Gold Bar Developments Ltd. v. The Queen, 87 DTC 5152, [1987] 1 CTC 262 (FCTD)

Jerome, J.:—This is an action pursuant to section 172 of the Income Tax Act by way of appeal from a decision of the Tax Court of Canada. The matter came on for hearing at Edmonton, Alberta, on October 29, 1986. At issue is the classification, for income tax purposes, of an expenditure by the plaintiff for the repair or replacement of walls of an apartment building in the City of Edmonton.

The facts are not complex. The plaintiff is an Alberta corporation formed from the merger on March 31, 1980 between the plaintiff and Campus Corner Building Limited. It constructed an apartment building in the City of Edmonton in 1966 and continuously owned and operated the property for rental income. In 1979, an inspection revealed that the bricks were falling loose from the walls and that the entire brick facing on the east wall had become unsound. Further analysis indicated that the primary cause was inferior work of the original brick subcontractor. On the advice of professional engineers, the plaintiff carried out the necessary repairs, using metal cladding instead of brick veneer, at a cost of $241,665.76. The plaintiff deducted the cost of the repairs in the computation of its income for the year ending March 31, 1980, and reported a loss in that year of $194,866.99. In the return for that year, the plaintiff invoked section 111 of the Income Tax Act, applied $150,609.20 of the loss to its 1979 taxation year and filed an amended 1979 return accordingly.

On March 4, 1983, the Minister reassessed the plaintiff for both years by disallowing the deductions as repairs and reclassifying them as capital expenditures. The plaintiff filed notices of objection on May 12, 1983 and the Minister confirmed the reassessments on October 24 of the same year. On January 12, 1984, the plaintiff launched an appeal to the Tax Court of Canada. The matter was heard in Edmonton on December 12, 1984 and by oral judgment delivered December 14, 1984, the plaintiff's appeal was dismissed. In written reasons filed, the concluding paragraph of the judgment of the learned Tax Court judge is as follows:

Both counsel cited tests from various authorities, none of which are absolute. One asks, “Would the building have had the same value in the marketplace when the problem of the falling bricks existed, as compared to a value after the problem was remedied?” I think not.

A correction to the capital asset was needed; the expenditure was not of a recurring nature, but was made to bring about an advantage of an enduring nature to the capital asset.

The expenditure was not a current expense made in the ordinary course of the company’s business operation to earn income. Returning once again to the Haddon Hall case, Mr. Justice Abbott said at page 1002,

“Expenditures to replace capital assets which have become worn out or obsolete are something quite different from those ordinary annual expenditures for repairs which fall naturally into the category of income disbursements.”

While in this case, there is no replacement of a worn out or obsolete capital asset there is a major expenditure made to put the capital asset in a proper condition, and certainly the expenditure is not an ordinary annual one.

Applying then both a common sense approach to classify the expenditure and the test in the Haddon Hall case, I find that the expenditure in this case is of a capital nature and, accordingly, this appeal is dismissed.

With respect, I take a different view.

I do not think the solution to this problem can be found in the effect of the expenditure. It is expected that repairs to a capital asset should improve it. Where the source of income is a residential apartment building, that is always the case, especially where the repairs are substantial. Nor do I find the “once-in-a-lifetime” approach of much assistance. The more substantial the repair, the less likely it is to recur (certainly the fervent hope of the building owner) but it remains a repair expenditure nonetheless.

I think it is more helpful to emphasize the purpose of the outlay by the taxpayer. What was in the mind of the taxpayer in formulating the decision to spend this money at this time? Was it to improve the capital asset, to make it different, to make it better? That kind of decision involves a very important elective component — a choice or option which is not present in the genuine repair crisis.

It is not in dispute that the plaintiff discovered in 1979 that the bricks were coming loose and falling on the ground around the building used by tenants and passersby. Obviously, it was a risk that would be unacceptable to the public, but also one likely to meet a reaction from city officials, in the extreme even closure of the premises. In the circumstances, I cannot conclude that the plaintiff had any real choice. To ignore that condition would certainly have brought about a reduction in occupation, or in rental income.

It is also common ground that the cause of the premature break-down of the brick veneer was faulty work by the original subcontractor when the plaintiff had arranged to have the building constructed some ten years earlier. That is not directly relevant to the taxation issue, but certainly verifies the fact that the plaintiff had this decision forced upon him and did not initiate it. This was not a voluntary expenditure with a view to bringing into existence a new Capital asset for the purpose of producing income, or for the purpose of creating an improved building so as to produce greater income. The plaintiff was faced with an unexpected deterioration in the walls of the building which put the viability of the property at risk. The decision to spend the money was a decision to repair to meet that crisis and despite the fact that I am sure the plaintiff’s expectation was, and still is, that it will not recur in the lifetime of the building, it remains fundamentally a repair expenditure.

There remain two other considerations that arise from the jurisprudence. An expenditure which is in the nature of repair will not be allowed as a deduction from income if it becomes so substantial as to constitute a replacement of the asset. See Canada Steamship Lines Limited v. M.N.R., [1966] C.T.C. 255; 66 D.T.C. 5205; M.N.R. v. Haddon Hall Realty Inc., [1961] C.T.C. 509; 62 D.T.C. 1001; and M.N.R. v. Vancouver Tugboat Company, Limited, [1957] C.T.C. 178; 57 D.T.C. 1126. Here, however, while the sum of money is certainly substantial, the undisputed evidence is that this building's value at the material time was in the range of $8 million so that the sum in issue represents less than three per cent of the value of the asset. There is no justification therefore to reclassify the expenditure on that basis.

Finally, there have been a number of decisions in which repairs, either alone or in combination with other work, have rendered the capital asset not simply restored to its original condition, but greatly improved because of its new-found resistance to those factors which caused the deterioration. See Shabro Investments Ltd. v. The Queen, [1979] C.T.C. 125; 79 D.T.C. 5104 and Sydney Harold Healey v. M.N.R., [1984] C.T.C. 2004; 84 D.T.C. 1017.

Counsel for the defendant invites me to reach that conclusion here because the walls to the plaintiff's building were not replaced with brick as before, but with a metal cladding that went beyond answering the defects, and made the building not only fully resistant to the problem of falling bricks, but also substantially improved in appearance. I cannot accept the suggestion, however, that once the decision to repair is forced upon the taxpayer, he must ignore advancements in building techniques and technology in carrying out the work. In remedying the situation, the plaintiff was given two or three options, including the replacement of the original brick. In pursuing the option of curtain-wall cladding, the plaintiff adopted an extremely popular modern construction technique. I am not satisfied that the appearance of the building was any better than it would have been had the original brick been replaced.

Nothing in this repair project attempted to change the structure of the building. What was done was neither more nor less than was required to replace the deteriorating and dangerous brick condition. The Minister was therefore in error in requiring the taxpayer to treat this as an expenditure on account of capital. The appeal is allowed and the matter will be returned to the Minister for the appropriate reassessment. Costs to the plaintiff.

Appeal allowed.