E.R. Squibb & Sons Ltd. v. MNR, 73 DTC 5139, [1973] CTC 120 (FCTD)

Cattanach, J:—These are appeals from assessmets to income tax made by the Minister with respect to the appellant’s 1963, 1964, 1965 and 1966 taxation years.

The appellant, which is a wholly owned subsidiary of a foreign company, was incorporated under the laws of Canada in 1925 and since that time has carried on the business of manufacturing and selling pharmaceutical products.

Prior to 1952 the appellant carried on the business from rented premises in the more densely populated area of Montreal, Quebec.

In 1952 the appellant’s business had expanded to the extent that the rented premises were inadequate so the appellant decided to construct its own premises in Montreal for the conduct of its own research, manufacturing and marketing.

With this objective in view the appellant purchased a farm consisting of approximately 52 acres in the parish of St Laurent, Quebec which is on the outskirts of Montreal and which area was rural in character at that time.

In 1954 the appellant began the construction of the appropriate buildings and facilities for its purposes which were completed and occupied by the appellant in May 1955. These buildings and facilities utilized approximately 16% of the total area of 52 acres.

In the taxation years under review the appellant was assessed for and paid municipal and school taxes.

In computing its income for the taxation years in question the appellant deducted the municipal and school taxes paid by it in the respective years.

The Minister allowed 16% of the amounts of municipal and school taxes paid by the appellant as a deduction in the respective taxation years but disallowed as a deduction 84% of the amounts so paid and claimed by the appellant.

He allowed the 16% of the total amount claimed as a deduction on the ground that only 16% of the total area of the land was used by the appellant and he disallowed the balance of 84% of the amount on the ground that 84% of the total area of land was left unused and vacant and accordingly only 16% of the taxes so paid by the appellant was an outlay or expense made or incurred by the appellant for the purpose of gaining or producing income from its property or business within the meaning of paragraph 12(1 )(a) of the Income Tax Act and the balance of 84% was not an outlay or expense within paragraph 12(1 )(a) but was rather an outlay or payment on account of capital within the meaning of paragraph 12(1 )(b).

The paragraphs referred to read as follows:

2. (1) In computing income, no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer,

(b) an outlay, loss or replacement of capital, a payment on account of Capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part,

The first matter to be determined in deciding whether an outlay or expense is outside the prohibition of paragraph 12(1)(a) is whether it was made or incurred by the taxpayer in accordance with the ordinary principles of commercial trading or well accepted principles of business practice. Of this there can be no doubt. Payment of taxes is obligatory.

The next step is to consider whether the deduction of the taxes so paid by the appellant herein is prohibited by paragraph 12(1)(a) or falls within its expressed exception. The mere fact that outlay or expense was made or incurred by the taxpayer in accordance with good business practice does not automatically make it deductible for income tax purposes.

The essential limitation expressed in paragraph 12(1)(a) is that the Outlay should have been made by the taxpayer “for the purpose of gaining or producing income from the business”.

While taxes imposed on income are not expenses incurred for the purpose of producing that income but on that income when earned, nevertheless, there are types of taxes which, if paid, are deductible as having been incurred in the course of the income earning process. There is no doubt that a taxpayer engaged in business pays municipal and school tax on real property owned in the capacity of a taxpayer but he also pays those taxes in the capacity of a trader because those taxes are paid to enable him to carry on business from the premises on which the taxes are imposed and if the tax was not paid there are procedures available to the municipality to remedy non-payment of the tax which, if enforced, would make it impossible for the taxpayer to carry on business from those premises.

In British Columbia Electric Railway Company Limited v MNR, [1958] SCR 133; [1958] CTC 21; 58 DTC 1022, Mr Justice Abbott said at page 137 [31, 1027-8]:

Since the main purpose of every business undertaking is presumably to make a profit, any expenditure made “for the purpose of gaining or producing income’’ comes within the terms of Section 12(1)(a) whether it be classified as an income expense or as a Capital outlay.

Once it is determined that a particular expenditure is one made for the purpose of gaining or producing income in order to compute income tax liability it must next be ascertained whether the disbursement is an income expense or a capital outlay.

Counsel for the Minister during argument did not concede that the payment of municipal and school taxes herein was for the purpose of gaining or producing income from the appellant’s business. As i understood his refusal to so concede it was predicated upon his position that payment of taxes with respect to the unoccupied land should not be regarded as an income expense but rather because the payment of taxes was with respect to an anticipated building expansion thereon the payments should be considered as capital outlays.

In my view there is a patent inconsistency in such submission. It would seem to me that if his position were accepted that the payment of taxes with respect to the 84% unoccupied land were capital outlays because of anticipated building expansion thereon, then the same contention would be applicable with stronger force in connection with the taxes paid by the appellant on 16% of the occupied land on which buildings had been erected. Those taxes were paid on acknowledged capital assets.

Furthermore this position is inconsistent with the pleadings. In paragraph 5(c) of his statement of defence the Minister alleges that he allowed the deduction of 16% of taxes paid on the assumption that they were outlays or expenses incurred for the purpose of gaining or producing income from its business (whereas in paragraph 5(d) he alleges that he disallowed 84% of the taxes paid and claimed by the appellant on the assumption that they were not outlays or expenses for the purpose of gaining or producing income from its business) but rather they were outlays of a payment made by the appellant on account of capital within the meaning of paragraph 12(1)(b) of the Act.

Lord Morris of Borth-y-Gest in Regent Oil Co Ltd v Strick, [1966] AC 295, said that there is a difference between the profit-yielding subject and the cost of operating it. There is no question that in the present case the real estate on which the buildings were constructed and these buildings are capital assets and as such are a “profit yielding subject”. The payment of municipal taxes thereon is akin to the maintenance costs of that subject and as such is, in my view, likewise a cost incurred in the process of operating that subject and so made for the purpose of gaining or producing income, within the meaning of paragraph 12(1 )(a).

However, different considerations may apply with respect to the taxes on the 84% of the vacant land. It is the position of the Minister that the vacant land could not be a profit-yielding subject. On the other hand the position of the appellant is that the acquisition of land surplus to its immediate needs was in accordance with well accepted principles of business practice and that it was a sound and foresighted policy to provide for future expansion the foreseeability of which had been demonstrated to the appellant and its parent by past experience.

It is not a condition of the deductibility of a disbursement or expense that it may have been made in vain. Rather, the question is whether the expenditure was in the course of the current operation of the business as part of the policy of the taxpayer in conducting its operations in a business-like way.

This question is, in my view, one of fact and the onus of establishing that fact is upon the appellant.

Prior to trial counsel by their respective counsel agreed upon the following statement of facts together with the exhibits appended thereto as indicated.

AGREED STATEMENT OF FACTS

1. THAT the appellant acquired a certain property from Dame Rose-Anna Crevier, wife of Jean Baptiste Lacroix, by Deed of Sale executed before Notary Eugène Poirier on November 19, 1952, at a cost of $302,321.23.

2. THAT the property contained approximately 2,232,500 square feet, which amounts to approximately fifty acres.

3. THAT on or about March 22, 1954, a section of land on the Western side of the property, running its entire length, was sold to the City of St Laurent for the sum of $1.00 in order to permit the construction of rue Deslauriers.

4. THAT the net book loss from this transaction was $7,907.82, which was treated as a capital loss in the books of the appellant.

5. THAT on March 1, 1956, 5 /2 city lots adjoining the property described in paragraph (1) hereof were purchased by the appellant at a cost of $13,362.80.

6. THAT in September 1956 the appellant agreed to permit the Metropolitan Corporation to use a triangular section of land across the South end of the property for utilities and other services relating to the construction of Cote de Liesse.

7. THAT in October 1956 a portion of the property which had been affected by an homologated line at the time of its purchase was expropriated by the City of St Laurent for use as a highway.

8. THAT the proceeds of the expropriation referred to in paragraph (7) hereof amounted to $37,572.92 and were treated as a capital gain by the appellant.

9. THAT on April 28, 1958 the appellant purchased two small lots connecting the rear portion of its plant to rue Gagnon on the East side of the property described in paragraph (1) hereof at a cost of $12,202.63.

10. THAT during the fall of 1963 the City of St Laurent attempted to expropriate two sections of the property described in paragraph (1) hereof for the purposes of constructing two streets.

11. THAT the appellant objected strenuously to the proposed expropriation.

12. THAT Exhibit ASF 1 attached hereto is a true copy of a letter dated September 26, 1963, sent by the Vice-President and Managing Director of the appellant to the then General Counsel of the appellant.

13. THAT Exhibit ASF 2 attached hereto is a true copy of a Motion to Extend Delays dated October 3, 1963, together with a supporting Affidavit and Notice served on the City of St Laurent as part of the contestation of the proposed expropriation referred to in paragraph 10. hereof.

14. THAT Exhibit ASF 3 attached hereto is a true copy of a letter dated October 25, 1963, sent by registered mail to the City of St Laurent by the appellant with respect to the proposed expropriation.

15. THAT as a result of the opposition by the appellant to the proposed expropriation a compromise was reached, whereby only one of the two proposed expropriations took place, being that portion of the property furthest from the part of the property described in paragraph (1) hereof occupied by the appellant’s plant.

16. THAT Exhibit ASF 4 attached hereto is a true copy of an historical net sales analysis of the appellant for the years 1949 through 1971, inclusive.

17. THAT Exhibit ASF 5 attached hereto is a true copy of an analysis of taxes affecting the property described in paragraph (1) hereof, for the years 1954 through 1971 inclusive.

18. THAT the appellant sold a total of 1,280,116 square feet of the property described in paragraph (1) hereof, as follows:

(a) 425,261 square feet by Deed of Sale dated August 18, 1970, to Black and White Holdings Ltd;

(b) 233,045 square feet by Deed of Sale dated August 17, 1971, to Black and White Holdings Ltd; and

(c) 621,810 square feet by Deed of Sale dated September 15, 1971, to Black and White Holdings Ltd.

19. THAT the appellant still retains 716,670 square feet of the property described in paragraph (1) hereof, together with the additional small pieces of property subsequently acquired as described in paragraphs (5) and (9) hereof.

20. THAT all municipal and school taxes incurred by the appellant have been deducted by it for the purposes of computing its income.

These facts were supplemented by those adduced in oral evidence.

The sale of a small portion of the land by the appellant referred to in paragraph 3 was to accommodate the municipality in constructing a street adjacent to the property. This did not detrimentally effect the property as a whole for the appellant’s purposes but was an advantage to it.

The same considerations were applicable to the use of the small portion of land referred to in paragraph 6 and to the land referred to in paragraph 7 which was expropriated.

The purchase of 5 /2 city lots referred to in paragraph 5 and the two lots referred to in paragraph 9 were first to complete or round out the area of the property and second to give access to a rear street.

Those sales and purchases are consistent with the avowed purpose of the appellant that it intended to use the entire area for the business although the use of a portion might be delayed.

The opposition by the appellant to the expropriation of certain portions of its lands by the municipality for the construction of streets is in confirmation of the appellant’s proposed use of the total area for the construction of plant for use in its business. The proposed streets would divide the land into three segments. The construction of those streets would increase the value of the land for purposes of sale but would destroy its efficacy for the appellant’s contemplated use. The compromise eventually reached between the appellant and the municipality eliminated the construction of one street which would bisect the property, but the construction of the street agreed upon between them was at the extreme rear of the property, served only a small area and still left a substantial area for expansion by the appellant.

The appellant, one of the largest manufacturers of pharmaceuticals in Canada, is the wholly owned subsidiary of E R Squibb Inc, a company incorporated under the laws of one of the states of the United States of America which conducts a world-wide business in pharmaceuticals through subsidiary companies in forty countries and through licencees in sixty countries.

From its incorporation in 1925 the appellant’s sales grew to $1,453,000 in 1950. At the same time the sales of the parent company had grown to $84,000,000. At that time the decision was taken by the parent to expand its international operation.

In 1952 the appellant operated from rented quarters which were overcrowded and unsatisfactory.

At this time the parent company merged with Mathieson Chemical Co each of which companies had annual sales of $125,000,000 and when combined the annual sales would be $250,000,000.

In 1952 the sales of the appellant had increased to $2,188,000.

In that year the parent company gave approval to the expansion of the appellant by the conduct of injectible and other operations, the resultant products of which processes had been imported previously.

It was in this year that the property here in question was acquired by the appellant for these purposes.

Construction of facilities on the land acquired was completed in 1954 with an area 2 /2 times greater than that of the rented premises and with modern production facilities.

Also in 1954, the parent company which had merged with Mathieson Chemical Co was merged again, this time with Olin Industries. The total annual sales of the resultant merged corporation were $500,000,000.

The policy of this new conglomerate (Olin Industries manufactured a great variety of wares different from pharmaceuticals and chemicals) was an aggressive penetration in international markets for all products utilizing the existing Squibb pharmaceutical international operation as an entry into those markets.

For several years there was a plateau in growth of the pharmaceutical branch of the business because the merged corporation concentrated capital expenditures on an aluminum operation which drained the capital which would have otherwise been available for pharmaceutical expansion. However, even at this time of arrested expansion of the pharmaceutical business, there was under very active consideration the construction of a very large antibiotic plant on the Canadian site. This plant was eventually built in Southern Ireland because of the numerous incentives offered by the government of that country to locate the plant in a depressed area which were so advantageous that it was uneconomic to build elsewhere. This plant occupies 20 acres. u;

In 1963 the pharmaceutical operations which were conducted by the Squibb organization were “spun off”. This resulted in the cessation of the drain of capital for the aluminum operation and a substantial in- crease in pharmaceutical sales which increase, in turn, triggered active and aggressive expansion plans.

It is not realistic that the appellant should be considered in isolation. It was part of a larger overall organization. Its shares were wholly owned by the parent corporation and the policy of the whole organization was necessarily that of the appellant. The pragmatic or practical approach clearly points to the policy and intention of the parent corporation as relevant to the policy and intention of the appellant. In fact they were coincidental.

There was a Capital appropriation committee of the parent organization the function of which was to decide upon the acquisition and disposal of capital properties by the subsidiaries throughout the world. Naturally this committee would consider recommendations of local managers but because of its knowledge of the overall policy in the Organization as a whole, divorced from local interest, it follows that the decisions of the committee were final. If a recommendation of a local manager for an acquisition of properly was acceptable and in accordance with the expansion policy of which the committee was fully cognizant, then one of ils development experts would view the proposed site to determine its suitability. The capital appropriation committee worked in close liaison with a corporate development committee and a technical committee as well as budgeting and planning committees.

The parent organization frequently had plans for the expansion of a subsidiary by the development of new products or other long range planning of which the management of the subsidiary might be unaware. it was the parent which dictated the policy of the subsidiaries, including the appellant, and the parent would often require the subsidiary to expand in ways the subsidiary never contemplated.

The parent organization was well aware of the certain future development and that of its subsidiaries. There were numerous instances given where large areas of land were acquired far in excess of the immediate need but all of which was eventually occupied and proven not sufficient for the expansion that occurred and still further land had to be acquired.

The fifty-acre site acquired by the appellant was acquired with the concurrence of the capital appropriations committee with a view to expansion thereon for which plans were formulated.

It was the capital appropriations committee which resisted the proposed expropriation of part of the appellant’s property in 1963 for the construction of streets.

In 1966 the organization policy for expansion in Canada did not permit of disposing of any property owned by the appellant. The local management of the appellant received substantial offers for the land not then occupied by it. These offers were communicated to the capital appropriations committee with a recommendation for their acceptance. The appellant was advised to put any prospective sale “on the back burner”.

The foregoing evidence leads me to the inevitable conclusion that the fifty-acre site was acquired by the appellant with the view of future expansion thereon to the full area of the site and that the portion of the site which was not built on in 1959 was retained for the purpose of expanding thereon and furthermore that possibility of the unoccupied land being used for expansion was realistic.

In 1970 and 1971 the capital appropriations committee authorized the appellant to dispose of 1,200,000 square feet of the unoccupied land while retaining approximately 700,000 square feet for actual and future use. There was approximately 400,000 square feet occupied by buildings so that 300,000 square feet were retained for future use.

The decision to sell 1,200,000 square feet was dictated by two sound reasons. The site, while originally rural and in a sparsely populated area, was now surrounded by the city. By-laws had been enacted which prevented the site being used for fermentation and other plants in contemplation. This is the first reason for the sale. With the urbanization of this formerly predominate rural area the municipal taxes rose astronomically. In 1954 the municipal and school taxes had been $242. In 1966 they had risen to $34,112 an increase of approximately 13,600%. In 1968 the municipal and school taxes on the property had increased to $89,629 an increase of more than 250% over the 1966 figure. In 1970 the taxes had increased to $105,000. With the municipal taxes escalating at such an alarming rate it was no longer economically feasible to retain the land in that area for expansion purposes. This is the second reason for sale.

In view of the foregoing facts it is my view that the appellant has discharged the onus cast upon it of establishing that the vacant land was retained in the reasonable expectation of future expansion for which that land would be utilized. That being so it follows that the payment of municipal and school taxes was an expenditure on revenue account and as such was laid out for the purpose of gaining or producing income within the meaning of paragraph 12(1 )(a).

The appeals are, therefore, allowed with costs to the appellant.