Suzy Creamcheese (Canada) Ltd. v. The Queen, 92 DTC 6291, [1992] 1 CTC 242 (FCTD)

Collier, J.:—This is an appeal, by the plaintiff taxpayer, in respect of income tax assessments issued by the Minister of National Revenue.

The Minister, for the plaintiff's taxation years 1981, 1982, 1983 and 1984, included in its income certain "leasehold inducement payments" received by the plaintiff. The plaintiff had treated the payments as on account of capital.

The facts are not in dispute.

The plaintiff is a private British Columbia company. At the relevant times, it carried on a retail women's clothing business in the "better ladies’ wear market”. It sold its products from premises leased from various landlords in shopping malls and other centres. In the taxation years in issue, the plaintiff expanded its retail clothing business. This necessitated the acquiring of additional retail leasehold premises in western Canada. From August 1, 1980 to January 31, 1984, the plaintiff opened eighteen new stores in leased premises. As of January 31, 1984, the plaintiff had a total of 29 stores.

The witness, John Petris, on behalf of the plaintiff, was examined for discovery by the defendant. He described negotiating with landlords for leasehold property. If the company became interested in opening new stores in say, shopping malls, it tried to find what it felt to be the best locations. The plaintiff's practice was to build more expensive and attractive stores in accordance with its higher class women's clothes. Often, landlords solicited the company to open a new store in the landlord's mall. The plaintiff frequently could not, as a practical business matter, expend too much money, on relatively expensive leasehold premises at the risk of no, or little, net profit. Landlords offered to assist financially on the leasehold improvements. In the years in issue, the plaintiff received this financial assistance from landlords. The term for these payments, adopted by the parties to this litigation, is leasehold inducement payments.

Out of the eighteen new stores, earlier referred to, the plaintiff received leasehold inducements, or allowances, in respect of twelve or thirteen of them. The amounts, for the taxation years in issue, are:

The payments were paid either as a fixed sum or on a square footage basis. They were applied to the leasehold improvements or fixtures in accordance with the terms of the lease. The total cost of the improvements made by the plaintiff, always exceeded the allowances, or payments, made by the landlords.

The following, among other matters, was agreed to by the parties:

4. The leasehold improvements and fixtures were at all times capital assets of the plaintiff.

5. The plaintiff is not in the business of buying and selling leases, that is, in the business of trading in leases.

6. The plaintiff's leases are capital property to the plaintiff.

7. The plaintiff paid fair market value rent with respect to the leases in question.

8. The inducements paid to the plaintiff were not paid as an allowance for or as an offset against the cost of inventory.

9. The expert evidence is that pursuant to generally accepted accounting principles (GAAP) such inducements or allowances reduce, for financial statement purposes, (not income tax purposes), the cost of depreciable property.

As earlier noted, the plaintiff treated the payments as on account of capital; the Minister brought them into income.

This issue of leasehold inducement payments, and the proper tax treatment of them, has been before this court in two other cases: French Shoes Ltd. v. The Queen, [1986] 2 C.T.C. 132, 86 D.T.C. 6359 (F.C.T.D.—Teitelbaum, J.), and Woodward Stores Ltd. v. The Queen, [1991] 1 C.T.C. 233 (F.C.T.D.—Joyal, J.). Also relevant is Westfair Foods Ltd. v. The Queen, [1991] 1 C.T.C. 146 (F.C.T.D.—Reed, J.)

The facts in the Woodward decision are quite similar to the facts before me. The plaintiff operated department stores in British Columbia and Alberta. A developer approached the plaintiff about opening stores in two of its shopping centres. There were complex leasing negotiations. As part of the leasing arrangements, the developer paid a "fixturing allowance" to the plaintiff of $3,750,000. As here, the full cost of the leasehold improvements exceeded the amount of the allowance. The plaintiff claimed the allowances as receipts on account of capital; the Minister of National Revenue included the amount in income.

My colleague, Joyal, J., found for the taxpayer.

He went into an extensive review of the relevant case law. Many of the decisions cited to me, were dealt with by him. I do not propose to here set out those portions of his reasons. I accept and adopt his review.

I do, however, set out Joyal, J.'s reasoning and conclusions on the factual situation before him (at pages 243-44):

In the case before me, the Crown alleges that the $3,750,000 received by the plaintiff from the developer is income and as such taxable in the year of receipt. It is a material consideration, however, that such a sum was earmarked for capital purposes, i.e., the installation of the necessary fixtures in an otherwise barren space. The benefit received by the taxpayer was of course to reduce the total capital expenditure by an equivalent amount.

Yet this so-called benefit would not necessarily change the nature of the transaction. As the lengthy exhibits disclose, parties do not enter into hundred- year leases without a lot of number-crunching and fine-tuning by both sides. The various proposals exchanged between the plaintiff and the developer refer to ancillary business contracts either for management services or for leasing services. That the plaintiff had developed a certain expertise in these fields was obviously known and recognized. No doubt any profits accruing from these contracts would have been taxable in the hands of the plaintiff. I note, however, that throughout the negotiations, as the parties played one proposal against the other, the figures relating to the base rent remained fairly stable and in fact were somewhat reduced when the final deal was completed.

Does it follow, as the Crown contends, that the plaintiff was running a leasing business and moneys received from the developer represent current income? On the facts before me, I should not think so. As in the Westfair Foods case, the leasing of property to conduct a general merchandising business may be said to be part of the plaintiff's business, but the plaintiff is not in the business of buying or selling leases and to quote Hugessen J.A. in Consumers’ Gas No. 2, (supra), the mere fact that certain receipts are not reflected in income does not make them income.

The other aspect of the case which I find favourable to the plaintiff reflects the general economy of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63) (the "Act") in dealing with either capital or income receipts as well as with capital or current expenditures. Absent some special statutory provisions, of which of course there are many, there is a general respect for the matching principle between capital receipt and capital expense as well as between operating income and operating expense. Furthermore, it could be said that the benefit received by the plaintiff is no more than the benefit it would otherwise have enjoyed if the developer, as part of the lease conditions, had undertaken to provide leasehold improvements at the lessee's specification to a maximum of $3,750,000. As far as the plaintiff is concerned, what tax connotations would that have provoked? None that I can see.

Finally, it would appear to me that the fixturing payment becoming categorized as operating income might logically create out of the matching fixturing expense an operating expense, again one neutralizing the other. There are, however, statutory provisions against this kind of logic, just as, in my view, it would require a statutory provision to categorize a payment for a capital purpose as income.

Courts have repeatedly said in tax matters that one must look at the pith and substance of a transaction and not at the particular form that the ingenuity of tax planners might devise. Such an approach has often resulted in findings which are quite unfavourable to taxpayers. Well, it works both ways.

Courts have also repeatedly stated that the classification of receipts or expenditures into capital or income depend on all the surrounding facts and circumstances of each case, judicial precedents being no more than guidelines to a court to make sure that all material and relevant facts are considered or analyzed. In the case at bar, absent any statutory enactment to the contrary, the treatment given to the fixture allowances is in accordance with GAAP. Furthermore, an analysis of the contract documents submitted to me does not convince me that the terms incorporating such allowances are other than what they clearly appear to be, namely capital payments earmarked for capital purposes.

I see no real distinction between this case, and the Woodward case. I come to the same conclusion as my colleague. The leasehold improvement payments here are on account of capital, not on income receivable.

Counsel for the respondent submitted that I should not follow the Woodward case, but rather the French Shoes decision. It was further contended the numerous lease transactions by the taxpayer here were an integral part of its business of merchandising ladies’ wear; these were contracts in the course of business.

In my opinion, the French Shoes decision is distinguishable. The lump sum of $50,000 received by the lessee in that case, appeared to have no relationship to the cost, or otherwise, of the leasehold improvements. Under the terms of the lease, the amount was to be applied to the lessee's inventory. I agree with the remarks of my colleague, Reed, J., when she distinguished the French Shoes case in Westfair. I also concur with my colleague Joyal, J. in the Woodward decision at page 246, where he too agrees the French Shoes case is distinguishable.

Finally, I do not agree that the number of lease transactions entered into by the plaintiff taxpayer here, with ensuing payments, was a business activity converting the receipts into income. The business activity of the plaintiff was the retailing of ladies’ wear. That required the use of premises where the goods could be displayed and customers served. The plaintiff, in the case before me, leased premises to do that. This retailer was not in the business, per se, of negotiating or leasing premises. That was merely a vehicle for carrying on its business.

The appeal is allowed. The assessment of the Minister, dated March 5, 1986, (and confirmed May 3, 1989) for the plaintiff's 1981 taxation year is vacated.

I assume, although it was not too clear, that the plaintiff has filed separate appeals for the 1982, 1983, and 1984 taxation years. If that is the case, and if the parties are in agreement that I do so, I direct that these reasons be filed in the other three appeals. Again, if the parties wish and agree, formal pronouncements will be issued in those actions. If so, counsel may draw those judgments.

The plaintiff will recover its costs of this action.

Appeal allowed.