October 07, 2011

Minister of National Revenue (Appellant) v. Enjay Chemical Co. Limited (Respondent)

71 DTC 5293
Federal Court-Trial Division
July 30, 1971

Income or capital receipt — Forgiveness of debt — Large purchase of chemicals from related company in U.S. — Drop in market price — Increase in indebtedness due to decline in value of Canadian dollar — Anticipated insolvency — Forgiveness of portion of price by seller in year following year of purchase — Conferring benefit on taxpayer — Income Tax Act, R.S.C. 1952, ss. 3, 4 and 137(2).

In 1961 the respondent chemical company purchased a shipment of a certain chemical from a related U.S. company for $732,202.37. In 1962 the market price of the chemical fell by some 13 per cent and there was also a decline in the value of the Canadian dollar resulting in an increase in the respondent company’s indebtedness to its related U.S. company. In view of these circumstances, in 1962 the related U.S. company unconditionally reduced the respondent company’s indebtedness by $112,350. This abatement was shown in the accounts as a forgiveness of debt and treated as a capital receipt, and hence was not shown as income in the respondent company’s 1962 tax return. The Minister, in assessing the company for 1962, disagreed with the respondent company’s treatment of the amount of the abatement and included it in its taxable income for the year. The Appeal Board (70 DTC 1477) allowed the respondent company’s appeal on the ground that the abatement of a portion of the indebtedness did not constitute that portion a part of the company’s profit from the carrying on of its business for taxation purposes. Further, the Board was of the view that forgiveness of an absolute and undisputed trade debt incurred in an earlier taxation period did not give rise to income in the hands of a taxpayer in the year in which the forgiveness was granted and, particularly so, when the forgiveness was complete and not subject to any contingency. The Minister then appealed to the Federal Court.

Held: The appeal was allowed in part. Taking a common sense commercial view of the matter, it was evident that the respondent, as a result of the forgiveness of debt was able to make a profit in its 1962 taxation year and should accordingly pay appropriate tax on this profit. Since the abatement was to a large extent made for the purpose of covering the losses occasioned by the reduction in the selling price of the chemical, the benefit of the abatement should be spread over the 1962 and 1963 taxation years when the chemical was sold. The respondent should have reduced its cost of inventory on hand in 1962 by the sum of $112,350 following the forgiveness of debt in this amount, and this reduction should have been reflected in its cost of goods sold in 1962 and 1963 by reference to the amounts of the chemical sold in each of those years respectively. This would result in including as income only that portion of the said sum of $112,350 attributable to the respondent’s 1962 sales. It could also be found that the respondent’s abatement of indebtedness was taxable as income under the provisions of section 137(2)(a) as a benefit conferred on it by the related company.