Canada v. Bombardier Inc.

Canada v. Bombardier Inc.
Court (s) Database
Federal Court of Appeal Decisions
Date
2012-02-08
Neutral citation
2012 FCA 46
File numbers
A-90-11
Decision Content
Federal Court of Appeal
Cour d’appel fédérale
Date: 20120208
Docket: A‑90‑11
Citation: 2012 FCA 46
CORAM: LÉTOURNEAU J.A.
PELLETIER J.A.
MAINVILLE J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
and
BOMBARDIER INC.
Respondent
Heard at Montréal, Quebec, on January 16, 2012.
Judgment delivered at Ottawa, Ontario, on February 8, 2012.
REASONS FOR JUDGMENT BY: LÉTOURNEAU J.A.
CONCURRED IN BY: PELLETIER J.A.
MAINVILLE J.A.
Federal Court of Appeal
Cour d’appel fédérale
Date: 20120208
Docket: A‑90‑11
Citation: 2012 FCA 46
CORAM: LÉTOURNEAU J.A.
PELLETIER J.A.
MAINVILLE J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
and
BOMBARDIER INC.
Respondent
REASONS FOR JUDGMENT
LÉTOURNEAU J.A.
Issues
[1] Her Majesty the Queen (appellant) is appealing the decision by Justice Archambault of the Tax Court of Canada (judge) delivered on January 28, 2011, in respect of the notices of assessment issued by the Minister of National Revenue for 1990 to 2001 under Part 1.3 of the Income Tax Act, R.S.C. c. 1 (5th Supp.) (Act). This Part concerns the capital tax on large corporations.
[2] The judge allowed the appeal of Bombardier Inc. (the respondent in this appeal), with costs. He referred the assessments back to the Minister for reconsideration, on the assumption that the only advances included in the appellant’s capital under paragraph 181.2(3)(c) are the following:
1990 taxation year: $73,781,000;
1991 taxation year: $66,463,000;
1992 taxation year: $207,820,000;
1993 taxation year: $224,301,347;
1994 taxation year: $423,237,117;
1995 taxation year: $477,658,576;
1996 taxation year: $250,700,000;
1997 taxation year: $249,400,000;
1998 taxation year: $332,100,000;
1999 taxation year: $1,246,100,000;
2000 taxation year: $1,482,400,000; and
2001 taxation year: $1,304,100,000.
[3] For the 1990 to 1997 and 2000 taxation years, the judge gave effect to the consent to judgment agreed to by the parties and dated September 13, 2010.
[4] The appellant is appealing the judge’s decision for the following reasons:
(a) He erred in law in concluding that the taxable advances are only those that appear directly in the body of the balance sheet as liability elements, and not those shown in assets reducing an asset element or in the supplementary notes which are an integral part of the financial statements; and
(b) He erred in fact and in law in concluding that the advances received by the respondent and identified as advances in the notes to the financial statements were not advances within the meaning of paragraph 181.2(3)(c) of the Act.
[5] To be more specific, it is argued that the judge erred in concluding, first, that the advances received by the respondent lost their nature as advances as costs were incurred in performing the contract and, second, that they did not appear on the respondent’s balance sheet for the years at issue.
[6] On appeal in the Tax Court of Canada, the judge dismissed the respondent’s alternative argument that the amounts shown in liabilities on its balance sheet and those disclosed in the note on the Inventory had to be excluded from the respondent’s capital as reserves in accordance with paragraph 181.2(3)(b) of the Act. The respondent is cross‑appealing the dismissal of this ground for appeal which would have led to the appeal’s being dismissed in the Tax Court of Canada if its appeal had not been allowed by the judge on the first ground of appeal. Since I conclude that this appeal must be dismissed, there is no need to rule on the cross‑appeal.
[7] Before dealing with the issues and the parties’ submissions, a brief summary of the facts is in order to better illustrate the problem.
Facts giving rise to the dispute
[8] The respondent is a business operating in the manufacture and sale of aircraft and public transportation equipment. The hearing in the Tax Court of Canada was conducted in reliance on a partial agreement on the facts reached by the parties, supplemented by the documentary and testimonial evidence of the parties at trial. This agreement is found at paragraph 8 of the trial decision, which I reproduce here:
[8] This is the statement of facts taken from the agreement as to the facts:
[translation]
FACTS
1. The appellant operates, inter alia, (i) a business for the development, manufacture and sale of aircraft and aircraft parts and components; and (ii) a business for the manufacture and sale of public transportation equipment (train cars, etc.).9. (9 Footnotes are added; footnotes in the agreement are omitted.)
2. Its fiscal year and taxation year run from February 1 to January 31 of each year.
3. The contracts that the appellant enters into with its customers for the sale of aircraft and aircraft parts and components and public transportation equipment cover the usual points found in agreements of that nature: (i) a description of the item to be produced and delivered; (ii) the price and terms of payment; (iii) terms relating to delivery; (iv) the parties’ liability; and (v) all of the other rights and obligations of the purchaser and the vendor. On this point, the parties agree that the contracts found at tabs 69 and 70 of the Compendium are standard form contracts that are representative of all contracts signed by the appellant during the period under appeal.
4. In accounting terms, the appellant recognizes its long‑term contracts in accordance with the generally accepted accounting principles of Canada (“GAAP”), to the extent that there is a note to the financial statements that explains the calculation of the inventory.
.
5. The appellant’s financial statements for the years in issue were prepared in accordance with GAAP.
Aerospace Division (aircraft sale contracts)
6. The income from contracts for aircraft sales is recognized as work progresses, on the basis of the delivery date.
7. Contracts for aircraft sales provide that amounts calculated on the basis of the purchase price must be paid by the purchaser on predetermined dates, according to a timetable that generally starts when the contract is signed and ends with delivery.10 (10 According to the standard form contract referred to by the parties during the hearing (Exhibit A‑1, tab 69, section 5), the following amounts had to be paid as the purchase price for each aircraft (totalling four) provided for in the contract: $50,000 down payment, 5% when the purchase contract is signed, 7.5% 12 months before delivery of the aircraft, and 7.5% six months before delivery of the aircraft.)
8. Subject to the additional details and information to be provided by the ordinary and expert witnesses called to testify, where applicable, the parties also state that the appellant presents those contracts as follows in its financial statements:
1990–1995 FISCAL YEARS11 (11 Bombardier admitted that for the calculation of the capital tax for 1990 to 1995, the amount of its advances must be calculated on the same basis as was used for the 1996 to 2001 fiscal years: each advance must be calculated aircraft by aircraft, not for all contracts. The consequence of that is to increase the amount of the advances that must be added in calculating Bombardier’s taxable capital for 1990 to 1995. See Exhibit A‑5)
(a) Before delivery, the amounts received from customers for all contracts are applied against the costs incurred;
(b) The amount by which the costs incurred exceed the amounts received from customers for all contracts is shown in assets on the balance sheet under the item “inventory”. The amounts received from customers are shown in the note in the financial statements concerning inventory on the “advances received” line;
(c) At delivery: (i) the total proceeds of the sale are recognized as income on the profit statement; and (ii) total costs of manufacturing are shown under the item “cost of sales and operating expenses” in the profit statement;
1996–2001 FISCAL YEARS
(d) Before delivery, the amounts received from customers for a particular contract are applied against the costs incurred for the contract;
(e) For a particular contract, if the costs incurred are greater than the amounts received from the customers, the excess is shown in assets on the balance sheet under the item “inventory”. The amounts received from customers are shown in the note in the financial statements concerning inventory on the “advances” or “advances and progress billings” line;
(f) If the amounts received from the customers for a particular contract are greater than the costs incurred for the contract, the excess is shown in liabilities on the balance sheet under the item “advances” or “advances and progress billings in excess of related costs”; and
(g) At delivery: (i) the total proceeds of the sale are recognized as income on the profit statement; and (ii) the total manufacturing costs are entered under the item “costs of sales and operating expenses” in the profit statement.
. . .
Transportation Division (public transportation equipment) and aircraft parts and components
10. Income from long‑term contracts is recognized as work progresses, on the basis of costs incurred.
11. The sales contracts for public transportation equipment and aircraft parts and components provide that amounts must be paid by the purchaser on predetermined dates or at the occurrence of predetermined events generally referred to as “milestones”.
12. Subject to the additional details and information to be provided by the ordinary and expert witnesses called to testify, where applicable, the parties also state that the appellant presents those contracts as follows in its financial statements:
1990–1995 FISCAL YEARS
(a) Before delivery, the amounts received from the customers for all contracts are applied against the costs incurred and the associated profit, where the funds are received;
(b) The amount by which the costs incurred and the associated profit exceed the amounts received from the customers for all contracts is shown in assets on the balance sheet under the item “inventory”. The amounts received from customers are shown in the note in the financial statements concerning inventory on the “advances received” line;
(c) Income is recognized in the profit statement as work progresses on the basis of the costs incurred. The related costs are entered under the item “cost of sales and manufacturing expenses” in the profit statement, generally as costs are incurred;
1996–2001 FISCAL YEARS
(d) Before delivery, the amounts received from customers for a particular contract are applied against the costs incurred for and profits associated with the contract, when the money is received;
(e) For a particular contract, if the costs incurred and the associated profits are greater than the amounts received from the customers, the excess is shown in assets on the balance sheet under the item “inventory”. The amounts received from customers are shown in the note in the financial statements concerning inventory on the “advances” or “advances and progress billings” line;
(f) For a particular contract, if the amounts received from the customers are greater than the costs incurred and the associated profits, the excess is shown in liabilities on the balance sheet under the item “advances” or “advances and progress billings in excess of related costs”; and
(g) Income is recognized in the profit statement as work progresses on the basis of the costs incurred. The related costs are entered under the item “costs of sales and operating costs” and the associated profit is shown in the profit statement, generally as costs are incurred.
[Emphasis added by the judge.]
[9] It can be seen from this agreement that the respondent has two divisions: the Aerospace Division (aircraft sale contracts) and the Transportation Division (public transportation equipment) and aircraft parts and components. It can also be seen that, in the Aerospace Division, as shown at paragraph 6 of the agreement, “[t]he income from contracts for aircraft sales is recognized as work progresses, on the basis of the delivery date, whereas in the Transportation Division, as shown in paragraph 10, “[i]ncome from long‑term contracts is recognized as work progresses, on the basis of costs incurred”.
[10] In summary, in the Aerospace Division, financing for long‑term work is obtained through advances of funds paid on dates predetermined in the contract of sale. The amounts of these advances do not depend on the work in progress or the work completed. They correspond to a portion of the selling price.
[11] Conversely, in the Transport Division, financing for work of the same nature is acquired through payments in amounts determined by progressive billing proportionate to the work completed.
[12] By mutual agreement, the parties chose the contract between Bombardier Inc. and Jersey European Airlines as a contract representative of the parties’ obligations and rights and of the payment of advances in the Aerospace Division: see Tab H of Volume 1 of the Appeal Book. According to counsel for the appellant, a reading of the contract reveals the following information:
(a) The contract is a contract of sale at a fixed price, which the purchaser agrees to pay in accordance with the conditions and a timetable set out in the contract;
(b) The purchaser must pay 5 percent of the selling price upon signing the contract, 7.5 percent twelve (12) months before the scheduled delivery date for the aircraft, 7.5 percent six (6) months before the scheduled delivery date and the balance of the selling price upon delivery;
(c) The percentages may be higher in some contracts;
(d) The respondent retains ownership of the work in progress and assumes the risks up to the time of delivery: see clauses 5.4 and 10.1 of the contract;
(e) If the purchaser terminates the contract by reason of the respondent’s failure to fulfill its obligations, the respondent must refund the advances received: see clauses 16.2(c) and 16.4 of the contract;
(f) If the respondent terminates the contract by reason of the purchaser’s failure to fulfill its obligations, the respondent may retain the advances received and apply them against the costs, expenses, losses and damages it incurred: see clauses 16.2(b) and 16.3(c) of the contract; and
(g) With the exception of clause 16.3 mentioned above, nothing in the contract allows the respondent to apply the advances received against the costs incurred, even if those costs are identifiable.
I note in passing that clause (f) does not mean that the respondent can only apply the advances received against costs incurred when the respondent fails to fulfill its obligations. This clause determines the measure of the amounts it may keep in the event of default, the excess of costs over amounts received, and the damages incurred that must be reimbursed.
[13] The appellant stated that the respondent receives advances without issuing invoices, to which the respondent replies that the contract that provides for them serves as an invoice.
[14] The appellant also emphasizes the opposite state of affairs in the Transportation Division, where the ownership of property is transferred to the client as payments are received following the issue of invoices.
[15] The respondent does not dispute that the amounts it received are advances. The point of discord between the appellant and respondent springs from the accounting treatment given to the advances by the respondent, although the appellant and its expert recognize that the respondent’s financial statements for each of the years at issue were prepared in accordance with the Generally Accepted Accounting Principles (GAAP). I will return to that issue. This leads me to the judge’s decision and the contentions of the parties. But first, I must preface this analysis with the legislative provisions relied on by the parties.
Relevant legislative provisions
[16] The relevant legislative provisions are paragraphs 12(1)(a) and 20(1)(m) and sections 181 to 181.2(6) of the Act, which deal with elements to be included in the income and taxable capital of a large corporation under Part 1.3. I have appended them to these reasons.
Analysis of the judge’s decision and the contentions of the parties
(a) Appropriate standard of review
[17] Since this is an appeal of a decision by the Tax Court of Canada, the applicable standard of review is the one established in Housen v. Nikolaisen, [2002] 2 S.C.R. 235: the questions of law, including those that may be separated from a question of mixed fact and law, are reviewable on a standard of correctness, while the others, that is, the questions of fact or of mixed fact and law, are subject to the standard of palpable and overriding error.
(b) The purpose of Part 1.3 and the capital tax on large corporations
[18] The parties to the dispute agree on the purpose of Part 1.3. It is an additional minimum tax imposed on large corporations to ensure their contribution to the reduction of the deficit. This tax was to be temporary and, when it was brought into force in 1989, the rate was set at 0.175% of the capital in excess of $10 million used in Canada by corporations: see the Budget Papers tabled in the House of Commons on April 27, 1989, at the item Corporate Income Tax, Joint Book of Authorities, Vol. II, Tab 37, at page 40.
[19] An important fact, as set out in the Budget Papers filed, is that “[t]he tax base [would] be calculated using the accounts of a corporation determined in accordance with the Generally Accepted Accounting Principles and presented on an unconsolidated basis” and “[c]urrent year‑end balances [would] be used”: ibidem, at page 41 (emphasis added). Included in the tax base was the amount of all the loans and advances to the corporation at the end of the year. The method for computing the amounts is set out a subparagraph 181(3)(b)(i), and loans and advances are included at paragraph 181.2(3)(c) of the Act.
[20] In the absence of specific accounting rules for long‑term contracts in Canada, the respondent, which is a business operating on an international scale, used the existing United States accounting standard SOP 81‑1 for the disclosure of these types of contracts. Standard SOP 81‑1 applies, among other things, to the accounting treatment given to and the disclosure of advances received during long‑term contracts: see the testimony of Mr. Paré, the respondent’s vice‑president of financial reporting, Appeal Book, Volume 7, at pages 76 and 84 to 86.
[21] The accounting principles used by the respondent in this case are recognized for long‑term construction contracts by the American Institute of Certified Public Accountants, Inc. (AICPA), and by the Financial Accounting Standards Board. In the following excerpt drawn from standard SOP 81‑1, and reproduced in the AICPA Audit and Accounting Guide: Construction Contractors, the respondent relies more specifically, by analogy, on clause 6.19, even if its contracts are not “cost‑plus contracts”:
Offsetting or Netting Amounts fn ‡(38)
6.16 A basic principle of accounting is that assets and liabilities should not be offset unless a right of offset exists. Thus the net debit balances for certain contracts should not ordinarily be offset against net credit balances relating to others, unless the balances relate to contracts that meet the criteria for combining in the SOP.
6.17 ARB No. 45, Long‑Term Construction‑Type Contracts, recognized the principle of offsetting in discussing the two accepted methods of accounting for long‑term construction‑type contracts. For the percentage‑of‑completion method, the bulletin states
… current assets may include costs and recognized income not yet billed, with respect to certain contracts; and liabilities, in most cases current liabilities, may include billings in excess of costs and recognized income with respect to other contracts.
In commenting on the completed‑contract method, the bulletin states
… an excess of accumulated costs over related billings should be shown in the balance sheet as a current asset, and an excess of accumulated billings over related costs should be shown among the liabilities, in most cases as a current liability. If costs exceed billings on some contracts, and billings exceed costs on others, the contracts should ordinarily be segregated so that the figures on the asset side include only those contracts on which costs exceed billings, and those on the liability side include only those on which billings exceed costs.
Offsetting should be applied in the same way under the percentage‑of‑completion method.
6.18 Although the suggested mechanics of segregating contracts between those on which costs exceed billings and those on which billings exceed costs do not indicate whether billings and related costs should be presented separately or combined (netted), separate disclosure in comparative statements is preferable because it shows the dollar volume of billings and costs (but not an indication of future profit or loss). In addition, grantors of credit, such as banks and insurance companies, have expressed a preference for separate disclosure. Disclosure may be made by short extension of the amounts on the balance sheet or in the notes to the financial statements. Thus, under the percentage‑of‑completion method, the current assets may disclose separately total costs and total recognized income not yet billed for certain contracts, and current liabilities may disclose separately total billings and total costs and recognized income for other contracts. The separate disclosure of revenue and costs in statements of income is the generally accepted practice. Only through comparable presentation of such data in the balance sheet can the reader adequately evaluate the contractor’s comparative position.
6.19 An advance received on a cost‑plus contract is usually not offset against accumulated costs unless it is definitely regarded as a payment on account of work in progress. Such advances generally are made to provide a revolving fund and are not usually applied as partial payment until the contract is nearly or fully completed. However, advances that are definitely regarded as payments on account of work in progress should be shown as a deduction from the related asset, and the amounts should be disclosed. Also, for advance payments on a terminated government contract, the financial statements of the contractor issued before collection of the claim should ordinarily reflect any balance of those advances as deductions from the claim receivable.
[Emphasis added.]
(c) The respondent’s chosen method of accounting for work
[22] Given the nature and certain specificities of long‑term construction contracts, such as those for the design and manufacture of aircraft, the accounting profession, as shown by the above‑referenced U.S. standard, recognizes two methods of accounting for this work: the percentage‑of‑completion method and the completed‑contract method: see Nadi Chlala, Louis Ménard et al., Comptabilité intermédiaire, 2nd ed., Éditions du Renouveau Pédagogique inc., Saint‑Laurent, 2005, Appeal Book, Vol. 1, at page 9; Thomas H. Beechy and Joan E.D. Conrod, Intermediate Accounting, McGraw‑Hill Ryerson Ltd., Toronto, Appeal Book, Vol. 1, at page 257.
[23] At pages 9 and 10 of their work, Messrs. Chlala, Ménard et al. describe, in the following terms, the accounting methods and the conditions required to use the percentage‑of‑completion method:
[translation]
1. Percentage‑of‑completion method. Revenues and gross profit are recognized each period based on the progress of the construction, that is, the percentage of completion. The sum billed may not necessarily correspond to the revenues relating to construction progress. Construction costs plus gross profit earned to date are accumulated in an inventory account (Construction in Process) and progress billings are accumulated in a contra inventory account (Billings on Construction in Process).
2. Completed‑contract method. Revenues and gross profit are recognized only when the contract is completed. Construction costs are accumulated in an inventory account (Construction in Process) and progress billings are accumulated in a contra inventory account (Billings on Construction in Process).
The rationale for using percentage‑of‑completion accounting is that, in most long‑term construction contracts, the buyer and seller have obtained enforceable rights. The buyer has the legal right to require specific performance on the contract; the seller has the right to require progress payments that provide evidence of the buyer’s ownership interest. As a result, the economics of the situation suggest that a continuous sale occurs as the work progresses, and revenue should be recognized accordingly.
The percentage‑of‑completion method is used (1) when performance consists of carrying out more than one act, (2) when the business can reasonably estimate the extent of progress toward completion, and (3) when the amount of consideration receivable is measurable with reasonable precision. If performance consists of only a single act, or if the above conditions are not met, then the completed‑contract method should be used.
Furthermore, the accounting profession allows for the percentage‑of‑completion method to be used when reasonably reliable data on the extent of progress, on revenues and on expenses is available and when all of the following conditions are met:
1. The contract clearly stipulates the enforceable rights regarding the products and services to be provided and received by the parties, the consideration that is receivable and the terms of the arrangement and how the arrangement will be carried out.
2. It is reasonable to expect that the buyer will fulfill all of its contractual obligations.
3. It is reasonable to expect that the contractor will fulfill all of its contractual obligations.
The contract‑completion method should only be used (1) when the entity mainly undertakes short‑term contracts, or (2) when the conditions for using the percentage‑of‑completion method cannot be met, or (3) when there are inherent hazards in the contract beyond the normal, recurring business risks.
[Emphasis added.]
[24] Conversely, the completed‑contract method, as the above‑quoted excerpt shows, is used in short‑term contracts, when the contract involves inherent hazards that exceed normal, recurring business risks, or when the conditions for using the percentage‑of‑completion method cannot be fulfilled.
[25] The respondent was of the opinion that it fulfilled the conditions for using the percentage‑of‑completion method and that, unlike its competitors in the aircraft industry, such as Boeing, Textron, Gulf Stream and General Dynamics, it could use it. The respondent satisfied the going concern principle presumed in accounting. It dealt with the amounts received as payments on account for the work in progress. That was the opinion of Jean Paré, the respondent’s vice‑president, a chartered accountant (CA) who is also a chartered public accountant (CPA), which corresponds or is equivalent to the United States chartered accountant designation: see Appeal Book, Vol. 7, transcript, at pages 54 to 59 and 99 to 109. For seven years, Mr. Paré was a member of the Canadian Accounting Standards Board, responsible for deciding on the Canadian Generally Accepted Accounting Principles of the Canadian Institute of Chartered Accountants.
[26] The respondent’s position regarding the accounting treatment of the advances received was first adopted by its finance department, with the approval of the accounting policy auditing committee, the company’s upper management and the external accounting auditors from Toronto in consultation with their New York colleagues: ibidem, at pages 110 to 114. According to Mr. Paré, these experts were unanimous in stating that the respondent’s position complied with standard SOP 81‑1 and with GAAP: ibidem. In addition, the balance sheet drawn up in accordance with this standard provided a good picture of the respondent’s financial situation on a given date and reflected the extent of the work and operations of the financial statements’ users—in short, the respondent’s economic resources. In accordance with the accounting principles, [translation] “the transactions and events are accounted for and presented in a manner that conveys their substance rather than necessarily their legal form”: ibidem, at pages 122 and 254. See also the cross‑examination of the respondent’s expert, Mr. Chlala, Appeal Book, Vol. 9, at pages 62 to 67.
[27] The fact that the respondent’s balance sheet was GAAP‑compliant in all respects is recognized and acknowledged by the appellant and its expert. Indeed, the appellant’s expert, Mr. Thornton, confirmed this on cross‑examination. He also admitted that the respondent had correctly exercised its judgment regarding the advances, seemed to have applied standard SOP 81‑1 and had used paragraph 6.19 as a basis for its judgment; and that standard SOP 81‑1 was an acceptable source: see Mr. Thornton’s cross‑examination, Appeal Book, Vol. 10, at pages 109 to 114. He also acknowledged that the advances had been allocated to the project for which they had been paid, not used to finance other projects: ibidem, at page 117.
[28] In reply to a question by the judge for clarification, the appellant’s expert admitted that the amounts of the advances had to be deducted as liabilities in accordance with the billing in progress and, in a pre‑delivery context, it was possible to have the advances reduced in accordance with the cost of the work without there being income to report at this stage: ibidem, at pages 182 and 183.
(d) Submissions of the parties
[29] The appellant is relying on the decision of this Court in Oerlikon Aérospatiale Inc. v. Canada, [1999] F.C.J. No. 496, and the Court of Québec’s decision in Bombardier c. Sous‑ministre du Revenu du Québec, 2010 QCCQ 3036 (Can LII), 2010 QCCQ 3036. The appellant submits that, first, the decision in Oerlikon is determinative in this case and, second, that this Court should arrive at the same conclusion as did the Court of Québec.
[30] With respect, I agree with the judge that the decision of this Court in Oerlikon has no bearing on the issue here. In Oerlikon, as pointed out by the judge at paragraph 26 of his reasons for decision, the issue was to determine the legal nature of an advance and whether the Act applied to advances on account or was limited in its application to advances in the nature of loans. It was not a matter of determining the amount of the advances for the purposes of calculating the taxable capital, as is the issue here. Moreover, as previously stated, the respondent does not dispute that the amounts received are advances. Instead, the respondent is arguing that the amount of these advances must be reduced by the cost of the work performed in order to determine the balance of this amount at the end of the fiscal year as required by paragraphs 181(3)(b) and 181.2(3)(c) of the Act.
[31] The Court of Québec’s decision, which concerned precisely this same tax dispute but between the respondent and Revenu Québec, is contrary to the judge’s decision at trial. The Court of Québec judge focused on the terms of the contract between the parties, under which the respondent retains ownership of the aircraft until it is delivered to the purchaser and the advances received may be reimbursed to the purchaser in the event that the respondent fails to fulfill its obligations. Consequently, the advances remain potentially reimbursable advances, even if the costs of operations and of completing the work were drawn from them in the course of performing the contract. This decision is pending before the Court of Appeal of Québec following an appeal by the respondent and has not yet been heard.
[32] The appellant’s position, with which the Court of Québec agreed, gives precedence to the legal reality over the commercial and accounting reality by not allowing the amount of the advances to be reduced by the cost of the work for the purposes of calculating the taxable capital under paragraph 181(3)(b). According to the respondent’s expert, by designating the full amount of the advances as liabilities, the appellant is refusing to recognize that, on a commercial and economic level, the respondent used its inventory to perform the contract and sold that inventory, although from a legal standpoint ownership had not yet been transferred: see Mr. Chlala’s cross‑examination, Appeal Book, Vol. 9, at pages 40 to 43. In other words, the appellant’s position does not reflect the [translation] “economics of the situation” prevailing between the parties, which [translation] “suggest that a continuous sale occurs as the work progresses, and revenue should be recognized accordingly”: see the excerpt from the work by Messrs. Chlala, Ménard et al., quoted above in connection with the percentage‑of‑completion method.
[33] As this Court ruled through the decision penned by Justice Ryer in Attorney General of Canada v. Ford Credit Canada Ltd., 2007 FCA 225, [2007] 4 C.T.C. 157, 2007 D.T.C. 5431, affirming the decision of Chief Justice Bowman of the Tax Court of Canada in the same case, 2006 TCC 441, [2006] 5 C.T.C. 2300, 2006 D.T.C. 3424, and the similar conclusions reached by Justice Bowie in PCL Construction Management Inc. v. R., [2001] 1 C.T.C. 2132, and Justice Sarchuk in Royal Trust Co. v. R., [2001] 3 C.T.C. 2263, subsection 181(3) of the Act requires that the accounting characterization or definition of the terminology appearing on the balance sheet be used in order to determine a corporation’s capital for its capital tax.
[34] In response to an argument similar to the one put forward by the appellant in this appeal, that is, that the ordinary legal sense of a component part of capital, if such a sense exists, must prevail over the accounting sense, Justice Ryer wrote the following at paragraphs 18 to 24:
[18] The Minister argued that Chief Justice Bowman was in error when he concluded that the existing jurisprudence and the plain meaning of subsection 181(3) mandate that the accounting characterization of terms in a balance sheet must be accepted in the determination of the capital of a corporation for LCT purposes. The Minister stated that most components of the capital of a corporation, for LCT purposes, originate in accounting principles and that if a component of capital derives its meaning primarily from GAAP, then the accounting meaning ascribed to that component must prevail. However, according to the Minister, where a component of the capital of a corporation has an ordinary legal meaning, that meaning is to be given precedence.
[19] With respect, I do not agree with the suggested dichotomy. The meaning to be accorded to the term capital stock, for the purposes of Part I.3 of the ITA, is to be discerned in light of the provisions of subsection 181(3). In my view, the language of subsection 181(3) does not contemplate a distinction between terms with ordinary legal meanings and terms with primarily accounting meanings.
[20] The proper interpretation of subsection 181(3) of the ITA must be determined in the context of its approximately sixteen year history, from mid‑1989 to the beginning of 2006. In enacting the LCT as a deficit reduction measure, Parliament must have intended the tax to be temporary in nature. Presumably, Parliament did not envisage that federal deficits would occur each and every year. Against that background, it was open to Parliament either to enact a comprehensive legislative scheme to impose the temporary new capital tax or to adopt a more simplified approach. In my view, in enacting subsection 181(3), Parliament basically chose to adopt a method of computing capital for the purpose of the temporary new tax that was well known to large corporations. The financial statements of large corporations are routinely prepared on an audited basis in accordance with GAAP, and therefore, adopting GAAP as the principal determinant of the capital tax base for most corporations ensured that the new and temporary tax would be relatively simple to implement and administer. However, a complete adoption of GAAP did not occur.
[21] When Parliament determined that deviations from GAAP were desirable, the necessary modifications were made by the enactment of specific legislative provisions. Two important components of capital, “long‑term debt” and “reserves”, were given statutory meanings in subsection 181(1). In addition, paragraph 181(3)(a) provides that for the purposes specified in the opening portion of subsection 181(3), neither the equity nor the consolidation method of accounting is to be used. Moreover, if subsection 181(3) was not intended to be interpreted as providing that GAAP should be the principal determinant of the capital tax base for most corporations, Parliament could have so stated.
[22] Both parties to this appeal referred to the fact that since its enactment in 1989, Part I.3 of the ITA has undergone a number of amendments. In 1997, an amendment was made to subsection 181.2(3) to provide for the inclusion of deferred unrealized foreign exchange gains and losses in the computation of the capital of corporations other than financial institutions. In my view, this Parliamentary action in addressing a perceived deficiency in the GAAP treatment of deferred unrealized foreign exchange gains and losses in relation to LCT, supports the proposition that Parliament intended to defer to GAAP as the principal determinant of capital for the purposes of the LCT, except to the extent specifically otherwise provided in Part I.3 of the ITA.
[23] A similar view was expressed by the Department of Finance in a “comfort letter”, dated August 24, 1995, that was referred to in the Minister’s factum. The letter dealt with the changes to subsection 181.2(3) that were referred to above and a portion of it is apposite:
As you are no doubt aware, it is generally the Department’s policy to defer to Generally Accepted Accounting Principles (“GAAP”) in the calculation of capital for the purposes of LCT. However, the consideration of foreign exchange gains and losses in accordance with GAAP could lead to changes in a company’s LCT where there has been no change in the make‑up of the company’s capital base. This is undesirable from a policy perspective, so a narrow exception to the application of GAAP is adopted.
[24] Subsection 181(3)(b)(ii) illustrates that Parliament intended to rely upon external standards in relation to the determination of LCT liability. That provision applies to banks and insurance corporations and specifies that the amounts reflected in the balance sheets of those corporations that have been accepted by their regulators are required to be used, without condition or qualification, for the purposes described in the opening portion of subsection 181(3).
[Emphasis added.]
[35] With respect, my view is that the determination of the issue in the case at bar is governed by this Court’s decision in Ford Credit Canada Ltd., above, and that the judge did not err in his interpretation and application of subsection 181(3) of the Act regarding the determination of a corporation’s taxable capital for the purposes of capital tax under Part 1.3.
[36] The appellant submits that the amounts of the advances appearing in the supplementary notes on inventory are amounts that appear on the balance sheet and should have been accounted for in determining the taxable capital. However, the supplementary notes are not considered an element of the financial statements: see the CICA Handbook – Accounting, Section 1000, Financial Statement Concepts, Appeal Book, Volume 2, at page 425. They are useful only for the purpose of “clarification or further explanation of the items in financial statements”: ibidem. To u