer must be in the negative. Apart from the difficulties of ascertaining in the United Kingdom the facts relating to the internal management of a foreign company, the process of exploring payments beyond their immediate source, if once admitted for this purpose, would have no end. The matter, however, does not rest merely on considerations of convenience or expediency. The trustees and the company are distinct entities, and must be so regarded, but, if the answer to the question now under discussion were in the affirmative, the words of case V "income arising from possessions" would have to be read as relating to the possessions of the person charged or, at his option, to the possessions of someone else instead, and that is a cons-truction for which I am unable to find any justification either in principle or authority. If I am right in this, it means that the application of the true income rule has to be determined by reference to the dividend and the shareholding alone, 135Canadian Eagle Oil Co., Ltd. v. The King, [1945] 2 All E.R. 499, at p. 508. 136(1949] 1 All E.R. 354. 131[bid., per Lord Morton, at p. 362.

INCOME FROM PROPERTY

173

but here the shareholding, which was the only relevant capital in the trustees' hands, rested as it was, and the dividend cannot, therefore, be said to have contained an element of capital. No doubt, the shares abated in market value after the payment of the dividend, but they nevertheless remained intact. The ripe tree loses weight and worth when it sheds its fruit, but the fruit remains fruit and no more unless in its fall it has taken part of the tree with it.1ss

In Canada, where income tax is imposed on persons and is measured with reference to their income from all sources, the multiple taxation of income derived from the businesses of incorporated companies is the rule rather than the exception. Originally, for purposes of a "normal tax," payable on all individual incomes of less than $6,000, the Canadian Income War Tax Act expressly provided ins. S (1) (d) against the "double taxation" of company profits, as follows: ( d) for the purposes of the normal tax, the income embraced in a personal return shall be oredited with the amount received as dividends upon the stock or from the net earnings of any company or other person which is taxable upon its income under this Act: Provided, however, that in determining the income the personal and living expenses shall not be taken into consideration.

In addition to "normal tax" a "super-tax" was imposed at a graduated scale on all incomes in excess of $6,000 and in this connection no allowance was made for the taxes already paid by corporations on their profits in determining the tax on the income from shares. Since 1925 a single schedule of graduated tax rates has applied to all personal incomes and the allowance for tax paid on company incomes has been removed. 139 Companies carrying on business or resident in Canada are now taxed at corporation rates while both resident and nonresident shareholders pay personal income tax on dividends when they are received. 140 However, exceptional provision is made in the case of personal corporations, where the corporation is ignored and the corporate earnings are taxed as if they were directly received by the shareholders. 141 Apart from this provision, however, personal corporations are to be regarded as separate entities in Canadian tax law. 142 By way of added exception, companies deriving practically all their income from investment in stocks, bonds, and securities are exempted ISBJbid., at p. 363. 139 16-17 Geo. 5 (Can.), c. 10; applicable from Jan. I, 1925. 140Jncome War Tax Act, s. 9 (1) (2); Income Tax Act, ss. 2, 31, 36, 96, 127 (1) (ab). 141Jncome War Tax Act, ss. 21 and 2 (I) (i), Income Tax Act, s. 61; and see also the explanatory observations of Maclean P. in Black v. M.N.R., [1928-34] C.T.C. 82. 142Wilson v. M.N.R., [1938-39] C.T.C. 161; Richardson v. M.N.R., [1940-41] C.T.C. 258.

174

THE MEANING OF INCOME

from paying corporation income tax, thus relieving taxpayers from what would be triple taxation on income, in the economics sense.143 Similar considerations led to the exemption from corporate tax of the dividends received ,by one corporation from another.144 Also, the income of foreign companies with their business and assets situated outside Canada is exempt from corporate tax.145 Apart from these and other lesser exceptions, income tax has continued to be levied both on companies and on shareholders with respect to income from the same true source. A change in this general policy, introduced in 1949, gave some measure of relief from the taxation of income from shares. In his budget speech of March 22, 1949, the Minister of Finance explained the purpose and content of these proposals as follows: Today we find governments in this country, as well as in most other countries, taxing away at least a third of corporate profits. In addition, the personal income tax rates apply in full to what is distributed out of the remaining two-thirds. The tax may be as high as 80% upon distributions to shareholders. It seems to me that under a system of private enterprise which depends for its existence on a steady flow of venture capital we cannot afford to neglect the implication of this defect in our tax system, which has been accentuated by the increase in both corporate and personal income tax rates ... . it [this question] is a matter of concern for the future under a system where we depend, and must depend, for full employment and the creation of new wealth on the willingness of our people to risk their money in constructive enterprises. As a first step in dealing with ·this problem I am proposing that Parliament should allow individuals a credit against their personal income tax equal to 10% of the dividends they receive from common shares of Canadian taxpaying corporations. While I have used the expression "common" shares, the law will actually confine the credit to the most junior class of shareholders of a company, and it will not be granted in respect of shares that enjoy any special preference. Generally speaking, the incidence of the corporate tax is upon the common shareholders, and I believe that they rather than preferred shareholders should be granted such relief as can be given at this time.146 At the present time, this amendment allows the deduction of 10 per cent of the dividend received from taxable Canadian corporations 143Income War Tax Act, ss. 4 (w), 9 (8) ; Income Tax Act, ss. 57 (1) (l), 62. Under the Income War Tax Act investment companies were exempted only to the extent of one-half the normal corporations tax if they had oustanding bonds or other securities evidencing funded indebtedness. See s. 9 ( 8). Under the Income Tax Act this requirement is no longer necessary in order to claim complete exemption. 144lncome War Tax Act, s. 4 (h); Income Tax Act, s. 27 (1). 145Income War Tax Act, s. 4 ( k); Income Tax Act, ss. 57 ( 1) ( m) and 64; and see Alberta Pacific Consolidated Oils, Ltd. v. M.N.R., [1946] C.T.C. 296. 146House of Commons Debates, vol. 88, no. 40, 5th Sess., 20th Parliament, March 22, 1949, p. 1799.

INCOME FROM PROPERTY

175

irrespective of the class of share on which such dividend was declared.147 In view of the very heavy incidence of taxation on the income earned through the corporate form of enterprise, it is not surprising that every effort should have been made by shareholders to realize the wealth coming into the hands of companies without further payment of income tax. This objective is attainable by three methods, (a) by avoiding the receipt of dividends, ( b) by realizing capital gains on shares, and ( c) by entering into profitable bargains with and at the expense of the company. Income arising from the last of these methods will be determined as income arising from business. The realization of income or capital gains by any but bona fide transactions with the company appears now to be effectively precluded by the Canadian acts.148 The two former methods directly concern the problem of income arising from share ownership and their application forms a necessary background to the many provisions of the Canadian Acts relative to dividend profits.

The receipt of income by shareholders From the legal rule that companies and their shareholders are separate both as to person and as to property it follows that no part of the income of a company is the income of any shareholder. Undistributed company profits remain the property of the company. 149 Income from shares arises only upon the company's declaration and payment of an income to shareholders in the form of a dividend or bonus. Here again, the term by which payment is described does not affect its nature as income. The common law rule that income must be received might appear to have been altered, with respect to income from shares, by the definition of "income" in s. 3 ( 1) of the Income War Tax Act which provided that income should include the "dividends or profits directly or indirectly received from stocks .. . whether such gains or profits are divided or distributed or not. . . ." The effect of this provision has never been clarified by the courts, but the common law rule seemed clearly reaffirmed by s. 12 of that Act which stated that "dividends or shareholders' bonuses shall be taxable 147Jncome Tax Act, s. 35. 148See the Income War Tax Act, ss. 23, 23A, 23B, 32A ( 1), 32B; and Income Tax Act, ss. 17, 19, 127 ( 5), which prevent the gift, rental, or sale of company property to shareholders or affiliates for inadequate consideration in order that the latter may realize a gain thereon free of income tax. But see the recent decision in Robson v. M.N .R., [1951] C.T.C. 201, and the editorial comment thereon. That decision appears to show that an unprofitable bar~ain entered into with the company may result in the distribution of a "dividend' where the asset sold to shareholders was purchased from distributable surplus and the transaction was carried out with the "intention" to distribute that surplus. 149Gagne v. Minister of Finance, [1917-27] C.T.C. 255.

176

THE MEANING OF INCOME

income of the taxpayer in the year in which they are paid or distributed." The same rule prevails under the present Income Tax Act. 160 Share dividends are usually declared and paid in the form of money, whereupon the profit earned by the corporation passes into the hands of shareholders as income. Theoretically, the shares on which dividend is declared suffer a corresponding decline in value. But a decline in value of capital assets does not affect the determination of income arising from them. 151 The dividend on shares may also be distributed in the form of money's worth of the company. For example, in Waterous v. Minister of National Revenue152 a dividend payment in the form of income-tax-free Canadian victory bonds was held taxable. Audette J. there says: The dividend paid and distributed from the gains and profits of the company remains as gain and profit in the hands of the shareholder, whether that dividend is paid in kind, specie or in bond; because it is all through a dividend from, and of, profit and gain; it remains of such nature in the hands of both the company and the shareholder. 153

Again, a dividend declared and distributed in the form of shares in another company has been held taxable as income. 154 The application of a money dividend after it has been declared does not, of course, affect its character as income. Thus, where a dividend is declared to enable the purchase of further shares in the company it is taxable as income received by the shareholder.155 As long as a dividend is declared and paid in money or in some form of property acquired by the company there is no problem of receipt. However, the decided cases give rise to considerable difficulty when a dividend paid in some form of security of the declaring corporation is considered. This problem arose in Inland Revenue Commissioners v. Blott156 in which it was decided that paid-up stock received in satisfaction of a declared dividend was not income in the hands of the shareholder for purposes of English super-tax on income. The facts were that a leather manufacturing company had made large profits. It was not considered advisable to distribute all this profit as dividend ll>OJncome Tax Act, s. 6 (a). v. Guardian Investment Trust Co., [1922] 1 K.B. 347; I.R.C. v. Reid's Trustees, [1949] 1 All E.R. 354, esp. at p. 358. 152[1928-34) C.T.C. 163 (Ex.); affirmed [1928-34) C.T.C. 168 ( S.C. Can.). 153 [1928-34) C.T.C. 163 (Ex. ), at p. 165. The suggestion that to be income a dividend must be paid out of profits and gains seems hardly correct. . 1 MPool v. Guardian Investment Trust Co., [1922) 1 K.B. 347. 1 55Roe v. C.I.R., (1924) 131 L.T.R. 255; Swan Brewery Co. Ltd. v. The King, [1914) A.C. 231, as explained in Commissioner of Income Tax v. Mercantile Bank of India, [1936) 2 All E.R. 857. 156[1921] 2 A.C. 171. 151Pool

INCOME FROM PROPERTY

177

and the company decided that a portion of it should not merely be held in reserve. but should be transferred to capital account by the issue of paid-up second preference shares to the holders of ordinary shares. To comply with the Companies Acts' requirements respecting the issuing of shares for consideration other than cash, a contract was entered into between the company and a nominee for the ordinary shareholders whereby the company agreed to issue and the shareholders to accept fully paid shares in satisfaction of a 33¼ per cent declared bonus on the ordinary shares. However, the courts assumed that the shareholder had no option but to agree to this arrangement. Payment of this share bonus on these terms was then directed by a general meeting of shareholders. The appellant shareholder was assessed for super-tax on the full amount of the bonus as being part of his "total income from all sources." A majority of the House of Lords held that the bonus was not taxable. It might appear that this decision sanctions a departure from the strict view that any gain from shareholding is income as long as the original investment, i.e. the share, remains intact, and that it allowed the shareholder to receive a tax-free gain in the form of a marketable commodity with an ascertainable value. However, it must be pointed out that it was not argued in this case that there had been a receipt of income in money's worth from shareholding, as such. The Crown sought to tax the appellant, not on the money's worth or market value of his share dividend, but on its face value or, more than that, on its face value plus the income tax paid upon that amount by the company before the division, since the bonus was declared "free of income tax" and income tax paid by the company on the profits before division had to be added in order to arrive at the appellant's total income chargeable with super-tax ( as distinct from income tax which had already been paid on this income by the company). The English scheme of taxation imposes income tax only once on the income earned through an incorporated business. The company pays the tax and is then entitled to deduct the tax when profits are paid to the shareholder. "Income" for purposes of super-tax was at this time to be determined as it would be estimated for the purpose of claiming exemption or abatement under the Income Tax Act, 1842. Those claims arose only upon a shareholder suffering a deduction of tax from an "annual payment" of income received by him from profits which had already undergone tax. The question in the Blott Case, therefore, was whether he had been paid in money's worth out of the company's profits; and was not whether he had received income from his share, measured by the

178

THE MEANING OF INCOME

market value of the share accretion received as a dividend. Rowlatt J., the trial judge, decided the case squarely upon the ground that the company's income had not been paid to the shareholder. He says: . .• all that the Inoome Tax Act of 1842 gives one to go upon is the "annual payment" derived by the shareholder from his holding . . . what I do lay stress on is that one has ,to look for a "payment." Now I do not think thait there is a payment of a dividend to a shareholder unless a part of the profits of the company is thereby liberated ito him in the sense that the company parts with it and he takes it. If, in this case, the company could have found means to capitalize their profits and divide them as capital without adopting the machinery of declaring a bonus and allotting shares by agreement (not, be it a observed, a voluntary agreement) in satisfaction of such bonus, I do not think the case would have been arguable. I am asked to decide that there was a "payment" of this bonus upon the sitrength of what I consider hare machinery. I cannot do so. The fact is simply that the shareholder was given shares instead of a bonus. 157

In the House of Lords, Viscount Cave adopted the same view: "The question is whether there was a distribution of profits among the shareholders in money or money's worth. . . . The transaction took nothing out of the company's coffers, and put nothing into the shareholders' pockets; and the only result was that the company, which before the resolution oould have distributed the profit by way of dividend or carried it temporarily to reserve, oame ,thenceforth under an obligation to retain it permanently as capital. It is true that the shareholder could sell his bonus shares, but in that case he would be realizing a capital asset producing income, and the proceeds would not be income in his hands. 158

His lordship then proceeded to follow the property settlement case of Bouche v. Sproule and to indicate that in his opinion the company had made a distribution of its capital. Viscount Finlay also approved of what Rowlatt J. had said, but he too was inclined to the view that there had been a capital distribution; while Viscount Haldane stressed the capital distribution. Lord Dunedin and Lord Sumner dissented. They both regarded the transaction as amounting to a payment of profits to the shareholders to be applied, by agreement, in the purchase of preference shares. We will leave aside, for the time being, the reasoning by which there was held to be a capital distribution. Their lordships' decision that there was no release of company income to shareholders is not helpful in deciding the question whether there was a receipt of money's worth from share ownership, as such. There would appear to be no doubt that, as their lordships admitted, there had been a beneficial receipt in money's worth in that case. The only relevant question from 157[1920] 1 K.B. 114, at p. 133. 158[1921] 2 A.C. 171, at p. 200.

INCOME FROM PROPERTY

179

the Canadian tax standpoint is whether that benefit was capital or income. The problem of payment of company income to shareholders was again considered by the English courts in the case of Fishers Executors v. Inland Revenue Commissioners, 159 where a company's distributable surplus was "capitalized" in the company's accounts by creating and issuing debenture stock to ordinary shareholders in satisfaction of a bonus declared on the shares. Again, as in the Blott Case, the shareholders had no option but to accept this debenture stock. This stock was a charge on the company's business and assets, was enforceable upon the happening of certain events, and was redeemable after six years at the company's option. A shareholder was assessed for super-tax on the amount of the bonus paid to him in debenture stock and, again, the question was whether the company's profits had actually been paid to its shareholders. Rowlatt J. was of the opinion that to issue a realizable security upon property is to place part of that property in the hands of the person to whom it is issued, and, therefore, that the shareholder had been paid part of the undivided profits payable to him by way of declared bonus. He was further of the opinion that the face value of the debenture stock was not a proper measure of this payment and he ordered the case back to the commissioners for an assessment of the stock's worth. The Court of Appeal, following the Blott Case, reversed Rowlatt J. on the principle that the company had parted with none of its assets and could not, therefore, be taken to have distributed any profits. Pollock M.R. and Warrington L.J. also suggest that, as in the Blott Case, the company profits had been "capitalized" and could not therefore be considered income. On appeal to the House of Lords this decision was upheld. Viscount Cave L.C. and Lord Shaw were of the opinion that no payment had been made or received because no assets had been parted with. Viscount Cave says: The oompany was master of the situation, and it elected definitely and irrevocably not to distribute the fund as income, but to impound and apply it as income-producing capital; and that election, if made ( as I do not doubt that it was made) in good faith, was binding on the shareholders and could not be questioned by the Crown. No doubt, the shareholders got debenture stock which, like the shares in Blott's Case, was a valuable thing; but ·they had no power to call in the stock, which gave them no present right to receive any part of the company's assets either in money or in money's worth, but only entitled them to a sum to be carved out of those assets i.f and when the stock was paid off. It is true that debenture stock, unlike shares, creates a debt; but the debt in this case was not presently 159 (1925]

1 K.B. 451; affirmed [1926] A.C. 395.

180

THE MEANING OF INCOME

payable and may never become payable while the company is in existence. The whole transaction was "bare machinery" for capitalizing profits and involved no release of assets either as income or as capital. 160

It may be noted that the debenture stock was a form of marketable property and undoubtedly of ascertainable worth. Yet Viscount Cave and Lord Shaw had no hesitation in regarding the true nature of this property as a secured obligation to pay in the future. But Lord Sumner, in following the Blott Case, also felt constrained by that case to hold that the company's profits had been "capitalized" by act of the company and were not distributed as income. Lord Shaw also endorsed this view. In Associated Insulation Products, Ltd. v. Golder161 a shareholder in England had been paid a 16 per cent dividend on shares of a foreign company by the issue to him of interest-bearing certificates of indebtedness payable four years later. The question was whether he had received "income arising from securities out of the United Kingdom" either in the year in which the certificates were issued or the year in which they were redeemed. The court did not view the acts of the corporation as amounting to a "capitalization" of profits and the problem of receipt of share income was here considered apart from any possible effects of that doctrine. It was held that income was received only upon payment pursuant to the certificates of indebtedness. Again, the certificates of indebtedness constituted a valuable and realizable security. But the courts adhere to the view that where a promise to pay dividends is accepted in satisfaction of an immediate obligation to pay them, its receipt does not constitute an execution of the obligation to pay. This principle is firmly established in English law and has been fully explained and applied to the case of dividend payments in the recent Canadian Exchequer Court decision in Flinn v. Minister of National Revenue. 162 There, a company declared a dividend of 31¼ cents per share in respect of its 7 per cent cumulative preference stock. By the provisions of the resolution declaring the dividend, payment was postponed for twenty years and, as evidence of the right to receive such dividend, dividend notes payable in twenty years were given for the amount involved. It was held, following the English authorities, that the appellant was not assessable in respect of the notes. Angers J. concludes: A careful perusal of ·the Act, of the doctrine and of the precedents has convinced me that the dividend note for $47.25 dated the 22nd day of December, 1944, payable on December 15, 1964, or on such earlier date 160(1926] A.C. 395, at p. 403. 162 [1948] C.T.C. 90.

161(1944] 2 All E .R. 203.

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as the principal monies of the note become payable in accordance with the conditions endorsed thereon, received by the appellant from the United Service Corporation Limited, is not "interest, dividends or profits" received from "91:ocks" during the year 1944. In my opinion, it will only acquire that quality when it is paid. Presently it merely constitutes an acknowledgment of debt in so far as the company is concerned and a claim with £egard to the appellant. Like many other claims it may never be satisfied. 163

The effect of this decision is now overborne by amendment to the Canadian income tax acts requiring that the value of any such security be included in computing the income of the recipient. 164 But even at common law, the situation might be different where a dividend is both declared and paid in money's worth in such form as certificates of indebtedness. 165 An obvious method by which shareholders might acquire the benefit of company profits without undergoing a receipt of any dividend income on the shares is that of borrowing distributable surplus from the company. The funds of a company might be distributed to a shareholder by way of loans which might then be allowed to remain unpaid indefinitely. Thus, in Sansom v. Inland Revenue Commiss-ioners 166 a company lent money to a shareholder holding all but one of its shares. These loans were made without security, were free of interest, and were evidenced only by a debit entry against the shareholder in the company's ledger. It was held that the shareholder had not received any income from the company. The Canadian income tax acts provide against this practice by deeming such loans to be a dividend. 167 The reaUzation of capital from shares We have stressed that the property and income of a company is not owned by the individual shareholders. The shareholder owns only the share. This share may be sold at a profit, in which case the shareholder will realize the capital value of his property and will not be taxable on any gain from such sale notwithstanding that the increased value of the share may be due to the accumulation of large undistributed profits in the hands of the company. Conversely, where a dividend has been declared and paid to shareholders, the nature of the at p. 107. 164Jncome War Tax Act, ss. 3 (11), 12; Income Tax Act, ss. 24, 68 (6). 165See the judgment of Scott L.J. in Associated Insulation Products, Ltd. v. Golder, [1944] 2 All E.R. 203, at p. 203, and the discussion supra, p. 40. 166(1921] 2 K.B. 492. 167The Income War Tax Act, s. 18, which deemed such loans to be income received by the shareholder in the year they were made to the extent that the corporation had undistributed income on hand. The Income Tax Act, s. 8 (2), makes similar provision but does not require that there be undistributed income on hand. 163Ibid.,

182

THE MEANING OF INCOME

fund from which it has been paid has no bearing on its receipt as income in their hands. Thus, it has been held that dividends paid from company income exempt from income tax are none the less taxable.168 The recent decision of the House of Lords that dividends paid out of capital gains from a sale of fixed company assets are taxable income is in full accord with this principle.169 The terms of the taxing statute may of course require that the corporate fiction be disregarded and attention be paid to the income fund of the company in determining the income received by the shareholder. Thus, in Gilhooly v. Minister of National Revenue, Cameron D.J. sanctioned the deparbnental practice of allowing taxpayers a deduction for depletion from their income from shares in mining companies under s. 5 of the Income War Tax Act, which granted a depletion allowance "in determining the income derived from mining." "The emphasis in that section," he says, ". .. is on the derivation of the income-not on the recipient-and I have no difficulty in reaching ,the conclusion that a shareholder in a mining company does derive his income from mining and is clearly entitled to the deduction established from time to time by the Minister."170 Again, as already noted, the Canadian acts disregard corporate entity in specially providing for the taxation of income of personal corporations as if it were directly received by the shareholders. A very special situation also prevailed under the English income tax acts with regard to the computation of share dividend income for purposes of super-tax. The English acts required that "total income" should be calculated in the same way that it is calculated for claiming the income tax reliefs of exemption or abatement, which meant that shareholders' income, to be taxable, had to be paid out of company profits already subjected to income tax. In the case of Inland Revenue Commissioners v. Blott discussed above it was decided that a paid-up preferred stock dividend on common shares was not liable to super-tax. Strictly regarded, the decision turned on the fact that the company's income had been capitalized and thereby retained by the company. Yet this decision has marked the beginning of an important development in the law distinguishing capital and income gains from share ownership. The majority of the judgments delivered in the House of Lords suggested that the share dividend was a capital receipt in the hands of shareholders. This aspect of those judgments has received 1681n re Thomas Jackson & Sons, [1935-37] C.T.C. 166 (S.C. Can. ); Re Wallace Realty Co. and City of Ottawa, ( 1929) 64 O.L.R. 265; Hope v. M .N.R., (1928--34] C.T.C. 30. 1691.R.C. v. Reid's Trustees, [1949] 1 All E.R. 354. 170 (1945] C.T.C. 203, at p. 219. This practice is now confirmed bys. 11 (2) of the Canadian Income Tax Act.

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183

later emphasis and the doctrine that a share dividend represents a payment on return of capital is now widely accepted. It is important to examine the foundations for this doctrine in order to ascertain its precise nature and extent. The following are the more relevant portions of Viscount Haldane's judgment: What we have to decide is whether the allobnent of bonus shares to the respondent was capital, or was in reality an allobnent of annual profits which conferred a benefit chargeable in his hands with income tax . .. it is, as a matter of principle, within the power of an ordinary joint stock company with articles such as those in the case before us to determine conclusively against the whole world whether it will withhold profits it has accumulated from distribution to its shareholders as income, and as an alternative not distribute them at all, but apply them in paying up the capital sums which shareholders electing to take up unissued shares would otherwise have to contribute. ff this is done the money so applied is capital and never becomes profits in the hands of the shareholder at all. What the latter gets is no doubt a valuable thing. But it is a thing in the nature of an extra share certificate in the company. His new shares do not give him an immediate right to a larger amount of the existing assets. These remain where they were. The new shares simply confer a title to a larger proportion of the surplus assets, if and when a general distribution takes place as a winding up.m

Viscount Finlay says: The general scope and effect of these transactions is beyond dispute. There was an increase in the capital of the company by the retention of the amounts av,ailable for dividends. Though the number of shares was increased by the issue of the new preference shares to the ordinary shareholders, this did not affect the proportions to which they were entitled in the undertaking and in any profits. All the shareholders received these new preference shares, so that the proportion in which they were to share in any profits remained the same. As the capital was increased it might reasonably be expected that the profits of the company would be increased, and that the shareholders would benefit in this way, but their relative shares in the undertaking remained the same. The use of the sums which had been available for dividend to increase capital would enable the company to carry on a larger and more profitable business, which might be expected to yield larger dividends. These dividends, however, were to be in the future. So far as the present was concerned there was no dividend out of the accumulated profits; these were devoted to increasing the capital of the company. . . . What he gained was that the business in which he had the same proportionate interest had become more valuable owing to the increase of capital. Super-tax cannot be levied on such an increase in the capital value of the business. It will be received from time to time on the larger dividend, which it is hoped will be yielded by the increase in the capital put into the business.17 2 171(1921] 2 A.C. 171, at p. 184. 1721bid., at pp. 192, 196.

184

THE MEANING OF INCOME

Viscount Cave also supported the view that the shareholder had realized capital on distribution of this dividend. The majority all relied upon the authority of the property settlement case of Bouche v. Sproule173 which had decided that a remainderman was entitled to a stock dividend in preference to a tenant for life. However, their lordships admitted that this decision had no direct bearing on the problem of distinguishing capital from income for income tax purposes. The above portions of the judgments of Viscount Haldane and Viscount Finlay suggest three lines of reasoning by which a share dividend can be said to represent capital: ( 1) the dividend share, being revenue-producing property, was capital by nature; (2) the dividend share and original share together represented the capital interest formerly represented by the original share alone; ( 3) the company "capitalized" its earnings, thereby converting income to capital. The first of these suggestions seems clearly to be without foundation since it has been held that company shares may be distributed as an income dividend where they are owned by the company. Their lordships' second suggestion appears to have overlooked the fact that every declaration of a dividend results theoretically in a corresponding decline in the capital value of the company's shares. The third suggestion is more elusive. The transactions carried out in the Blott Case fall within the familiar concept of "capitalization" in the field of company administration where, within established limits, a transfer of assets from income to capital account is regarded as a matter of company internal management and free from interference by the courts. That process of capitalization was here held to exclude the share dividend from income assessable for super-tax in the year of its receipt for reasons which we have explained as peculiar to the English income tax acts. Moreover, as was pointed out (but not decided) in the Blott Case, any eventual realization of the capitalized company profits represented by the share would not be income. But this result would not follow directly from the capitalization but would depend upon the English rule of income tax law that the distribution of company profits to shareholders on liquidation or reduction of capital results in a return to them of capital.174 The "capitalization" procedure carried out in the Blott Case has therefore the appearance of effecting a final conversion of income to capital for income tax purposes. Moreover, it would follow from the present analysis that such an apparent conversion of income to capital by process of capitalization would, in order to be fully effective, require that payment to shareholders be 173(1887) 12 App. Cas. 385.

t74J.R.C.

v. Burrell, [1924) 2 K.B. 52.

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185

in the form of paid-up shares or securities which cannot lawfully be redeemed by the company. A dividend in any form of readily redeemable company share or security does not preclude later distribution to shareholders of the company income thereby represented. The decision in the Blott Case has been assumed to have authoritative value and general application outside the English scheme of taxation. This view is assisted by the fact that the capital nature of a share dividend is justifiable on principle.175 If a share be strictly viewed as a species of property, freely marketable and of identifiable value, the declaration of a share dividend leaves the original property investment intact and at the same time confers on the holder a gain equal to the market value of the share. On the other hand, if we examine the original and dividend shares from the standpoint of the rights conferred by them, it is apparent that the rights ( sharing and controlling) conferred by the share dividend correspond to the rights formerly held. The dividend confers benefits which are identical in form as well as theoretically identical in amount with the original share investment. The original investment may, therefore, be viewed as simply continuing in a divided form. It is apparent that this view is weakened when the share dividend confers rights which do not correspond to those held under the original share. In the Blott Case a dividend in second preferred shares was declared on ordinary shares but the extent to which their accompanying rights differed is not fully dealt with since the English courts were not there concerned with any theoretical analysis of the meaning of income. In Fisher's Executors v. Inland Revenue Commissioners176 the English House of Lords appears to have carried this supposed doctrine of capitalization much further than in the Blott Case. It was there decided that where company income was applied in paying up that company's debenture stock issued to shareholders in payment of a declared dividend the shareholders were not liable to the payment of super-tax on the face value of such stock. They would clearly have been liable if the dividend had been paid in cash and then invested by the shareholders in the company. The judgments of Viscount Cave and Lord Shaw appear to be based on two equally valid grounds: (a) the company parted with none of its income, thus omitting an essential requirement from the standpoint of super-tax; ( b) debenture stock is a form of property which, when examined, simply represents a secured promise to pay and this promise to pay did not constitute 175See in this connection the judgments of the Supreme Court of the United States in Eisner v. Macomber ( 1919) 252 U.S. 189, and the discussion in R. F. Magill, Taxable Income (New York, 1945), pp. 24-47. 176(1926] A.C. 395.

186

THE MEANING OF INCOME

payment of the declared dividend. On the question of capitalization, Rowlatt J., the trial judge, was of the opinion that capitalization ·of profits meant only "that the proprietary capital of the company is increased." But Lord Sumner ( who dissented in the Blott Case) and, to a lesser extent, Lord Shaw emphasized that there had been a capitalization transaction in which the income fund of the company was converted to capital. But a transfer of income to the borrowed capital account does not preclude its later distribution to shareholders. It is therefore difficult to accept that their lordships meant more than simply to indicate the handling of the income fund and negative the suggestion that it had been distributed to shareholders. The discussion devoted to capitalization in the judgments of Pollock M.R. and Warrington L.J. in the Court of Appeal is plainly to be interpreted along these lines. However, on facts indistinguishable from the facts of the Fisher's Executors Case, the Judicial Committee of the Privy Council held in Commisswner of Income Tax, Bengal v. Mercantile Bank of India, Ltd. 177 that the issue of redeemable debentures by way of dividend on preference shares was not "income, profits or gains .. . accruing or arising or received" within s. 4 of the Indian Income Tax Act. The judgment delivered by Lord Thankerton does not rely on the reasoning that the dividend had not been paid by giving a promise to pay but appears to rest on the capitalization doctrine of the Blott Case and the Fisher's Executors Case. Neither the Fisher's Executors Case nor the Mercantile Bank Case decided whether a payment on redemption of the dividend debentures would be income. It is this question that would have raised the fundamental problem of whether the capitalization of income in company accounts will effect its conversion to capital in an income tax sense. On principle, it is difficult to justify any suggestion that the manner in which profits are dealt with in the accounts of a company ought to affect the income nature of a dividend paid to shareholders. The English House of Lords has refused to recognize this form of conversion to capital of income payable under contracts178 and their lordships' suggestion in the Fisher's Executors Case or the Mercantile Bank Case that company profits may thus be capitalized appears to have confused the usage of the term "capitalization" in the fields of company law and taxation. Lord Sterndale M.R., in rejecting the argument that mortgage interest which had been compounded by adding it to principal had thereby been capitalized and rendered a capital payment to the mortgagee, observes: 2 All E.R. 857. 11s1.R.C. v. Oswald, [1945] I All. E.R. 641.

177(1936]

INC,O ME FROM PROPERTY

181

I think that the word "capitalization" used in many of the books quoted is a convenient word, but for the purposes for which it has been used in the argument before us it is a fallacious word, because it is taken as referring to capitalization for all purposes, income tax and otherwise. I do not think that is the meaning of the word. In my opinion-not to beg the questionwhen these sums of interest come to be paid at the end of the time when payment is made, although interest has been charged upon them, and although, as a matter of bookkeeping, they have from time to time been added to capital, they do not cease to be interest of money-that is to say, they are overdue interest upon which interest has been paid. 179

We are also inclined to agree with Lord Dunedin who, in dissenting in the Blott Case, observed: "Lastly . . . it is said the company might and did 'capitalize' its profits. I confess I am shy of the word 'capitalize.' It seems to me to leave one in a hazy state of mind as to what is the legal operation which is so described."180 The view that a dividend will not become a payment of capital to shareholders as a result of the manner in which company profits have been dealt with in the internal management and accounts of the company seems more proper. It follows logically from the rule that those profits do not belong to the shareholders. It also appears to be borne out by the Canadian decisions. In Northern Securities Co. v. The King 181 a mining company paid a dividend of two dollars per share from a "depletion reserve fund" which was a capital account of the company set aside out of and as a deduction from company profits with the approval of the Minister of National Revenue. The appellant shareholder contended that this dividend was a return of capital. Maclean J. held that the dividends originated from company profits and that these profits were not made capital in the hands of shareholders by their transfer to a reserve account of the company. His judgment proceeds further in suggesting that even in circumstances where a payment of dividends impairs the capital of a company such dividends retain their character as income from shares. This decision was followed by Angers J. in McConkey v. Minister of National Revenue 182 where the only substantial difference in the facts was that the company's articles of association directed that dividends were to be paid only out of the profits arising from the business of the company. Also, in Bahamas General Trust Co. v. Provincial Treasurer of Alberta183 the Supreme Court of Alberta held that a dividend paid out of a reserve for depreciation was income to the shareholder. Yet in the judgments in both the latter cases there remains the suggestion, no doubt prompted by the Blott Case, that the income of a company 1791n re Morris, [1922] 1 Ch. 126, at p. 133. 180(1921] 2 A.C., at p. 203. 181[1935-37] C.T.C. 23. 182(1935-37] C.T.C. 341. 183(1940-41) C.T.C. 478.

188

THE MEANING OF INCOME

might somehow be "capitalized" by the company and remain capital when paid to shareholders. In the former case Angers J. points out "that until a reserve fund is effectively capitalized it retains the characteristics of distributable profits" and in the Bahamas General Trust Co. Case O'Connor J. says: "It was sound financing to make the bor.::ctceeping entries to set up the reserve [for depreciation] but neither ~uch entries nor the styling of the dividend as a 'depreciation dividend' turned income into capital. Only the investment and maintenance of the reserve fund could do this." It would appear that "capitalization" of profits will be taken by Canadian courts to mean only a permanent and unretractable application of profits to company capital account such as arises upon the declaration of a paid-up share dividend. In Bagg v. Minister of National Revenue 184 a company having $38,091.61 undistributed profits on hand, an authorized capital of $200,000 of 2,000 shares of $100 par value, and an issued capital of 1,800 fully paid-up shares, or $180,000, took out supplementary letters-patent to decrease its authorized capital to $79,200 by cancelling 200 unissued shares of $100 par value and cancelling $56 upon each of the 1800 issued shares, thus reducing their par value from $100 to $44 per share. It was held that this reduction effected a capitalization of the undistributed income on hand, it being shown that that income fund was regarded in the supplementary letters-patent and by the company's accountant as forming part of the available assets of the company on hand in bringing about the new equation of capital with available assets. Rand J. expresses the view adopted by the majority: An increase of capital assets may be effected in several ways, but where the shares are of one class only with the same rights, I see no reason why the company hy such action as was taken here, cannot appropriate profits to lost capital. Whether it does so is a question of intention and it must appear that the appropriation was to be irrevocable.185 The law governing the question of income arising from the payment of dividends on shares is summed up on behalf of the Judicial Committee in Hill v. Permanent Trustee Company of New South Wales, Ltd. 186 While that case concerned the division of profits as between tenant for life and remainderman under a settlement of shares, the following extract from the judgment of Lord Russell of Killowen has been repeatedly quoted and approved in taxation cases, including some of the Canadian cases just mentioned: A limited company not in liquidation can make no payment by way of return of capital to its shareholders except as a step in an authorized re184(1948] C.T.C. 55; affirmed [1949] C.T.C. 316. 185(1949] C.T.C., at p. 331. 186(1930] A.C. 720.

INCOME FROM PROPERTY

189

duction of capital. Any other payment made by it by means of which it parts with moneys to its shareholders must and can only be made by way of dividing profits. Whether the payment is called "dividend" or "bonus," or any other name, it still must remain a payment on division of profits.•. . Other considerations arise when a limited company with power to increase its capital and possessing a fund of undivided profits, so deals with it that no part of it leaves the possession of the company, but the whole is applied in paying up new shares which are issued and allotted proportionately to the shareholders, who would have been entitled to receive the fund had it been, in fact, divided and paid away as dividend. 187 Aside from the declaration of a share dividend, Lord Russell's statement may be seen to allow for two methods by which capital may be returned from a company to its shareholders. The flrst of these is by an authorized reduction of capital; the second is by liquidation proceedings. In Inland Revenue Commissioners v. Burrell188 the capital nature of payments received under both of these methods was confirmed for purposes of English super-tax imposed on income received from every source. Payments pursuant to an authorized reduction of capital are obviously a return of capital. This result was apparently assumed in the trial judgment of Rowlatt J. But the main point of law in that case was whether undistributed profits formed part of the recipient's income for super-tax purposes when distributed by the liquidator on the liquidation of ,the company. It was held that, on liquidation, the profits were received from surplus assets and not from profits. The reasoning on which that conclusion was reached is clearly indicated by Sargent L.J.: In the liquidation of a limited company the distribution of the surplus assets of the company is almost necessarily of a final and non-recurrent character, and reaches the hands of the shareholders quite irrespective of the sources from which the assets have accrued to the company. It is true that so far as the assets can be identified, as here, as having arisen from profits, they might while the company was a going concern have been distributed by way of declaration of dividend; but though this power, if exercised, would have removed the assets from the ownership of the company and divided them amongst the shareholders by way of income, the mere existence of the power while unexercised cannot, in my judgment, have any effect of the kind. These assets, though capable of distribution as income, remain, while not so distributed, part of the general mass of the property of the company and are subject to the debts and all the accruing liabilities and possible losses of the company, and the expenses of any liquidation; and I cannot see enough in the mere history of the accruer of the assets to the 1 81[bid., at p. 731. Quoted with approval in I.R.C. v. Reid's Trustees, [1949] 1 All E.R. 354, at p. 359. Similar principles are affirmed and applied in William's Executors v. C.I.R., (1942] 2 All E.R. 266. 188(1923] 2 K.B. 478; affirmed (1924] 2 K.B. 52( C.A.) .

190

THE MEANING OF INCOME

company to enable a distinction to be made for the present purpose between that part of a final distribution of assets of the company which arises from profits of the company capable of distribution as income, and the other parts of that distribution. A somewhat similar example is that of the purchase of stocks just after the declaration of a dividend and a sale of them just before the declaration of a new dividend at a profit which is practically based on the accrued dividend-a case in which I think that there can be no question of the increased price being taxable as income.189 This decision has been accepted by Canadian courts; 190 but not without some qualification. In Hope v. Minister of National Revenue the suggestion is made that undistributed income is not converted to capital in the event of liquidation in circumstances where the company by-laws require that such surplus shall be used only for the payment of a dividend. 191 Also, it was the view of Angers J., in MacLaren v. Minister of National Revenue, that where income was received by the liquidator during liquidation and distributed to the shareholders it could not be regarded on the authority of Burrell's Case as converted to capital. "Under this system,'' he explains, "a Company could liquidate its business, voluntarily, with the assistance of a liquidator, sell all its assets under long deferred payment agreements and make the liquidation last for years in such a way that its shareholders would withdraw, in dividends, an income derived from the interest paid by the purchasers of the assets and avoid payment of income tax on the same."192 However, as will presently be pointed out, the Canadian acts have been extended to control any widespread tax avoidance through reliance on common law doctrines.

Special Canadian legislation Under the Canadian scheme of income taxation the second ( and frequently more onerous) tax on the income from incorporated business is imposed on the declaration and payment by the company of a "share" dividend. That event is unrelated to the pursuit of the income and it occurs at a time when that income, while in the hands of the company, is reduced to the control of the shareholder-taxpayers without being legally owned or received by them. This plan of taxation has given rise to two problems from the standpoint of the tax administration. The first problem has been to overcome the ingenuity of shareholders in their efforts to withdraw company profits by methods which avoid the payment of tax. The second has been to prevent tax avoidance through withholding distribution of company profits. We have 189(1924] 2 K.B., at p. 73. 190See Re Anderson Estate, [1925] 3 W.W.R. 312. 191(1928-34) C.T.C. 30, per Audette J., at p. 32. l92(1928-34] C.T.C. 135, at f· 146, .

INCOME FROM PROPERTY

191

already noted that the Canadian acts preclude recourse to the methods of borrowing from the company and of the company distribution of valuable promises to pay. Similarly, legislation has been enacted to prevent the conversion of company income to capital in the hands of shareholders and to prevent the accumulation of company profits. S. 19 ( 1) of the Canadian Income War Tax Act was passed to preclude reliance on the principle that company income becomes capital when distributed on a winding-up. That section, in its final form, provided that the distribution in any form of company property on the winding-up, discontinuance, or reorganization of the business should be deemed to be the payment of a dividend to the extent that the company had on hand undistributed income. 193 Similar provision is now contained in s. 73 ( 1) of the Income Tax Act which, on such events, taxes each shareholder on the lesser of his pro rata share of the undistributed income or the value of the distribution actually received by him. S. 32B of the Income War Tax Act also affected the situation on winding-up. It applied to all distributions, on winding-up or otherwise, of company assets among shareholders for less than their market value and empowered the Minister of National Revenue to determine their fair market value which was thereupon deemed to have been received by the company and distributed to shareholders. S. 17 (4) of the Income Tax Act deals with the same situation, but only to the extent of deeming the corporation to have sold the property and received its fair market value. However, s. 8 of that Act provides that where a company confers such value on shareholders it must be included in their income; while s. 73 ( 1), referred to above, which extends to property distributions to shareholders on winding-up, deems there to have been a dividend to shareholders, but to the extent only that the company has undistributed income on hand. Arrangements are sometimes made for the redemption of shares at a premium, or shares may be issued under terms allowing for their redemption at a predetermined price. The fact that in such event the share is surrendered and lost is favourable to the view that any gain in the form of premium is capital gain. S. 17 of the Income War Tax Act enacted that premiums should be included as income where a corporation "redeems" any of its shares. This section was held to apply equally where redemption at a premium was established by letterspatent and where provided for by agreement. 194 But in one case it was 193S. 19 was held to overrule the application to Canadian law of Burrell's Case. See Hope v. M.N.R., [1928-34] C.T.C. 30; MacLaren v. M.N.R., [1928-341 C.T.C. 135. Merritt v. M.N.R., [1942] C.T.C. 80 ( S.C. Can. ); Moose Jaw Flying Club v. M.N.R., [1949] C.T.C. 279; Woon v. M.N.R., [1950] C.T.C. 263. 1otNational Trust Co. v. M.N.R., [1935--37] C.T.C. 35.

192

THE MEANING OF INCOME

suggested that a compulsory purchase of shares at a premium might not be within its scope.195 It may have been to resolve this doubt that the succeeding section, s. 6 (g) of the Income Tax Act was drafted to include as income the premiums paid on the "redemption or acquisition" of company shares. Avoidance or postponment of taxation through any form of legally authorized repayment of company capital was precluded by s. 16 of the Income War Tax Act which provided that the value of any consideration or right received by a shareholder by virtue of a reduction, redemption, or conversion of shares should be deemed to be income to the extent that the shareholder would be entitled to share in a total distribution of the undistributed income of the company. This provision did not extend to the redemption or reduction of preferred types of shares with limited rights of participation in the company's assets. S. 73 ( 2) of the Income Tax Act makes similar provision with respect to the redemption, reduction, or conversion of "common shares," defined by s. 127 ( 1) ( g) to include all shares which entitle the shareholder to participate in the company's assets beyond the amount paid up thereon plus a fixed premium and defined rate of interest. The realization of company income by shareholders through the process of capitalization was prevented by s. 15 of the Income War Tax Act which provided: 15. When, as a result of the reorganization of a corporation or the readjustment of its capital stock, the whole or any part of its undistributed income is capitalized, the amount capitalized shall be deemed to be distributed as a dividend during the year in which the reorganization or readjustment takes place and the shareholders of the said corporation shall be deemed to receive such dividend in proportion to their interest in the capital stock of the corporation or in the class of capital stock affected.

S. 2 ( b) of that Act defined "dividends" to include stock dividends, thus bringing the latter within the statutory designation of income in s. 3 ( 1) of the Act. The word "capitalization" in this section was held to mean the permanent and irrevocable application of company profits to capital account. 196 A shareholder may realize capital gains resulting from company profits apart altogether from transactions between the shareholder and the company. Whenever a company accumulates undistributed profits, whether these profits be retained intact or invested in its business, the value of shares in that company will ordinarily increase. This increase in share value may be realized by various methods, notably through l95Massey Executors v. M.N.R., [1938--39] C.T.C. 440, per Davis 196Bagg v. M.N.R., [1949] C.T.C. 316 (S.C. Can.).

J., at p. 457.

INCOME FROM PROPERTY

193

borrowing on their security or through their outright sale. Ordinarily the selling price of shares in a company having large undistributed profits will be influenced by the fact that eventually income tax will have to be paid by a purchaser, 197 and, leaving aside any variations in the tax rates applicable to the incomes of the vendor and such purchaser, the Crown will eventually suffer no loss of revenue through the transfer of share ownership. But where the purchaser of shares is a company the situation is different in that, as already noted, the Canadian acts exempt from taxation the dividends paid by one corporation to another. Advantage might .therefore be taken of this exemption to avoid tax by means of a sale of shares by a shareholder to a company controlled by him which could realize this undistributed income tax free. S. 14 of the Income War Tax Act was passed to meet this situation by taxing the shareholder on the full amount of any subsequently declared dividend where any part of it was applied directly or indirectly by the controlled company to payment for the purchase of his shares. The exemption of inter-company dividends from taxation might also be used to avoid the effect of legislation deeming corporate distributions to shareholders on winding-up to be a dividend to the extent that the company had undistributed income on hand. Shareholders of a company about to be wound up could incorporate another company and sell their shares to it. A distribution to that company would result in a deemed dividend which would be tax free. The second company could be wound up and its assets distributed, but, since it would have no undistributed income on hand, no dividend would be deemed paid to shareholders. This possibility explains the purpose of s. 19 ( 2) of the Income War Tax Act which provided that in these circumstances the deemed dividend to the second corporation should be taxable. The most far-reaching provision to prevent tax avoidance in this form was contained in s. 32A of the Income War Tax Act which was added to prevent successful recourse to similar schemes extending beyond the strict scope of the Act. That section empowered the Treasury Board to find the main purpose of any transactions through the medium of third parties or the creation of new or intermediary third companies and resulting in receipt of a benefit from a company with an undistributed surplus on hand was "the avoidance or reduction of liability to tax" and, thereupon, deemed the recipient to have received income in an amount determinable by the Board. The Board was given power to make the same finding where substantially all the shares in a company having an undistributed 197See Gagne v. Minister of Finance, [1917-27) C.T.C. 255; I.R.C. v. Farrut, ( 1924) 8 T.C. 704.

194

THE MEANING OF INCOME

surplus were sold to another company. In such event, the dividends paid to that company were made taxable. The Income Tax Act, as will presently be noted, allows the distribution of undistributed surpluses upon the payment of personal income tax provided that the company pays an added tax. S. 27 ( lA) thereof prevents the withdrawal of company income without payment of this tax through a sale of shares to a controlled company. S. 126 continues the broad power of the Treasury Board to make adjustments where it finds that one of the main purposes of a transaction was an improper avoidance or reduction of taxation. The Canadian income tax acts also provide against loss of revenue through the retention by companies of large undistributed surpluses. S. 13 of the Income War Tax Act conferred on the Minister of National Revenue the power to deem there to have been a distribution of undistributed profits which were in his opinion in excess of "what is reasonably required for the purposes of the business." Similar provision was continued in s. 9 (6) of the Income Tax Act. Obviously, this law was difficult to administer. Such direct interference in company management was greatly resented and the retention of large undistributed surpluses was not in fact checked by this legislation. This practice of accumulating profits was objectionable from the standpoint of shareholders as well as from the standpoint of the Crown. In the case of private companies such surpluses were frequently invested in the business and, due to lack of practical alternative methods of financing, could not be readily withdrawn without injury to the business. Shareholders in such companies when suddenly faced with the need for money could not always meet it by borrowing on the security of their shares. Frequently the shares of private companies were not readily salable for value and, even where the shares might be sold, there was a resulting diminution of control of the business. Frequently a demand for large amounts of money arose upon death for the payment of succession duties. In some cases of estates consisting largely of shares, the high rates of income and estates taxation resulted in virtual confiscation of their entire worth. Such considerations, including the threat of a high rate of wartime taxation on surpluses which had been accumulated in prior years of low taxation, led to the appointment in 1944 of a Royal Commission ( the Ives Commission) to study the problem of accumulated surpluses in closelyheld corporations. Following the report of the Commission, Part XVIII was added to the Income War Tax Act which allowed private companies ( defined as companies with not more than seventy-five shareholders exclusive of employees) to distribute as a tax-free dividend

INCOME FROM PROPERTY

195

their distributable surpluses on hand at the end of the 1939 fiscal year upon payment of a special graduated tax. Not all private companies took advantage of this opportunity to dispose of surpluses arising before 1939, and profits earned since that year also continued to accumulate. In 1950 the Income Tax Act was amended to provide a permanent solution to this problem. In brief, these amendments removed the arbitrary power of the Minister of National Revenue to deem profits to have been distributed and provided that upon payment by the company of a special rate of tax on undistributed earnings they might thenceforth be capitalized without any income being deemed paid to and received by shareholders. In 1951 this privilege was extended to public as well as private companies.198 No method of distribution to shareholders following capitalization is laid down by this legislation and such recognized methods as the redemption of a declared share dividend, share reduction or conversion, and winding-up would appear to be equally available for the attainment of that object. 198This legislation is presently contained in ss. 27, 73, 73A, and 95A of the Income Tax Act.

CHAPTER

FIVE

Income from Personal Services received as the direct reward for personal services rendered under contract with another is plainly within the ordinary meaning of "income" or of "profit and gain from any ... source" in s. 3 of the Income War Tax Act. Equa11y, such payment would appear to be within the designation "income . . . from all sources" in s. 3 of the Canadian Income Tax Act. This view is confirmed by Lord Macnaghten in delivering judgment for the Judicial Committee of the Privy Council in Attornl!!J•General of British Columbia v. Ostrum where he interprets the meaning of "income" for purposes of the law of income tax as follows :

PAYMENT

Their Lordships are of opinion that there is no ground for cutting down the plain and ordinary meaning of the word "income." In their view the expression was intended to include, and does include, all gains and profits derived from personal exertions, whether such gains and profits are fixed or fluctuating, certain or precarious, whatever may be the principle or basis of calculation.1

The manner in which such payment is calculated or made does not alter its character as income. In the Ostrum Case payment received by a locomotive engineer and calculated on a mileage basis was held to be income; and income from services may be paid in a lump sum or in instalments. 2 The time of payment is also immaterial and income A.C. 144, at p. 147. which, if paid by instabnents over a number of years, would be income, is income though paid once and for all in a lump sum, just as much as the capital consideration for a sale, say, of land is capital, even though payable by instalments spread over a number of years." Lord Romer in Cameron v. Prendergast, (1940] 2 All E.R. 35, at p. 44. 1 [1904]

2"Remuneration

196

INCOME FROM PERSONAL SERVICES

197

payments may be deferred3 or made in advance of service rendered. 4 The income from personal services is, of course, subject to the usual requirement of being beneficially received but such receipt may be direct or indirect and in money or in money's worth." INCOME FROM OFFICES AND EMPLOYMENTS

No doubt as a matter of caution, the Income War Tax Act provided, by s. 3, that, for the purposes of that Act, " 'income' means the annual net profit or gain or gratuity . . . as being wages, salary, or other fixed amount . . . directly or indirectly received by a person from any office or employment. . . ." The Income Tax Act likewise states, in ss. 3 and 5, that income "includes income ... from all offices and employments"6 and that "income ... from an office or employment is the salary, wages and other remuneration, including gratuities, received by the taxpayer in the year. . . ." On the other hand, the value of gifts was specifically excluded from income by s. 3 ( 1) (a) of the Income War Tax Act which stated that income included the annual profit or gain from any source including "the income from but not the value of property acquired by gift, bequest, devise or descent." While no similar provision is to be found in the Canadian Income Tax Act, the exclusion from income of amounts received by gift is well established in English common law7 and has been reaffirmed by the Canadian courts. 8 The matter of distinguishing gifts from gratuitous payments for services rendered is one of the main problems met with in determining the income from offices or employments. Since either form of payment is entirely without obligation there is obviously no distinction to be drawn from the legal consequences attending both of them. In the absence of authority, it might he supposed that the distinction rests on the proximity of relationship which may be shown to exist between the making of the gratuitous payment and the services rendered to 3 See Riddell v. M.N.R., [1938--39] C.T.C. 66; Henry v. Foster, (1931) 145 L.T.R. 225. 4 Cameron v. Prendergast, [1940] 2 All E.R. 35; Wilson v. Daniels, [1943] 2 All E.R. 732. fiSee In re Gillespie Estate, [1943] C.T.C. 127; Salter v. M.N.R., [1947] C.T.C. 29; Hartland v. Diggines, [1926] A.C. 289. And note also the Income War Tax Act, ss. 3 (1) (e), 3 (4); the Income Tax Act, ss. 5,127 (1) (a). 6"Office" and "employment" are defined in the Act by s. 127 (1) ( aa) and (1). 7"The second class of cases to be excluded consists of gifts and receipts, whether the emolument is from a gift inter vivos, or by will, or from finding an article of value, or from winning a bet. All these cases must be ruled out because they are not profits or gains at all." Ryall v. Hoare, [1923] 2 K.B. 447, per Rowlatt J., at p. 454. BMalkin v. M.N.R., [1938-39] C.T.C. 128; Malkin v. M.N.R., [1942] C.T.C. 135.

198

THE MEANING OF INCOME

or for the benefit of the payor. There is little Canadian authority on which to draw any distinction, and in so far as the matter has been discussed in the English cases, there is always the question as to how far they may be regarded as authoritative or of assistance in Canadian law. In England, prior to 1918, the income from offices and employments was taxed under the Income Tax Act, 1842, schedule E, rule 1, of which schedule s. 146 provided: "The said Duties shall be annually charged on the Persons respectively having, using, or exercising the Offices or Employments of profit mentioned in the said Schedule ( E.) ... for all Salaries, Fees, Wages, Perquisites or Profits whatsoever accruing by reason of such Offices, Employments or Pensions. . . ." The language of the Income Tax Act, 1918, is somewhat different. Again, the income from all offices and employments is taxed under schedule E, 9 rule 1 of which provides: "Tax under this Schedule shall be annually charged on every person having or exercising an office or employment of profit mentioned in this Schedule . . . in respect of all salaries, fees, wages, perquisites or profits whatsoever therefrom. . . ." While the rule of the 1842 Act included all profits "accruing by reason of' any office or employment the present rule includes only the "profits therefrom." While this difference in terminology has not been stressed by the English courts it would appear on its face to be of considerable importance and probably accounts largely for the fact that English decisions on the question of income arising from offices and employments are difficult to reconcile. The reasoning in the case of Herbert v. McQuade 10 is typical of the English cases arising prior to 1918. In that case a clergyman was paid an annual grant of money from the Queen Victoria Clergy Sustention Fund, a body incorporated with the object of providing adequate remuneration for beneficed clergymen. That fund was administered with the aim of raising the incomes of benefices under £200 per year to equal that amount in cases where, in the opinion of the administrating council, the personal circumstances of the particular clergyman warranted it. It was held that this voluntary payment from an independent body was taxable as coming within "perquisites or profits accruing by reason of his office" in schedule E, rule 1. Collins M.R. says, in considering the payment in the light of this rule: 9Schedule E of the Income Tax Act, 1918, applied only to "public offices and employments of profit" and all other employments were charged under schedule D. But by the Finance Act, 1922, s. 18, all employments under an employer, including weekly wage-earners, were transferred to schedule E and charged under the rules applicable to the schedule. 10(1902] 2 K.B. 631.

INCOME FROM PERSONAL SERVICES

199

For what other reason or in what other respect does it come to him? It comes to him only because he is the incumbent for . the time being of a parish that is inadequately provided for, and it seems to me that such a payment falls directly within the words "accruing by reason of such office. . . . the test is whether, from the standpoint of the person who receives it, it accrues to him in virtue of his office; if irt does, it does not matter whether it was voluntary or whether it was compulsory on the part of the persons who paid it. That seems to me to be the test; and if we once get to this -that the money has come to, or accrued to, a person by virtue of his office-it seems to me that the liability to income tax is not negatived merely by reason of the fact that there was no legal obligation on the part of the persons who contributed the money to pay it. 11

The test thus laid down by Collins M.R. was adopted by the House of Lords in the leading case of Blakiston v. Cooper12 which also arose under the English Act of 1842. In that case the vicar of a church was paid the receipts from a special Church offering customarily solicited at Easter time each year under supervision of the Church for the benefit of all vicars with insufficient stipends. The evidence disclosed that many of the donors throughout the parish were not members of the church and that_some donors were motivated by friendship and goodwill prompted by the personal qualities of the vicar. The House of Lords held, in view of the fact that the collection was supervised and endorsed by the Church and was made on behalf of all clergymen on insufficient stipends, that the proceeds of the collection accrued to the appellant "by reason of" hls office. But in Cowan v. Seymour13 it was held that where the act of giving can be shown to have depended on the personality of an employee, rather than on the office held and service rendered by him, it constitutes a personal contribution and does not accrue by reason of an office or employment. There the appellant acted as secretary of a company, without benefit of remuneration, from its incorporation in 1912 down to 1916 when it went into voluntary liquidation. He then acted as liquidator without remuneration. At the final general meeting of the shareholders it was resolved to pay the appellant £586 from the surplus remaining in their hands. The Court of Appeal discharged the assessment, laying special stress on the fact that the office had been terminated at the time of the payment and that the payment was made by persons other than the employer, viz. the shareholders. Lord Sterndale says: . . . the payment was not a payment for services rendered in the true sense, nor a profit which accrued to the appellant by reason of his office, ll[bid., at pp. 647, 649. 12(1909] A.C. 104. 13(1920] 1 K.B. 500.

200

THE MEANING OF INCOME

but was very much more in the nature of a testimonial to him for what he had done in the past while his office, which had terminated, was in existence. . .. the inference therefore is that this was money paid to the appellant as a testimonial or tribute for what he had done after his services were over and not a payment for those services. 14

Younger

L.J.

stated:

Here as it appears to me the personality of the appellant, and I may say also the personality of the chairman, were everything; their office or offices as such, whatever they were, were relatively nothing. They may have been the causa sine qua non, but they were not the causa causans. 15

From these observations it would appear that the English courts will not preclude a payment from being in the nature of a personal gift by reason only of the fact that it arose out of the goodwill engendered through devotion and loyalty in carrying out an office or employment.16 This view is more in evidence in cases arising under the altered language of the Act of 1918 which taxes all "profits whatsoever therefrom" in respect of offices and employments. In Seymour v. Reed17 the appellant, a professional cricket player of many years standing, was indirectly paid the gate proceeds from a benefit cricket match. This was a common practice in rewarding professional cricketers and was usually contemplated both by players and by their clubs, though the terms of employment did not require the employers to confer a benefit match on the appellant. The House of Lords confirmed the commissioners' finding that the proceeds from the match did not constitute a profit arising from an office or employment of profit. Lord Phillimore explains away the "clerical" cases as containing the element of periodicity of payment. He adds: 14Jbid., at p. 510. 15(1920] 1 K.B. 500, at p. 517. 16 Rowlatt J. has explained, with characteristic lucidity, the distinction between a gift, or testimonial, and a gratuitous payment of income for services: "When a man is given a testimonial because of his work in the past, not directly remunerating him for that work, but recognizing how high a regard has been held for him in the association of people with him arising out of the performance of those services, and people recognize the good qualities he has and how zealous and kind he has been and how eager to advance the interests of his employers or his parishioners or his constituents or whatever they may be, and they say 'We would like to give you something as a mark of our esteem and regard,' that is a testimonial. But where a man does a business operation of this kind which he could not be called upon to do, but it is a business operation and would have to be paid for handsomely if done by somebody else, and it is said 'One of our directors did it for us and he ought to have something besides his fees as director because of this,' that seems to me to be paying him for his services.. . ." Mudd v. Collins, ( 1925) 9 T.C. 297, at p. 300. 17(1927] A.C. 554.

INCOME FROM PERSONAL SERVICES

201

. . . I do not feel compelled by any of these authorities to hold that an employer cannot make a solitary gift to his employee without rendering the gift liable to taxation under Sch. E. Nor do I think it matters that the gift is made during the period of service and not after its termination, or that it is made in respect of good, faithful and valuable service. 18 Again, in Benyon v. Thorpe 19 Rowlatt J. held that a pension paid voluntarily by a company to its retired managing director, in accordance with its custom in dealing with retired members of its senior staff, was not a profit from that office. "The payments in question were," he says, "in reality, nothing more than gifts moved by remembrance of past services already sufficiently remunerated, and stood on the same footing as gifts to a child or any other person whom the donor thought ought to be provided with funds. The relation of employment which had generated the gifts was merely a matter of history.''20 Recently, in Calvert v. Wainwright 21 the tips paid by fares to a taxicab driver were held to come within "all salaries, fees, wages, perquisites or profits" from an "office or employment of profit" within rule 1, contrary to any suggestion in that rule that the payment must be a legal incident of the employment or be received from the employer. Atkinson J. does suggest, however, that a large donation to a driver at Christmas or prior to his holidays, and given out of personal regard arising from devotion to duty, would not be taxable. He states, as his view of the authorities: Tips received by a man as a reward for services rendered, although voluntary gifts made by people other than his employers, are assessable to tax as part of the profits arising out of his employment if they are given in the ordinary way as a reward for services, but, on the other hand, personal gifts, which means gifts to a man on personal grounds irrespective of and without regard to the question whether services have been rendered or not, are not assessable. 22 It would appear, therefore, that, where voluntary payments to the present holder of an office or employment are concerned, the question whether they are or are not income may be answered by inquiring if such payments would have been made to a different person presently in the same office or employment. In the case of voluntary payments made after an office or employment has terminated there is greater difficulty in finding that they constitute "profits whatsoever therefrom." But if the evidence is sufficient to justify the inference that the voluntary payment is given as compensation for past services it will 18(1927] A.C. 554, at p. 571. But compare with this decision, Davis v. Harrison, ( 1927) 137 L.T.R. 324, and Corbett v. Duff, [1941] 1 K.B. 730. 19( 1928) 97 L.J. K.B. 705. 20Jbid., at p . 706. 21(1947] 1 All E .R. 282. 221bid., at p . 282.

202

THE MEANING OF INCOME

be taxed as income from the office previously held. 23 If the payment made after the termination of services is no longer voluntary, for instance where it is stipulated for as part of the terms of hiring, such payment is then clearly in the nature of deferred income from the past office or employment.24 The provisions of the Canadian income tax acts relating to income from offices and employments may be seen as almost identical in wording with rule I of schedule E of the English Act of 1918. The Income War Tax Act taxes the "net profit or gain or gratuity," and the Income Tax Act the "income . .. including gratuities,'' received "from" offices and employments. It appears likely, therefore, that the English cases under the English Act of 1918 would be followed by the Canadian courts. A statement of Maclean J. in the Canadian Exchequer Court goes even further in suggesting the application under the Income War Tax Act of the test evolved by the English courts in decisions under the Act of 1842, which, as already noted, imposed tax on all payments arising "by reason of' the employment in question. He says: The test as to whether payments of the nature in question here are taxable is frequently put in this way : Was the payment made in virtue of his office? If it were it is taxable, but otherwise it is not ta~able as "income." I do not think there is any substantial distinction between the English Income Tax Act, and the corresponding Canadian Act, in respect of the point falling for determination here.211

The problem of income arising from personal services rendered in an office or employment has arisen in two recent cases before the Canadian Exchequer Court. In Jackson v. Minister of National, Revenue26 the appellant had resigned after thirty years of service as a judge of the Alberta district court and was granted a life annuity by the government of Canada. On appeal from assessment thereon it was contended that the office had been terminated by resignation, that the government was under no obligation under the Judges Act to pay this annuity, and that therefore it was paid to him gratuitously in his personal capacity and was not an "annual net profit or gain or gratuity . .. received . . . from any office or employment" within the meaning of s. 3 (1) of the Income War Tax Act. Cameron J. held that the annuity was payable as a matter of right and that the payments 23As, for example, in Wing v . O'Connell, [1927) I.R. 84; Hofman v. Wadman, (1946) 27 T.C. 192. 24Henry v. Foster, ( 1931) 145 L.T.R. 225. 25Fullerton v. M.N.R., [1938-39] C.T.C. 207, at p. 215. Compare Collins M.R., p. 199 above. 26[1951] C.T.C. 9.

INCOME FROM PERSONAL SERVICES

203

were within the words "any payment out of any superannuation or pension fund or plan" in s. 3 ( 1) ( c) and he affirmed the assessment on that ground. The judgment does not discuss the problem whether the annuity would be income from the appellant's office if paid to him gratuitously at a time when he had resigned from that office. It would seem difficult to have successfully maintained that the annuity was a personal gratuity and not a payment as compensation for services rendered. The facts were that the annuity was paid from public revenue and under letters-patent which recited that the appellant had served in his office for thirty years or upwards and referred to the annuity provisions of the Judges Act as the authority for the grant. In Goldman v. Minister of Nationa,l Revenue21 the facts were somewhat more complicated. The appellant became chairman of a committee formed to protect the interests of certain preferred shareholders in a reorganization of the Abitibi Power and Paper Company carried out under the supervision of the Ontario government. Toe appellant retained one Black as counsel for the committee and shareholders. The plan of reorganization which was finally adopted provided that the company should pay the expenses of the committee and its counsel, but did not allow the payment of remuneration to members of the committee. Black tendered his bill for $20,044.70, of which amount he assigned $14,000 to the appellant payable in two annual instalments of $7,000 each. It was clearly understood between all parties concerned that part of this fee was being claimed by Black on behalf of the committee. The appellant retained the full amount of $14,000 on the view that he was alone entitled to it. He maintained that this amount was not paid to him as a reward for services ( a result that the terms of reorganization did not permit) but was a personal gratuity given to him by Black out of friendship or for personal reasons. This view would have rendered Black taxable on the full amount of his solicitor's bill. Without deciding whether the appellant had any legal right to claim payment of $14,000 Thorson P. held, on the evidence, that the $14,000 was paid to and received by the appellant as remuneration for services rendered by the committee and was kept by him as remuneration for his own services as chairman of the committee. He also held, relying on English cases, that that finding was conclusive on the issue of its receipt by the appellant as income. He says : The finding that the money was paid and received as remuneration for services concludes the matter against the appellant's claim. It does not then matter what the source of the payment was or that it was made by someone other than the person for whom the services were rendered. Nor 27(1951) C.T.C. ~l.

204

THE MEANING OF INCOME

does it matter whether it was made pursuant to an enforceable obligation or was voluntary. . .. The sum was a profit or gain from the appellant's activity on the committee and it came to him because of and for such adivity and would not have come otherwise.%8 It is to be noted that special provisions have been added to the Canadian income tax acts whereby persons receiving a single income payment on or after retirement from office are relieved from paying the high tax which would ordinarily result from applying a progressive rate of taxation on large receipts of income in one year. S. 3 ( 6) of the Income War Tax Act deemed one-fifth of a single payment upon retirement from an employer to an employee between January 1, 1944, and June 27, 1946, to be income in the year of receipt and four-fifths to be income in each of the four succeeding years, where the Minister was satisfied that such payment was made in recognition of long service. In the case of such single payments made after June 27, 1946, the ,taxpayer was given an option of having them deemed not to be income for purposes of the charging section whereupon he would be liable to pay additional tax in the proportion borne by his tax to his income in the last complete taxation year of his employment. These sections probably operated also to the detriment of taxpayers. Thus, payments upon retirement made by an employer between January 1, 1944, and June 27, 1946, were taxable upon the Minister being satisfied that they were "in recognition of long service" without regard to whether they were income payments, gratuitous or otherwise, from the employment or were gratuitous payments by way of gift. But the legislation applying to payments made after June 27, 1946, omitted to deem such payments to be income except at the option of the taxpayer by whom they were received, so that it is unlikely that the legislation was necessarily prejudicial to taxpayers. Payments made by persons other than the employer, such as were considered, for example, in Cowan v. Seymour (supra, p. 199), were not affected by these sections. This legislation would also appear to have affected only payments made to an employee. The corresponding provisions of the Income Tax Act are more definite in subjecting to tax all amounts paid upon retirement in recognition of long service without regard to the identity of the payor or payee. S. 6 provides that "there shall be included in computing the income of a taxpayer for a taxation year . . . amounts received in the year as, on account or in lieu of payment of, or in satisfaction of ... retiring allowances." "Retiring allowances" is defined by s. 127 ( 1) ( ai) to mean "an amount received upon or after retirement . . . ( other than a superannuation or pension benefit), whether 28 Ibld.,

at p. 254.

INCOME FROM PERSONAL SERVICES

205

the recipient is the officer or employee or a dependent, relation or legal representative." The taxpayer is then afforded the option of having single payments of this nature deemed not to be income and paying a uniform rate of tax thereon, in the following terms: 34. In the case of (a) a single payment ... upon retirement of an employee

in recognition of long service and not made out of or under a superannuation fund or plan ... the payment or payments made in a taxation year may, at the option of the taxpayer by whom it is or they are received, be deemed not to be income of the taxpayer for the purpose of this Part, in which case the taxpayer shall pay, in addition to any other tax payable for the year, a tax on the payment or aggregate of the payments equal to the proportion thereof that, (i) the aggregate of the taxes otherwise payable by the employee under this Part for the last year (preceding the taxation year) for which the employee had an income from the office or employment and the two years immediately preceding that year ... is of (ii) the .aggregate of the employee's incomes for those three years.

It may be noted that the option is available only with respect to single payments in recognition of long service. The question whether any payment has in fact been made "in recognition of long service" within each of the above sections falls to be ultimately determined by the courts. But true gifts or other payments of a non-income nature made other than on or after retirement a.n d in recognition of anything but length of service appear to remain unaffected by the provisions of this Act. CAPITAL RECEIPTS Arus1NG IN CONNECTION WITII CoNTRAcrs OF SERVICE

There is a line of recent English decisions which, though phrased in terms of the rules to schedule E, would appear to be at least partly founded on judicial recognition of a certain capital element arising under contracts of service in circumstances where the rights acquired or surrendered by employees thereunder are sufficiently enduring and definite. The rule that income tax does not tax the value of a source of income or the amount of a capital gain therefrom ought on principle to apply equally to the gains from every form of transaction. Accordingly, payments received for the surrender of rights acquired under a service agreement and found to be in the nature of capital would be excluded from taxation as income. Payment for rights voluntarily surrendered In Beak v. Robson29 the respondent was hired to serve as director and manager of a coal-exporting company at an agreed salary for a term of five years. He was entitled to terminate the agreement at any 29 [1942]

1 All E.R. 639 (C.A.); [1943] I All E.R. 46 (H.L.).

206

THE MEANING OF INCOME

time on giving proper notice and he was subject to discharge at any time for breach of duty. He further covenanted that for a certain period after the event of his resignation or discharge from office he would not engage or become interested in the business of exporting coal within a radius of fifty miles of the company's place of business without obtaining its prior consent. In consideration for entering into this covenant the respondent was paid .£ 7,000. It wa:s held by the House of Lords, affirming Lawrence J. and the Court of Appeal, that this amount was not taxable as a profit from the office of managing director. On behalf of the Crown, it had been argued that the payment arose "by reason of' the office, but in rejecting this contention the courts appear to have proceeded mainly on the reasoning that the covenant for which payment was made did not become effective unless and until the office had been terminated. In delivering judgment for the House of Lords, Viscount Simon L.C. says: The sum of £7,000 is not paid for anything done in performing the services in respect of which Robson is chargeable under Sched. E. The consideration which he has to give under the covenant is to be given not during the period of his employment, but after its termination. He is giving to the company for a sum of £ 7,000 the benefit of a covenant which will only come into effect when the service is concluded. I agree with the Court of Appeal in the view that to treat this £7,000 as a profit arising from the respondent's office is to ignore the real nature of the transaction.so

The main reason of Lord Greene M.R. in giving judgment for the Court of Appeal is much the same. But he appears to regard the transaction as amounting also to the sale of a capital asset. 'While he does not classify the .£ 7,000 as a capital receipt in so many words he compares the transaction to an agreement for the sale of a motor car by an employee to his employer: It seems to me that it would be quite impossible to suggest in such a case that the sum he received in consideration for the undertaking to transfer the motor car would be remuneration from his employment. I cannot myself see any difference between that case and the present. In each case the employee is contracting to sell something to his employer at the termination of his agreement and receives a particular and specific consideration for it.SI

In phrasing their conclusions in this case in terms of the rules to schedule E the courts have left unsettled whether the receipt in question was not taxable as capital or as an income payment arising from a source other than the office or employment. In emphasizing that the office of service or employment was terminated their lordships 30(1943) 1 All E .R. 46, at p. 47. 31(1942) I All E.R. 639, at p. 641.

INCOME FROM PERSONAL SERVICES

2