Ikea Ltd. v. The Queen, 94 DTC 1112, [1994] 1 CTC 2140 (TCC), aff'd 96 DTC 6526 (FCA), aff'd 98 DTC 6092 (SCC)

Bowman, J.T.C.C.:—This appeal, from an assessment for the appellant’s 1986 taxation year, raises once again the question of the treatment under the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), prior to the coming into force of paragraph 12(1 )(x) thereof, of what are commonly referred to as "tenant inducement payments”. The appellant's position is that the inducement payment of $2,650,000 that it received in 1986 is a tax-free capital receipt, or, if it is income, that it should be amortized over the term of the lease. The position of the Minister of National Revenue is that it should be included in income in the year of receipt.

The basic facts are relatively simple and substantially undisputed. The appellant carries on the business of. selling furniture and other related items through retail outlets which it owns or leases throughout Canada. By an agreement dated May 10, 1985, with West Edmonton Mal? Shopping Centre Ltd., the appellant leased premises for ten years for the purpose of carrying on its retail business with an option to extend the term of the lease for a further ten years. The base rent was $8 per square foot, or $896,000 per year, payable in monthly instalments. The lease also provided for a percentage rent based on sales.

By an agreement dated May 16, 1985, the appellant became entitled to receive $2,650,000 from West Edmonton Mall. The agreement is short and since it is central to the determination of the issues in this appeal I reproduce it in full.

WHEREAS:

A. West Edmonton and IKEA have agreed on the terms set forth herein to enter into a lease (the "lease") of premises (the "premises") constituting approximately 112,000 square feet located in West Edmonton Mall (Phase III) in Edmonton, Alberta.

B. It has been agreed between the parties that West Edmonton will pay an inducement to IKEA to enter into the “lease” of the premises and to take possession of the premises and carry on business therein all in accordance with the terms and conditions of the lease.

NOW THEREFORE THIS AGREEMENT WITNESSETH THAT in consideration of the premises and the mutual covenants, agreements and conditions herein contained, the parties hereby covenant and agree as follows:

INDUCEMENT

1. West Edmonton hereby agrees to pay to IKEA the sum of $2,650,000 (the "inducement") in order to induce IKEA to enter into the lease and to take possession of and carry on business within the premises, all in accordance with the terms of the lease.

2. The inducement shall be paid in Canadian funds within seven days after the date the tenant's work in the premises is complete and IKEA enters the premises and commences the conduct of its business as described in section 1.1(h) of the lease from the premises.

3. The tenant shall notify the landlord 20 days prior to the date (the “opening date") upon which the events in paragraph 2 shall take place and the landlord shall deposit in trust for the tenant with the landlord's solicitors the inducement one day prior to the opening date. The landlord's solicitors shall thereupon confirm in writing to the tenant and its solicitors that such deposit has been made as aforesaid.

4. IKEA shall not be obliged to enter the premises on the opening date unless it receives notice from the landlord's solicitor of the deposit in trust for the tenant as described in paragraph 3.

5. Time is of the essence of this agreement.

6. This agreement shall not be assignable by IKEA.

It might be noted that the lease was dated May 10, 1985 and the agreement relating to the inducement payment was executed on May 16, 1985. Neither counsel invited me to draw any particular inference from this sequence, and I do not do so.

The agreement placed no obligation upon IKEA to do anything with the payment, such as applying it against the cost of inventory or fixtures. It was free to spend it as it saw fit.

The accounting evidence

Although I have concluded that the evidence of the accounting treatment of the receipt in the appellant's books does not assist in the determination of the question before the court, this evidence pervaded the case and it is appropriate that I deal with it immediately.

The appellant filed with the court a statement in writing signed by a chartered accountant, Patricia L. O’Malley, F.C.A., a member of the national accounting firm of Peat Marwick Thorne. In light of the position taken by the appellant with respect to the treatment of the payment for income tax purposes it is important that Ms. O'Malley's statement be set out in full.

This is my report as an expert as to the proper treatment to be afforded pursuant to generally accepted accounting principles ("GAAP") to a payment received by Ikea Ltd. ("Ikea") from West Edmonton Mall Shopping Centre Ltd. ("West Edmonton Mall"). I understand the facts of the situation to be as follows:

FACTS

1. Ikea carries on the business of selling furniture and other related items

through various retail outlets which it owns or leases throughout Canada.

2. By agreement dated May 10, 1985 with West Edmonton Mall, Ikea agreed to lease premises for a period of 10 years, with an option to extend the term of the lease for a further 10 years at a rental to be determined subsequently, for the purpose of carrying on its retail business.

3. By agreement dated May 16, 1985, West Edmonton Mall agreed to pay to Ikea $2,650,000 to induce Ikea to enter into the lease agreement and to take possession of the premises and carry on business in West Edmonton Mall. The agreement did not specify to which, if any, of Ikea's expenditures the inducement was to be applied. The payment was received during Ikea's year ended August 31,1986.

4, Ikea incurred costs in the amount of $825,189 in respect of "fixturing of premises" in question.

5. In preparing its financial statements for its 1986 taxation year, Ikea:

(a) did not include the entire $2,650,000 in determining its earnings for the year;

(b) offset the cost of fixturing ($825,189) by a portion of the inducement payment; and

(c) included in earnings for the year, $152,068, being an amortized portion of the balance of the inducement payment, after deducting the $825,189 which offset the cost of fixturing.

OPINION REQUESTED

You requested my opinion as to the following:

1. Was it proper treatment in accordance with GAAP for Ikea not to include the

entire payment of $2,650,000 in determining its earnings for the 1986 year?

2. Was it proper treatment in accordance with GAAP for Ikea to offset $825,189

of the payment of $2,650,000 against the cost of fixtures of $825,189?

3. Was it proper treatment in accordance with GAAP for Ikea to include an amortized portion of the balance of the payment of $2,650,000 (after deducting $825,189) in its earnings for 1986?

4. How is the offset or reduction in the cost of fixtures of $825,129 properly reflected in the company's income in 1986 and subsequent years for purposes of GAAP?

5. How is the balance of the inducement payment of ($2,650,000 - $825,129) $1,824,811 properly reflected in the company’s income in 1986 and subsequent years for purposes of GAAP?

OPINION

In my opinion:

1. It was proper treatment in accordance with GAAP for Ikea not to include the entire lease inducement payment of $2,650,000 in determining its earnings for the 1986 year.

2. It was proper treatment in accordance with GAAP for Ikea to offset $825,189 of the lease inducement payment of $2,650,000 against the cost of fixtures for the related leased premises, with the following proviso. The offset treatment is proper provided that, had the cost of the fixtures been reflected as capital assets (leasehold improvements), they would have been amortized to earnings over approximately the same time period used to amortize the balance of the lease inducement payment. This requirement is explained more fully in items 4 and 5 below.

3. It was proper treatment in accordance with GAAP for Ikea to include an amortized portion of the balance of the payment of $2,650,000 (after deducting $825,189) in its earnings for 1986.

4, For purposes of GAAP, the capital cost of fixtures is charged to income over their useful life commencing in the period in which they are put into service. The offset, or reduction of the cost of fixtures may properly be reflected in the company’s income in 1986 and subsequent years in one of two ways. The most technically correct treatment would be to:

— capitalize the fixtures as leasehold improvements and amortize them to income over their useful lives, and

— defer the related reduction of the cost of fixtures, and amortize it to income over the term of the lease.

Alternatively, if the estimated useful life of the fixtures is approximately the same as the term of the lease, the reduction of the cost of the fixtures could simply be offset against the cost of the fixtures, with the remaining balance, if any, amortized to income over the estimated useful life of the fixtures. This is the approach the company adopted. The alternative is acceptable since it produces a net income result that is virtually identical to that obtained using the more technically correct method.

5. For purposes of GAAP, the balance of the inducement payment of ($2,650,000 — $825,129) $1,824,811 is properly amortized to income on a straight-line basis over the term of the lease. The amortization would commence in the period in which the leased premises were occupied, or became available for the company's occupation, rather than the period in which the agreement to lease was signed. Since the lease has an initial term of ten years, the monthly amortization of the balance of the inducement payment would amount to ($1,824,811/120) $15,206.76. Ikea included amortization of the inducement of $152,068 in income in 1986 which indicates that the premises were used for ten months of that year. The amortization for subsequent years would amount to $182,481 for 12 months.

Mr. Meghji, counsel for the respondent, did not challenge Ms. O'Malley's evidence and she was not called as a witness or cross-examined. He accepted that the treatment of the payment in the appellant's books of account was in accordance with generally accepted accounting principles. His position was, however, that the accounting treatment was irrelevant to any issue raised in this appeal.

Unlike the treatment in its financial statements, the appellant, in filing its return of income for 1986, did not, in calculating the capital cost of its depreciable property, reduce the cost of its fixtures by $825,189 as a result of the payment, nor did it include any portion of the inducement payment in its income.

The accounting treatment does not affect the determination whether the receipt Was on revenue or capital account. That determination is one of law based upon a consideration of all of the facts. The legal distinction between receipts or expenditures that are on capital account and receipts or expenditures that are on revenue account is both meaningful and important in the context of the Income Tax Act. It is not meaningful in the preparation of financial statements. "Capital" or "revenue" receipts in the sense in which those terms are used for income tax purposes are not accounting concepts. To the accountant the essential question is the manner in which an expense or receipt is to be recognized, that is to say, whether it is more appropriate to recognize it in the year in which the amount is received or the expense incurred, whether principles of conservatism and matching require that such an amount be amortized over the term to which it relates, whether it should be capitalized" in the sense of being allocated to the cost of an asset, or whether it should be designated as an extraordinary receipt.

Mr. Mitchell did contend, however, that if I decided that the receipt was on revenue account the treatment under generally accepted accounting principles required that for income tax purposes the recognition thereof should be deferred over the term of the lease.

Counsel did not challenge the opinion of Ms. O'Malley, and her opinion on generally accepted accounting principles is a matter of fact. If, however, the accounting treatment is relevant to any aspect of this appeal it is unfortunate that Ms. O’Malley did not set out the reasoning that supported her opinion and was not cross-examined on this point. I presume (and this is to some extent conjectural) that the rationale for the accounting treatment of the $825,189 is that since this amount was the cost of the fixtures, it was not inappropriate for accounting purposes to offset it against that cost, thereby achieving an effective amortization over the term of the lease by reducing the basis against which annual depreciation would be deducted. If it is correct to assume that this is the unstated premise upon which the accounting treatment is based it may be acceptable, for accounting purposes, to amortize it over the useful life of the fixtures, or the term of the lease, which according to Ms. O'Malley amounts to substantially the same thing. There is, however, no legal or factual basis for this treatment in the determination of income for the purposes of the Income Tax Act.

It is more difficult to determine, in the absence of any explanation of the accounting justification, the basis upon which the balance of $1,824,811 was amortized over the term of the lease. It is rudimentary that, as an accounting matter, expenditures are to be attributed to the period that they benefit and receipts are to be allocated to the period in which they are "earned", as revenues, or are to be applied as a reduction of expenses for the period to which such expenses relate. Here the tenant inducement agreement states that the sum of $2,650,000 is paid:

. . . in order to induce IKEA to enter into the lease and to take possession of and carry on business within the premises, all in accordance with the terms of the lease.

When, then, was the payment earned? That it was earned in the sense that IKEA had to do something to get it is incontrovertible. It was not paid as an act of charity or largesse by West Edmonton Mall. On one view it is earned when the tenant's work (as defined) was completed and IKEA entered the property and commenced carrying on its business. The right thereto became absolute seven days after that event.

On this analysis, the payment, whether it be on capital or income account, was completely earned by the signing of the lease, the completion of the fixturing, the entering into the premises and the commencement of business. This analysis does not lead to the accounting treatment that was in fact accorded to it. That treatment can therefore be rationalized on one of two alternative premises:

(a) that the consideration flowing from IKEA for the payment consisted not only in its signing of the lease and fulfilling the other conditions precedent to its entitlement to be paid, but also in its continuing obligation to carry on its business in the premises during the term of the lease; or

(b) that the payment may reasonably be regarded as a reduction of the rent payable over the term of the lease.

No other hypothesis suggests itself and none was suggested. Possibly the rationale for the treatment contains elements of both. The second, being simpler, commends itself as a matter of commercial common sense. Neither hypothesis supports the treatment as capital. Both support the conclusion that the payment is on revenue account.

The role of accountants in the Court's determination of a question of this sort must be kept in perspective. Certainly the accountant, in describing the financial results of a transaction, is not concerned with the niceties of the legal distinction between capital and income receipts and payments. In that determination the accounting treatment plays no part. Moreover, the accounting treatment does not create reality. The commercial reality consists in facts that exist independently of the manner in which they are reflected in the books of account, and, indeed, independently of whether any accounting records are kept at all. If, however, the accountant is properly apprised of the facts, the treatment of a transaction in the books of account may at least provide some indication of the underlying commercial and economic reality that the transaction represents, free of tax considerations. It is in this respect that evidence of the accounting treatment may be of some marginal assistance in income tax cases. The observations of Lord Denning, M.R. and Orr, L.J. in Heather (Inspector of Taxes) v. P-E Consulting Group Ltd., [1973] Ch. 189, [1973] 1 All E.R. 8 (C.A.), at pages 13 and 19 (All E.R.), respectively, are consistent with this view and are helpful in describing the role of accountants in income tax cases.

Lord Denning said at page 13 (All E.R.):

On the cases, therefore, it seems to me that the payments to the trust were revenue and not capital expenditure. In addition, I have no doubt that the commissioners were influenced considerably by the evidence of a distinguished accountant, Mr Bailey of Messrs Price Waterhouse:

Mr Bailey gave evidence (which we accepted) to the effect that the cost to a company in securing and retaining the services of employees was usually treated as revenue expenditure, and that as it was impossible to evaluate "employee goodwill” it was the normal practice to write off expenditure for that purpose.

The commissioners were entitled to give weight to that evidence of Mr Bailey, but the Judge went further ([1972] 2 All E.R. 107 at page 121, [1972] 2 W.L.R. 918 at page 934 (Ch. D.)). He seems to have thought that, as a result of the decision of this Court in Odeon Associated Theatres Ltd. v. Jones (Inspector of Taxes), [1972] 1 All E.R. 681, [1972] 2 W.L.R. 331, the evidence of accountants should be treated as conclusive and that all the commissioners or the Court would have to do would be to evaluate their evidence. And counsel for the taxpayer company submitted to us that the Odeon case, supra, had upgraded the evidence of accountants so that the commissioners and the courts were bound by their evidence to a greater degree than they had been in the past. I cannot agree with that for a moment. It seems to me that that case does not add to or detract from the value of accountancy evidence. The courts have always been assisted greatly by the evidence of accountants. Their practice should be given due weight; but the courts have never regarded themselves as being bound by it. It would be wrong to do so. The question of what is capital and what is revenue is a question of law for the courts. They are not to be deflected from their true course by the evidence of accountants, however eminent. However in the end the judge agreed with the commissioners—as I agree with them—that the payments here were revenue and not capital expenditure.

Orr L.J. said at page 19:

Nothing in any of the judgments in the Odeon case, supra, throws any doubt on the proposition, which was common ground in this appeal and is supported by a long line of authority, that the question whether an expenditure is for tax purposes on revenue or on capital account is ultimately a question of law. Accountancy evidence may be helpful in a case of this kind insofar as it discloses in what manner accountants dealt in practice with a particular item; but it is for the court to decide whether what is done in practice is in accordance with sound accountancy practices; and, further, what is in other respects properly done in practice may not, for the reasons given by Lord Greene, MR in Associated Portland Cement Manufacturers Ltd. v. Inland Revenue Comrs, [1946] 1 All E.R. 68 at page 70, accurately reflect the difference between income and capital expenditure for the purposes of income tax.

The question of the role of generally accepted accounting principles in income tax matters was discussed by Walsh, J. in The Queen v. Metropolitan Properties Co., [1985] 1 C.T.C. 169, 85 D.T.C. 5128 (F.C.T.D.). In that case the taxpayer, a land developer, added in its financial statements certain costs of installing municipal services to the cost of its land inventory. For income tax purposes it deducted the costs as a current expense. Walsh, J. held that the accounting treatment prevailed and that in the absence of any statutory direction to the contrary generally accepted accounting principles were to be followed. The principle stated by him was not necessary to his decision and is not consistent with other binding authority. The question there was whether the expense properly related to the cost of inventory or was a running expense relating to the business as a whole. Once that factual determination is made the treatment under the Income Tax Act is essentially one of law for the Court and generally accepted accounting principles are not relevant.

In Neonex International Ltd. v. The Queen, [1978] C.T.C. 485, 78 D.T.C. 6339 (F.C.A.), Urie, J. stated at page 499 (D.T.C. 6348):

There is no doubt that the proper treatment of revenue and expenses in the calculation of profits for income tax purposes with a view to obtaining an accurate reflection of the taxable income of a taxpayer, is not necessarily based on generally accepted accounting principles. Whether it is so based or not is a question of law for determination by the Court having regard to those principles (see: M.N.R. v. Anaconda American Brass Ltd., [1955] C.T.C. 311, 55 D.T.C. 1220; see also: Associated Investors of Canada Ltd. v. M.N.R., [1967] C.T.C. 138, 67 D.T.C. 5096).

In Oxford Shopping Centres Ltd. v. The Queen, [1980] C.T.C. 7, 79 D.T.C. 5458 (F.C.T.D.) Thurlow, J. rejected the submission that the accounting treatment of an item of expense was determinative of the proper treatment for income tax purposes. His decision was affirmed by the Federal Court of Appeal ([1981] C.T.C. 128, 81 D.T.C. 5065).

In Associated Investors of Canada Ltd. v. M.N.R., [1967] C.T.C. 138, 67 D.T.C. 5096 (Ex. Ct.), Jackett, P. (as he then was) stated at pages 143-44 (D.T.C. 5099):

Profit from a business, subject to any special directions in the statute, must be determined in accordance with ordinary commercial principles. (Canadian General Electric Co. v. M.N.R., [1962] S.C.R. 3, [1961] C.T.C. 512, 61 D.T.C. 1300, per Martland, J. at page 12 (C.T.C. 520). The question is ultimately “one of law for the Court". It must be answered having regard to the facts of the particular case and the weight which must be given to a Particular circumstance must depend upon practical considerations. As it is a question of law, the evidence of experts is not conclusive. (See Oxford Motors Ltd. v. M.N.R., [1959] S.C.R. 548, [1959] C.T.C. 195, 59 D.T.C. 1119, per Abbott, J. at page 553 (C.T.C. 202; D.T.C. 1122), and Strick v. Regent Oil Co., [1966] A.C. 295, 3 W.L.R. 636 per Reid, J., at pages 645-46 (W.L.R.). See also M.N.R. v. Anaconda American Brass Ltd., supra, at page 319 (D.T.C. 1220)).

My first task is therefore to determine the proper treatment of the amounts in question in accordance with ordinary commercial principles. Having ascertained that, I must consider whether any different treatment is dictated by any special provision of the statute.

Ordinary commercial principles dictate, according to the decisions, that the annual profit from a business must be ascertained by setting against the revenues from the business for the year, the expenses incurred in earning such revenues.

Jackett, P. stated that what constituted “ordinary commercial principles" was a question of law. What constitute generally accepted accounting principles is, of course, a question of fact, albeit one of accounting opinion. The two concepts are obviously not synonymous. The limited circumstances in which generally accepted accounting principles are of any assistance are illustrated in Coppley Noyes & Randall Ltd. v. Canada, [1991] 1 C.T.C. 541, 91 D.T.C. 5291 (F.C.T.D.), where the Court found such evidence of assistance in determining the appropriate method of computing a reserve for doubtful debts.

It is important that the set of rules sanctioned by the Canadian Institute of Chartered Accountants for the presentation of the financial results of a business, and known as “generally accepted accounting principles" (GAAP) be assigned their proper role in the calculation of income for the purposes of the Income Tax Act. One needs only to read the one and one-half page explanation of the meaning of “generally accepted accounting principles" in the CICA Handbook to realize that to found a system of fiscal law upon practices and policies based upon subjective professional accounting judgment would quickly lead to a state of uncertainty and confusion. It is not surprising that courts have been reluctant to place reliance upon GAAP in the determination of income for income tax purposes. GAAP is not relevant in determining whether a receipt or expense is on revenue or capital account. It is not relevant in determining whether an item of revenue is to be recognized in the year of receipt or in a later year. (Burrard Yarrows Corp. v. The Queen, [1986] 2 C.T.C. 313, 86 D.T.C. 6459 (F.C.T.D.); aff'd [1988] 2 C.T.C. 90, 88 D.T.C. 6352 (F.C.A.).) The relevancy of GAAP in determining the timing of a deduction is highly questionable: Oxford Shopping Centres Ltd., supra; cf. M.N.R. v. Tower Investment Inc., [1972] C.T.C. 182, 72 D.T.C. 6161 (F.C.T.D.). GAAP may be relevant in determining the manner in which a reserve that is sanctioned by statute is to be calculated (Coppley Noyes & Randall Ltd., supra). GAAP was decisively rejected as a basis for inventory valuation in Anaconda American Brass, supra. It may have an extremely circumscribed subordinate function within the framework of principles of law enunciated by the courts as “ordinary commercial principles". It cannot supersede those principles.

This view is consistent with that expressed by lacobucci, J. in Symes v. Canada, [1994] 1 C.T.C. 40, 94 D.T.C. 6001 (S.C.C.) at page 52 (D.T.C. 6009):

As the trial judge rightly noted, the determination of profit under subsection 9(1) is a question of law: Neonex International Ltd. v. The Queen, [1978] C.T.C. 485, 78 D.T.C. 6339 (F.C.A.). Perhaps for this reason, and as Neonex itself impliedly suggests, courts have been reluctant to posit a subsection 9(1) test based upon “generally accepted accounting principles" (G.A.A.P.): see also ‘Business Income and Taxable Income” (1953 Conference Report: Canadian Tax Foundation) cited in B., J. Arnold and T. W. Edgar, eds., Materials on Canadian Income Tax (9th ed. 1990), at page 336. Any reference to GAAP connotes a degree of control by professional accountants which is inconsistent with a legal test for "profit" under subsection 9(1). Further, whereas an accountant questioning the propriety of a deduction may be motivated by a desire to present an appropriately conservative picture of current profitability, the Income Tax Act is motivated by a different

purpose: the raising of public revenues. For these reasons, it is more appropriate in considering the subsection 9(1) business test to speak of “ well accepted principles of business (or accounting) practice” or” well accepted principles of commercial trading".

Analysis

There are essentially two questions that need to be determined here:

(a) Is the receipt of $2,650,000 on income account or on capital account?

(b) If it is on income account, in what year is it to be recognized for the purposes of the Income Tax Act!

In answering the first question, a number of factors might be noted.

(a) IKEA is not in the business of entering into leases. The leasing of property from which to carry on its retail business is obviously a necessary part of its overall commercial operations but the leases are part of its fixed and not its circulating capital. They are capital assets in its hands.

(b) The leasing of premises by IKEA is not of such frequency that the negotiation of leases could be regarded as a recurrent or ordinary phenomenon in its business. The cost of paying rent under those leases is an obvious current expense.

(c) In the negotiation of the lease IKEA asked for a lease inducement payment. The amount of the payment was negotiated as a part of the overall economic package. Originally IKEA asked for about $3,000,000. Ultimately $2,650,000 was agreed to.

(d) In the reply to the notice of appeal, it was stated that one of the Minister's assumptions was that:

(d) as part of its retailing operations, the appellant regularly negotiates leases for space and the terms and conditions of the leases have an ongoing impact on the profits earned by the appellant.

Although I might question the use of the word "regularly"—only four of the appellant’s business premises in Canada are leased—I should think it self- evident that the terms and conditions of the leases would affect on an ongoing basis the appellant's profits.

(e) The base rent of $8 per square foot was suggested early in the negotiations and it never changed. It was, like the inducement payment and the percentage rent, the subject of discussion between the parties.

(f) The accounting treatment appears to have been based on the hypothesis that it was appropriate to allocate $825,189 out of the entire payment of $2,650,000 as a reduction of the cost of fixtures.

An expert witness, Mr. V. Philip Boname, was called on behalf of the respondent. Mr. Boname has had extensive experience in commercial real estate in Canada, in the field of development, leasing and management of shopping centres and office buildings and as a consultant in real estate development. Two questions were put to him, as follows:

— In 1985, what was the role of tenant inducement payments in the real estate industry generally and in the shopping centre rental business in the Edmonton area specifically?

— Do the value of tenant inducments made by the owners of regional shopping centres generally bear any relationship to the amount of rent to be earned by the owner from a particular retail lease?

His report was lengthy and detailed. I shall reproduce only a few paragraphs which I think represent the essence of his opinion.

It is my personal and first-hand opinion, as well as those of every marketing executive I have spoken to, that in the years 1984-85, it was the practice in the regional shopping centre industry, and West Edmonton Mall in particular, to ensure that tenant improvement or inducement costs were recovered, to the extent possible, through increases in negotiated minimum guaranteed rents. This was particularly important in relation to those retailers that were perceived to have above-average covenant values, such as IKEA.

The practice of the day was for the landlord’s leasing executive/agent to run a financial pro forma on each rental transaction including the deal's total development cost, including the cost of tenant inducements. The negotiated market rent, in each instance, depending on the landlord’s negotiating abilities and "leverage" would approximate, to the extent possible, the desired or targeted economic rent—one which would amortize all of the development costs and still provide the landlord/developer with some margin of profit.

It is my opinion, that in the instance of the West Edmonton Mall/IKEA deal, a tenant inducement, in 1985, of $2,650,000, or $23.60 per square foot of leased space (the gross leasable area of IKEA being 112,000 square feet), represented a rather significant tenant inducement. In exchange for this inducement, IKEA was willing to participate in the project at a minimum guaranteed rent of $8 per square foot of leased space for a guaranteed primary term of 10 years. It is also my considered opinion that in exchange for this inducement, IKEA was willing to enter into two percentage rent provisions which, in the absence of such an inducement, they might have been reluctant to provide. One percentage rent factor, commencing in the fifth year of the term, related to a two per cent factor of all food and beverage gross sales conducted in IKEA. The second provision, of even greater importance, was a three per cent factor on all non-food/beverage gross sales throughout the term and any renewal term of the lease. While I am not privy to the sales performance of IKEA at West Edmonton Mall, I am of the opinion that these percentage rent factors have operated to the landlord's benefit with increased rental revenues being realized over and above the minimum guaranteed rent of $8 per square foot of leased space. In other words, in reviewing the correlation between the inducement payment of $2,650,000 and rental income, one must look at the aggregate negotiated rental income package which, in this instance, was a combination of not only the minimum guaranteed rent, but also the provision for percentage rent against both food/beverage and, non-food/beverage gross sales.

It is my opinion, that while IKEA, in the instance of the West Edmonton Mall, may have been reluctant to participate in this project had the tenant inducement been significantly lower, based on my experience, a lower tenant inducement level would have resulted in the tenant having a lower rental"exposure"—either in the form of a lower minimum guaranteed rent and/or a lower"exposure" with respect to percentage rent obligations.

III. Findings & Conclusions

Given a detailed review of the West Edmonton/IKEA lease, the financial obligations of the landlord in respect to building the IKEA store, the amount of tenant inducements provided by the landlord, being $2,650,000, I am of the opinion that these undertakings, by the landlord, resulted in an increase in the aggregate value of the rental income that IKEA agreed to pay to the landlord, Triple Five Corporation.

The converse of this opinion is that had Triple Five Corporation refused to enter in to the full extent of its financial obligations, including the amount of the tenant inducement, the aggregate value of total rental incomes (both minimum guaranteed rent and percentage rents) agreed upon by IKEA, would likely have been proportionately less.

As previously noted, from my experience throughout the Canadian shopping centre industry, there is a direct correlation between the use of tenant inducements and the developer's/landlord's ability to realize higher rents. Everything else being equal, a landlord who is willing to provide a higher value of tenant inducements can typically expect a higher stream of rental revenue than one who provides a lower inducement.

His conclusions are admittedly to some degree conjectural, but given his qualifications and experience his opinions are entitled to be given weight. Moreover, his conclusions conform to obvious commercial common sense. One does not need a master's degree in business administration to realize that where two economically powerful and sophisticated business persons negotiate the terms of a lease, the size of a tenant inducement payment would bear directly on the annual rent to be paid. To conclude otherwise would be to ignore economic reality.

This is borne out as well by the other evidence. Counsel for the respondent read into the record portions of the examination for discovery of Mr. M. McDonald, an officer of the appellant. The following passages illustrate the manner in which IKEA, as a potential tenant, approached the matter of the inducement payment in the negotiations:

42. Q. I think this is important. So bear with me if I am pursuing it a bit too much. When you came in, the $8 rent was decided; or the parties had agreed that there would be an $8 base rent, right?

A. No. What I said was, there was a letter of intent prepared with an understanding that they had offered us $8 a foot, base rent.

43. Q. At that time, at the time that the letter of intent was prepared, there was an understanding that they would give you 2.65 million dollars worth of inducements or a cash inducement of 2.65 million dollars?

A. At the time the letter of intent was signed?. No, there was not.

44. Q. There was not. There was no agreement on the . . .

A. No.

45. Q. So there was an understanding that there would be a rent per square foot of $8, but there was no understanding at that time that there would be an inducement payment of 2.65 million dollars, correct?

A. That is correct.

46. Q. When did the inducement issue first come up?

A. I think, somewhere probably in late 1984.

47. Q. How did it come up?

A. In the completion of the final lease negotiations, there was a number of items still left outstanding that had to be completed in the process of completing the lease and that is where it came out.

48. Q. Did Ikea ask for the inducement payment for 2.65 million dollars?

A. We asked for an inducement payment.

BY MR. MEGHII:

55. Q. Maybe you can tell me, try and recall as best you can, you say that you don't remember what Ikea's initial figure was, but do you have an idea of what the ballpark number was? Was it far in excess of 2.65 million dollars?

A. I think it was perhaps around $3,000,000.

56. Q. How did you arrive at $3,000,000? How did you pick $3,000,000?

A. Yes, I guess you have to take the whole frame of the lease, you know, what we were paying as a base rent, what we thought the ten year frame might be for the sales expectations, what we could afford to pay in that location and still make some reasonable profit for ourselves, what the CAM costs were. . . .

57, Q. What is the CAM cost?

A. The common area maintenance costs.

58. Q. I see, okay.

A. And all those commercial factors put together gave us heart of the sum which was the inducements.

59. Q. What was the relevance, you have mentioned some of the factors? Can you, for example, tell me, why was the amount of sales you were going to generate relevant for the amount of inducement that you were going to ask for?

A. Well, I guess, the sales was on two parts. First of all, it was a percentage rent clause in the agreement, and secondly, the sales was really the basis of where you are going to decide what profit level you are at. So if sales were $10,000,000, for example, versus $20,000,000, there was obviously a bottom line effect.

60. Q. You said that the lease had a percentage of sales. You mentioned that?

A. Yes.

61. Q. Can you elaborate on why that is relevant? So what, if the lease has a percentage of sales. How does that affect the amount of inducements you were asking for?

A. How does it affect it?

62. Q. Yes.

A. Well for example, I guess, if you are committed to a two or three per cent percentage rent in sales, then the overall costs that we are starting up with, you have that as one situation. We have the racking; we have equipment; we have fixturing of the store, which has to be amortized over the period of the lease, and so any inducement could offset that. Also, it sort of shows then what the net cost is to Ikea.

63. Q. But you were taking into account the net sales, the $8 per square foot, etc.

A. The CAM costs.

64. Q. You are saying all these things and you are saying . . .

A. The additional rent cost.

65. Q. . . . "These are all the amounts that we have to pay, and we have a certain target of profitability, and we want to work out an effective rent.” Isn't that fair?

A. That is fair, yes. That is right.

66. Q. So the idea of the lease inducement payment was to work out what you would call an "effective rent figure per annum”. So you, for example, would say, three million dollars will result in an effective rent of this much, which is what we are looking to. . . ."

A. Well, whether it is an effective rent or not, I am not sure if that is the proper classification, but it certainly is an economic consideration taken into account.

67. Q. So for example, if Ikea was required under the lease to pay $10 a square foot. . . and what was the percentage of the sales you were required to pay?

A. Two per cent.

68. Q. . . . and the percentage sale was three per cent, and presumably, because you are trying to arrive at the economic rent, you might ask for a higher inducement. Is that correct?

A. Yes, that is potentially. Yes.

98. Q. Maybe I can go back to the question then. So is it your evidence that there were no negotiations on the 2.65 million dollars until the base rent was completely set, or were there negotiations of that figure about the same time?

A. I think there was negotiations. Once we had . . . the letter of intent was established. . . .

99. Q. Yes.

A. . . . there was negotiations on the full economic package.

100. Q. And that included the base rent?

A. That is right. It was a factor certainly.

101. Q. So when you were negotiating the base rent, you were also at that time negotiating the 2.65 million dollars or whatever?

A. Yes, the final conclusion comes to it. Yes, that is right.

102. Q. So in the course of the negotiations, do you recall any discussions wherein either yourselves or West Edmonton Mall said, “if it is $9 a square foot, then we want a 2.8 million dollar inducement. If it is a $6 per square foot, we want a lesser inducement"?

A. No, it wasn't calculated in that manner.

103. Q. But there was some relationship?

A. I am sure, on both parties, there was a relationship of what West Edmonton was paying to Ikea and receiving from Ikea and there was calculation on our part on location, whether it was a commercial location to be in, what the rent was, what our estimated sales were. Of course, that was a calculation that one went through.

104. Q. I can understand that. I think, of course, your words make sense to me, because you testified earlier that you were trying to arrive at an economic package, at what you would call an “economic rent". And your economic rent included everything you were paying out and everything you were getting?

A. That is right.

105. Q. That is a fair statement?

A. M'hmm.

127. Q. What did you use the 2.6 million dollars for, when it came in?

A. Well, it came in as I recall, probably on the day of opening, once we commenced the operation of the store. At that point in time, the equipment, the racking, the pre-opening costs such as advertising and things like that, the tenant fit-outs were already paid for and complete out of offering capital. So the 2.6 million dollars went into the bank or to reduce any operating lines we might have had at the time.

Mr. McDonald's evidence confirms the obvious: the lease inducement payment was an integral part of the overall economic package negotiated by the parties. It was inextricably bound up with the rent that was to be paid and the economic return that the parties expected from the commercial relationship between them.

On the evidence, in what direction then, capital or income, does the law point?

There seems to have been a widely held assumption that, prior to the enactment of paragraph 12(1)(x), tenant inducement payments were not taxable, either as income, capital gains or a reduction of the capital cost of property. It is not entirely clear just where this view originated, but it ultimately found expression in Interpretation Bulletin IT-359R2, paragraph 9 of which is as follows:

9. A payment received by a tenant from a landlord as an inducement to enter into a lease will be considered in the hands of the tenant as

(a) a non-taxable capital receipt where the payment is a reimbursement of part or all of the tenant's capital cost of leasehold improvements within the meaning of Regulation 1102(4);

(b) a reduction of those expenses where the payment is a reimbursement of other expenses incurred by the tenant;

(c) income where the negotiation of leases is a regular part of the tenant's business operations (e.g. a chain store);

(d) a reduction of what would otherwise be the rental expense of the tenant where the payment is a rebate of rent for a period of the lease;

(e) a non-taxable capital receipt in other cases.

These ideas did not spring fully armed from the head of the Minister of National Revenue. They came from somewhere. In all likelihood their source can be traced ultimately to a judgment of the House of Lords in Corp. of Birmingham v. Barnes, [1935] A.C. 292, 19 T.C. 195. In that case the corporation received a subsidy from the government to cover part of the cost of the reconstruction of certain of its tramlines. It also received a contribution toward the cost of a new line from a company that the line was intended to serve. The House of Lords held that these contributions were not required to be taken into account in determining the “actual cost" to the corporation of its tramlines. Lord Atkin said at page 296 (A.C.):

The question now is whether this meaning of “actual cost to the person" is correct. My Lords, in my opinion the words the actual cost to the person by whom the trade is carried on” used in this context have no relation to the source from which that person has received the money which he has expended on the plant.

and at page 298:

What a man pays for construction or for the purchase of a work seems to me to be the cost to him : and that whether some one has given him the money to construct or purchase for himself; or, before the event, has promised to give him the money after he has paid for the work; or, after the event, has promised or given the money which recoups him what he has spent.

The principle in Birmingham v. Barnes, supra, was followed in the Federal Court of Appeal in The Queen v. Canadian Pacific Ltd., [1977] C.T.C. 606, 77 D.T.C. 5383. In that case the Court rejected the Crown's contention that the capital cost to the taxpayer of depreciable property was the amount expended thereon less any contributions or reimbursements made to it by third parties. Pratte, J., speaking for the Court, after quoting the second passage from Lord Atkin's speech set out above, said at page 612 (D.T.C. 5386):

Counsel for the appellant has argued that the decision in the Birmingham case is distinguishable on two grounds. In that case, said he, the capital expenditure had not been incurred at the request of the third party and the amount contributed by the third party was not earmarked for any special purpose.

As to the first proposed distinction, I will merely say that it appears to me entirely irrelevant; as to the second one, I do not understand it. In the five cases here in question, the respondent entered into contracts with third parties under which the respondent agreed to make certain capital expenditures and the third parties agreed, in return, to pay the respondent sums not exceeding the amount of the expenditures made or to be made by it. I do not understand how it can be said that, in those circumstances, the sums paid by the third parties were "earmarked" and were not at the respondent's free disposal.

The matter came before the Court again in Consumers' Gas Co. v. The Queen, [1982] C.T.C. 339, 82 D.T.C. 6300 (F.C.T.D.). The taxpayer, a processor and distributor of natural gas, received reimbursement from governments, municipalities and other public authorities for expenditures made by it in replacing, modifying or altering its pipelines. It was argued that the receipts were on income account or, in the alternative, that they reduced the taxpayer's capital cost of depreciable property. Walsh, J. rejected both contentions and, with respect to the second contention, relied upon the Canadian Pacific and Birmingham cases. An appeal from the trial division was dismissed by the Federal Court of Appeal, which stated that the case was indistinguishable from the Canadian Pacific case. As to the alternative argument of the Crown, that the expenditures were on capital account and the receipts on income account, the Court held that it was not properly raised in the pleadings.

Consumers' Gas Co. again came before the Court, [1986] 1 C.T.C. 380, 86 D.T.C. 6132 (F.C.T.D.), in an appeal from assessments for subsequent years. At trial the Crown contended that the reimbursement should be treated as income. Muldoon, J. agreed with Walsh, J.'s earlier decision and allowed the appeal. The Federal Court of Appeal dismissed an appeal from his judgment ([1987] 1 C.T.C. 79, 87 D.T.C. 5008).

The facts in the two Consumers’ Gas cases differ significantly from those present here. The distinguishing and, in my opinion, critical feature is set out in a passage from the judgment of Hugessen, J. in the Federal Court of Appeal in the second case at page 81 (D.T.C. 5010).

It is common ground on the present appeal that the expenditures made by Consumers' Gas for pipeline relocations in the circumstances described are for capital account. In the judgment now under appeal, Muldoon, J. in the Trial Division ([1986] 1 C.T.C. 380, 86 D.T.C. 6132) held that the partially offsetting receipts from third parties were also for capital account and need not be taken into income for the purposes of the Income Tax Act. In my view, he was right.

There is no dispute, and indeed the expert evidence called on both sides was unanimous on the point, that generally accepted accounting principles require these receipts to be treated in the way that Consumers’ Gas in fact treated them for financial statement purposes. In other words, proper accounting practice required that the receipts be offset against the capital expenditure in respect of which they were paid by third parties so that only the net cost of the relocation be carried to the asset side of the balance sheet. It was also not disputed that Consumers' Gas’ practice of taking straight line depreciation over a period of 70 years calculated on the net cost of pipeline relocations was consistent with generally accepted accounting principles. Finally, the expert accounting evidence was that the receipts should be treated as capital receipts and not as income.

The principal argument advanced by counsel for the appellant is disarmingly simple. He urges that the method employed by Consumers' Gas for financial statement purposes, which is, as stated, in accordance with generally accepted accounting principles, results in the disputed receipts being reflected in the income statement. Hence, he argues, the treatment accorded for income tax purposes should also produce this result and the receipts should be treated as revenues.

[Emphasis in original.]

I do not read the judgment of Hugessen, J. as suggesting for a moment that generally accepted accounting principles have any bearing on whether a receipt is on capital or income account. He accepted the trial judge's finding that the expenditures made by the appellant were capital expenditures and the receipts, which were partial reimbursements of those expenditures, were for that reason capital receipts. This is in accordance with well established authority that where money is received to replace a loss or reimburse an expense, the receipt acquires the nature of the expense or loss that it reimburses. All that the accounting treatment did was reflect the reality that the payments were a reimbursement of certain capital costs.

In London and Thames Haven Oil Wharves Ltd. v. Attwooll, [1967] 2 All E.R. 124, 43 T.C. 491, Diplock, L.J. said at pages 134-35:

The question whether a sum of money received by a trader ought to be taken into account in computing the profits or gains arising in any year from his trade is one which ought to be susceptible of solution by applying rational criteria; and so, I think, it is. I see nothing in experience as enbalmed in the authorities to convince me that this question of law, even though it is fiscal law, cannot be solved by logic, and that, with some temerity, is what I propose to try to do.

I start by formulating what I believe to be the relevant rule. Where, pursuant to a legal right, a trader receives from another person compensation for the trader’s failure to receive a sum of money which, if it had been received, would have been credited to the amount of profits (if any) arising in any year from the trade carried on by him at the time when the compensation is so received, the compensation is to be treated for income tax purposes in the same way as that sum of money would have been treated if it had been received instead of the compensation. The rule is applicable whatever the source of the legal right of the trader to recover the compensation. It may arise from a primary obligation under a contract, such as a contract of insurance; from a secondary obligation arising out of non-performance of a contract, such as a right to damages, either liquidated, as under the demurrage clause in a charterparty, or unliquidated; from an obligation to pay damages for tort, as in the present case; from a statutory obligation; or in any other way in which legal obligations arise.

The source of a legal right is relevant, however, to the first problem involved in the application of the rule to the particular case, viz., to identify for what the compensation was paid. If the solution to the first problem is that the compensation was paid for the failure of the trader to receive a sum of money, the second problem involved is to decide whether, if that sum of money has been received by the trader, it would have been credited to the amount of profits (if any) arising in any year from the trade carried on by him at the date of receipt, i.e., would have been what I shall call for brevity an income receipt of that trade. The source of the legal right to the compensation is irrelevant to the second problem. The method by which the compensation has been assessed in the particular case does not identify for what it was paid; it is no more than a factor which may assist in the solution of the problem of identification. I will not again traverse the cases. They seem to me to be directed to the solution of one or other of these two problems, which are not always distinguished in the judgments. In the course of these judgments different metaphors and similies (appropriate no doubt to the particular facts of the case) have been used. But I do not think that any of these conflict with the rule as I have expressed it.

The same principle applies whether the receipt reimburses a loss or an expenditure. The crucial question is “what is the nature of the expense that the receipt is designed to reimburse?” If the reimbursement is of a capital loss or a capital expenditure the receipt is on capital account.

The other cases referred to by counsel are consistent with this analysis. In Woodward Stores Ltd. v. The Queen, [1991] 1 C.T.C. 233, 91 D.T.C. 5090 (F.C.T.D.), Joyal, J., after an extensive review of the cases, concluded that a payment made by a landlord to reimburse a tenant for fixturing expenses was to be treated as a capital receipt by the tenant. The result is in accordance with the principle set out above. The fixturing expense was itself a capital expenditure. The Court's comments on generally accepted accounting principles do not appear to have been particularly germane to the decision.

Similarly Collier, J., in Suzy Creamcheese (Canada) Ltd. v. The Queen, [1992] 1 C.T.C. 242, 92 D.T.C. 6291 (F.C.T.D.), held that allowances paid to the tenant by a landlord to defray in part the cost of fixturing were capital receipts to the tenant. The case is consistent with the principle that a payment to reimburse the cost of a capital expenditure is itself capital. Collier, J. distinguished the decision of Teitelbaum, J. in French Shoes Ltd. v. The Queen, [1986] 2 C.T.C. 132, 86 D.T.C. 6359 (F.C.T.D.). The two cases are obviously distinguishable. In French Shoes it was agreed that the payment was to be applied against inventory. There is no inconsistency between the cases. The payments were simply a reimbursement of a different type of expense.

The decision of Reed, J. in Westfair Foods Ltd. v. Canada, [1991] 1 C.T.C. 146, 91 D.T.C. 5073 (F.C.T.D.); aff'd [1991] 2 C.T.C. 343, 91 D.T.C. 5625 (F.C.A.), has no application to this case. It affirmed the well established principle that a payment for the cancellation of a capital asset, (in that case two leases) was itself a capital receipt to the lessee. The cancellation of a lease is a disposition of a capital asset. What one receives for that disposition is obviously a capital receipt.

In IBM Canada Ltd. v. M.N.R., [1993] 2 C.T.C. 2860, 93 D.T.C. 1266 (T.C.C.), Mogan, J. of this Court held that lease inducement payments received by the taxpayer from different landlords in respect of seven leased locations were properly included in the taxpayer's income. He distinguished the Canadian Pacific and Consumers' Gas cases as follows at 2865 (1269-70):

In my opinion, the decisions of the Federal Court of Appeal in Canadian Pacific and Consumers' Gas have no application to this appeal because (i) the payments received in those cases were clearly intended by the payor and the recipient to reimburse the recipient for costs incurred to modify or relocate a portion of the recipient's tangible capital property; (ii) the payments received in those cases had a capital character imposed upon them by their clearly intended purpose; and (iii) there was no direct evidence in this appeal that the lease inducement payments received by IBM were intended to reimburse the appellant for any costs at all, either of a capital or revenue nature. I am left to infer from all of the surrounding circumstances the intent or purpose of the lease inducement payments.

Many other cases were cited by counsel. They need not be quoted. For the most part they are consistent with the following principles:

(a) In the absence of a statutory provision to the contrary, a payment made to a taxpayer to reimburse that taxpayer for the cost of capital property does not, irrespective of the manner in which it might be treated for accounting purposes, reduce the capital cost of the property for income tax purposes.

(b) Such a payment is, however, a capital receipt and is not to be included in income under the Income Tax Act, regardless of the accounting treatment.

(c) A payment made that has as its purpose the reimbursement of a taxpayer for an expense that is on revenue account or the reduction of such an expense is an income receipt and is to be included in income.

We have here a lump sum of $2,650,000 paid

. . . to induce IKEA to enter into the lease and to take possession of and carry on business within the premises, all in accordance with the terms of the lease.

Under the inducement agreement IKEA was not obliged to apply that payment to anything. Although the accountants treated part of it as a reimbursement of IKEA for the cost of the leasehold improvements and the balance as bearing directly upon the profit earned by IKEA from its business in that it effectively reduced the rent that it would otherwise have paid, nothing in the evidence supports the conclusion that the payment or any part of it was made to reimburse a capital expenditure or a capital loss. Indeed, nothing in the evidence links any part of the payment, whether in its purpose or in its application, to anything that could be described as capital.

The payment of $2,650,000 was negotiated as an integral part of the bargaining that culminated in the lease. The amount is not designated in the contract to be used for any purpose but about one-third was treated by the accountants as an offset to the capital cost of fixtures and the balance was reflected in income for financial statement purposes over the term of the lease. While such treatment may be in accordance with generally accepted accounting principles, it is irrelevant to the question of the payment's quality as capital or income.

So far as the $825,189 is concerned, does the use attributed to it by the accounting treatment stamp it as a capital receipt? No case in Canadian or English jurisprudence has gone this far and I can see no reason as a matter of principle for extending Birmingham v. Barnes, supra, any further than the courts have already taken it. In all of the other cases such payments have either explicitly or implicitly been designated to be used to offset capital expenditures. While I am sure that the parties could not in their negotiations have been oblivious to the fact that some part of the inducement payment could be used to reimburse the fixturing costs there is nothing to indicate that it had to be, or was intended to be, so used. In fact the money for fixturing had already been spent by the time the inducement payment was received and as Mr. MacDonald stated, the money "went into the bank or to reduce any operating lines we might have had at the time”. It was not earmarked for any purpose. Nothing in the evidence indicates that the actual or projected fixturing costs formed a separate and identifiable ingredient in the negotiation of the inducement payment. To treat all or any portion of the payment as capital merely because it may, on one accounting view of the matter, have been seen as not inappropriate for accounting purposes to attribute a portion to the cost of fixed assets would be arbitrary and would, moreover, be an abdication to the professional judgment of accountants of the court's obligation to determine what is essentially a question of law. The effect on the appellant's annual profits for accounting purposes would have been precisely the same had the $825,189 not been attributed to the cost of fixtures and the entire $2,650,000 had been amortized to income on a straight-line basis over the term of the lease. Indeed Ms. O'Malley's evidence indicated that this would have been the more technically correct procedure.

Since the payment cannot be connected with any capital purpose the question therefore is whether this automatically makes it income to the appellant. It was neither a gift nor a windfall. It was not fortuitous. It arose out of the negotiation of an obligation whose incidents, the payment of rent and the carrying on of business in the premises in the West Edmonton Mall, were to the appellant of a purely revenue nature. It is true that the lease is a capital asset in the appellant's hands and the appellant is not in the business of negotiating leases. The negotiation of the lease and the payment of rent are, however, necessary incidents of the conduct of the appellant’s business, and in determining the cost to the appellant of carrying on its business in the West Edmonton Mall it is impossible to imagine how such a payment could be ignored. Indeed, this is clear from Mr. McDonald's evidence. It is true, as Reed, J. observed in Westfair Foods Ltd., supra, that not every receipt that is related to a business is necessarily income from that business. She was, however, dealing with a receipt that, albeit related to the business, was nonetheless one that arose from a disposition of a capital asset of that business. Here we are concerned with a receipt that, although it does not arise from the sale of the goods or services in which the company deals, is directly and inextricably bound up with the economics of the operation. It impinges immediately upon the costs that must be satisfied out of the appellant's trading operations.

Analogies are seldom helpful, but the practical commercial approach developed in cases involving the question whether a payment made is on capital or revenue account is instructive here. In B.P. Australia Ltd. v. Commissioner of Taxation, [1966] A.C. 224, [1965] 3 All E.R. 209, the Privy Council had to deal with the deductibility of payments made by an oil company to retailers to tie them to the supplier for a period of years. Lord Reid said at page 266 (A.C.):

The sums in question were sums which had to come back penny by penny with every order during the period in order to reimburse and justify the particular outlay. If one imagines a B.P. agent justifying the price of petrol to a retailer or discussing whether price reduction was possible, it is hard to imagine him omitting the lump sum so paid (divided by the estimated gallonage) as an item in the cost per gallon. It is doubtful if he would even relegate it to overheads since it was in the forefront of the wholesaler's selling costs. Nor can one imagine the retailer demurring at such a calculation. Prima facie therefore the lump sums were circulating capital which is turned over and in the process of being turned over yields a profit or loss; they were part of the constant demand which must be answered out of the returns of the trade. This, however, is merely one indication and by no means concludes the matter.

The same reasoning applies to a receipt. The payment received by the appellant was an integral element in its day-to-day costs of running its business.

Earlier in these reasons there were postulated two, and only two, possible hypotheses upon which the accounting treatment of amortizing the payment over the term of the lease could be justified as an accurate reflection of the economic reality that underlay the transaction. There is no evidentiary basis for a third, that a portion, $825,189 represented a reimbursement of the capital cost of fixtures. The second hypothesis, that the payment represented a reduction of rent, seemed to make more economic sense and to be more consistent with the evidence as a whole. If, however, the first hypothesis, that it was consideration for moving into the premises, paying rent and carrying on business there, accurately reflected the economic basis for the payment, the receipt is patently income. It was an incident of the appellant’s carrying on business.

In my opinion the amount of $2,650,000 was income to the appellant from its business.

The second question is whether the accounting treatment relating to the timing of the recognition of this payment must prevail in the determination of the appellant’s profit under subsection 9(1). I do not think so. The Income Tax Act provides for a number of reserves in section 20. No such reserves are available in respect of the type of income receipt involved here. The law is clear from Foothills Pipe Lines (Yukon) Ltd. v. Canada, [1990] 2 C.T.C. 448, 90 D.T.C. 6607, at page 455 (D.T.C. 6612), that, whatever might be the accepted accounting treatment,

as a matter of law, amounts become taxable as income in the year of receipt provided the amounts received exhibit the nature and quality of income at that time.

In Kenneth B.S. Robertson Ltd. v. M.N.R., [1944] C.T.C. 75, 2 D.T.C. 655 (Ex. Ct.), Thorson, J. put the question as follows at page 91 (D.T.C. 661):

Is his right to it absolute and under no restriction, contractual or otherwise, as to its disposition, use or enjoyment? To put it in another way, can an amount in a taxpayer's hands be regarded as an item of profit or gain from his business, as long as he holds it subject to specific and unfulfilled conditions and his right to retain it and apply it to his own use has not yet accrued, and may never accrue?

See also Diamond Taxicab Assn. Ltd. v. M.N.R., [1953] C.T.C. 104, 53 D.T.C. 1111 (S.C.C.); The Queen v. Imperial General Properties Ltd., [1985] 1 C.T.C. 40, 85 D.T.C. 5045; cf. M.N.R. v. Atlantic Engine Rebuilders Ltd., [1967] S.C.R. 477, [1967] C.T.C. 230, 67 D.T.C. 5155.

There is no question that the right to the amount received became absolute in 1986 and accordingly the amount is taxable in that year.

The appeal is therefore dismissed with costs.

Appeal dismissed.