Nesbitt Thomson Inc. v. MNR, 91 DTC 1113, [1991] 2 CTC 2352 (TCC)

Bonner, T.CJ.:—This is an appeal from an assessment of income tax for the 1985 taxation year. The fiscal period in question ended on March 31. On assessment the Minister included in the computation of the appellant's income the sum of $1,947,703 which he described as “leasehold inducements". The sum was received by the appellant from persons with whom it had entered into leases.

It was the position of the respondent that the amounts in question were received by the appellant as a result of business activities carried on by it in the year and thus represented a portion of the appellant's profit from its business.

The appellant was described by Brian Usher-Jones, its chief financial officer, as a holding company which operated a group of subsidiary companies. Those subsidiary companies were described by him as integrated investment dealers which buy and sell equities and debt instruments. The subsidiaries operate 23 retail branches in Canada which serve the needs of both individual members of the public and institutional clients. The appellant supplies to its subsidiaries senior management, legal and accounting services. As well it furnishes funding, insurance, and the leased space required by the subsidiaries for the purposes of carrying on their operations.

When space is required by a member of the Nesbitt Thomson group of companies, the appellant enters into the necessary lease and then allocates the space to the subsidiary company. No written sublease by the appellant to the operating subsidiary is drawn up. The appellant recovers its costs, including an amortized amount in respect of leasehold improvements, from the subsidiary. The cost recovery system applies not only to premises but to all direct costs expended by the appellant on behalf of the subsidiary. The appellant does not, according to Mr. Usher-Jones, exact a mark-up on costs. However, it does charge each subsidiary a management fee based on a specified percentage of the pre-tax profits of that subsidiary.

Mr. Usher-Jones testified that it was a very common practice both before and after 1985 to negotiate and receive inducement payments upon entering into leases.

During the 1985 fiscal period the appellant negotiated four leases, one with Sun Life Assurance Company of Canada pertaining to space at 150 King Street West now occupied as the Nesbitt Thomson head office. It was for a term of three years with an option for a further two years and three additional five-year options. The agreement for lease provided for payment by the landlord "as an inducement for the tenant to execute the lease” of an amount equal to $30 per square foot. Payment was to be made as to $15 per square foot on the commencement date provided that the formal lease had been executed and delivered and the tenant's work as defined in the lease had been substantially completed. The remaining $15 was to be paid by way of an abatement of basic rent. The taxability of the first part of the inducement is in issue.

The next part of the amount in issue arises from the lease of premises in the Bow Valley Square building in Calgary, Alberta. The lease was for a term of seven years with two rights of renewal. A rider to the lease provided that the landlord pay to the appellant "as an inducement to enter into this lease" the sum of $460,260 computed at a rate of $45 per square foot. Payment was to be made on the date of occupancy.

The third payment was made pursuant to the terms of the lease between the appellant and West Coast Savings Credit Union with respect to 2,800 square feet in a building in Victoria, British Columbia. The lease provided for payment by the landlord to the appellant of "the sum of $70,475 on the day the tenant commences business in the premises".

The Calgary and Victoria premises were acquired for occupation by the retail subsidiaries of the appellant when premises which they had formerly occupied were found to be inadequate.

The last of the disputed inducement payments was in the amount of $34,480. It was made in respect of a lease entered into between Sun Life as lessor and Nesbitt Thomson Bongard Inc. and H. Reisman & Associates Ltd., a partnership carrying on business under the name The Nesbitt Consulting Group. The lease related to space at 200 King Street West, Toronto. Nesbitt Thomson Bongard Inc. was one of the wholly-owned subsidiaries of the appellant. The space was required for use by the partnership in carrying on a business of providing consulting services.

Mr. Usher-Jones testified that this inducement was received by the appellant and held by it on behalf of the partnership because the partnership had no bank account. It was, he said, never recorded in the appellant's books. This evidence was given without reference to any notes or records either of the appellant or Nesbitt Thomson Bongard Inc. If the amount really belonged to the partnership, I should have thought that it would have been relatively easy to adduce evidence to demonstrate that it was entered in the books of the partnership. That was never done and I therefore believe that Mr. Usher-Jones was mistaken.

Exhibit R-5 makes it clear that the sum of $1,416,968 was taken into account by the appellant as a reduction of the cost of its fixed assets. That amount is quite obviously the precise total of the two cash inducements paid by Sun Life, namely the inducement for 150 King Street West and the inducement for 200 King Street West. The $34,480 would not have been credited to fixed assets on the appellant's records if it had not been received and retained by the appellant.

On the main issue, it is essential, in my view, to determine whether the appellant when entering into the leases was establishing or extending its business organization or carrying on its business. Here, I rely on the language of Dixon, J. in Hallstroms v. F.C.T. (1946), 72 C.L.R. 634; 8 A.T.D. 190, where, in dealing with the question whether expenditures were on current or capital account, he said that the difference is:

. . . between the acquisition of the means of production and the use of them; between establishing or extending a business organization and carrying on the business; between the implements employed in work and the regular performance of the work . . .; between an enterprise itself and the sustained effort of those engaged in it.

In order to answer that question it is essential to look to the nature of the business in which the leases were to be utilized. In doing that, great care must be taken to distinguish between the business of the subsidiary companies and the business of the appellant. It is well-settled law that the mere fact that a person holds all of the shares in a company does not make the business carried on by that company the shareholder's business. The appellant's subsidiaries were, as previously noted, described as operating companies. They engaged in various aspects of the securities business.

The appellant, on the other hand, was a holding company. It held the shares of the subsidiaries, derived dividend income therefrom, and provided the accounting, legal, management, and other services required by them. The appellant also provided and fitted out the space required by the subsidiaries for their operations. It was in the course of doing so that it entered into the leases and received the inducement payments in issue. It is significant that, as Mr. Usher-Jones testified, in 1985 only about 5 per cent of all leased space was used by the appellant as opposed to the subsidiary companies. The profit and loss statement at the fourth page of Exhibit R-3 reflects the management fee received by the appellant as compensation for all the activity which I have described.

It was argued that the appellant did not deal in leases and did not seek profit by re-leasing space to the subsidiary companies at a mark-up on cost. That argument has no force in the circumstances of this case. Mr. Usher-Jones stated that the appellant was compensated globally for its efforts on behalf of the subsidiaries. It recovered the direct costs which it incurred and in addition it imposed the mark-up which I have mentioned and which Mr. Usher-Jones described as global compensation, that being the management fee calculated as a percentage of the pre-tax profits of each of the subsidiaries.

It is not necessary in order to demonstrate that an activity is an integral part of the current profit making operations of a business to show that a specific mark-up is applied to that particular activity. Thus, for example, a pharmacist may not charge extra to deliver a prescription to a customer, but that fact would not by itself be sufficient to take delivery operations out of the ambit of the ordinary operations of the pharmacist's business.

It is useful to refer to the following passage from the reasons for judgment of Rand, J. in Gairdner Securities v. M.N.R., [1954] C.T.C. 24; 54 D.T.C. 1015 at 27 (D.T.C. 1016). There His Lordship said:

Ordinarily, a business is a scheme involving a series of transactions of one or more modes of dealings, more or less repetitive, for making a profit from the total activities.

[Emphasis added]

It is significant that Mr. Usher-Jones admitted that the appellant received inducements to enter into leases both before and after 1985 and, further, that the payment of such inducements was a common practice.

The payments cannot in my view be seen to be windfalls. They were neither unusual nor unexpected, and in this regard I refer to The Queen v. Cranswick, [1982] C.T.C. 69; 82 D.T.C. 6073. The payments were the subject of bargaining between the landlords and the appellant and were, when settled, made the subject of enforceable provisions in the leases or agreements for leases. The word windfall is, I think, totally inappropriate to describe payments of the sort under review.

This case is distinguishable from that of a businessman who receives an isolated inducement payment in connection with the negotiation of a lease of space which he intends to occupy. He is establishing or extending his business organization or possibly moving the location thereof and not, as the appellant was, performing the day-to-day tasks involved in operating that business itself.

The present case is not analogous to that under consideration in Westfair Foods v. The Queen, [1991] 1 C.T.C. 146; 91 D.T.C. 5073. That case is one in which Reed, J. held at page 150 (D.T.C. 5076) that the taxpayer:

. . . does not trade in leases. The headleases in its hands are capital assets. It needs physical premises from which to conduct its food distribution and sales business and these are obtained either by outright ownership of the premises or by way of long-term leases.

The decision of the Federal Court-Trial Division in Woodward Stores Limited v. Canada, [1991] 1 C.T.C. 233; 91 D.T.C. 5090, is also distinguishable. There the taxpayer received payments characterized as fixturing allowances as inducements to enter into two long-term leases of space for use by it in conducting its general merchandising business. The payments were related to tenant improvements, that is to say the cost to the tenant of finishing space within the bare concrete perimeter walls, ceiling, and floor.

In the present case, although the space leased by the appellant was bare, the payments were not shown to be intended to defray fixturing costs. All that was shown was that the payments were not intended to be made until after tenant's work was completed or until time of move-in. Indeed, in the case of the Calgary premises, the inducement payments exceeded fixturing costs.

However, nothing, in my view, turns on the dedication or non-dedication of the payments to expenditures made in fitting out the premises. What is significant is that the payment to Woodward related to leases taken by it in expanding the structure of its business and not, as here, to leases taken as part of the day-to-day operation of the business.

In Canada Starch v. M.N.R., [1968] C.T.C. 466; 68 D.T.C. 5320, Jackett, P. expressed the distinction as follows at page 472 (D.T.C. 5323).

In other words, as I understand it, generally speaking,

(a) on the one hand, an expenditure for the acquisition or creation of a business entity, structure or organization, for the earning of profit, or for an addition to such an entity, structure or organization, is an expenditure on account of capital, and

(b) on the other hand, an expenditure in the process of operation of a profitmaking entity, structure or organization is an expenditure on revenue account.

The same distinction applies, of course, to receipts as to expenditures.

Finally, I turn to the evidence of Wayne Musselman, an experienced chartered accountant called to testify on behalf of the appellant. He expressed the opinion that, “including inducements of the type described above in income would result in a distortion of the income results for the year in which the inducement is received and would not be in accordance with the principle of matching revenues and expenses." What Mr. Musselman said may well be so, but his opinion did not touch on the nature of the payments ana counsel for the appellant did not contend that if the payments were properly included in income for tax purposes they must be included in income for some taxation year other than 1985.

For the foregoing reasons, I will dismiss the appeal.

Appeal dismissed.