Roywood Investments Ltd. v. The Queen, 79 DTC 5451, [1980] CTC 19 (FCTD), aff'd 81 DTC 5148, [1981] CTC 206 (FCA)

Grant, DJ:—1. This is an appeal by the plaintiff in respect of the reassessments of its income tax for the years 1970 and 1971 made by the Minister of National Revenue on January 15, 1976 and on January 28, 1976, respectively.

2. The plaintiff was, at all material times, a corporation incorporated under the laws of the Province of Ontario. Its fiscal year end was December 31.

3. The plaintiff is the owner of the lands and premises on the south side of Adelaide Street in the City of Toronto, known municipally as numbers 119-129 Adelaide Street West, Toronto, and being all of lots 6, 7, 8, 9, and 10 on the south side of Adelaide Street, according to Plan D-32 for the registry division of the city of Toronto (hereinafter referred to as the “lands and premises’’).

4. The plaintiff by agreement in writing under seal dated January 8, 1965, agreed with the trustees of the Estate of William Willcocks Baldwin to buy the said lands and premises from such trustees at a price of $550,000.

5. By deed dated May 18, 1965, such trustees conveyed the said lands and premises to the plaintiff herein.

6. By head lease under seal dated April 15,1925, Stephen Yarwood Baldwin and Hamilton Cassels, the sole surviving trustees under the last will and testament of William Willcocks Baldwin, deceased, duly leased to York Street Buildings Limited, as lessee, its successors and assigns, the said lands and premises for and during the term of 966 years and four months to be computed from April 1, 1925, yielding and paying therefore unto the said lessors for the period from April 1,1925 to July 1,1925 the sum of $1,666.67 to be payable on May 1, 1925 and yearly and every year during the periof of 21 years from August 1, 1925 the yearly sum of $10,000 to be payable in equal quarterly instalments of $2,500 each in advance on August 1, and November 1, in the year 1925 and on February 1, May 1, August 1, and November 1, in each succeeding year during the said period of 21 years and paying therefore yearly during each successive period of 21 years after the said first period of 21 years from August 1,1925 such yearly sum as shall for each such period of 21 years be agreed upon or as shall be fixed as therein provided to be payable in advance in equal quarterly instalments on February 1, May 1, August 1, and November 1, in each year.

7. For the purposes of this appeal the parties hereto have agreed as to the following admitted facts:

(a) At all material times, the head lease was in effect and enjoyed priority over the deed. The purchase price of the lands and premises was $589,312 which was apportioned by the plaintiff as follows:

(b) At the time that the lands and premises were purchased and at all times material to this appeal, there were located on the lands two buildings which were approximately 40 years old and which were buildings converted to office building use. They were No 129 Adelaide Street West, Toronto located at the corner of York and Adelaide Streets, being a five-story structure with frontage on Adelaide, York and Pearl Streets and No 119 Adelaide Street West, Toronto, being a two-storey and basement structure fronting on Adelaide Street and backing on Pearl Street, both buildings having a total gross floor area of approximately 124,623 square feet (hereinafter referred to as the “buildings”).

(c) The head tenant of the head lease sub-leased the lands and premises and the sub-lessee in turn leased space in the buildings to tenants actually in occupation and collected the building rentals. The plaintiff collected the rent under the head lease directly from the head tenant, and did not collect the rent from the tenants in actual occupation of the various spaces of the building. No defaults under the head lease occurred during the relevant periods.

(d) At all material times, the buildings were fully rented.

(e) At the time that the lands and premises were purchased, the net rental due the landlord from the head lease was in the amount of $10,000 per annum. This rental had been set in 1946 for the 21 year period ending July 31, 1967, and as of August 1, 1967, the rental due the landlord under the head lease was to be re-negotiated and it was anticipated that the new rental would reflect current economic conditions.

(f) At all material times, Roywood’s interest as owner of the building was insured in the total amount of $1,892,000.

(g) As of August 1, 1967 and in accordance with the terms of the head lease, the rental payable under the head lease throughout the twenty-one year period commencing on August 1, 1967 was to be re-negotiated. No agreement could be reached during the course of the negotiations and, accordingly, the matter was arbitrated. The decision of the arbitrators was quashed by the Supreme Court of Ontario and as a result of lengthy negotiations, further arbitrations, further appeals to the Court of Appeal and to the Supreme Court of Canada, all of these proceedings lasting for a period of about seven years, the matter was settled. The rent to be paid under the head lease was fixed at $240,000 per annum for the period ending July 31, 1988.

(h) Under the terms of the settlement Olympia & York Developments Limited, which had by this time purchased the sublease of the lands and premises was authorized by the plaintiff to demolish the buildings.

(i) The plaintiff was provided with the permanent covenant of Olympia & York Developments Limited guaranteeing the terms of the head lease.

(j) During the year 1975, the buildings were demolished at the expense of Olympia & York Developments Limited.

(k) In calculating its taxable income for its taxation years 1965 to 1968 inclusive, the plaintiff claimed the following capital costs allowance on the buildings located on the lands:

In its 1969, 1970 and 1971 taxation years, the plaintiff made no claim for capital cost allowance in respect of the buildings located on the lands.

(l) The Minister of National Revenue mailed notices of original assessment to the plaintiff in respect of its 1967, 1968, 1969 and 1970 taxation years on August 6, 1968, August 8, 1969, July 30, 1970 and August 20, 1971, respectively.

(m) By notices of reassessment dated September 28, 1972, the Minister of National Revenue reassessed the plaintiff for its 1968, 1969 and 1970 taxation years.

(n) By notices of reassessment each dated November 15,1973, in respect of the plaintiff’s 1967 to 1971 taxation years, inclusive, the Minister of National Revenue disallowed the plaintiff’s claim for capital cost allowance on the buildings located on the lands, and also disallowed to the plaintiff any loss carry forward resulting from the aforesaid claims for capital cost allowance.

(o) On or about January 23, 1974, the plaintiff duly filed notices of objection with respect to the notices of reassessment dated November 15, 1973.

(p) By notices of reassessment each mailed on January 15, 1976, the Minister of National Revenue reassessed the plaintiff as follows:

(q) On reassessing the plaintiff by the notices of reassessment mailed on January 15, 1976, the Minister of National Revenue did not allow to the plaintiff its claims for capital cost allowance, nor any loss carry forward resulting from its claim for capital cost allowance. However, in arriving at a revised taxable income in the amount of $46,011.38 in respect of the plaintiff’s 1970 taxation year, the Minister of National Revenue allowed to the plaintiff loss carry forwards from its 1968 and 1969 taxation years in the total amount of $53,281.95 which did not arise from the plaintiff’s claim for capital cost allowance in respect of the buildings.

(r) By notification mailed on January 28, 1976 with respect to the plaintiff’s 1971 taxation year, the Minister of National Revenue confirmed the notice of reassessment mailed on November 15,1973, which disallowed a loss carry forward in the amount of $4,883 resulting in taxable income to the plaintiff in that year of $4,883.

The said head lease contained the following terms, conditions and covenants:

the Lessors have demised and leased and by these presents do demise and lease unto the Lessee, its successors and assigns, (the lands and premises)

TO HAVE AND TO HOLD the said demised lands and premises for and during the term of 966 years and 4 months

AND THE SAID LESSEE doth hereby covenant with the said Lessors in manner following, that is to say: . ..

And also will during the said term well and sufficiently repair, maintain, amend and keep the said demised lands with the appurtenances in good and substantial repair and all buildings and other improvements which at any time during the said term shall be erected or made thereon: And also will on or before the First day of October 1925, in a good, substantial and workmanlike manner build and complete, so as to be fit for occupation and use, buildings on the lands described in Schedule C hereto annexed (being in substitution for the structures now standing on said parcel) of the value of not less than $150,000: And also will at all times during the said term keep and maintain on the said lands (subject in the event of loss or damage of fire or otherwise to a reasonable and proper time being allowed for restoration, and for the replacement of buildings which may be obsolete or unsuitable to maintain) structures in good and substantial repair and suitable for the purposes for which the said demised lands may from time to time be profitably used, and of a value during the first period of 21 years equal to the value of the building known as the Adelaide Building now standing on the lands described in Schedule B hereto annexed, and of the said new building to be erected on the lands described in the said Schedule C, subject to a reasonable allowance for depreciation from year to year during the said first period, and of a value during each succeeding period of 21 years to be agreed upon or fixed as hereinafter provided at or prior to the beginning of such 21 year period: And further that the said Lessee will at the expiration or other sooner determination of the said term peaceably surrender and yield up unto the Lessors the said lands hereby demised with the appurtenances together with all the buildings, erections and fixtures erected or made by the Lessee thereon in good and substantial repair and condition:

PROVIDED ALSO and it is hereby further declared and agreed by and between the Lessors and the Lessee that the rental of the said demised lands for the second and each succeeding period of 21 years of the said term and the value of the buildings to be maintained thereon shall in default of agreement be fixed by arbitration, the rental to be fixed on the basis of the value of the land only without buildings or improvements, and the value of the structures so to be maintained to be fixed having regard for the purposes for which the land can then be profitably used so as to produce a revenue therefrom sufficient to pay the rental reserved during such period, the said insurance premiums, taxes, rates, duties and assessments and the cost of maintaining the said structures in good and substantial repair and condition.

AND IT IS FURTHER PROVIDED and agreed that the covenants, stipulations and conditions herein contained shall run with and be binding upon the demised lands and premises.

The said deed to the plaintiffs dated May 18, 1969, was expressed to be Subject to the aforementioned lease.

The right to deduct capital cost allowance in the computation of taxable income under the Act is set out in subsection 12(1) of the Income Tax Act, RSC 1952, c 148 which reads:

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,

Paragraph 11(1)(a) of such Act reads,

Notwithstanding paragraph 12(1)(a)(b) and (g), the following amounts may be deducted in computing the income of a taxpayer for a taxation year;

(a) such part of the capital cost to the taxpayer or property, or such amount in respect of the capital cost to the taxpayer of property, if any, as is allowed by regulation;

Section 1100 of the Income Tax Regulations permits the taxpayer, in computing his taxable income from a business or property, as the case may be, deductions for each taxation year equal to but not exceeding the percentages set forth in paragraph 1(a) of such section. In the present case the property falls within class three where the rate is limited to 5%. The right of the taxpayer to deduct such capital cost allowance in the first instance is based on the capital cost of the building to himself and in subsequent years to that amount less such amounts as have by then been deducted by him for such purpose in previous years. It is essential therefore, in this appeal, to ascertain what portion, if any, of such purchase price of $589,312 was paid by the plaintiff for the buildings that then stood on the land. In determining such fact the court may consider the evidence of accountants and real estate valuators L H Mandel v The Queen, [1978] CTC 780; 78 DTC 6518 and C R Upper v The Queen, [1979] CTC 316; 79 DTC 5246.

John W Beaton who is a real estate appraiser and consultant with extensive experience in the area of the land with which we are concerned, was called as a witness by the defendant. He first appraised the property in 1971. It lies at the south east corner of York and Adelaide Street with 207 feet on Adelaide Street and 187 feet nine inches on York Street for a total of 38916 square feet. The buildings had been built by the lessees or their predecessors about 40 years ago. They had consisted of a five storey and a two storey building. He stated its highest and best use was in redevelopment as a high density office building. This would involve much higher buildings to produce greater rentals to take advantage of the land which was in a very high priced area. He has given a very comprehensive report which sets forth in detail particulars of his evidence and the reasons for his conclusions. He states that the land in a vacant state was much more valuable in January of 1965 than the land plus the buildings thereon because new construction would involve additional cost of removing the old buildings. He compared this property with other comparable sales of approximately the same time in coming to his decision. He gave as his opinion that at such time a fair market value of the land if it were in its freehold state and without buildings or other improvements thereon would be $2,335,000. Some confirmation of this valuation is found in the fact that two and one half years later when the rent under the head lease for the next 21 years was being arbitrated pursuant to the provisions of such lease that the parties, including the plaintiff herein, mutually agreed that the market value of the land free and clear of buildings or other improvements was $60 per square foot or almost the same figure that Beaton had valued it at. By the terms of the lease most of the plaintiff’s rights in the property had been released to the head tenant for a further period of 924 years and the plaintiff would not be entitled to a reversion of the land and buildings until that time. A deferment for that period would render such a reversion of buildings to be of little or no value. Unless the head tenant should make default under the lease and thereby give the plaintiff the right to repossess, the only right left in the owner was that of receiving the ground rents that would be payable from time to time. It had no legal right, in the absence of further agreement, to use or develop the property in that period of time. Beaton gives as his opinion that at the time of purchase the buildings did not enhance the price paid by the plaintiff and for the above reasons they had no rational or market value at that time. He also states that the buildings were making less money for the head tenant each year and were becoming economically obsolete although not physically obsolete.

The provision in the head lease to the effect that the rental was to be fixed, when done so by arbitration, in successive 21 year periods, on the basis of the value of the land only without buildings or improvements was a logical arrangement because the land was all that the owner provided under such lease. The buildings were to be erected and maintained by such head tenant.

The appellant plaintiff called as it’s only witness M Maurice Simmons who is a solicitor with wide experience in all respects of real estate business and valuation. He represented the estate of the late Samuel Godfrey estate which has an interest in the plaintiff company.

He testified as to the value of the property in the arbitration proceedings and was present in court through the subsequent litigation in respect thereof. He stated that the purchase of the property by the plaintiff in 1965 was such an exceptional bargain that, to use his words, “‘the plaintiff had to buy it”. The price paid works out to $14.10 per square foot. In giving evidence before such arbitrators he said he didn’t think that the buildings on the premises had any value at that time. However it was to the advantage of the plaintiff to estimate the value of the land as opposed to the building at the highest level as the amount of the future rentals was to be based thereon. He explains his evidence which is to some extent conflicting with that given by him in these proceedings by stating that he used the word “land” when he meant the total of land and buildings. However in view of the relevance and importance of the value of the land as opposed to that of the buildings in such arbitration proceedings it is unlikely that he would have made such an error.

In such arbitration proceedings the plaintiff sought an order that the head tenant should be required to construct and maintain on the said lands in accordance with the terms of such lease a building to the value of $8,000,000 as of August 1,1967. If such an obligation had been imposed on the head tenant he may well have chosen to abandon the lease. However that request was not granted.

By settlement of such litigation in the year 1972 the rent for the 21 years following August, 1967 was fixed at $240,000 per annum and the head tenant was thereby permitted to tear down the buildings which it did in 1975. The plaintiff is still receiving its rent on the land but the same is still vacant.

David H Bonham a chartered accountant gave evidence for the defendant. He stated that under generally accepted principles of accounting the proper allocation of such purchase price would have been to allocate all or substantially all of the cost to land and nothing or merely a nominal amount to the building.

I accept the testimony of the defendant’s two expert witnesses. Mr Simmons testimony was to some extent contrary to that given by him on the former occasion in respect to the valuations made by him and he has a direct financial interest in the outcome of these proceedings.

From all of the evidence and the circumstances surrounding the purchase of such property I am convinced that at the time of such purchase by the plaintiff the buildings thereon were of little, if any, value and were an abstacle to the redevelopment of the land as they would have to be removed for such purpose and that in proper accounting practise the total amount of the purchase price should have been allocated to the purchase of the land.

I am further convinced from the testimony and the exceptional bargain that the purchase provided that the sole purpose of the plaintiff in purchasing the same was to realize a substantial capital gain therefrom when the opportunity to do so arose and that the buildings were not acquired for the purpose of gaining or producing income. Paragraph 1102(1)(c) of the Income Tax Regulations reads:

The classes of property described in this part and in schedule B shall be deemed not to include property (c) that was not acquired by the taxpayer for the purpose of gaining or producing income.

In Ben’s Limited v MNR, [1955] CTC 249; 55 DTC 1152, Cameron, J, in dealing with such principle, stated:

In my view, therefor, the question is not whether the appellant’s outlay as a whole was for the purpose of gaining or producing the income, but rather this. “Was the property referred to in class 6 as a “binding of frame” acquired by the appellant for the purpose of gaining or producing income.

In filing it’s income tax returns for the years 1965 to 1968 inclusive the plaintiff claimed capital cost allowance on the buildings. In 1969, 1970 and 1971 the plaintiff made no such claim. The Minister of National Revenue mailed a notice of original assessment to the plaintiff for each of the following years, for 1967 on August 6,1968, for 1968 on August 8,1969, for 1969 on July 30, 1970 and for 1970 on August 20, 1971. In assessment of such 1967 and 1968 returns, the Minister did not disallow the claim for capital cost allowance by the appellant. By notices of reassessment dated November 15, 1973, the Minister disallowed the plaintiff’s claim for such capital cost allowance in such years 1967 and 1968 and any loss carry forwards resulting from such claim. The plaintiff claims the Minister had no right to reassess the 1968 or earlier returns in such manner but takes the position that such action could be taken only within four years from the day that notice of the original assessment or notification that no tax was payable had been mailed to the taxpayer. It is acknowledged that there was no misrepresentation attributable to neglect, carelessness, or wilful default nor any fraud in filing the returns or in supplying information. In support of its contention the plaintiff relies on subsection 46(4) of the Income Tax Act, RSC 1952, c 148 as amended by 1956, c 39, subsection 11(1) substituted by 1960, c 44, subsection 15(1) which now appears as subsection 152(4) of the present Act and reads as follows:

The Minister may at any time assess tax, interest or penalties under this part or notify in writing any person by whom a return of income for a taxation year has been filed that no tax is payable for the taxation year, and may

(a) at any time, if misrepresentation . . .

(b) within 4 years from the day referred to in subparagraph (a)(ii), in any other case, reassess or make additional assessments, or assess tax, interest or penalties under this part, as the circumstances require.

The assessments of which the plaintiff now complains are those of its returns for the year 1970 and 1971 for which years the Minister assessed the plaintiffs taxable income at $46,011.30 and $4,883 respectively. In respect of those assessments the Minister mailed the original notice of assessments for the taxation year 1970 on August 20, 1971 assessing nil taxes for that year. By notice of reassessment dated November 15,1973 the Minister notified the plaintiff of his reassessment of the 1970 returns at $46,011.30. By notice dated January 28, 1976 with respect to the 1971 taxation year the Minister confirmed its reassessment of the plaintiff’s return for such year 1971 dated November 15, 1973 at $4,883. In both such reassessments the Minister did not allow to the plaintiff its capital cost allowance claim for the years 1968 and 1969 or any carry forward thereof. It follows that the reassessments for the years 1970 and 1971 were made within four years of the mailing of the notice of original assessment for those years and within the requirements of the statute. The facts that the Minister did not disallow the claim for capital cost allowance in the 1968 returns and the years previous thereto did not require him to allow such a claim in his assessment of the 1970 and 1971 returns.

In assessing such later returns the Minister was making an assessment for those two years only and therein took the position that the plaintiff was not entitled to reduce its taxable income for those years by deducting therefrom the capital cost allowance of the previous years or the carry forward therefrom. He was not then reassessing the 1969 or any earlier assessment and subsection 152(4) has no application thereto.

The plaintiff’s appeal should therefore be dismissed with costs.