The Queen v. Dorchester Drummond Corp. Ltd., 79 DTC 5163, [1979] CTC 219 (FCTD)

Walsh, J:—This section concerns the assessments of defendant for its 1970 and 1971 taxation year in which plaintiff disallowed the deduction claimed by defendant of the amounts of $23,988 and $19,357 respectively for realty taxes paid to the City of Montreal. As the result of the deduction defendant reported net income in a negative amount of $4,470 for its 1970 taxation year, and net income of $17,178 in 1971 but claimed that in the taxation year 1971 it could deduct in the computation of its taxable income the amount of $17,178 representing property losses from previous taxation years.

On September 26, 1975, the Tax Review Board rendered judgment allowing the appeal of defendant against the reassessments which had allowed the deduction of these realty taxes and the property losses from previous taxation years and plaintiff now appeals this decision of the Tax Review Board.

Defendant was incorporated in 1957 for the principal purpose of acquiring a piece of real estate in Montreal at the corner of Dorchester and Drummond Streets which it bought for a price of $461,000. It was intended to build a highrise office building on the property and in due course architects were retained and plans drawn at a cost of $70,000 which amount was added by defendant to the cost of the land. There was an old existing building on the property and up to 1960 defendant derived rental income from it. It was demolished in 1961 but the defendant did not deem the time propitious for constructing its proposed building as, while development on Dorchester Street was proceeding rapidly at the time, the Place Ville Marie Building, the Canadian Bank of Commerce, the Canadian Industry Limited and other major buildings which had come on the market had created a surfeit of office space. From 1961 to 1964 defendant therefore operated a parking lot on the said property deriving the following income therefrom:

This operation had to be abandoned in 1965 when the City of Montreal amended its bylaws so as to prohibit the operation of parking lots on the area of Dorchester Street where defendant’s property was located. As the result no income was derived from the use or holding of the said real estate after 1965.

Nevertheless defendant claims deductibility of the following real estate taxes paid with respect to the said property:

Defendant had other income however resulting from interest on loans made to affiliated corporations. The funds with which to make these loans were provided to it interest free by its principals, and the income from these loans was as follows:

It was against this interest income that realty taxes were deducted resulting in losses in all taxation years except 1965, 1966 and 1971, which losses were carried forward as business losses.

Plaintiff relies on sections 3, 4, paragraphs 12(1)(a) and 27(1)(e) of the Income Tax Act in effect at the time (1952 RSC, c 148). Sections 3, 4 and paragraph 12(1)(a) read respectively as follows:

3. The income of a taxpayer for a taxation year for the purposes of this Part is his income for the year from all sources inside or outside Canada and, without restricting the generality of the foregoing, includes income for the year from all

(a) businesses,

(b) property, and

(c) offices and employments.

4. Subject to the other provisions of this Part, income for a taxation year from a business or property is the profit therefrom for the year.

12.(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.

and paragraph 27(1)(e) is the section providing for deducting business losses sustained in the five taxation years immediately preceding and the taxation year immediately following the taxation year, permitted pursuant to the terms of that section. It is plaintiff’s contention that defendant did not hold the Dorchester-Drummond property for the purpose of earning income from property or a business during the years in question and that the realty taxes paid to the City of Montreal were not expenses made or incurred for the purpose of gaining or producing income. Furthermore plaintiff contends that with respect to the 1971 taxation year there was no loss available to defendant carried forward from previous taxation years which could be deducted since the realty taxes were not deductible expenses in these previous taxation years. Subsidiarily plaintiff contends that even if the realty taxes could be considered as deductible expenses which is denied, the losses incurred in the previous taxation years would be property losses and not deductible pursuant to the provisions of paragraph 27(1 )(e) in the computation of defendant’s taxable income for its 1971 taxation year.

Defendant pleads that the income from parking operations commenced in 1958 rather than in 1961 as implied in plaintiff’s statement of claim and that with respect to the deductibility of realty taxes from interest income this was already disposed of, except insofar as the years 1970 and 1971 are concerned, by a final judgment of the Tax Review Board in March 1973 from which there was no appeal so it is res judicata. Defendant further contends that the property was of a revenue-bearing nature when it was acquired and that substantial efforts were made and considerable sums expended with the intention of erecting a large office building on the premises and that pending the fulfillment of this intention a parking lot was operated so as to derive income therefrom until this was restrained by the City of Montreal, that the municipal taxes are annual regular recurring charges and that this issue was already litigated between the parties before the Tax Review Board in respect of an earlier year and its decision in favour of the taxpayer was not appealed, that the property was neither acquired nor utilized for any purpose except to earn revenue, payments of municipal taxes were not capital in nature but properly chargeable against income whether or not any income resulted from such expenditures until the law was changed in 1972 so that municipal taxes ceased to be a deductible expense in a situation of this kind for 1972 and subsequent years, and that the taxes imposed by the municipality are not property losses as contended in plaintiff’s subsidiary pleading but business losses properly deductible under paragraph 27(1)(e) of the Act.

There is little dispute on the facts, most of which were set out in a documentary evidence book produced. The land was disposed of at a profit in December 1972 which was treated as a capital gain in defendant’s 1973 return and there is no issue respecting this. In 1965 the Minister disallowed deductions of the real estate taxes but the taxpayer’s appeal from this decision was allowed by the Tax Review Board and there was no further appeal. This decision was rendered on March 26, 1973, and as the representative of the Minister pointed out it was then too late to revise the assessments for the 1966 or 1967 taxation years, and since the assessments in 1968 and 1969 would have been nil assessments in any event as the income was negligible, no disallowance was made of the real estate taxes for those years.

Plaintiff’s counsel distinguishes two cases relied on by the Tax Review Board in its decision of September 26, 1975, maintaining defendant’s appeal against its 1970 and 1971 assessments, the subject of the present action. In the first of these E R Squibb and Sons Ltd v MNR, [1973] CTC 120; 73 DTC 5139, appellant purchased a 50 acre farm on the outskirts of the city on which to construct a new plant, using only 16% of the land. The Minister sought to disallow as a deduction 84% of the municipal and school taxes on the ground that they were not laid out to earn income from the business. It was held that the appellant was able to discharge the onus of establishing that the vacant land had been retained in the reasonable expectation of future expansion of its plant and were therefore laid out for the purpose of earning income pursuant to paragraph 12(1)(a). In the second such case that of Mrs Katie Esar and Mr Reuben Esar v Her Majesty The Queen, [1974] CTC 34; 74 DTC 6062, plaintiffs had for a long time been investors in mortgages and real estate. One farm property which they acquired had a house on it which was rented for $40 a month which was demolished, after which the land remained vacant. The issue was whether the property was acquired for the purpose of earning income so as to justify the deduction of property taxes paid after it ceased to produce income. It was held that the facts indicate that the land was retained with the reasonable expectation of eventual development for leasing and that the taxes were therefore revenue expenses paid out for the purpose of gaining or producing the income within paragraph 12(1 )(a). In rendering judgment in this case Heald, J referred at 37 to the decision of the late President Thorson in the case of Consolidated Textiles Limited v MNR, [1947] CTC 63 at 68; 3 DTC 958 at 960 in which he stated:

it is not a condition of the deductibility of a disbursement or expense that it should result in any particular income or that any income should be traceable to it. It is never necessary to show a causal connection between an expenditure and a receipt.

It is evident that the facts of the present case are substantially different from those cases in that the subject property is the sole asset of defendant corporation, which did not carry on property development business in general, but whose proposed development was confined to this one property. I share the doubt expressed by the Chairman of the Tax Review Board however as to whether this makes any difference.

Arnold Echenberg CA the auditor of the company since 1960 testified that municipal taxes were deducted as expenses because his review of the company’s operations indicated to him that they were ongoing operations. The taxes did not in his view increase the value of the property. The company’s ongoing operations consisted of its lending operations as well as the maintenance of its real estate asset. He stated that in a company this size there is no need to break down its operations into various divisions such as might be done with a conglomerate, which would in any event be primarily for the interest of shareholders, as for example a retail merchandiser which might show in its accounting records a breakdown of profits or losses for each individual store. The final statement would however combine the income and this would be the one on which the taxes would be based. He did not consider that the company’s operations therefore should be divided between its money lending operations and its attempts to develop the subject property.

André Bruneau testified that he was secretary of defendant from 1963 to 1971. Defendant was wholly owned by Edper Investments. He was Vice- President of that company in charge of their very large real estate portfolio. That company in turn is controlled by Edward and Peter Bronfman and there is no question that defendant company had both the financial capacity to develop and access to considerable experience in real estate development. In addition to having plans prepared for the building he testified that various negotiations took place with the Hyatt hotels, Howard Johnsons and Voyageur Bus Terminals which was located adjacent to the subject property at that time, and others, in an attempt to secure tenants for the proposed building. After the company was obliged to cease its parking lot operation as a result of an injunction obtained by the city in the Superior Court on January 17, 1964, a subsequent attempt was made to reopen it which nearly did succeed during the year of Expo 67 when there was a greatly increased need for parking space in downtown Montreal. Negotiations to have the city tolerate such parking for that year fell through. The witness testified that many meetings were held with the Bronfman brothers to try to find a use for the property. Consideration was given to building a small hotel or apartment building. He conceded that only 5% of his overall time was devoted to the affairs of the Dorchester-Drummond Corporation which had no employees of its own after the cessation of the parking lot operation. He stated that after 1968-69 efforts were continued to do something with the property but without any results.

At an examination for discovery Jack Cockwell a chartered accountant and officer of the company, being treasurer of it in 1970 and 1971, testified that the property was purchased with funds advanced by the shareholders Peter and Edward Bronfman.* [1] The financial statements of the company show no interest expenses and advances made by the shareholders bore no interest. He stated that they were considered as part of the capital of the company. He confirmed the previous evidence that the planned 16 storey building would be financed partly through equities or contributions by the shareholders by additional loans, and partly through a mortgage loan but that it was uneconomic to place the maximum amount of the mortgage loan on the project as the return on equity would not have justified this in 1959-60 when there was a tremendous surplus of office space and depressed rates at the time. He confirmed that the money which subsequently allowed defendant company to lend large sums at interest came from the company’s capital which was provided by the shareholders by subscribed capital and shareholders’ loans. Looking at the balance sheet at the end of 1970 he testified that there was $1,215,000 advanced by shareholders and another amount of $56,000 advanced by an affiliated company. The amounts advanced by Messrs Peter and Edward Bronfman would have been made equally out of surplus funds they had on hand. All advances were made interest free because, he stated, they were considered as capital. The company then lent the money at interest, in some cases to affiliated companies.

While extensive jurisprudence was referred to by counsel for both parties much of it can be distinguished on the facts. Although the company was formed primarily for the development of the property in question as a revenue producing investment it was certainly within the powers of the company to also earn income by the making of interest bearing loans. The fact that this was made possible by its being furnished with substantial funds interest free by its shareholders or affiliated companies controlled by them is not pertinent. It is trite law that a taxpayer may so arrange his affairs to the extent that this can be done under the existing law as to attract the minimum of taxation. The shareholders in this case, whether considered as the actual company which owned the shares or the individual shareholders who controlled it, are highly Knowledgeable investors and developers and undoubtedly were aware that if the realty taxes were to be deducted as an expense when the real estate was no longer producing any income there would have to be some other source of income from which this expense could be deducted, and arranged their affairs accordingly. The provision of these funds to defendant company was not an artificial or sham transaction within the provisions of section 137 of the Act nor can it be brought into the tax avoidance section 138 and plaintiff did not even attempt to do so. The Supreme Court case of Anderson Logging Company v The King, [1917-27] CTC 198; 52 DTC 1209, held at 207 [1214]:

The sole raison d’etre of a public company is to have a business and to carry it on. If the transaction in question belongs to a class of profit-making operations contemplated by the memorandum of association, prima facie, at all events, the profit derived from it is a profit derived from the business of the company.

Certainly the company had to pay the realty taxes in order to retain its property but the payment of these taxes added nothing to the value of the property. The fact that they were incurred in the years in question when no revenue was being derived from the property itself would not appear to be a valid ground for disallowing them. Reference has already been made (supra) to the judgment of Thorson, P in the Consolidated Textiles Limited case which established the principle that deductible expenses need not be related to any particular income.

It cannot be contended that the company was not carrying on a business during the years in question. This was established in the case of MRT Investments Limited et al v The Queen, [1975] CTC 354; 75 DTC 5224 (confirmed on appeal) which dealt with what constituted an “active business” within the meaning of section 125 of the new Income Tax Act. It was held that business activities need be neither extensive nor profitable in order for the taxpayer to be considered as carrying on an active business. Gibson, J reached the same conclusion in Her Majesty The Queen v Cadboro Bay Holdings Limited, [1977] CTC 186; 77 DTC 5115, after carefully reviewing the jurisprudence. Defendant was therefore undoubtedly carrying on business during the years in question.

On the question of deductibility of expenses when no income is realized the recent Court of Appeal case of MNR v M P Drilling Ltd, [1976] CTC 58; 76 DTC 6028, is of interest. While the primary question there was whether the expenses were capital expenses and hence not deductible under the provisions of paragraph 12(1 )(b) of the Act, which is not the issue here, the issue also arose as to whether expert analyses and feasibility studies by a company attempting to get into the business of marketing propane and butane gas abroad which was unsuccessful so the company went into a different business of driling wells, were properly deductible on the grounds that these expenses never produced any revenue. In rendering the judgment of the Court Urie, J stated at 63:

It was then argued that there must be revenue before any deduction can be made for expenses which might otherwise properly be deductible as made for the purpose of earning income. I cannot agree that because the respondent had not generated any revenue, let alone profit, makes it any less “the process of operation of a profit making entity’’. Nor does the fact that no revenues were generated from the activity transform what would have been deductible outlays for the purpose of gaining income, had there been any revenue, into expenditures made for the acquisition or creation of a business entity, or, to put it in the way earlier cases have put it, to bring into existence an asset or advantage of an enduring benefit of a trade.

Plaintiff relies strongly inter alia on the case of Lyle A Meredith v Her Majesty The Queen, [1975] CTC 570; 75 DTC 5412. In that case the taxpayer had acquired 22 acres of land on which he installed fish ponds and other improvements in order to permit customers to fish on payment of a $3 fee without licence. Some two years later the Provincial Government required that the fishermen obtain a licence even to fish in private ponds and while the taxpayer attempted to continue business for two more years he then encountered pollution problems making it impossible to stock the ponds with fish so the business was stopped. In the three following years he claimed as deductions from other income his taxes, insurance and other expenses in connection with his property. Cattanach, J held that because the business was not being carried on in the years in question the general expenses were not deductible including interest on borrowed money since this money was no longer being used in the business and that there had been a change in the use of the property which now became a capital asset and not stock in trade, and the taxpayer’s profits on the eventual sale of it were treated as capital gain. Without disagreeing with this decision I believe that it can be distinguished on the facts, however, as there was no possibility of doing anything further with the fishing ponds at the time the taxpayer ceased deriving any revenue from them, while in the present case the evidence indicates that the taxpayer never entirely abandoned its desire to develop the subject land as a revenue producing property, although as time passed it became more and more apparent that this intention might not be realizable.

Defendant submitted a further argument that since by subsection 18(2) of the new Income Tax Act realty taxes can no longer be deducted from other income in situations where the property is being held as a capital investment but must be capitalized, this implies that prior to that date the converse was true. I do not accept this reasoning however which is contrary to the provisions of subsections 37(2) and (4) of the Interpretation Act (RSC 1970, c I-23) which read respectively as follows:

(2) The amendment of an enactment shall not be deemed to be or to involve a declaration that the law under such enactment was or was considered by Parliament or other body or person by whom the enactment was enacted to have been different from the law as it is under the enactment as amended.

(4) A re-enactment, revision, consolidation or amendment of an enactment shall not be deemed to be or to involve an adoption of the construction that has by judicial decision or otherwise been placed upon the language used in the enactment or upon similar language.

While the amendment had the effect of settling the issue which is in controversy in the present case for the 1972 and following taxation years it cannot be concluded that this infers that the taxes were properly deductible in the 1970 and 1971 taxation years. The deductibility must be considered solely on the basis of the laws that existed at that time.

I have concluded that on the facts of this case the better view is that the deduction of these taxes should be permitted. Certainly up to and including the year 1967 there were reasonable possibilities of deriving revenue, even if not profit, from the real estate in question, and even after that date evidence does not indicate that all hope of developing the property had been abandoned. Moreover it is of some significance to note that while parking income was still being received in 1963 and 1964 the company was already deriving income from interest on loans, so that it cannot be said that entered into this other type of business only when all income from parking ceased.

Having concluded that the company was carrying on business, and that the realty taxes were properly deductible as a business expense, it follows that plaintiff’s contention that the losses incurred were property losses and not business losses cannot be sustained.

Plaintiff’s action is therefore dismissed with costs and the reassessments made for defendant’s 1970 and 1971 taxation year are vacated.