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Citation: 2007TCC74
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Date: 20070328
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Docket: 2004-4482(IT)G
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BETWEEN:
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PARKER BROTHERS TEXTILE MILLS LIMITED,
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Appellant,
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And
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Hershfield J.
[1] The Appellant appeals the reassessment made of its 2001 taxation year ending April 30. The reassessment denied the deduction of an expense of $222,500.00 described as "consulting fees". Of this amount $200,000.00 was paid to Resciniti Holdings Inc. ("RHI"). Appellant's counsel conceded at the hearing that the remaining $22,500.00 was no longer at issue and was not being pursued.
[2] The Appellant argued that the consulting fee paid to RHI in its 2001 taxation year was for site investigation in respect of a plant that the Appellant required to be built for its occupation and for carrying on its business. A site suitable for the Appellant's intended use was found in Bowmanville, Ontario. It was acquired by a related company that constructed a building to the Appellant's specific requirements and the Appellant occupied the building as a tenant in the course of carrying on its business. The Appellant relies on paragraph 20(1)(dd) of the Income Tax Act ("Act") to support its claim for a deduction of the consulting fees paid in the year and argues that such a claim is not adversely affected by the fact that it was the tenant of the building rather than the owner and builder of it.
[3] The Respondent's primary assessing position does not relate directly to paragraph 20(1)(dd). However, if the assumptions set out in the Reply are factually correct, then they clearly support the Respondent's submission that paragraph 20(1)(dd) cannot apply. The Respondent's Reply sets out the assumptions as follows:
(a) the Appellant's fiscal year is from May 1st to April 30th of each year;
(b) the Appellant is wholly-owned by 133672 Canada Inc., which in turn is wholly-owned by Mr. Roger Parker;
(c) 374573 Canada Inc. is 100% owned by Ms. Debbie Parker, daughter of Roger Parker (the "related corporation");
(d) the Appellant paid to RHI between May 2000 and April 2001 "consulting fees" relating to a land and building located in Bowmanville, Ontario;
(e) the land was purchased not by the Appellant but by the related corporation, which then proceeded to construct a building on said land;
(f) the land was purchased by the related corporation in April 2000;
(g) the expenses paid by the Appellant to RHI were incurred after that date;
(h) the building constructed by the related corporation was rented to the Appellant who used it as one of its manufacturing plant and paid rental income to the related corporation;
(i) the appellant never owned the land nor the building after its construction by the related corporation.
[4] The Reply goes on to set out the statutory provisions relied on and the grounds for the relief sought as follows:
13) He relies on, inter alia, paragraphs 18(1)(a), 18(1)(b) and 20(1)(dd) of the Income Tax Act, R.S.C. 1985 c.1 (5th Supp.), as amended.
14) He submits that the deduction claimed was not made to earn income by the Appellant, within the meaning of paragraph 18(1)(a) of the I.T.A., since the land and building are business assets of the related corporation which uses them to earn rental income.
15) He also submits that since the land and building are not the property of the Appellant, the expenses cannot be capitalized by the Appellant under paragraph 18(1)(b) of the I.T.A.
16) Finally, he submits that the Appellant cannot deduct the expenses under paragraph 20(1)(dd) of the I.T.A., firstly because the expenses were incurred after the land was purchased, and accordingly not incurred for site investigation, and secondly, because the building, after its construction, was not a business asset of the Appellant, said building having been constructed by the related corporation and thereafter being owned by it.
[5] The assumption, as presented by the Respondent, that the expenses paid by the Appellant to RHI were incurred after the purchase of the lands clearly suggests that the consulting services provided could not have been for site investigation, although no such assumption is specifically pleaded. Indeed no assumptions are made as to what the RHI services were. There is an unstated, but implicit assumption; namely, that the RHI services relate to the construction of the subject building rather than to site investigation.[1] Still, based on the assumptions that the RHI services were performed after the land was bought and that the related company owned the land and built the building to earn rental income, the Respondent's principal position is that the consulting fees paid by the Appellant were in respect of the building and that the expenses incurred in respect of another taxpayer's income asset cannot be claimed as an income expense. Essentially the Respondent's theory of the case is the RHI expense was incurred for and as a benefit to the related company and accordingly was not made to earn income, but rather was a capital expense. While this theory of the case was argued, it is not entirely clear from the pleadings that such theory is anything but implicit.
[6] I note at this point that Appellant's counsel took issue with what he saw as the Respondent's misdirection as to the basis for the subject assessments. It does appear that there was poor communication as to the reasons for the assessment, particularly regarding the auditor's position on the services performed by RHI. The main point argued by Appellant's counsel was that the assumption that the RHI services were performed after the lands were acquired was not made when the reassessment was made. Appellant's counsel spent considerable time presenting evidence of this and arguing that issuing the assessment before this assumption was made invoked principles set out by Chief Justice Bowman in Anchor Pointe Energy Ltd. v. R.[2] so as to place the burden of proof on the Respondent to establish that the subject expenses were not site investigation expenses.
[7] I agree that the Appellant believed and had reason to believe that the auditor was satisfied that the subject services were performed before the land was acquired. The Appellant believed the basis for the reassessment related only to the availability of site investigation expenses under paragraph 20(1)(dd) to prospective tenants of a building built by a landlord. Indeed it was argued that the auditor made certain concessions relative to paragraph 20(1)(dd) at the pre-assessment proposal stage that indicate her focus was on the application of that provision. However such perception of events was based on the Appellant's belief that the auditor accepted that RHI was engaged in 1999 to do site investigation for the Appellant. But the auditor did not accept that. Her testimony was clear and credible on the point. She testified that she never intended to make concessions regarding paragraph 20(1)(dd). She regarded it as irrelevant. The basis of her proceeding with the assessment was that the expenses were simply made to benefit the related company after the land was purchased. She relied solely on paragraphs 18(1)(a) and (b) in issuing the reassessment. It was her failure to communicate this that caused the problem complained of by the Appellant.
[8] I accept then that the auditor relied on the fact that the subject expenditure was incurred in respect of the construction of the related company's building as the principal basis of the reassessment. That basis for reassessing was based on the view held by the auditor that the RHI expenses were incurred after the land was acquired. That this view or assumption was not communicated to the taxpayer's representatives until after the reassessment does not cause a change in the burden of proof. These are issues of procedural fairness. Poor communication and misdirection can easily frustrate the appeal process. Appeals are time consuming and expensive and it is incumbent on the Minister of National Revenue (the "Minister") and his agents to do everything possible to ensure that taxpayers and their professional advisers are made aware of the assumptions relied on by the Minister prior to a reassessment at least when there is a reassessment proposal to which a taxpayer has fully and earnestly responded. That appears to be the case here but the expected communication was lacking. Still, the law has not gone quite so far as to address this failure by reversing the onus of proof placed on the taxpayer.
[9] In spite of the Appellant's failure to convince me that the burden of proof falls on the Respondent to prove that the RHI services were not for site investigation, I am in any event satisfied on the evidence that the RHI services were performed prior to the acquisition of the subject lands. Furthermore, these services were rendered for the purpose of investigating the suitability of various sites on which to construct a building in which the Appellant was to carry on its business. That narrows the issue to whether paragraph 20(1)(dd) applies to tenants in the circumstances of the case.
[10] Before reviewing the evidence that has led me to conclude that the RHI services were performed prior to the acquisition of the lands, I note that there can be no dispute as to the following facts:
(a) the land on which the plant was constructed was acquired by the related company in April 2000 and was held by that company for its own account. The related company built the plant to the specific requirements of the Appellant with the intent to rent the plant to the Appellant, who in turn intended to rent the plant for use of its business; and
(b) RHI first invoiced the fees paid by the Appellant in June 2000. That invoice is the first documented evidence of the $200,000 fee payable to RHI. It shows a contract date and an invoice date of June 1, 2000. It shows a total "Consulting Fee" of $200,000 with a "Progress Draw" of $20,000 and a balance to be billed of $180,000. There are six more monthly invoices (four for $20,000 and two for $50,000) all of which appear on the face of the invoice to be payments for work in progress with invoicing corresponding to "progress to date". All invoiced amounts were paid by the Appellant in its 2001 taxation year ending April 30.
[11] Given the timing of payments and the wording on the invoices, the Respondent's theory of the case takes on some life. That is, the June contract date occurs more than a month after the land was acquired and the invoices do not refer to site investigation but rather refer to work in progress. All this suggests that the subject payments must have been for something other than a site investigation. As well in the return filed for the year, the Appellant claimed the expense as a consulting fee not as a site investigation expense.
[12] However, the Appellant gave evidence that casts a different light on the events leading up to the construction of the new plant. The Appellant called two witnesses: Mr. Parker, the sole shareholder and principal officer of the Appellant, and Mr. Resciniti, the principal of RHI. Both gave evidence as to the work performed by RHI for the Appellant. Mr. Parker testified, that he personally retained the services of RHI and that Mr. Resciniti was personally responsible for the performance of the services on behalf of RHI. Both testified that they met personally and struck a bargain, well prior to the purchase of the land, for RHI to locate a site for a new plant for the Appellant.[3] The Appellant's requirements were discussed and the fee was agreed upon at the outset.
[13] Mr. Parker testified that the Appellant was a dyer and finisher of woollen goods - a business started by his grandfather in 1939 - that had expanded to fabric manufacturing. It had two weaving mills - one in Trenton and one in Toronto. The business was expanding and needed larger facilities, consequently, the company had to move out of the Toronto premises. Combining facilities at a new premises, possibly east of Toronto for the convenience of workers from both plants, was seen as necessary to accommodate the business.
[14] Mr. Parker testified that a lot of leg work was required to find a suitable location for the new facilities. Mr. Parker said he needed someone to find a location and that Mr. Resciniti was recommended to him. Mr. Parker knew a lot of municipalities could not accommodate such a large weaving, dying and finishing business given the large water, power and sewage disposal and acreage requirements for a one hundred thousand square foot building. As a result, he needed someone to survey a 30 - 70 kilometre area and do the "running back and forth" dealing with municipal offices that would permit and handle their facilities' requirements. Mr. Resciniti brought forward several proposed sites before the Bowmanville site was chosen.
[15] Mr. Parker said he agreed to a $200,000.00 fee at the outset and expected he would have to pay the full fee even if the project did not go ahead. He acknowledged that Mr. Resciniti was also going to get the contract to build the building and that was additional incentive for him to find a suitable site.
[16] Mr. Resciniti testified that he spent a year investigating possible sites and brought several prospects forward before the Bowmanville site was acquired in April, 2000. He said a fee was agreed to in advance and was not intended to be contingent. He said he billed the fee as progress payments to accommodate the Appellant's cash flow needs. The progress billing shown on the invoicing was not intended to mean that RHI's services were then "in progress". They were intended as instalment invoices against the consulting fee owing under the 1999 agreement for site investigation services which led to the eventual purchase of the Bowmanville site.
[17] When the offer to purchase the subject lands went in, the purchaser was named as a company to be incorporated. That was to be and became the related company. It was clear from the evidence that Mr. Parker relied solely on the advice of his accountants in having a different company purchase the lands and build the plant. The Appellant's accountant testified that this choice of purchaser was due to financial presentation preferences. Regardless, the Appellant guaranteed the mortgage on the property (as did Mr. Parker personally as to a portion) and was to occupy the premises as a tenant. Although financing was not finalized until September 2000, the building permit was issued July 4, 2000 and construction started shortly thereafter. The financing was for $2,500,000 with working capital required of $1,200,000.[4] It appears the Appellant provided at least some of the working capital in the form of a loan.[5] In addition to paying rent sufficient to cover the mortgage, the Appellant, as tenant, also paid all the expenses relating to the land and building.
[18] Respondent's counsel found all the testimony of the Appellant's witnesses untrustworthy. She argued that there was no agreement entered into in 1999 for site investigation. The Respondent further contends the invoices, as written, and the payments when made evidence that the services performed by RHI were performed well after the land was acquired and that accordingly no site investigation services were performed.
[19] While there are some aspects of the testimony of both Mr. Parker and Mr. Resciniti that are troublesome, none are that troublesome as to cause me not to believe that RHI performed services related to the site investigation for the Appellant prior to the acquisition of the subject lands. The Appellant needed a new site to merge the functions and workforce of two plants being closed. These events happened. A new plant in a new community does not just appear. The site requirements would be considerable and site investigation would be a major project. Mr. Parker's testimony that it was Mr. Resciniti who did months of leg work to find the Bowmanville site was not effectively challenged by the Respondent.
[20] That the payment for the services was not all paid in a lump sum is not so extraordinary. That payment of $200,000.00 was commenced a short time after closing the land purchase and was fully paid within months after payments commenced does not seem like an extraordinary indulgence on RHI's part considering the circumstances. The invoice showing a contract date that might simply reflect the date the parties agreed on payment terms does not discredit the otherwise credible state of events as testified to by the Appellant's witnesses. That a building permit was issued and construction of the plant commenced so shortly after the purchase of the lands evidences further that considerable work must have been done before the purchase. One does not acquire land to build a major plant with major emission, water, sewer and power issues (just to name a few) unless one has done a lot of work to ensure that the actual building of the plant will not be blocked because of an oversight regarding such issues. These issues had to have been substantially dealt with prior to the purchase. That was the substance of Mr. Parker's testimony as to what he relied on Mr. Resciniti to do and that is what he paid RHI $200,000.00 to do. There is no reason to suspect a conspiracy here to adduce false evidence before this Court and no effective challenge was made of the testimony that it was RHI that did this work.
[21] Accordingly, I am satisfied on the evidence that an agreement existed between RHI and the Appellant in about March 1999 whereby RHI was engaged to investigate the suitability of various sites for the purpose of building a plant that would be used by the Appellant in connection with its business. I am satisfied that such services were in fact performed by RHI and that they led to the acquisition of the subject lands and the construction of a plant by the related company. As well, as noted early, there is no dispute that the related company bought the land and built the plant in order to meet the specific requirements of the Appellant and intended to rent it to the Appellant. Nor is it disputed that the Appellant relied on the related company to build and rent out the plant to the Appellant who intended to use the plant in the course of carrying on its business.
[22] That should take me to the analysis of paragraph 20(1)(dd) but there are still a few points that need be mentioned before I start that analysis. I said that there were some troublesome issues with the Appellant's evidence. One concerns the idea that the $200,000.00 was fixed at the outset, non-contingent and only for pre-acquisition site suitability investigations. I have serious doubts as to this aspect of the oral evidence. Mr. Resciniti could not remember the exact fee agreed to at the outset and only said it was about $200,000.00. Mr. Parker said the fee included post acquisition services such as getting the building permit. Whether the amount was fixed or not or contingent or not is of little consequence in my view given the Appellant's reliance on paragraph 20(1)(dd) which provides for cash basis accounting. A price for RHI's services was fixed and paid by the Appellant in its 2001 taxation year. That is sufficient. While there is a possibility, if not a real likelihood, that some of the fees were attributable to post acquisition services, that does not diminish the evidence that substantially all of the consulting fee paid was related to the year's work leading up to the acquisition. Mr. Parker testified, in effect, that even though the $200,000.00 included the building permit issued in July, he was satisfied prior to acquisition that the permit would be issued and that it was in respect of the prior lead-up work that he had agreed to pay RHI $200,000.00.
[23] Still, had the Respondent raised an allocation issue I would have been prepared to deal with it on the basis that some part of the amount paid was not for site investigation. The burden of proof in respect of such issue would arguably fall on the Respondent since no specific assumptions were made as to what the services provided were. However, not only did Respondent's counsel not pursue the issue of allocation, she also made it clear at the hearing that there was no alternate position being taken by the Respondent as to that possibility. Further, there was no alternative argument made as to the reasonableness of the expenditure as a site investigation expenditure.
[24] Instead the Respondent argued that the necessary conclusion to be drawn from the facts was that the subject amount whenever paid was paid for the benefit of the related company and cannot or should not be considered to have been incurred for another purpose. Accordingly, such expenditure is not deductible under paragraphs 18(1)(a), which denies expenses not made for the purpose of gaining income, and under 18(1)(b), which denies payments on account of capital. This argument carries no weight. While the related company benefited from its relationship with the Appellant by having the opportunity to buy a site on which to construct a building for a tenant, the site investigation expense was incurred by and for the benefit of the Appellant. That expenditure was for the purpose of earning income from its business. That arms-length parties would have entered into a documented lease arrangement to better secure each party's investment in the development of the site is not relevant in the circumstances before me. The relationship between the landlord and the tenant here are sufficiently interdependent. Further, even if the related company failed to rent the plant back to the Appellant, the fee for the service performed by RHI would still be owing to RHI by the Appellant and the purpose for having incurred the expense would still have been to earn income from its business. The accrual basis of accounting for income and expenses would afford a deduction in the Appellant's 2000 taxation year unless paragraph 20(1)(dd) applies to put the expense on a cash basis. Similarly, reliance on that paragraph is required to obviate any concern that the subject expenses cannot be claimed except as an addition to the cost of the building or leasehold interest by virtue of the application of paragraph 18(1)(b).
[25] Further, with respect to paragraph 18(1)(b) and expenditures of a capital nature I note that there is another way to approach the subject site investigation expense that seems to have insinuated itself into the Respondent's "benefit" theory of this case. That is to approach the subject expense on the basis that the Appellant incurred it on behalf of the related company so that in effect the monies paid to RHI must be treated as capital advances to the related company. Again, the facts do not support this approach. That the expenditure may be a benefit to the landowner is incidental and not relevant. As noted above, the Appellant still incurred the cost for the purpose of earning income from its business. There is nothing about the nature of the Appellant's actions that impugn this reality. The Appellant incurred the subject expense for its own account. It released a purchase opportunity to another who was to construct the plant and rent it back but that was simply a different way of satisfying its purpose to use the site in connection with its business. To ensure a deduction on the cash basis and to ensure against the denial of the expense under paragraph 18(1)(b) requires that paragraph 20(1)(dd) applies as asserted by the Appellant.
[26] I will now consider paragraph 20(1)(dd).
[27] The statutory framework that needs to be considered is as follows:
18. (1) In computing the income of a taxpayer from a business or property 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 the business or property;
(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;
20. (1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto
...
(dd) an amount paid by the taxpayer in the year for investigating the suitability of a site for a building or other structure planned by the taxpayer for use in connection with a business carried on by the taxpayer;
[28] Having found that the Appellant required a new plant at a new location and that it retained the services of RHI to find a suitable site for building such a plant it seems patently clear that a building was planned by the Appellant for use in connection with its business. The only argument the Respondent can make is that a site for a building "planned by the taxpayer" imputes a requirement that the builder be the taxpayer.
[29] Respondent's counsel argued that the French language version of paragraph 20(1)(dd) supported this construction of the provision. The French version reads as follows:
20 (1) Déductions admises dans le calcul du revenu tiré d'une entreprise ou d'un bien -- Malgré les alinéas 18(1)a), b) et h), sont déductibles dans le calcul du revenu tiré par un contribuable d'une entreprise ou d'un bien pour une année d'imposition celles des sommes suivantes qui se rapportent entièrement à cette source de revenus ou la partie des sommes suivantes qu'il est raisonnable de considérer comme s'y rapportant :
dd) Recherche d'emplacement -- une somme payée par le contribuable au cours de l'année pour des recherches destinées à déterminer si un emplacement convenait ou non à la construction d'un bâtiment ou de tout autre ouvrage que le contribuable projetait de construire pour l'utiliser dans le cadre d'une entreprise exploitée par lui;
[30] The phrase « que le contribuable projetait de construire » does support the Respondent's argument that paragraph 20(1)(dd) requires that the taxpayer claiming the expense also be the one who plans to build the hypothetical building or structure. The French version better highlights the identity of the taxpayer but in my view that should not necessarily be seen or taken as underlining the connection between the taxpayer and the builder as opposed to the connection between the taxpayer and the planner. A proper construction requires further consideration.
[31] It is clear that what triggers the subject deduction is the cost of investigating the suitability of a site for the planned use of a hypothetical building that may never be built. If it matters not whether a building is ever built, how can it be said that the operation of the section depends on who builds it? It is the taxpayer's contemplated use of a building to be built that is determinative not who owns the site or who builds on it and not the manner of holding or controlling the site being investigated or the building being contemplated.
[32] The construction I give to the subject provision would be better supported if the phrase "building or other structure planned by the taxpayer for use in connection with" read "building or other structure planned for use by the taxpayer in connection with" but taken in context it is my view that the former language must be read as having the same meaning as suggested by the latter language. Such position appears as well to be consistent with the Respondent's administrative practice. IT Bulletin 350R which has not changed since 1977 provides that:
... The taxpayer claiming a deduction under paragraph 20(1)(dd) may be the owner or potential owner of the site or may be a person who, as a possible tenant, is considering the construction of a building or other structure on the site under a lease granted by the owner of the land.
[33] Respondent's counsel suggests that this is not inconsistent with her position. For a tenant to be entitled to the deduction, pursuant to this Bulletin statement, it must be the builder or planned builder even if the site is owned by another. It is true that a tenant can build for its use on leased land.[6] That would be the case to which Respondent's counsel refers. Still, I do not understand the wording of the subject provision or the meaning of the Bulletin to be so narrow. The Bulletin clearly provides that:
... To qualify for a deduction under paragraph 20(1)(dd), an expenditure must meet the following three requirements:
(a) the expenditure must be made in the year the deduction is claimed;
(b) the purpose of the expenditure must be the investigation of a site to ascertain its suitability for a planned building or other structure; and
(c) the building or other structure referred to in (b) must be intended for use in a business carried on by the taxpayer.
[34] The requirements so stated would clearly afford the same deduction to a prospective tenant who sought out and approached a landowner whose land was available for development by the landowner[7] as would be allowed to a prospective tenant who built a building on leased land. Until a site is found, the manner of securing construction of a building for use in the business would be dependant on the bargain struck with the landowner. Should the subject provision be construed so as to leave the deduction contingent? I do not understand the subject provision as being so precisely worded as to distinguish these cases on the basis of who builds (landlord or tenant) any more than the stated requirements in the Bulletin would distinguish them. Where there is doubt as to the construction of a provision, an administrative position favouring the taxpayer should be applied.
[35] Notwithstanding the reasons stated above, which I regard as sufficient to allow the appeal, I note that even if the French and/or English versions of paragraph 20(1)(dd) require that the taxpayer be the builder or planned builder, it seems apparent that the Appellant in this case did indeed plan to build the plant but the plan simply changed. Consequently, the requirements laid out in paragraph 20(1)(dd) of the Act would still be met.
[36] It is clear that although the Appellant engaged the services of RHI at a time when the plan was in its formative stages, Mr. Parker believed that the Appellant would be the purchaser of the site and be the builder of the plant. While the deduction is timed on a when-paid basis, the relevant time in respect of having a plan to build is when the expense is incurred. At that time, the planned builder was the Appellant. As noted, the provision concerns a hypothetical building. It must therefore concern a hypothetical builder, which in this case was clearly the Appellant. Further still, if the provision applies to a failed plan or abandoned plan, as it clearly does, then it can readily be said that the Appellant abandoned the plan to build and is entitled to the deduction.[8]
[37] Accordingly, I find that the requirements of paragraph 20(1)(dd) are met. That obviates the need to consider the deduction limitation in respect of capital outlays. But for paragraph 20(1)(dd) being an exception to the paragraph 18(1)(b) limitation, site investigation expenses might be seen as attaching to the cost of a building or leasehold interest. Since that provision has no application, it matters not who owns the building or whether the absence of a lease would prevent a tenant from capitalizing the expense. Under paragraph 20(1)(dd), the expense is not a capital outlay for the purposes of claiming the deduction of the site investigation expenses.
[38] For all these reasons, the appeal is allowed with respect to the $200,000.00 fee paid by the Appellant to RHI. A judgment will be signed and issued accordingly in due course pending submissions on costs.
Signed at Ottawa, Canada, this 28th day of March 2007.
Hershfield J.
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