Pigott Investments Ltd. v. The Queen, 73 DTC 5507, [1973] CTC 693 (FCTD)

The Associate Chief Justice:—These are appeals by Pigott Investments Limited (hereinafter sometimes called Pigott, which prior to a change of name in 1973 was known as Pigott Construction Company Limited) from assessments for the 1967, 1968, 1969 and 1970 taxation years whereby the Department of National Revenue refused to allow the deduction of $1,110,292.49 of expenses, $19,111.21 of which was spent in 1967, $305,948.93 in 1968, $702,511.20 in 1969 and $82,720.06 in 1970, made up substantially of architects fees, legal fees and consulting fees relating to a proposed major redevelopment construction project in downtown Hamilton.

There is no question that Pigott in fact paid the amounts involved herein. The sole issue in these appeals is whether Pigott is entitled to deduct as a cost of carrying on its construction business the above amount of $1,110, 292.49.

The position taken by the defendant in disallowing the deduction of the above expenses appears to be that (1) Pigott was paying expenses of First Wentworth Limited, its subsidiary, a company used in an attempt to set up the realization and financing of the complex to be built in downtown Hamilton, and not its own expenses; (2) in so doing, it was “loaning” money to First Wentworth; (3) the “loan” was a capital investment in First Wentworth; and, finally, (4) the amounts were not laid out for the purposes of Pigott’s own profit-making operations.

The following agreement as to facts was filed and is reproduced hereunder with the exception of the schedules which consist in a breakdown of the expenses involved in the taxation years under review, the total of which has already been stated above:

1. The Plaintiff (hereinafter referred to as “Pigott”) was incorporated under the laws of Ontario by Letters Patent on July 29th, 1930, as a private company and carried on generally an extensive construction business in various parts of Canada, with particular emphasis on the construction of office buildings and commercial and institutional construction.

2. First Wentworth Limited (hereinafter referred to as “First Wentworth”) is a corporation incorporated under the laws of Ontario by Letters Patent on or about May 6th, 1965. The First permanent directors of First Wentworth were elected on May 6th, 1965 and were A W Ruby of the City of Toronto, James C Crang of the firm of architects, Crang & Boake, also of Toronto and Joseph M Pigott, Jr. All three persons were issued one common share each to qualify them as directors, however Mr Joseph M Pigott, Jr held his common share for the benefit of Pigott Construction Company Limited. On December 20th, 1967 A W Ruby and J C Crang resigned their positions as directors and transferred their common shares to Mr William P Pigott and Mr Joseph M Pigott, Sr respectively, who then each declared their respective common shares for the benefit of Pigott Construction Company Limited. At the same time Pigott acquired all other issued and outstanding preference shares of First Wentworth with the result that First Wentworth became a wholly owned subsidiary of Pigott. SARS ? e - _

3. Since the year 1965 Pigott was interested in a proposed redevelopment project of a portion of the downtown area of the City of Hamilton which was called the Hamilton Urban Renewal Development. Pigott desired to do the construction on this project.

4. On December 21st, 1967 Pigott caused First Wentworth to enter into an agreement with the Corporation of the City of Hamilton which constituted an acceptance by the City of a proposal to it for the development of the Hamilton Urban Renewal Development.

5. On January 16th, 1968 Pigott executed by its officers W P Pigott and Thomas Gray an unconditional and irrevocable guarantee of all present and future obligations of its subsidiary, First Wentworth Limited under the latter's agreement with the City.

6. On March 7th, 1969 Pigott caused First Wentworth to enter into an agreement with Crang & Boake, architects.

7. In 1967 Pigott paid the amounts as set out on Schedule “A” which is annexed hereto.

8. In 1968 Pigott paid the amounts set out on Schedule “B” annexed hereto.

9. In 1969 Pigott paid the amounts set out on Schedule “C” annexed hereto.

10. In 1970 Pigott paid the amounts set out on Schedule “D” annexed hereto.

11. Pigott deducted the amounts set forth in Schedules “A” through “D” in computing its income for the respective years 1967, 1968, 1969 and 1970.

In order to appreciate the manner in which the plaintiff expended the above amounts and to characterize the operations which led to them being so spent, it is helpful to describe briefly the plaintiff corporation, and the activities, which eventually led to it becoming involved in the Hamilton downtown complex development.

Pigott is a large Canadian construction company founded in the last century with its head office in Hamilton. For many years, it has been involved as contractor in major building projects throughout Canada. It was in the latter part of 1965 that the possibility for Pigott to become the general contractor in a development in Hamilton arose. The City of Hamilton decided upon the redevelopment of the downtown area, known as the Hamilton Urban Development and it called for proposals for the commercial development for part of the Civic Square Urban Renewal scheme.

In order to assist Pigott to become the contractor in the project, it was necessary for it to assume an active role as a prime mover at the development stage. This meant that steps had to be taken to interest developers and financiers and tenants in the project and to come up with a plan acceptable to the City of Hamilton together with the money necessary to bring it to fruition.

The cost of the first phase of the development was expected to run to upwards of $25,000,000 and the total cost of the project would exceed $45,000,000 and it. was therefore essential that investors be attracted who could provide the necessary financing.

According to the evidence of the Pigott brothers, it was at the time virtually impossible to attract pure debt financing for a project of this type. Investors had to be given an opportunity of participating in the equity of the project they were financing. Pigott Construction was a long established construction corporation controlled by the family and had, in the past, according to Mr Robinson, its general counsel, been involved in a minority shareholding problem which had caused considerable difficulty and concern until solved. It was therefore out of the question for it to offer a potential financier part of Pigott’s own shares in order to go ahead with the venture. On the other hand, it was doubtful whether a minority interest in Pigott would have been an attractive proposition to an investor interested in the acquiring of a portion of the equity of the downtown Hamilton redevelopment project. Since attracting financial backing for the project was essential to its proceeding, and therefore to Pigott’s obtaining the construction contract, it decided that the method that made the most business sense here was a company whose shares Pigot could dispose of partially or even totally to an interested investor and a subsidiary of Pigott, First Wentworth was chosen for this purpose. A number of folders printed over the period during which an attempt was made by Pigott with its subsidiary, First Wentworth, to obtain the Hamilton redevelopment project, indicate that the intent went from allowing those financing the project from 51% of the shares of the company or control to 80% and even, according to Mr Pigott, the president of the plaintiff, the totality of the shares if that was the only way to obtain the financing necessary to build the complex and to allow Pigott to do the construction work on the project.

Until December 20, 1967 the three common shares of First Wentworth were owned by Pigott, A W Ruby, vice-president of Pigott Construction Limited, a real estate developer and James C Crang, an architect.

At that time, Ruby and Crang transferred their shares to Joseph M Pigott Sr and William P Pigott, as nominees for Pigott Construction Company Limited.

On May 6, 1966 J M Pigott Jr wrote to the Urban Renewal Commission of the City of Hamilton, expressing an interest in the downtown Hamilton Urban Renewal Scheme and indicated that they “‘were prepared to organize a separate corporate entity to undertake this project with the Pigott organization playing a leading part”.

In October of 1967 a vice-president of Pigott, MacKenzie Robinson, wrote to Chagnon, MacGillivray, who had been retained by the City of Hamilton to assist in evaluating certain financial aspects of the proposed redevelopment stating:

First Wentworth would quite understandably require that Pigott Construction Company Limited be the general contractor for all work carried out on the leased land.

. We discussed briefly the relationship between First Wentworth and the rest of the Pigott group. It has always been the policy to regard the group of companies as a single entity. Accordingly, any obligation of wholly owned subsidiary companies are treated as those of the group as a whole. Such would apply to First Wentworth.

I should add that for First Wentworth to be the developer it had to sign the development contract with the City, to be assured of prime tenants and to interest a substantial financier.

Pigott was eventually successful in having First Wentworth enter into an interim development agreement dated December 21, 1967. That agreement provided that First Wentworth had nine months to negotiate with the City, Central Housing and Mortgage Corporation and the Province of Ontario, with a view to entering into a final development agreement. Under the above interim agreement, First Wentworth was obliged to employ architects, solicitors, consultants and others and to present plans, reports, designs and economic studies.

As the City looked to Pigott as the prime mover in the project and as the entity responsible for ensuring that the obligations under the interim agreement were performed (MacKenzie Robinson stated at the trial that there is no question that if Pigott had not been behind the project, the City would not have consented to an interim agreement with First Wentworth) Pigott, on January 16, 1965, signed an undertaking whereby it unconditionally and irrevocably guaranteed the obligations of its subsidiary, First Wentworth, under the interim agreement of December 21, 1967.

Pigott then retained a large number of experts: architects, consultants, traffic consultants, financial experts, planners and lawyers. An agreement, however, was entered into by First Wentworth with a firm of architects, Crang & Boake, to do the architectural work.

In order to initiate the project, it was necessary for Pigott to press forward both with the planning and architectural aspects of the redevelopment and also with the financing thereof. There were, according to the Pigott brothers, two reasons for the urgency. In the first place, they had, under the agreement with the City, only nine months to meet all of the requirements necessary to signing the development agreement; secondly, Stelco, which was intended to be the prime tenant, and whose presence as a tenant was essential to make the project an economic reality, was exerting increasing pressure on Pigott to ensure that the Stelco Tower, a part of the complex, be undertaken and completed so that it could move in as soon as possible.

Delays occurred and while Pigott was confident that the project would go ahead and that it would be the contractor, it however could not be sure of this unless the development agreement was signed and it obtained the construction contract. It continued, however, to pay architects, consultants and lawyers and to search, in a tight-money market, for a financier to finance the project. One extension of the nine month negotiation period in the interim development agreement was asked for by the City and two further extensions were granted by the City. The last one was given only after Pigott paid $33,000 to the City in lieu of taxes.

Notwithstanding the enormous effort put forward by Pigott, First Wentworth did not become the developer. It was unable to raise financing for the project and the City refused to give any further extensions. Pigott spent over $1,100,000 in the process and was left with shares of a shell company First Wentworth.

It is that expense that the Minister has disallowed on the basis that it was not Pigott’s expense.

The Minister appears to have analysed the dealings between the plaintiff and its subsidiary as one where the former provided working capital to the latter by way of loans and, therefore, merely financed its subsidiary.

There is some justification for that view in that the expenses covering architects, consultants and legal fees, which the plaintiff wishes to deduct, fall within the ambit of paragraph 3 of the interim agreement entered into by the subsidiary with the City of Hamilton on December 21, 1967. This paragraph indeed reads as follows:

For the purposes aforesaid the Developer shall employ architects, engineers, solicitors, consultants and others as may be appropriate in order to present to the city the requisite plans, reports, designs and economic studies and models and other data and information as may be necessary or desirable for the purpose of negotiating, preparing and completing the said Development Agreement.

It then lists a number of plans, including a site plan and a model of the entire Civic Square as being some of the things to be furnished.

Another agreement was also entered into by First Wentworth Limited with a firm of architects, Crang & Boake, on March 7, 1969, whereby the latter undertook to supply the architectural services for the building of the contemplated complex which they in part did and for which they charged Pigott, who paid them whatever fees they were entitled to. These fees came close to $713,000.

It was admittedly the intention of Pigott to bill Wentworth for these expenses if the development project was successfully entered into and realized, in which case the intent was, as expressed by Pigott’s auditor, to bring in these amounts as profits when paid by Wentworth.

If these were the only facts involved herein, there would be some grounds to the Minister’s submission that the amounts paid by Pigott are advances made to Wentworth as loans or as an investment in their subsidiary or even that they are but expenses of Wentworth.

The situation, however, is not as simple as this in that the amounts expended by Pigott happen to have been spent over a period of four years in an endeavour, unsuccessful it is true, but one attempted to obtain a construction contract which is plaintiff’s business. The question must, therefore, also be whether these expenses can be regarded as a cost of carrying on Pigott’s construction business on the basis that the benefit that the payment was calculated to achieve was, from Pigott’s own point of view, a benefit of a revenue nature, the earning of profit from the construction of the complex. Pigott was, as already mentioned, interested in the construction work involved in the development. It was also a necessary part of the venture and had guaranteed the obligations of First Wentworth under the interim agreement with the City. In paying as it did the expenses, it can, in one view of the matter, be considered as fulfilling its own obligations.

There is no question that if the payments had not been made by Pigott, if the architects, consultants and lawyers had not done the work, there would have been no possibility of the project being realized and, of course, Pigott would then not obtain the contract to do the construction work involved in the project: I should also add that the evidence disclosed that the Stelco Company was to be a tenant of the complex and that this was essential to the project. Pigott indeed had to ensure that as soon as the final Development Agreement with the City was signed, Pigott could start work on the Stelco Tower. It therefore appears that with deadlines from both the City and Stelco to meet, Pigott had to spend increasing amounts of money if the project were to go ahead with Pigott as the contractor.

Having regard to the above circumstances and even considering the undertaking by First Wentworth to supply the services for which the amounts were expended, it is not, in my view, possible to say that these expenses were only and necessarily First Wentworth expenses. As a matter of fact, the evidence indicates that they were not so. The evidence indeed disclosed that Pigott paid the expenses and most of the accounts were submitted to Pigott who never considered them to be First Wentworth’s expenses. Counsel for Pigott suggests that the latter regarded itself as liable both as a simple matter of commercial morality and as a matter of legal obligation in the light of its guarantee to the City and I must agree with this submission. It seems that whether or not they could be described on one view of the matter as First Wentworth’s expenses should not make them any the less expenses laid out by Pigott if, for valid business reasons, such expenses were incurred and paid by the latter. It does not appear to me that these expenses should be held non-deductible merely because someone else might also have had a legal obligation to pay them. I did suggest to counsel for the Crown during argument that some thought might be given to segregating the expenses made for the contracting jobs from those that may be tied to the leasing or developing aspects of the venture. He, however, stated that the matter was to be determined as far as the Crown was concerned as if all the expenses, whether they were early development expenses or expenses relating to the model of the buildings or to the buildings, as relating to “the building of the buildings Pigott would have built if the project had gone ahead’’. Pigott having thus paid its own expenses for the purpose of its construction operations, it then, I believe, follows that such expenses were laid out for the purpose of gaining income from its construction business. As a matter of fact, had Pigott alone undertaken the obligations under the interim agreement, there would appear to be no doubt as to the deductibility of these expenses.

I do not believe that, as submitted by counsel for the Crown, because the expenses paid by Pigott could, in the event the project was successful, have been paid by First Wentworth upon being billed by Pigott and then could have been considered by First Wentworth as capital expenses and recoverable as capital cost allowances under the Act, should render the expenses non-deductible to Pigott. First of all, the project never did get off the ground, and therefore, the question as to whether these expenses could have been recovered by. First Went worth as capital cost allowances does not arise. But even if First Wentworth could have charged these expenses off under the capital allowance regulations of the Act had the project been successful, it does not seem to me that such a possibility should prevent the amounts expended from being deductible in the event the project failed. I had a very similar situation in Bowater Power Company Limited v MNR, [1971] CTC 818; 71 DTC 5469, where at page 836 [5480] I asked the following question and gave the following answer:

. . . Should these expenses be less current expenses because instead of being laid out in the process of inducing the buying public to buy the goods or with a view to introducing particular products to the market, they were laid out for the purpose of determining whether a depreciable asset should be constructed from which business gains could be collected and would then have been added to the value of this capital asset which would have been subject to capital cost allowances? I do not think so. The law with regard to the deduction of what might be called borderline expenses or “nothings” has moved considerably ahead in the last few years, . ..

and at page 837 [5481] I concluded:

. . . These expenditures, it is true did not materialize into any concrete assets for which capital allowances could have been obtained but they were made for the purpose of effecting an increase in the volume and the efficiency of its business and, therefore, for the purpose of gaining income (in such a way that their deduction is not prohibited by Section 12(1)(a)) [cf. Canada Safeway Ltd v MNR, [1957] SCR 717; [1957] CTC 335] and, as such, should be accepted as current expenses.

Counsel for the Crown says that the amounts paid were loans. I do not believe that the outlays can be considered as a separate operation isolated from the initial venture or the context in which they were expended and paid. These expenses were not reflected as loans in either Pigott’s or First Wentworth’s books of account or in their audited financial statements as certified by their auditors. As a matter of fact, these payments had none of the indicia of intercorporate loans. There was not even an undertaking or obligation by First Wentworth to pay the amounts expended or even interest thereon. Pigott, of course, expected to recover the amounts paid if the project went ahead but this should not affect their deductibility or render them necessarily capital expenses in the hands of Pigott. All businesses expect to recover the money they spend in order to obtain a revenue. As Jackett, P (as he then was) stated in Ottawa Valley Power Company v MNR, [1969] 2 Ex CR 64 at 75-6; [1969] CTC 242 at 253; 69 DTC 5166 at 5173:

... if a business is well and successfully financed, all of the costs of the business, both revenue and capital, are over the course of the business, recouped out of the charges to customers in one way or another.

In MNR v Freud, [1968] CTC 438; 68 DTC 5279, Pigeon, J referred to the anticipated recovery of the so-called “advances” and did not hesitate to allow their deductions.

In BP Australia Ltd v Commissioner of Taxation, [1966] AC 224, Lord Borth-Y-Guest stated at page 266:

The sums in question had to come back, penny by penny with every order during the period in order to reimburse and justify the particular outlay.

The defendant submitted that there was no certainty that Pigott would get the construction work even if the project went ahead. There was, it is true, no firm contract or commitment signed whereby Pigott was assured that it would get the work but there was, upon payment to First Wentworth of the amount of $45,000 described as finder’s fee, an undertaking by the subsidiary that “whenever possible and practical, it would endeavour to see that the construction within the urban renewal area would be carried out by Pigott”.

Furthermore, as expressed by William Prince Pigott, president of Pigott, at the trial, the latter was not relying on the payment of the finder’s fee to secure the construction work but on the fact that Pigott controlled the subsidiary and that it had made substantial outlays for the designs and plans necessary to complete the project. Pigott, therefore, in my view, had an effective means of assuming itself of the ongoing construction.

Counsel for the Crown finally suggested that the amounts expended were investments made in their subsidiary, First Wentworth. I believe that it can be said that even if there was some thought by Pigott of participating in its subsidiary by retaining shares therein they, according to the president of Pigott, discarded any such hopes early in the proceedings as soon as they realized that no financial people would be interested in investing funds in this venture unless they had the near totality of the shares of the subsidiary. It appears to me that the amounts expended by Mr Freud in MNA v Freud (supra) were investments. The outlays made in the Freud case were so made in the hope of making a profit on the whole transaction of developing a prototype of a sports car. The outlays expended by Pigott were of a similar nature. The spending of the amounts by Pigott were merely, in my view, one facet of a commercial transaction, the ultimate object of which being to earn income therefrom. The subsidiary was, as we have seen, intended to eventually be disposed of in totality if necessary as part of the arrangement whereby Pigott was to be the general contractor. viewed in that light and having regard to the reluctance of Pigott to have outsiders sharing in their family company, and to the manner in which Mr Robinson, a vice-president of Pigott, described, in October 1967, the close relationship between Pigott and its subsidiary as “a single entity”, I think it is even open to the Court to come to the conclusion that First Wentworth here was used by Pigott as a vehicle in a commercial operation or a method of obtaining a profitable construction job. If that is the situation, and I believe that the proper inferences to be drawn from the evidence so indicate, then First Wentworth must be considered to have been or to have become the mere agent of Pigott and it follows, of course, that the expenses of the agent are those of the principal.

The treatment by Pigott of the expenses paid by it as properly deductible in computing its profit or loss for the years involved herein is, in my view, consistent with sound business common sense and in line with the recent decision of the Supreme Court of Canada by its Chief Justice in MNR v Algoma Central Railway, [1968] CTC 161; 68 DTC 9096, when he quoted with approval the following passage to be found in BP Australia Ltd v Commissioner of Taxation (supra) at page 264:

The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer.

In Hallstroms Pty Ltd v FCT (1946), 72 CLR 634 at 648, Dixon, J (as he then was) of the High Court of Australia stated that the answer to whether an expenditure is on revenue or capital accounts,

... depends ‘on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.

The conclusion here in the light of the business or commercial realities disclosed by the evidence is therefore that the benefit sought by the payments made was sought by Pigott and for Pigott was not of a capital nature but rather of a revenue nature to Pigott’s construction business and, therefore, these expenses are deductible.

The appeals are, therefore, maintained and the plaintiff shall be entitled to its costs after taxation. As all four cases were tried and argued at the same time and on the same grounds, counsel for the plaintiff shall be entitled to one counsel fee only.