On April 23, Morguard Corporation filed an appeal with the Federal Court of Appeal of the decision of Boyle J in the Tax Court of Canada, 2012 TCC 55, (Date: February 24, 2012) holding that a $7.7 million break fee was taxable. See my colleague Sebastian Elawny’s earlier blog post about the trial decision.

The taxpayer’s principal argument at trial (and, one assumes, on appeal): that the break fee was a non-taxable windfall. Windfalls are a very rare species in Canadian tax law. The last FCA decision to examine the issue of windfall in any detail dealt with penalty interest on an expropriation: Bellingham v. The Queen (1996) 50 DTC 6075 (per Robertson JA):

Against this background, we are left to pursue the judicial understanding of what items fall outside the grasp of paragraph 3(a). I begin with the recognized exclusionary categories: gambling gains, gifts and inheritances, and the residual category of windfall gains. I shall deal briefly with the first two categories as they provide the underlying framework for the third.

Gambling gains are non-taxable provided the taxpayer is not in the business of gambling: see Graham v. Green, [1925] 2 K.B. 37; Minister of National Revenue v. Walker William, S., [1952] Ex. C.R. 1; Morden, Harry Edgar v. Minister of National Revenue, [1962] Ex. C.R. 29. The classical reason for excluding such receipts from income is that a “bet” is based on an “irrational agreement”. A more compelling argument is that a gambling gain does not flow from a productive source. That is, a source that is capable of producing income: see F. E. LaBrie, The Principles of Canadian Income Taxation, (Don Mills, Ont.: CCH Canadian Ltd., 1965), at page 25.

There is no need to cite authorities for the proposition that gifts and inheritances are immune from taxation. It is well accepted that these items represent non-recurring amounts and the transfer of old wealth. Underlying the source doctrine is the understanding that income involves the creation of new wealth. Gifts do not flow from a productive source of income. Where a gift emanates from what otherwise is regarded as a productive source, e.g. the taxpayer’s employment, then the issue is one of concealed wages and employee benefits (see section 6 of the Act). To qualify as a gift, there must be voluntary and gratuitous transfer of property. There must be an absence of valuable consideration. Hence, a payment that takes the form of a quid pro quo will not be characterized as a gift.

The precise scope of the residual category “windfall gains” has proven problematic. At best, it can be said that a payment which is unexpected or unplanned and not of a recurring nature, is more likely than not to be characterized as a windfall gain. But like all generalizations, this observation must be scrutinized meticulously

The only somewhat recent Supreme Court of Canada decision to indirectly examine the question of windfall was Canada v. Fries, [1990] 2 S.C.R. 1322 (per Sopinka J):

We are not satisfied that the payments by way of strike pay in this case come within the definition of “income . . . from a source” within the meaning of s. 3 of the Income Tax Act, S.C. 1970-71-72, c. 63. In these circumstances the benefit of the doubt must go to the taxpayers. The appeal is therefore allowed and the decision of the Tax Review Board is restored. The appellant is to have his costs throughout.

If Morguard succeeds in its windfall argument in the Federal Court of Appeal, it will be a rare event – not unlike sighting a yeti. The odds are high that the Court will not disturb the careful reasons of Boyle J.