http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/71987/index.do 
Henco Industries Limited v. The Queen (May 9, 2014 – 2014 TCC 192) is a decision illustrating what is one of the rarest phenomena in Canadian income tax law – a non-taxable capital receipt. Moreover the complexity and novelty of the underlying fact situation assist in understanding why such receipts are so rare.
Henco owned a property known as Douglas Creek Estates (DCE) which was at the epicentre of a protest and occupation by members of the Six Nations in 2006.
[1] This is a story of a developer, Henco Industries Limited (“Henco”), who could not develop – through no fault of its own. Thwarted by a volatile situation in Caledonia, Ontario in 2006, including blockades by protesters from Six Nations (the “Occupation”), the Ontario Provincial Police (“OPP”) reluctance to remove the blockades and the Government of Ontario’s action rezoning certain Henco property, Henco was precluded from developing that property known as Douglas Creek Estates (“DCE”). Henco ultimately accepted $15,800,000 from the Government of Ontario to dispose of all its right and interest in the DCE property. It is the taxation of that amount that is primarily in dispute.
[2] The Respondent says the $15,800,000 was consideration either for Henco’s interest in the DCE property which was inventory, or for the business of Henco, and is in either case fully taxable as income. Henco says the DCE land was worthless and the $15,800,000 was a payment by the Government of Ontario to relieve a potentially catastrophic situation by eliminating lawlessness occasioned by the Occupation: a payment on capital account to compensate Henco for the destruction of its business. The payment being on capital account, the Appellant then argues that it could only be caught by the eligible capital property rules in section 14 of the
Income Tax Act (the “
Act”). Yet, the application of that section does not capture the amount and consequently it is a taxable nothing. The major issue is the characterization of the $15,800,000 payment as income or capital, and if it is capital, as an eligible capital amount or a non-taxable capital receipt.
The facts of the case are, by necessity, complex and lengthy (paras. [4] to [78]). Many of the facts were introduced by means of an Agreed Statement of Facts. Nevertheless there was considerable evidence to which the Crown objected on the basis of the parol evidence rule. This included materials from the province of Ontario, press reports, affidavits from other proceedings, press releases and other materials. The appellant succeeded in having most of this material admitted under the “factual matrix” principle of contractual interpretation. The decision contains a very scholarly exposition of the application of the “factual matrix” concept. The court also permitted the introduction of Ontario press releases on the “public document” principle accepting the appellant’s position that it would be a waste of time to call witness to authenticate the press releases. The court did however reject the admission of affidavits sworn by Ontario officials in other proceedings surrounding the Occupation holding that it they were simply unsworn hearsay in the Tax Court Appeal.
Reducing the facts to their bare bones the DCE property was occupied on February 28, 2006 and thereafter the appellant had no ability to utilize the property whatsoever and because of the Occupation the property had no value to any prospective purchaser. On June 30, 2006 Henco signed an agreement with Ontario under the terms of which it conveyed its interest in the DCE property and released Ontario Realty Corporation, Ontario and its agents in exchange for $12,300,000 and a yet to be determined “final compensation amount”. That final compensation amount was determined to be $3,500,000 on July 26, 2006 (hence the disputed total of $15,800,000). Henco reported the receipt as the proceeds of disposition of eligible capital property. CRA assessed the receipt as ordinary income. The battle lines were drawn. It appears that at that point Henco determined to take the position that the amount was a non-taxable capital receipt.
The court first concluded that the payment had not been for the DCE property:
[162] There was an extremely dangerous situation evolving in Caledonia. Ontario had to do something. Henco was caught in the middle and ultimately paid a price. Ontario removed Henco as a stumbling block. The only conclusion that can be drawn is that Ontario paid Henco to go away and in doing so enable Ontario to get rid of the injunction, acquire control of the volatile situation and restore peace. The effect was to destroy Henco’s business.
[163] Given the extraordinary surrounding circumstances, I cannot conclude Henco received $15,800,000 for the sale of worthless land. That captures neither the essence of the Agreement itself nor the intent of the Parties; from Henco’s perspective, to salvage what it could from the destruction of its business, and from Ontario’s perspective, to defuse a volatile situation and perhaps do the right thing by Henco. Although land was transferred as part of the deal, this was not a land deal.
Next it concluded that if the amount attached to the DCE property, it would be a capital receipt:
[169] What then do we have as far as characterizing the DCE land; it seems it is neither fish nor fowl. Is a tangible asset that is worth nothing a taxable nothing, even if someone (Ontario) is prepared to pay something for it? Or is an asset, such as land, which is found not to be a trading asset, by default a capital asset? This becomes something of a circuitous debate, leading to support for my earlier finding that in fact and in law Ontario could not have paid and did not pay $15,800,000 for the land. However, if the $15,800,000 does attach to the land, and I conclude the land is not inventory, I then also conclude it has to be on capital account and taxed as a capital gain.
The court held that there was a disposition. Further it held that the payment related to the business of Henco:
[193] The Appellant maintains that the payment was to effectively make the business go away. While it may be argued that, at the time the deal was struck between Henco and Ontario, Henco was no longer carrying on business, I find that the payment, especially given a provision in the Agreement requiring that Henco cease its business, was nevertheless “in respect of” the business carried on by Henco. There was a strong connection between the Occupation, which arose as a result of Henco carrying on the land development business, and the urgent need for Ontario to remove the blockades by eviscerating the ability of Henco to carry on business. I conclude, notwithstanding the timing of Henco ceasing to carry on business, that the amount was received “in respect of” the business carried on by Henco.
The payment was in respect of the loss of goodwill by Henco:
[199] Where does all this lead? As Justice Sharlow stated in Toronto Refiners, compensation for the loss of goodwill fits nowhere in the scheme of the Act unless within section 14. Is that what Ontario paid for? Compensation for the loss of goodwill? I believe it is. Ontario had to make Henco go away: Henco could not own the land; it could not carry on business; Ontario needed to ensure Henco could not sue it; Henco could not enforce the injunction. With all assets of its former business rendered valueless, the only possible result, based on the residual approach with regard to goodwill as set out in TransAlta, is that the $15,800,000 was for the loss of Henco’s goodwill. Viewing the situation in this manner, I see no need to try and distinguish between the whole loss of the business and disposition of particular rights: it falls into this residual category.
The payment was not however taxable since by the time it was made Henco no longer had a “source” of income:
[202] This sensible view renders the discussion of whether one looks at the mirror‑imaging test from the payor’s or the recipient’s perspective moot. There are some situations, such as this, where the rather technical process for the determination of consideration and the application of the mirror-imaging rule simply does not work. This allows me to step back from such a technical analysis to truly appreciate what has happened here. What has not happened is that Henco sold land as part of its land development business, as the Respondent would suggest. Nothing could be further from reality.
[203] Henco’s business was destroyed. By the time it struck an arrangement with Ontario, Henco had no value as a business however one might try to slice the analysis: there could not be and there was not a source of income. The capital receipt was non-taxable.
There were three other smaller amounts at issue in the appeal.
$650,000 Receipt from Ontario
This was a gratuitous payment made to Henco by Ontario:
[33] Agreed Statement of Facts
26. On May 3, 2006, Ontario made a payment of $650,000 to Henco.
27. Ontario did not require Henco to take any particular action or do any particular thing in respect of Henco’s use of the $650,000.
28. Ontario did not seek anything in return from Henco in exchange for the payment of $650,000.
The court concluded that this was a non-taxable windfall:
[125] The evidence was clear that after February 28, 2006, Henco could not access the DCE property. It could not carry on a business earning income. As the Appellant’s counsel put it, it had been materially crippled or sterilized. That sterilization became permanent later in May, ending the business. But from February 28 what Henco did was not in the course of earning income from a business. What it did was attempt to preserve the business itself, with an expectation, that clearly grew weaker as the Occupation went on, that blockades would be lifted and it might return to earning income from the business. It did this by taking the only step it could take, an attempt to legally have the blockades removed. Throughout the period from February 28 to May 3 it was physically impossible for Henco to do anything other than that. I conclude it did not receive the payment in the course of earning income from a business. It was not, for example, in the restart-up phase of a business after a catastrophic event such as a flood or an earthquake.
[126] If I am wrong in my conclusion that the amount was not received “in the course of earning income from a business”, I find the third condition has also not been met. Can the payment reasonably be considered to have been received as assistance in respect of an outlay or expense? There is no evidence from Henco as to what the $650,000 was used for. There is evidence from Ontario in its letter of April 27 and the enclosed Schedule A that the payment was to assist in respect of costs and expenses incurred because of the Occupation, but that was Ontario’s view, not Henco’s. There was no requirement for payment. There was no requirement for an accounting.
Seneca Property
The Seneca property was land close to the DCE property which was held for potential development as a golf course. Henco transferred the property to a related corporation at a value of $800,000 and treated the proceeds as a capital gain. CRA assessed the value of the property at $850,000 and treated the transaction as being on income account. The court accepted Henco’s valuation as being reasonable but concluded that it had not successfully rebutted the Minister’s assumption that the property was inventory:
[138] I am left with no evidence that favours one intention over the other: developed for sale as a golf course versus developed to be owned and operated by Henco as a golf course. One of the Minister’s assumptions was that “the Appellant made efforts to bring the property into a more marketable condition in order to sell it at a profit by carrying out preliminary planning to develop the Seneca property into a golf course”. The onus is on the Appellant to demolish that assumption. I find there has been no evidence presented to me that does so. All the evidence is just as consistent with an intention to develop the property for sale as a golf course as it is with an intention to develop the property to own and operate it as a golf course. The Appellant has not met the onus. The $800,000 is on income account.
Morrison Property
The Morrison property was even closer to the DCE property. Again Henco transferred the Morrison property to a related corporation and valued the property at $1,000,000. It reported the proceeds as being on income account. CRA assessed the value of the property at $1,400,000. The court held that Henco had not successfully rebutted the Minister’s evidence as to the higher value:
[139] The only issue with respect to the Morrison property is the correctness of the Minister’s reliance on the fair market value of $1,400,000, as opposed to Henco’s determination of the value of $1,000,000. Henco relies on the fact that the Minister accepted its write-down of the property to $1,000,000, as well as relying on Mr. Henning’s personal view of its value, given the circumstances at the time. The Minister relies on the retrospective appraisal obtained by Henco from Jacob Ellens & Associates Inc. that appraised the Morrison property at $1,400,000. The appraisal report, while included in the Appellant’s Book of Documents, was not put to Mr. Henning or any of the witnesses. The appraiser was not called.
…
[145] Mr. Henning has not provided a valuation based on any valuation method. His valuation is in effect Henco’s book value. He acknowledged he is not an appraiser, but said he was intimately familiar with the situation at the time. That familiarity, however, does not translate into a reasoned, methodical valuation.
[146] The explanation Mr. Henning gave (see paragraph 76 of these Reasons) is just not enough to rebut a value based on an expert appraisal, especially where that appraisal has not been subjected to any detailed review by another appraiser or even by Mr. Henning.
[147] I conclude that the Minister’s assessment of a value of $1,400,000 is correct.
In the result the appeal was allowed and the court gave the parties 30 days to make submissions on costs, failing which costs would be awarded to Henco in accordance with the court’s tariff.