Cadillac Fairview Corp. Ltd. v. The Queen, 97 DTC 405, [1996] 2 CTC 2197 (TCC)

Bowman J.T.C.C.: - In this appeal from an assessment for the appellant’s 1984 taxation year, two issues are raised:

(a) whether payments totalling $15,852,000 made by the appellant to lenders as part of the disengagement of five of its fifth-tier U.S. subsidiaries from a number of unsuccessful U.S. real estate partnerships or joint ventures give rise to a capital loss to the appellant for the purposes of the Income Tax Act; and

(b) whether the cost of obtaining zoning changes permitting a higher density in buildings which the appellant proposed to build on land owned by it in Toronto, amounting to $11,227,444, formed part of the cost of the land, or of the buildings, or was an eligible capital expenditure.

The appeal was originally heard by Judge Kempo of this court. She retired from the court, on which she had served with distinction for many years, before she could render judgment. Counsel were asked by the court whether they wished to have the case reheard before another judge or have it decided by another judge on the basis of the transcript of the evidence and argument that had been presented before Judge Kempo. They chose the latter and the case was assigned to me.

On January 31, 1996, the Registrar, at my suggestion, wrote to both counsel. In his letter, he stated:

Judge Bowman expects to have his review of the transcript completed by the end of this week. He has suggested that, in fairness to counsel, in light of the delay that has occurred in disposing of the case and the fact that a new judge who did not preside at the trial will be deciding it, counsel should be offered the opportunity, if they wish, of making any further oral representations to him that they may consider appropriate.

The letter also invited counsel, if they wished to make further representations, to communicate with the court as soon as possible to arrange a time.

Neither Mr. Templeton nor Ms. Van Der Hout responded.

Capital loss issue

It would appear useful, in order to give some focus to the factual background to the capital loss issue which follows, if I summarize briefly the principles that I think apply in a case of this type. The appellant’s claim to an allowable capital loss is premised upon the allegation that it guaranteed the indebtedness of its fifth-tier U.S. subsidiaries, that it paid lenders in satisfaction of those guarantees, that it became subrogated to the rights of the lenders, that it disposed of these rights for nil proceeds and that it thereby incurred a capital loss.

To arrive at the conclusion that a capital loss has been sustained for the purposes of the Act it is clear from sections 3, 38 and 39 that there must have been an actual or deemed disposition of property. The mere making of a capital payment does not, of itself, give rise to a capital loss. Where a guarantee of a primary debtor’s obligation is given and the guarantor is required under the guarantee to pay and does pay to the creditor the primary debtor’s obligation, the guarantor is in the normal course sub- rogated to the position of the creditor unless it has explicitly or implicitly waived those rights of subrogation or other circumstances [1] prevent such rights from arising. Absent such a factual or legal impediment, by operation of law a debtor-creditor relationship arises between the guarantor and the primary debtor. The guarantor’s cost of the debt would normally be the amount that it paid under the guarantee.

If, as is frequently the case, the principal debtor cannot pay, the debt may be regarded as having become bad. Section 50 of the Act deems the debt to have been disposed of by the guarantor at the end of the taxation year in which it became bad and to have been reacquired at a cost of nil immediately thereafter. Thus, through the combined operation of the law of subrogation and section 50 of the Act the disposition necessary to support the claim for a capital loss is achieved.

Subparagraph 40(2)(g)(ii) provides:

a taxpayer’s loss, if any, from the disposition of a property, to the extend that it is

ii) a loss from the disposition of a debt or other right to receive an amount, unless the debt or right, as the case may be, was acquired by the taxpayer for the purpose of gaining or producing income from a business or property (other than exempt income) or as consideration for the disposition of capital property to a person with whom the taxpayer was dealing at arm’s length.

is nil.

In many cases if a guarantor is obliged to make good under a guarantee it is because the principal debtor in unable to pay the obligation. From this, it follows that the guarantor’s right of subrogation against the principal debtor is, at the time of acquisition, likely to be, in many instances, worthless or virtually worthless. A narrow and mechanical reading of subparagraph 40(2)(g)(ii) would lead one to conclude that on the payment of the guaranteed amount the guarantor’s acquisition of the worthless subrogated debt could not possibly have as its purpose the gaining or producing of income from a business or property. Such an interpretation in my view lacks commercial sense. A functional and more commercially realistic interpretation would subsume in the purpose of the acquisition of the subrogated debt the purpose for which the guarantee was originally given.

The analysis of the facts requires that the following questions be answered:

(a) Were the subsidiaries’ obligations to the banks guaranteed by the appellant?

(b) Was the appellant’s payment of the amounts in question made pursuant to the obligation under the guarantees?

(c) Did the appellant acquire by subrogation [3] a debt owing by the subsidiary to the lenders?

(d) Was that debt disposed of in the year? The appellant argues that, quite apart from its position that the debt became bad, with the consequent deemed disposition under section 50 of the Income Tax Act, the appellant, in the case of four of the five subsidiaries involved here, disposed of the debts by waiving its rights of subrogation. The effect of the waiver is, in my view, critical, for reasons upon which I shall elaborate more fully below.

(e) Was that debt acquired for the purpose of gaining or producing income from a business or property of the appellant? More specifically, based on the analysis set out above, if the payments were made pursuant to the guarantees, were the guarantees given for the purpose of gaining or producing income from

The appellant pleaded that the payments were made pursuant to the guarantees and this allegation was denied. Counsel for the appel ant argued that since the Minister had not pleaded that he “assumed” that the payments were not made pursuant to the guarantees the Minister had the onus of establishing that the payments were not made pursuant to the guarantees. The question is, if not a pure question of law, at least a mixed one of law and fact. In any event the basic assumption made on assessing was that the appellant was not entitled to the capital loss claimed and it was for the appellant to establish the several legal components entitling it to the deduction claimed. An inordinate amount of time is wasted in income tax appeals on questions of onus of proof and on chasing the will-o’-the- wisp of what the Minister may or may not have “assumed”. I do not believe that Minister of National Revenue v. Pillsbury Holdings Ltd., [1964] C.T.C. 294, [1964] D.T.C. 5184, has completely turned the ordinary rules of practice and pleading on their head. The usual rule — and I see no reason why it should not apply in income tax appeals — is set out in Odgers’ Principles of Pleading and Practice, 2nd edition at page 532:

The “burden of proof” is the duty which lies on a party to establish his case. It will lie on A, whenever A must either call some evidence or have judgment given against him. As a rule (but not invariably) it lies upon the party who has in his pleading maintained the affirmative of the issue; for a negative is in general incapable of proof. Ei incumbit probatio qui dicit, non qui negat. The affirmative is generally, but not necessarily, maintained by the party who first raises the issue. Thus, the onus lies, as a rule, on the plaintiff to establish every fact which he has asserted in the statement of claim, and on the defendant to prove all facts which he has pleaded by way of confession and avoidance, such as fraud, performance, release, rescission, etc.

a business or property of the appellant?

If the answer to all five of the questions is in the affirmative the appellant must necessarily succeed. If the answer to any one of them is in the negative, it must fail, whatever commerciality may have motivated the payments. In a broad commercial sense the appellant lost money but its entitlement to the relief it claims is based upon legal concepts of some specificity. To arrive at the result it seeks the appellant must bring itself within those concepts. In particular, it must demonstrate that it acquired a debt for the purpose of gaining or producing income from a business or property and that the debt either became bad in 1984 or was otherwise disposed of at a loss.

Facts

In 1984, the appellant was a large Canadian public company whose principal business was the purchase, development, leasing and management of commercial, retail, industrial and residential real property and the sale of residential real property. This business was carried on either directly or through subsidiaries. It owned many subsidiaries in Canada and the United States. It provided management and financial support to its subsidiaries, for which it charged no fees. As the parent company of a vast corporate empire it evidently looked to other forms of economic reward. There can be little doubt that its objects, in providing financial support or management services, were purely commercial.

The five companies with which we are here concerned were incorporated in the United States. They were: CF Parkside Inc. (“Parkside”), CF Cleveland Inc. (“Cleveland”), CF Jocelyn Inc. (“Jocelyn”), CF Prospect Inc. (“Prospect”) and CF Society Hill Inc. (“Society Hill”). The chain of ownership was as follows: The appellant owned CFI Properties B.V., (“BV”), a Netherlands Antilles company. BV owned Cadillac Fairview U.S. Inc. (“CFUS”). CFUS owned Cadillac Fairview Residential Holdings Inc. (“Holdings”). Holdings owned Cadillac Fairview Residential Properties Inc. (“Properties”). Properties owned Society Hill, Prospect, Jocelyn, Cleveland and Parkside.

Society Hill

Society Hill, a Delaware corporation, formed a general partnership with Greenwood Properties Inc. (“Greenwood”) called Independence Place Associates (“IPA”) in December 1979 to construct two residential condominium apartments for sale in Philadelphia. IPA borrowed $53,000,000 US from the New York Agency of the Bank of Montreal. The appellant, on August 5, 1980, gave an unconditional continuing guarantee of the loan both as guarantor and as principal obligor. The guarantee was to be construed in accordance with the law of Ontario. A similar guarantee was given by Greenwood, to be construed under Pennsylvania law.

On March 1, 1983, Society Hill, Greenwood, Greenwood Management Company and IPA entered into an agreement whereby Society Hill withdrew as a partner from IPA.

Among the conditions to the withdrawal of Society Hill from IPA were the following, as contained in paragraph 2(2):

On or before June 1, 1983, Bank [i.e. the Bank of Montreal, New York Agency] shall have issued its undertaking to enter into a modification agreement if and at such time as the closing takes place hereunder, which modification shall have the effect of discharging and relieving CF [i.e. Society Hill] and The Cadillac Fairview Corporation Limited of all obligations and liabilities under the Construction Loan, the Cadillac Fairview Surety Agreement, and the CF Bond, and all other documents or instruments relating to the foregoing.

The agreement went on to provide that the undertaking by the Bank may be conditioned upon the delivery of other documents, essentially a restructured financial arrangement between the Bank, Greenwood and IPA.

Clause 3A of the agreement provided that:

CF shall contribute the cash sum of Three Million Five Hundred Thousand Dollars ($3,500,000), as the same may be adjusted pursuant to paragraph 2A(3), to IPA, which amount shall thereupon be applied in reduction of the principal balance of the Construction Loan.

Paragraph 2A(3) of the agreement provided that:

CF’s [i.e. Society Hill’s] internal auditors shall have conducted an audit of the Partnership’s books and records to determine the net sum owed by, or to, CF as of February 28, 1983 under the terms of paragraph 9 of the Partnership Agreement (the “Audited Net Sum”). The full amount of the Audited Net Sum (if and to the extent reconciled, compromised and/or settled, as aforesaid) shall be added to, or subtracted from, as applicable, the amount of the additional capital contributions required to be made by CF under the terms of paragraph 3A hereof.

Section 9 of the Partnership Agreement dealt with loans by the partners to the partnership.

The adjustment made under paragraph 2A(3) resulted in $3,266,324 being payable as a contribution to the partnership under clause 3A of the Agreement of March 1, 1983. In the result it was the appellant that paid the amount and it paid it directly to the Bank of Montreal. On July 4, 1983 Mr. John MacDonald wrote to the New York Branch of the Bank of Montreal and stated, inter alia:

This letter will confirm our present intention to pay to you pursuant to our guarantee of the subject loan a sum of $3,266,324.00 in partial fulfillment of one of the conditions precedent to the restructuring of the loan.

The Bank signified its confirmation that the arrangement was satisfactory, the payment was made, and on July 20, 1983 the Bank of Montreal released the appellant from its guarantee.

Although Mr. Wood, manager of taxation of the appellant, testified that the amount was paid because of the obligations under the guarantee, and the letter of July 4, 1983 reflects the same view, the agreement of March 1, 1983 makes it clear that it was paid on behalf of Society Hill, in fulfilment of Society Hill’s obligation under that agreement to contribute $3,500,000, as adjusted. I do not think that the fact that the appellant paid Society Hill’s obligation under the March 1, 1983 agreement constituted a fulfilment of the appellant’s obligation under its guarantee to the Bank. Moreover, there is no evidence in the record to show that the appellant ever treated Society Hill as its debtor by subrogation of the amount so paid, or that Society Hill ever regarded itself as having any liability to the appellant. Mr. Wood testified that at the end of the 1984 taxation year the appellant did not show on its financial statements any amounts owing by any person on account of the amounts paid to the Bank of Montreal. The $3,266,324 paid by the appellant was a payment made by it on behalf of Society Hill as the price of Society Hill’s being allowed to extricate itself from the IPA partnership.

Nothing in the record indicates that the appellant thereby acquired a debt to itself from Society Hill that was capable of becoming bad within the meaning of section 50 of the Income Tax Act or of being otherwise disposed of by the appellant.

Prospect, Parkside, Jocelyn and Cleveland

Prospect formed a general partnership on January 22, 1980 with Chateau Corporation (“Chateau”) called Prospect House Associates (“PHA”) to acquire an existing building in Virginia for conversion into condominiums for sale. PHA borrowed $26,600,000 U.S. from the Bank of Nova Scotia, Atlanta Agency, (“BNS”) and the appellant guaranteed 50% of the loan to BNS and Bank of Nova International (Curacao) N.V. (“BNSI”).

Parkside, Jocelyn and Cleveland each formed a separate partnership with Chateau in December 1979 to acquire existing buildings in the Washington D.C. area for conversion into condominiums for sale. The partnerships were called Parkside Associates (“PA”), Jocelyn House Associates (“JHA”) and Cleveland Terrace Associates (“CTA”). Each of PA, JHA and CTA borrowed from the First National Bank of Chicago (“FNBC”) as follows: PA $48,512,600 U.S., JHA $2,387,400 U.S. and CTA $3,200,000 U.S. A condition of the loans was that the appellant, Gary H. Nordheimer, Scott A. Nordheimer and Myer Feldman would jointly and severally guarantee the principal and interest of the loans. The Nordheimers and Feldman were principal shareholders of Chateau. The guarantees were given. PA was dissolved on June 25, 1982 and Parkside and Chateau became joint venturers.

The ventures encountered serious financial problems. The manner in which the appellant withdrew its economic involvement in the projects was accomplished in a manner that differed from the IPA arrangement, in that Properties, the immediate parent of Prospect, Parkside, Jocelyn and Cleveland, sold its shares of these companies to the principals of Chateau.

In the case of Prospect, the original agreement dated February 1983 was between Properties, as seller, and the Nordheimers and Feldman as purchasers. Clause 1.2 provided that, upon closing, the purchasers should pay to the lender (presumably BNS or BNSI) the outstanding balance, principal and interest, of the amounts owing under notes to the lenders in the amounts of $26,600,000 less the amount that the seller (Properties) would pay to the lender under clause 1.4 of the Agreement ($2,756,000).

The agreement was amended to include other parties, including the appellant. Clauses 8, 9, 10, 11 and 13 of the amended agreement read as follows: (In this agreement CF is Prospect and CFCL is the appellant).

8. The payment to be made by Seller pursuant to Section 1.4 of the Prospect Agreement shall be $3,756,000.00 plus certain interest which was accrued since the date of the Prospect Agreement rather than $2,756,000.00 and the payment to be made by Purchaser pursuant to Section 1.2 of the Prospect Agreement shall take into consideration, and be reduced by the payments to be made by Seller pursuant to Section 1.4 of the Prospect Agreement as modified by this paragraph 8.

9. At the Closing, CFCL shall pay to The Bank of Nova Scotia, Atlanta Agency (“BNSA”) or The Bank of Nova Scotia International (Curacao) N.V. (“BNSI”), as the case may be (BNSA and BNSI are hereinafter collectively referred to as “Lender”), the sum of THREE MILLION SEVEN HUNDRED NINETYSEVEN THOUSAND ONE HUNDRED SEVENTY- SEVEN AND 57/100 ($3,797,177.57) DOLLARS, in satisfaction of CFCL’s obligation pursuant to that certain guaranty, dated April 8, 1980, in favor of Lender (“Guarantee”), with respect to payment of the Prospect Notes, by wire transfer of immediately available federal funds to an account or accounts designated by Lender.

10. At the Closing, SEEF shall pay to Lender an amount equal to the outstanding principal balance and accrued interest owed to Lender under the Prospect Notes and any amounts owed by reason of legal fees and disbursements incurred by Lender in connection with the Prospect Notes, as of the date thereof, after first deducting the payment made by CFCL pursuant to Paragraph 9 above, by wire transfer of immediately available federal funds to an account or accounts designated by lender.

11. Immediately following the payment made by CFCL pursuant to Paragraph 10 above, CFCL hereby waives any claims, by way of subrogation or otherwise, which it may have against CF for the payment made by CFCL under the Guarantee and hereby releases CF from any liability in connection therewith.

12. Simultaneously with the waiver made by CFCL pursuant to Paragraph 11 above, CF hereby waives any claim it may have against CFCL under the Guarantee and hereby releases CFCL from any liability in connection with any such claim.

In the end, only the appellant paid $3,797,177.57 to the Bank, to be applied against the loan. Properties was also to pay $3,756,000 to the Bank, but evidently it did not do so.

With respect to the loan to PA, JHA, and CTA, a default would occur under the loan if 100% of the issued and outstanding shares of the capital stock of Parkside, Jocelyn, or Cleveland ceased to be owned by the appellant, or a wholly owned subsidiary of the appellant. A letter dated March 17, 1983 from the appellant to The First National Bank of Chicago, and confirmed by the Bank, indicated the position of the Bank concerning the proposed share sale:

You have been advised previously that Cadillac Fairview Residential Properties, Inc., an indirect wholly owned subsidiary of The Cadillac Fairview Corporation Limited, intends to sell the shares of capital stock of CF Parkside Inc., CF Jocelyn Inc., and CF Cleveland Inc., to a certain purchaser.

Under certain Deeds of Trust dated July 31, 1980, The First National Bank of Chicago has the right to approve the sale of the shares of capital stock of CF Parkside Inc., CF Jocelyn Inc., and CF Cleveland Inc., or may request payment of any outstanding indebtedness.

It is our understanding that the Bank does not approve of the sale of the capital stock of these companies, and, in the event the sale should proceed and close, the Bank requests the repayment in full of the outstanding loans to which these three companies are a party as borrower.

Your acknowledgement and confirmation of these facts is requested by signing and returning the duplicate of this letter.

The Bank did not consent to the sale of the shares and as a result the parties negotiated among themselves to effect the withdrawal of the economic interest of the appellant’s corporate organization in the ventures. This included dealing with the Bank loans.

In the original Stock Purchase Agreement for the Parkside shares between Properties and the principals of Chateau, all the shares of Parkside were to be sold to the principals of Chateau for $10,500,000. Under the original agreement, Properties was to pay to PA’s lenders the outstanding principal balance and accrued interest owed to the lender pursuant to the loan which the appellant had guaranteed. This agreement was later amended in March 1983, under which Chateau was to pay to the seller $1,000 for the shares, and it was to pay to the lender $10,499,000 as partial satisfaction of the outstanding principal balance and accrued interest owed to the lender. In addition, the appellant was to pay to the lender an amount equal to the outstanding principal balance in satisfaction of the loan. In the end, the appellant paid $4,994,500.86 to the Bank.

In the original Stock Purchase Agreement for the Jocelyn and Cleveland shares between Residential and the principals of Chateau, all the shares of Cleveland and Jocelyn (along with other subsidiaries of the appellant which are not at issue) were sold to the principals of Chateau for $1.00. Under this original agreement, Properties was to pay to The First National Bank of Chicago $1,700,000 to be applied to the loan which the appellant had guaranteed. The purchaser was responsible for the outstanding principal balance and accrued interest on this loan. This agreement was later amended in March 1983, under which the purchase price was $1,000, and the appellant was to pay to the lender $1,701,000 as partial satisfaction of the outstanding principal balance and accrued interest owed to the lender under the loan guaranteed by the appellant. In addition, the purchasers were to pay to the lender an amount equal to the outstanding principal balance in satisfaction of the loan. In the end, the appellant paid $1,194,400 to the Bank in respect of the CTA loan, and $506,600 in respect of the J A loan.

Clauses 4, 5, 6, 7, and 8 of the amending agreement relating to the sale of the Prospect shares, dated April 26, 1983 read as follows: (CF refers to Parkside and CFCL refers to the appellant).

5. At the Closing, Chateau shall pay to The First National Bank of Chicago (“Lender”), the sum of TEN MILLION FOUR HUNDRED NINETY-NINE THOUSAND and 00/100 ($10,499,000.00) DOLLARS, as partial satisfaction of the outstanding principal balance and accrued interest owed to Lender pursuant to the Notes, by wire transfer of immediately available federal funds to an account or accounts designated by Lender.

6. At the Closing, CFCL shall pay to Lender an amount equal to the outstanding principal balance and accrued interest owed to Lender under the Notes, as of the date thereof, after first deducting the payment made by Chateau pursuant to Paragraph 5 above, in satisfaction of CFCL’s obligations pursuant to that certain guaranty, dated July 31, 1980, in favor of Lender (“Guaranty”), with respect to payment of the Notes, by wire transfer of immediately available federal funds to an account or accounts designated by Lender.

7. Immediately following the payment made by CFCL pursuant to Paragraph 6 above, CFCL hereby waives any claims, by way of subrogation, or otherwise, which it may have against CF for the payment made CFCL under the Guaranty and hereby releases CF from any liability in connection therewith.

8. Simultaneously with the waiver made by CFCL pursuant to Paragraph 7 above, CF hereby waives any claim it may have against CFCL under the Guaranty and hereby releases CFCL from any liability in connection with any such claim.

Similarly, in the amending agreement dated as of March 23, 1983 relating to the sale of Jocelyn and Cleveland shares (described as the “DC Stock Purchase Agreement” because it dealt with the sale by Properties of the shares of a number of other subsidiaries besides those of Jocelyn and Cleveland). Clauses 4, 5, 6, 7 and 8 read as follows:

4. The Purchase Price for the Shares shall be ONE THOUSAND and 00/100 ($1,000.00) DOLLARS, subject to adjustment as provided in the D.C. Agreement, payable at the Closing by good certified or official bank check drawn on a bank or trust company which is a member of the New York Clearing House Association, to the direct order of CFRP.

5. At the Closing, CFCL shall pay to The First National Bank of Chicago (“Lender”), the sum of ONE MILLION SEVEN HUNDRED ONE THOUSAND and 00/100 ($1,701,000.00) DOLLARS, in satisfaction of CFCL’s obligations pursuant to that certain guaranty, dated July 31, 1980, in favor of Lender (“Guaranty”), with respect to the FNBC Notes, by wire transfer of immediately available federal funds to an account or accounts designated by Lender.

6. At the Closing, Chateau shall pay to Lender an amount equal to the outstanding principal balance and accrued interest owed to Lender under the FNBC Notes, as of the date thereof, after first deducting the payment made by CFCL pursuant to Paragraph 5 above, by wire transfer of immediately available federal funds to an account or accounts designated by Lender.

7. Immediately following the payment made by CFCL pursuant to Paragraph 5 above, CFCL hereby waives any claims, by way of subrogation, or otherwise, which it may have against CF for the payment made CFCL under the Guaranty and hereby releases CF from any liability in connection therewith.

8. Simultaneously with the waiver made by CFCL pursuant to Paragraph 7 above, CF hereby waives any claim it may have against CFCL under the Guaranty and hereby releases CFCL from any liability in connection with any such claim.

CF refers collectively to Jocelyn, Cleveland and the other companies whose shares were being sold.

If we look broadly at the appellant’s venture into real estate operations in the United States it will be evident that, as an economic matter, it suffered substantial reverses as the ultimate parent of a number of subsidiaries whose real estate ventures were unsuccessful. It paid the amounts of money that are in issue here to extricate the subsidiaries within its corporate empire from those ventures. It is however not sufficient to say that the capital amounts expended were laid out as part of its overall commercial operation and were therefore laid out for the purpose of gaining or producing income from a business. That is not the relevant question here. The question is whether the appellant disposed of property or was deemed to have disposed of property in circumstances giving rise to a capital loss. I do not think that it became the owner of a debt from Jocelyn, Cleveland, Parkside or Prospect. As part of the agreement under which it participated in the sale by Properties of the shares of these companies to Chateau it had to pay amounts that could be related to the guarantees. The payments were however attributable to the much more complex arrangements under which the appellant assisted its subsidiary Properties to extricate itself from the various real estate ventures in which its subsidiaries had become involved. The payment of the guaranteed amounts did not result from any default by the partnerships. It was related to a condition in the agreement with the Bank that an event of default would be deemed to occur if the shares of the subsidiaries were sold without the Bank’s consent but this fact was incidental to the entire transaction. The triggering of the deemed default, the payment of the negotiated amounts and the simultaneous waiver of any rights of subrogation (if indeed any could otherwise have come into existence considering that the event of default was occasioned by the act of Properties, a sub- sidiary of the guarantor, a transaction in which the appellant itself was intimately involved) were part of an interrelated series of transactions which achieved the overall economic goal of extricating the Cadillac Fairview organization from the U.S. ventures. They did not result in the appellant’s acquiring by way of subrogation any debt that could be disposed of under section 50 or otherwise. The waiver of any rights of subrogation by the appellant as an integral part of the overall transaction prevented such a debt from coming into existence. I do not accept the appellant’s argument that it acquired by subrogation debts of the subsidiaries when it paid the agreed amounts under the amended share purchase agreements, and that it then disposed of those debts by reason of its waiver. The words “hereby waives any claims, by way of subrogation, or otherwise, which it may have against CF” constituted an anticipatory waiver that prevented, and was intended to prevent, any right of subrogation from coming into existence. It is clear that the entire transaction was structured to ensure that the appellant, by reason of the payment, would acquire no enforceable subrogated rights against any of the subsidiaries whose shares were being sold. It is inaccurate and unduly simplistic to see this as a garden- variety payment by a guarantor of a principal debtor’s obligation, followed by a subsequent waiver, for no consideration, of the subrogated debt. The waiver was an essential ingredient in the entire transaction, and even if I accepted the appellant’s analysis (which I do not) that it acquired a debt which it waived, the consideration for that waiver cannot, either as a matter of law or as a matter of commercial common sense, be regarded as nil. The price paid for the appellant’s role in the matter, including the payment to the bank and the waiver, was Chateau’s participation in enabling the Cadillac Fairview organization to disengage itself from the fiasco.

In light of this conclusion, I need not deal at length with Ms. Van Der Hout’s argument that the guarantees were not given for the purpose of gaining or producing income. If the guarantees were not given for the purpose of gaining or producing income from a business or property of the appellant, I have difficulty in conceiving of any other basis on which they could have been given. The respondent’s argument seems to be that if the appellant had charged a fee for giving the guarantees it would have met the “for the purpose of gaining or producing income” test but that because it charged no fee it had no such purpose. The ultimate purpose of any parent company of a corporate organization is to earn income from its subsidiaries, generally in the form of dividends. To have the treatment of capital losses that it sustains in respect of shares or debts of its subsidiaries depend upon whether interest or guarantee fees are charged is, in today’s world of business, simply not an acceptable criterion to apply. That theory has been laid to rest in such cases as Brown v. R., [1996] 1 C.T.C. 276, 96 D.T.C. 6091 (F.C.T.D.), Byram v. R. (sub nom. Byram v. Canada), [1995] 1 C.T.C. 66, 95 D.T.C. 5069, Business Art Inc. v. Minister of National Revenue, [1987] 1 C.T.C. 2001, 86 D.T.C. 1842 and National Developments Ltd. v. R. (sub nom.. National Developments Ltd. v. Canada), [1993] 2 C.T.C. 3027, 94 D.T.C. 1061. The respondent relied heavily on Canada Safeway Ltd. v. Minister of National Revenue, [1957] S.C.R. 717, [1957] C.T.C. 335, 57 D.T.C. 1239. For the reasons given in Mark Resources Inc. v. R. (sub nom. Mark Resources Inc. v. Canada), [1993] 2 C.T.C. 2259, 93 D.T.C. 1004, at page 2268 (D.T.C. 1011) the Canada Safeway case has no application in the circumstances involved here.

It is unnecessary for me to deal with the other arguments advanced by the respondent. I have concluded that the payments made by the appellant under the restructuring arrangements did not give rise to the acquisition and disposition of debts resulting in the creation of a capital loss.

Density rights issue

In the appellant’s 1984 taxation year it engaged in a number of transactions in anticipation of the development of Phase II of the Eaton Centre. These transactions involved land exchanges with the City of Toronto and the Church of the Holy Trinity, conveyances to the City of Toronto of four land sites and a purchase from the Holy Trinity Church of 209,000 square feet of commercial development rights (density rights) which were transferred to the land upon which was to be situated the proposed Phase II of the Eaton Centre.

These transactions cost the appellant $11,227,444. Their result was that the appellant obtained a zoning change to a purely commercial zoning and eliminated a requirement that the development on the site include residential construction and enhanced the commercial density permitted on the site by “transferring” density from four sites that were conveyed to the City of Toronto and from the site of Phase I of the Eaton Centre and by “purchasing” rights to density from the Holy Trinity Church.

The appellant contends that these costs form part of the capital cost of the buildings that it proposed to erect on the land and that they therefore fall within Class 3 of Schedule II to the Income Tax Regulations as “a building or other structure.” The respondent contends that these costs form part of the land. The appellant contends in the alternative that the cost is an “eligible capital expenditure” within the meaning of subsection 14(5) of the Income Tax Act as:

any outlay or expense made or incurred by the taxpayer... on account of capital for the purpose of gaining or producing income from the business, other than any such outlay or expense

(c) that is the cost of, or any part of the cost of,

(i) tangible property of the taxpayer.

To begin with, we should be clear on just what “density rights” are and what the appellant was getting for its $11,227,444. We may start from the proposition that in the absence of legislative or other legal restrictions a landowner is free do to what it wants on its land. It can farm it, build highrise apartments or office buildings, or build the Tower of Babel. Its rights inhere in the ownership of the land. The exercise of those rights can, however, be restricted, regulated or prohibited by legislation. In this case the authority having that jurisdiction is the province and it delegates the power to the municipal authorities.

The power of municipal zoning is conferred upon the municipality by the Planning Act. Section 34 of the Planning Act of Ontario R.S.O. 1990,

c. P-13 reads in part as follows:

(1) Zoning by-laws may be passed by the councils of local municipalities:

1. For prohibiting the use of land, for or except for such purposes as may be set out in the by-law within the municipality or within any defined area or areas or abutting on any defined highway or part of a highway.

2. For prohibiting the erecting, locating or using of buildings or structures for or except for such purposes as may be set out in the by-law within the municipality or within any defined area or areas or upon land abutting on any defined highway or part of a highway.

3. For prohibiting the erection of any class or classes of buildings or structures on land that is subject to flooding or on land with steep slopes, or that is rocky, low-lying, marshy or unstable.

4. For regulating the type of construction and the height, bulk, location, size, floor area, spacing, character and use of buildings or structures to be erected or located within the municipality or within any defined area or areas or upon land abutting on any defined highway or part of a highway, and the minimum frontage and depth of the parcel of land and the proportion of the area thereof that any building or structure may occupy.

(3) The authority to regulate provided in paragraph 4 of subsection (1) includes and, despite the decision of any court, shall be deemed always to have included the authority to regulate the minimum area of the parcel of land mentioned therein and to regulate the density of development in the municipality or in the area or areas defined in the by-law.

The origin of that section is S.O. 1983, c. 1.

Presumably the zoning by-laws of Toronto were enacted by it under the authority of a predecessor to that section, possibly section 39 of the Planning Act, R.S.O. 1980, c. 379 which is substantially the same as that contained in R.S.O. 1990. It is important to recognize that zoning does not constitute a conferral of a right but rather a restriction of the otherwise unlimited right of a landowner to do what it wishes with its land. It is less accurate to describe a change in zoning to allow a further use of land as the conferral of a right than to describe it as a lifting or relaxation of a restriction on the otherwise unrestricted use of the property. It follows that the right to use property, whether restricted by zoning by-laws or not, is a right that inheres in the ownership of the property. It is part of the bundle of rights that a landowner has by reason of ownership of property. The cost of a modification of the restrictions of the rights that a landowner has with respect to the use of land is a part of the cost of the land. The cost of lifting restrictions on the exercise of those rights clearly relates to the cost of the bundle of rights that ownership entails. Density rights have to do with what the owner can do with the land. If a landowner is successful in improving the zoning of a parcel of land, and then sells it, it is inconceivable that the revenue authorities could demur at the inclusion of the cost of that rezoning in the cost of the land sold.

The position was put with clarity by the New York Court of Appeals in a decision MacMillan, Inc. v. CF Lex Associates (sub nom. MacMillan v. Cadillac Fairview Corporation) (1982), Ct. App., 452 N.Y.S. 2d 377. It said at page 380:

Moreover, air rights, at the heart of the concept of zoning lot merger, have historically been conceived as one of the bundle of rights associated with ownership of the land rather than with ownership of the structures erected on the land. Air rights are incident to the ownership of the surface property - the right of one who owns land to utilize the space above it. This right has been recognized as an inherent attribute of the ownership of land since the earliest times as reflected in the maxim, “[c]ujus est solum, ejus est usque ad coelum et ad inferos” [“to whomsoever the soil belongs, he owns also to the sky and to the depths”] (Butler v. Frontier Tel. Co., 186 N.Y. 486, 491, 79 N.E. 716; 2 Blackstone’s Comm., page 18; see Ball, Vertical Extent of Ownership in Land, 76 U. of Pa.L.Rev. 631 in which the maxim is attributed to the early 14th century scholar Cino da Pistoia).

The decision is of course not binding, but it is persuasive. The cost of modifying rights relating to what one can do with land are in my view a cost attributable to the land. They inhere in the land, whether or not a structure is erected on the land. In this case the proposed Phase II has not been erected. It requires something of a leap of faith to claim capital cost allowance under Class 3 on a building that does not exist and may never exist. The land however does exist, along with all of the rights that inhere in it. The rights do not exist independently of the ownership of the land. If the ownership of the land is transferred, the rights follow it.

Although one speaks colloquially of “acquiring” density rights from an adjoining landowner, this process involves persuading that landowner to accept on its land a “lower” zoning and, armed with that concession, persuading the municipality to give to that adjoining land a lower zoning and a correspondingly higher zoning to the neighbouring land. It is not a simple transfer of rights between owners. Zoning is not a commodity that can be bought and sold on the open market. It is something that the municipality confers on, or takes away from, the land itself.

Accordingly it is not necessary for me to consider the alternative argument that the costs are eligible capital expenditures. Since I have concluded that the cost of obtaining zoning that permitted a higher density on the land is a cost of land, it follows that it cannot, by reason of paragraph 14(5)(c)(i), be an eligible capital expenditure.

Appeal dismissed.