Buck Consultants v. The Queen, 96 DTC 1464, [1996] 3 CTC 2016 (TCC)

Bonner J.T.C.C.: — The appellant appeals from income tax assessments for the 1986, 1987, 1988 and 1989 taxation years. At issue is the proper timing of deductions in respect of rental payments under a lease to the appellant of office space which it occupied for purposes of conducting its business. The first 14 months of the 15-year lease were rent-free. The rent-free period fell in part in the appellants taxation year ending March 31, 1988 and in part in the appellants taxation year ending March 31, 1989. In computing its income for those years the appellant sought to deduct a notional rent expense in respect of the rent-free period, that is to say, it claimed rent expense not in accordance with the schedule for payment of rent, as laid down by the lease, but rather in accordance with a somewhat accelerated schedule said to reflect the application of generally accepted accounting principles (“gaap”). The Minister of National Revenue (“Minister”) assessed tax for the 1988 and 1989 taxation years on the basis that the deduction claimed was prohibited by paragraph 18(l)(a) of the Income Tax Act (“Act”) because, in respect of the 14-month period, no rental outlay or expense was “made or incurred” within the meaning of that provision. As a consequence of the disallowance of the rental expense claims for 1988 and 1989, claims to carry non capital losses back to the 1986 and 1987 taxation years were disallowed.

The issue is whether the appellant is entitled to deduct the notional rent expense. The evidence at the hearing of the appeal consisted of a Statement of Agreed Facts and the testimony of Allan G. Van Weelden, an accounting expert. The Statement of Agreed Facts reads in part as follows:

1. The Appellant is a corporation incorporated under the laws of the Province of Ontario with its principal place of business located at 95 Wellington Street West, Toronto. At all material times, the Appellants taxation year ended on March 31.

2. The Appellant entered into an agreement dated June 12, 1987 (the “Lease”) with an arms length third party to lease 28,741 square feet of office premises in downtown Toronto for the purposes of carrying on its business. The term of the Lease is for a period of 180 months commencing September 1, 1987 and ending August 31, 2002. The Lease provides for fluctuating rent, with the first fourteen months being rent free.

3. The amounts of rent which have been or will be paid by the Appellant, as required by the terms of the Lease, are as follows:

4. In its financial statements for the years ending March 31, 1988 and March 31, 1989, the Appellant claimed a rental expense relating to the fourteen month rent free period under the Lease. More particularly, the Appellant applied a market value of $30 per square foot per annum to the fourteen month rent free period and expensed the resulting notional rent over that fourteen month period. The value of the rent free period was quantified as $1,005,935 ($30 x 29,741 sq. ft. x 14/12) and was then amortized over a period of 120 months at $8,382.79 ($1,005,935 6 120) per month.

5. The Appellant amortized the benefit of the inducement over a 120 month period rather than over a 180 month period because the original negotiations were for a 120 month lease. The decision to extend to a 180 month lease was made late in the negotiations and the extension of the term did not result in a change in the rent-free period. In addition, the base rent for the last five years of the Lease was believed to be at a competitive rate.

6. In preparing its Federal income tax returns for the 1988 and 1989 taxation years, the Appellant made no adjustment to the manner in which it reported its expenses for accounting purposes.

7. In respect of its fiscal year ending March 31, 1988, the Appellant expensed the sum of $502,968 ($30 x 28,741 sq. ft. x 7/12) on account of rent (in respect of the period from September 1, 1987 to March 31, 1988) and reduced that expense by the amortized value of the Lease inducement [$502,967.50 less ($8,382.79 x 7) $444,287.94]. ...

8. In respect of its fiscal year ending March 31, 1989, the Appellant expensed the sum of $761,636.50 on account of rent, $359,262.50 of which is not in dispute. The sum in dispute pertains to the rental expense claimed in respect of the period from April 1, 1988 to October 1, 1988. With reference to this latter period, the Appellant expensed the sum of $502,968 ($30 x 28,741 sq. ft. x 7/12) on account of rent and reduced that expense by the amortized value of the Lease inducement [$502,967.50 less ($8,382.79 x 12) $402,374],

9. The deductions for rent claimed or to be claimed by the Appellant are as follows:

Fiscal Year	Number of Months	Deductions Claimed
1988	7
		$444387.96
1989	12
		$761,636.50
1990	12
		$761.636.50
1991	12
		$857.439 83
1992	12
		$876.600.53
1993	12
		$876.600.53
1994	12	$876,600.53
1995	12
		$1,020,305.50
1996	12
		$1,049,046.50
1997	12
		$1,049,046.50
1998	12
		$1,107,726.04
1999	12
		$1.293.345.00
2000	12
		$1.522,086.00
2001	12
		$1322.086 00
2002	12
		$1.322.086.00
2003	5
		$550,869.17
TOTAL	180
		$15.491399.00

The opinion of Mr. Van Weelden, a chartered accountant whose qualifications to testify as an expert in relation to generally accepted accounting principles were unchallenged, was that:

In my opinion under generally accepted accounting principles either of the following methods would have been appropriate:

1. determine the basic monthly rent expense by adding all of the monthly payments of basic rent required under the Lease and dividing the total by the Lease term of 180 months; or

2. determine the basic monthly rent expense in the manner followed by GBB with the exception that the lease inducement is amortized over a 180 month term.

The results of applying these methods are presented in Appendix II, with a comparison to the accounting treatment by GBB (the appellant). In 1988 and 1989 GBB claimed deductions for rental expense that were less than the amounts required under generally accepted accounting principles. [1]

Mr. Van Weelden reasoned that:

If generally accepted accounting principles permitted the lease rentals to be expensed for accounting purposes only as paid or payable, a reporting entity would have the ability to contract for a payment schedule that suited its desired cash flow or financial reporting objectives.

He noted that a well known accounting text, Accounting Standards in Evolution (1987 edition by R.M. Skinner) states:

The income measurement goal in accounting absolutely requires that all costs incurred or to be incurred be recognized as expense as their benefit in terms of service potential expires. That goal applies regardless of whether the cost in question becomes due and payable before the time its service is rendered or after. The important point is that the ultimate cost, whenever payment takes place, must be recognized as expense not later than the time its benefit is felt in operations (page 514).

Mr. Van Weelden relied as well on the handbook of the Canadian Institute of Public Real Estate Companies which satisfied him that there was sufficient support for the appellants treatment of the scheduled rent increases.

In argument, counsel for the appellant noted that the computation of profit for purposes of subsection 9(1) of the Act is an operation which involves the application of ordinary commercial principles subject, of course, to any special directions found in the statute. She acknowledged that the question is one of law but asserted that gaap will play a role in the process of computing profit, particularly in determining the timing of deductibility of an expense. She pointed to the evidence of Mr. Van Weelden which, she said, established that the amortization of the rent-free period under the appellants lease is in accordance with gaap and well established principles of commercial practice in the real estate industry. Such amortization, she said, provides the truest picture of the appellants income.

The respondents reliance on paragraph 18( 1 )(a) of the Act was, according to counsel for the appellant, ill founded. The respondents position was that, so far as the notional rent of the rent-free period was concerned, no rental outlay or expense had been made or incurred and that the paragraph 18(l)(a) prohibition applied. The response of counsel for the appellant was that paragraph 18(l)(a) embodies a purpose test and that the only question relevant under that provision was whether rental payments under the lease were incurred “for the purpose of gaining or producing income from a business”. Clearly, she said, the rental expenses were incurred for a business purpose. She submitted in the alternative that the rental expenses had been incurred during the rent-free period.

The appeal fails. Paragraph 18(1 )(a) prohibits the deduction sought. It reads:

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;

Obviously no outlay was in fact made during the rent-free period. Equally no rental expense was incurred during that period. The terms of the lease are clear. Article 4.01(a) reads:

4.01 The Tenant shall pay to the Landlord, yearly and every year during the Term, without any set-off, compensation or deduction whatsoever, a Basic Rent in Canadian dollars as follows:

(a) from September 1, 1987 to October 31, 1988 - nil;

The Statement of Agreed Facts uses apt language when it describes the expense claimed as “notional” rent. Rental expense is not incurred until payment of the rent is due. Paragraph 18(1 )(a) cannot be read as a provision directed to purpose alone. To do so, would treat the words “made or incurred” as meaningless.

Every word in a statute is presumed to make sense and to have a specific role to play in advancing the legislative purpose. [2]

Finally, I will observe that I am unaware of any authority for the proposition that ordinary commercial principles of accounting permit the deduction of rent accruing due. Ordinary office rent in my view is a classic example of a running expense, that is to say, an expense that cannot be allocated directly to a corresponding item of revenue and it is therefore deductible when payment is due. [3] . In effect the appellant seeks to deduct in computing its 1988 and 1989 income a part of amounts which, if the future unfolds as expected, it will be obliged to pay in later years in respect of the cost of earning the income of those later years. The deduction sought would not result in a true or accurate picture of the appellants income. Rather it would understate income during the rent-free period and overstate income of subsequent years.

At the hearing both counsel agreed that the Minister was correct in adding to the appellants income for the 1988 taxation year “NonDeductible Depreciation” of $58,680. For the foregoing reasons the appeals will be dismissed with costs.

Appeals dismissed.