Link to the original Supreme Court decision (May 22, 2008).
Case summary: M bought "an interest in proprietary seismic data" from an oil and gas exploration company by paying $15,000 up front and promising to pay $85,000 plus interest on a set date several years later. The seismic data was expected to generate income which would be used to pay the debt; and the data was security on the debt, so that the data would be repossessed and sold to cover the debt if the income was not enough to pay it off at that time - and if that still were not enough to cover the debt, tough cookies; M would not have to pay any more. He claimed tax deductions based on the idea that he had bought the data for $100,000 as soon as the deal was made (the details are complicated but amount to that). However, the tax authorities judged that the data was only worth $32,182, in which case it looks suspicious that he would have paid $100,000 for it; and implicitly that he and the company were cooperating ("not dealing at arm's length") to overstate the price so he could claim a bigger deduction. The main question now is whether M's liability to pay the $100,000 was absolute or contingent: in other words, whether he was committed to pay it for sure, or only under some conditions. If absolute, he would be allowed to claim it for tax purposes as soon as he was committed to pay it even if he had not actually paid it yet; if contingent, he would not be allowed to claim it until the conditions occurred and he was committed to pay. Also at issue is whether the transaction was at arm's length, which would determine whether we believe that $100,000 was the correct amount; the trial judge found that it was an arm's length transaction, but the Federal Court of Appeal set that aside.
Opinions:
(McLachlin, Binnie, LeBel, Deschamps, Fish, Charron, and Rothstein): The liability was absolute. M was committed to pay a total of $100,000 right from the start of the deal. Even though the property pledged as security on the debt, and the income stream earmarked to pay it, might not be enough to cover the debt - and even though some of the debt might go permanently unpaid in such an event - the amount of the debt was unconditional. (Much like a mortgage on a house, where the house might lose its value but the amount of the mortgage is unchanged.) Also, the trial judge's decision that the transaction was at arm's length can stand. Majority decision.
(Bastarache and Abella): The liability was contingent. Regardless of the notional value of the debt, the amount M would actually have to pay was conditional on the results of the exploration business: if it went well he would end up paying the full $100,000, but if it went poorly he would only pay as much as was generated and lose his interest in the seismic data. As a result, he was not committed to pay the $100,000 with certainty at the time of making the deal, and can only claim the amounts of his payments as he actually pays them. Also, (agreeing with the majority) the trial judge's decision that the transaction was at arm's length can stand.
Comments
Matt from 129.97.79.144 at Mon, 04 Aug 2008 16:44:05 +0000:
The exact terms of the promissory note are included in the decision, in paragraph 21 - you might like to look at them. However, they don't seem to answer your question. I'm not sure that reporting the sale of the data as taxable income would really be correct - I think the data might be capital property (things that you can sell usually are) and then M would report the difference between the proceeds and what he originally paid as a capital gain or loss. However, he did claim the original $100,000 as an "exploration expense". That may have implications (either way - I don't know) for whether it is or isn't capital property.
There is another factor here which I didn't include in my summary: the terms of the note provide that in the event of repossession, M would get to keep 40% of the proceeds from the sale even if the remaining 60% weren't enough to cover the debt. That may have some implications for whether the debt was for real or not - I didn't include it because it didn't seem to play a big role in the actual Justices' reasons and I wanted to save words for things that did.
A question that seems important to me, and for which I unfortunately also don't have an answer, would be: How reasonable was it to expect that he would end up paying the whole debt? Are we talking about almost certain and this repossession business was just insurance against emergencies? Are we talking about something like 50-50? Are we talking about almost certainly *not*, so that the parties intended to go through the repossession scenario right from the start?
Matt from 129.97.79.144 at Mon, 04 Aug 2008 17:05:11 +0000:
On reading the decision more carefully, I no longer think that the data would be capital property. It seems like because its purchase price was treated as an expense and set against income, it wasn't purchased as capital property and so can't become capital property before being sold. The money from selling it would have to be income, and presumably taxed.
It appears that in fact the data was sold in January 2006 for approximately $17,600; $7,100 of that would have gone to McLarty. Without seeing his tax return I don't know if he paid tax on it but my guess would now be "yes."
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kiwano from 76.67.61.124 at Mon, 04 Aug 2008 16:20:17 +0000:
Is there any information in the summary or in any of the decisions indicating how the repossession of the seismic data was (or ought to have been) reported in M's taxes? In particular, if the liability were to be considered as absolute, than I'd expect the repossession to be reported as income covering the balance of the liability.
In the absence of any indication that this is the case, I'm inclined to choose the contingent interpretation, since it is the interpretation that would certainly leave a tax record that is consistent with M's actual financial position, though I would choose absolute liability to keep things more consistent with other debts, were I to know that an accurate tax record would exist in that case.