Gulf Canada Resources Ltd. v. The Queen, 93 DTC 5345, [1993] 2 CTC 198 (FCTD)

Rothstein, J.:—

Introduction

The issue in this appeal is whether, in the taxation year 1980, the Gulf Canada Square Building in Calgary, which was owned by Gulf Oil Canada Ltd., the predecessor of the plaintiff, Gulf Canada Resources Ltd. ("CGL"), was “rental property" as that term is defined in subsection 1100(14) of the Income Tax Regulations, C.R.C. c. 945.

If it was “rental property", capital cost allowance ("CCA") in respect of the building is limited to GCL's income from renting or leasing the building, computed before taking CCA into account, i.e., CCA can only be used to reduce the taxable income from the building. (This will sometimes be referred to as restricted CCA".) If the building is not "rental property", CCA is not so limited and may be an amount up to five per cent of the undepreciated capital cost of the building, i.e., CCA can be used to reduce GCL's total taxable income and not just taxable income from the building. (This will sometimes be referred to as “full CCA".)

In this case, GCL treated the building for income tax purposes in 1980 as other than "rental property" and deducted from its income $3,212,069 as CCA in respect of the building. The Minister reassessed GCL on the basis that the building was “ rental property". He disallowed $1,969,615 of the CCA, to reduce the CCA deduction to $1,242,454 which, according to the Minister, was the income from the renting of the building before computing CCA.

Relevant statutory provision

Income Tax Regulation 1100(14) provides:

1100.(14) In this section and section 1101, "rental property" of a taxpayer or a partnership means

(a) a building, other than property of Class 31 or 32 in Schedule Il, owned by the taxpayer or partnership, whether jointly with another person or otherwise, or

(b) a leasehold interest in real property, if the leasehold interest is property of

Class 3, 6 or 13 in Schedule Il and is owned by the taxpayer or partnership,

if, in the taxation year in respect of which the expression is being applied, the property was used by the taxpayer or the partnership principally for the purpose of gaining or producing gross revenue that is rent, but, for greater certainty, does not include a property leased by the taxpayer or the partnership to a lessee, in the ordinary course of the taxpayer's or partnership's business of selling goods or rendering services, under an agreement by which the lessee undertakes to use the property to carry on the business of selling, or promoting the sale of, the taxpayer's or partnership's goods or services.

[Emphasis added.]

The underlined words are the ones at issue in this case.

Facts:

The facts are not in dispute and are summarized from the statement of agreed facts:

1. During the latter 1970s, GCL was going through a period of rapid expansion. Office space was difficult to obtain in Calgary and it was impossible to have all GCL employees at one existing location.

2. The employees of GCL were housed in four separate office buildings in Calgary. This gave rise to problems such as the need for multiple communication systems, expenses in providing transportation between locations, lost time of employees travelling between locations, and the maintenance of separate supplies and systems such as a separate mail room in each location.

3. In early 1976, GCL formed a task force to look into possible solutions to these problems. The task force recommended that all Calgary employees be housed in a new office building in the downtown area, preferably by 1979. Accordingly, GCL determined that a building must be built for it or that it must acquire its own building to house its existing staff and to allow for expansion.

4. GCL was approached by Canada Square (Calgary) Ltd. after GCL had circulated its requirements for an office building in Calgary to developers. GCL entered into a purchase agreement with Canada Square (Calgary) Ltd., dated Jul 1, 1977. Pursuant to this agreement, Canada Square (Calgary) Ltd. was to build Gulf Canada Square having an area of approximately 1.1 million square feet, which, upon its completion, would be purchased by GCL.

5. On January 1, 1979, GCL established a wholly-owned Calgary based resource subsidiary, Gulf Canada Resources Inc. ("GCRI"). GCRI was a separate corporate entity. GCL transferred its upstream (resource) operations to GCRI. (The upstream sector was composed of exploration, development and production.) The reasons for the formation of GCRI were: (1) to remove from Ontario capital tax, assets situated in Alberta and (2) as a result of the rapid growth in the business of GCL, to create an upstream entity so that there would be one executive ultimately responsible for the upstream sector reporting to the board of directors of GCL.

6. Also in 1979, Gulf Canada Products Co. (GCPC) was formed. GCPC was a division of GCL. It was formed as a result of the rapid growth in the business of GCL and because it was considered desirable that there be one executive ultimately responsible for the downstream sector reporting to the board of directors of GCL. (The downstream sector was composed of refining, marketing, chemicals, supply and distribution (retail sales) and propane operations.)

7. The decision to create GCRI occurred after GCL committed itself to purchase Gulf Canada Square. The creation of GCRI had no effect on the planning or purpose of Gulf Canada Square and the building of Gulf Canada Square had no effect on the decision to create GCRI.

8. Gulf Canada Square was occupied as of September 1, 1979. The employees of both GCL and GCRI moved into the building and were allocated office locations based on functional responsibility. Although GCRI was now a separate legal entity, its employees were the same persons who had been employed in the upstream business of GCL prior to January 1, 1979, and their functions were the same.

9, G&C Realty Ltd. was a realty company owned fifty per cent by GCL and fifty per cent by Canada Square (Calgary) Ltd. G&C Realty Ltd. was a general partner in a limited partnership, G&C Realty. G&C Realty was formed solely to lease to third parties that space in Gulf Canada Square not used by GCL and GCRI.

10. GCL and GCRI entered into an Administrative Services Agreement dated January 1, 1979, whereby GCL would provide realty services for the operations and employees of GCRI and provide administrative services for GCRI's operations. GCRI paid to GCL "the cost of building space and building services based on the square footage occupied by GCRI". The payment of costs was recorded on the books of account of GCL as a reduction of GCL's cost in maintaining Gulf Canada Square. GCRI recorded the payment as an expense under the accounting classification "Gulf Realty Space and Service Costs Allocated". GCRI paid GCL $4.26 per square foot. Comparable office space in Calgary was renting for approximately $14 per square foot in 1980.

11. In the 1980 taxation year, Gulf Canada Square was occupied approximately as follows:

With respect to the 517,063 square feet being leased to tenants by G&C Realty, GCL retained the right to increase the Gulf space by up to 170,102 square feet if it was required for its own use.

Position of the parties

Counsel for GCL takes the position that Gulf Canada Square is not "rental property". He concedes that the forty-five per cent of the building leased to G&C Realty Ltd. was used for the purpose of producing rent. However, he says that when the space occupied by GCL and GCRI are taken together, fifty-five per cent of the building was used by GCL for purposes other than to produce rent. Thus, the principal use of the building by GCL was not for the purpose of producing rent and therefore the building does not fall within the definition of “rental property" in subsection 1100(14) of the Income Tax Regulations. Accordingly, GCL's CCA deduction from income for the year 1980 should not have been restricted in the manner reassessed by the Minister.

Counsel for the Minister submits that the premises occupied by GCRI must be considered as having been used by GCL for the purpose of producing rent. When the GCRI space and the space leased to G&C Realty Ltd. are combined, 71.5 per cent of the building was used by GCL for the purpose of producing rent and therefore the building is "rental property". Accordingly, in her view, the Minister correctly limited GCL's CCA deduction to an amount not exceeding GCL's income (before CCA deduction) from renting Gulf Canada Square in 1980.

Analysis

The question whether Gulf Canada Square was "rental property" in 1980 requires consideration of the following words in subsection 1100(14) of the Income Tax Regulations:

. . ."rental property" of a taxpayer. . . means a building. . .owned by the taxpayer . . . if, in the (relevant) taxation year. . .the property was used by the taxpayer. . . principally for the purpose of gaining or producing gross revenue that is rent. . . .

Three cases were referred to by counsel in which subsection 1100(14) has been considered.

In Turner v. M.N.R., [1975] C.T.C. 2198, 75 D.T.C. 190 (T.R.B.), an optometrist constructed a building in a prestigious area of downtown Vernon, B.C. A two- storey building was the most practical type of building to construct. The optometrist felt that it would be advantageous to his own practice if he could house some related businesses in the building. He had in mind a business that would turn out prescription optical lenses and frames. This in fact occurred, so that the optometrist occupied 25 per cent of the building and the optical lens and frame business occupied about 25 per cent. The remainder of the building was occupied by unrelated tenants. In that case, K.A. Flanigan (as he then was) of the Tax Review Board found that the building in question was not "rental property”. In coming to this conclusion, he considered the circumstances leading to the construction of the building, why it was constructed to a size which allowed for tenants and the purpose of the owner in having a related business lease space in the building. Having regard to these considerations, Mr. Flanigan was satisfied that allowing the owner to deduct full CCA from the undepreciated capital cost of the building was consistent with the object and purpose of subsection 1100(14).

In Canada Trust Co. v. M.N.R., [1979] C.T.C. 2199, 79 D.T.C. 177 (T.R.B.), a trust company constructed a building in which three-fifths to three-quarters of the building, according to counsel for the Minister in that case, was actually used for the purpose of producing rent. Mr. Taylor, for the Tax Review Board, found the building was not "rental property", having regard to the principal purpose of the building. He concluded that the owner's business rather than its investment needs was the principal purpose. In Canada Trust Co. v. M.N.R., [1985] 1 C.T.C. 2367, 85 D.T.C. 322 (T.C.C.), the same issue was considered involving the same building for a subsequent taxation year. This time, Tremblay, T.C.C.J., found the building was "rental property" based on the fact that 64.9 per cent of the building was rented to arm's length tenants and only 35.1 per cent was used by the owner.

Having regard to the various approaches in the decided cases, it is safe to say that the interpretation and application of the words in subsection 1100(14) are not without some doubt.

It seems to me that for the purposes of this case, the interpretation and intended application of subsection 1100(14) can be deduced from a consideration of the subsection in its entirety, together with some assistance from IT-195R4 dated September 6, 1991. I refer to IT-195R4 on the authority of Vaillancourt v. The Queen, [1991] 2 C.T.C. 42, 91 D.T.C. 5408, at page 48 (D.T.C. 5412).

After the phrase in subsection 1100(14) which is of concern in this case, the following words appear:

. . . but for greater certainty, does not include a property leased by the taxpayer or the partnership to a lessee, in the ordinary course of the taxpayer's or partnership's business of selling goods or rendering services, under an agreement by which the lessee undertakes to use the property to carry on the business of selling, or promoting the sale of, the taxpayer's or partnership's goods or services.

The specific situation described in these words is an example of the application of the general principle enunciated in the preceding words.

According to IT-195R4, the words after "but for greater certainty” apply, for example, to a service station leased by an oil company to a dealer. At page 3, the following is found:

For example, a building leased by an oil company to a dealer for the operation of a service station in order to display and sell the oil company's goods is not a“ rental property" of the oil company.

This indicates that a property will not necessarily be a" rental property", for the purposes of subsection 1100(14), even if it is leased 100 per cent to a tenant and rent is paid by the tenant to the owner.

IT-195R4 also suggests that if more than 50 per cent of a total area is rented, this is an indication that the property is being used principally for the purpose of producing rent. Paragraph 4 of IT-195R4 states in part:

4. As used in the definition of rental property in subsection 1100(14), the word "principally" means "primarily" or "chiefly". In establishing whether a property is used principally for a given purpose . . . (an) important factor to be considered is the proportion of the amount of space rented in relation to the total area of the building. Again, if more than 50 per cent of the total area is rented, that is an indication that the property is being used principally for producing rental revenue.

Subsection 1100(14) in its entirety and IT-195R4 suggest that the words "used . . . principally for the purpose . . .” are to be considered having regard to two approaches, one quantitative and the other qualitative. Under the quantitative approach, regard is to be had to the proportion of a building that is used to produce rent. This is essentially the approach referred to in paragraph 4 of IT-195R4. If more than 50 per cent of a building is rented, this is an indication that the building is used by the taxpayer mainly for the purpose of producing rent and it would likely be "rental property"; if less than 50 per cent is rented, it would likely not be“ rental property".

Under the qualitative approach, the owner's main purpose in using the property in the taxation year must be considered; hence, the words following “but for greater certainty. . .” in subsection 1100(14) and the service station example in IT-195R4. Thus, even if a property is leased and rent is collected, if the use of the property is mainly for a purpose other than the producing of rent, e.g. the selling of the owner's goods and services as in the service station example, the property will not be "rental property". While each case must be decided on its own facts, I would think that this qualitative assessment requires taking into account evidence as to the owner's business and the business carried out in the rented premises and the relationship between the two. Where there is little or no relationship between the owner's business and the business carried on in rented premises, the presumption would be that the owner was using the rented premises principally for the purpose of producing rent and it would be “rental property”. Where there is a relationship between the owner's business and the business carried on in the rented premises, the nature of the relationship between the businesses would have to be considered. Where it could be demonstrated that the leasing of the rented premises was for a business purpose other than for producing rent, the property would likely not be” "rental property".

As I understand the purpose of subsection 1100(14), it is to restrict taxpayers from using the capital cost allowance on real property, essentially buildings, to shelter unrelated business income. It is the qualitative assessment that most directly addresses this rationale that lies behind subsection 1100(14) and it is therefore important that this assessment be accorded significant weight.

Application of what I have termed the quantitative and qualitative approaches is consistent with paragraph 16 of IT-331R under the heading "Meaning of Primarily and Principally” which states:

In the case of a building, the amount of space dedicated to the different purposes is usually a reliable indicator of degree of use attributable to those purposes but this cannot be considered in isolation. The purpose of the activities of those persons accommodated in the building, as well as the purpose and value of properties protected by the building, are also relevant factors.

In the case at bar, there is no dispute that the 28.5 per cent of Gulf Canada Square occupied by GCL was for its own use and not for the purpose of producing rent. Nor is there any dispute that the 45 per cent of the building leased to G&C Realty Ltd. was for the purpose of producing rent. The question of whether the building was used principally for the purpose of producing rent depends on how the use by GCL of the GCRI space is characterized, i.e., was it used by GCL to produce rent or was it used by GCL for another purpose? The qualitative assessment to which I have referred addresses this question.

The evidence in this case indicates that the decision to construct Gulf Canada Square was made for the purpose of housing all Gulf Calgary employees in one building. The building was necessary because office space was difficult to obtain in Calgary in the latter 19705. The decision to construct the building was made in 1977, almost two years before the incorporation of GCRI when all Gulf business activity was conducted by GCL. The incorporation of GCRI had no impact on the building decision. Although GCRI was a separate legal entity in 1980, its employees housed in Gulf Canada Square were the same persons who had been employed in the upstream business of GCL prior to January 1,1979. There is no dispute that GCL's premises in the building were not used to produce rent. Nothing in the evidence suggests that with the incorporation of GCRI, GCL's purpose in housing GCRI's employees in Gulf Canada Square changed from what it had been when these employees were employed by GCL and GCL was carrying on the operations later carried on by GCRI.

The purpose of housing all Gulf Calgary employees in Gulf Canada Square was for purposes relating to efficiency — eliminating multiple communications systems, eliminating the time and expense in employees' travelling between locations, and reducing supplies and systems. Efficiency is a logical and reasonable business purpose for housing all business operations in one location.

GCL charged GCRI $4.26 per square foot. Market rents for the space occupied by GCRI were in the range of $14 per square foot. Had the purpose of GCL been to produce rent from the space occupied by GCRI, GCL would have charged market rent to GCRI or, alternatively, leased the space to arm's length tenants for market rent.

Under the lease between GCL and G&C Realty Ltd., the rentable area of the building under the lease was 517,063 square feet. This excluded the GCL and GCRI space. Thus, the renting of space through the G&C Realty channel did not cover the GCRI space. The indication is that GCL treated GCRI space as space for its own use as opposed to rental use.

Under the G&C Realty Ltd. lease, GCL had an option to “designate a portion or portions of the premises at or above the third floor level and not exceeding 170,102 square feet in the aggregate as being required for the landlord's own use". Under the arrangements with G&C Realty Ltd., and consistent with the original intention that all Gulf Calgary operations be housed in one building, "landlord's own use" would include space required for GCRI.

Further, GCRI did not have a lease for a fixed period. Compensation under the Administrative Services Agreement was to be determined each year. If GCL's intention was to use the GCRI space for the purpose of producing rent, GCL and GCRI would have entered into a lease for a fixed term. This was not done.

It is true that GCRI was a separate legal entity from GCL and that under the Administrative Services Agreement, compensation was paid by GCRI to GCL for the GCRI premises in Gulf Canada Square. But these facts cannot be considered in isolation. The service station example in IT-195R4 indicates that even when an arm's length entity pays rent for leasing property, the property will not be considered rental property" where the main purpose of the lease is for a business reason of the owner other than the producing of rent. Although each case must be considered on its own facts, when companies are related, it is not unreasonable to expect that they would, for business reasons, be located in the same building. Where this is the case, it would be a strained interpretation of subsection 1100(14) to treat a building as “rental property" simply because separate legal entities are involved and rent is paid.

The evidence in this case leads me to conclude that GCRI was housed in Gulf Canada Square as part of the arrangements to house all Gulf Calgary operations in one building. There were legitimate efficiency reasons for doing so. The business of GCL and GCRI were connected such that locating them in the same building was a logical and reasonable business objective.

I conclude that the GCRI space in Gulf Canada Square was not used by GCL principally for the purpose of producing rent in 1980. The GCL and GCRI space amounted to 55 per cent of the building. Only 45 per cent was used for the purpose of producing rent. I conclude that in 1980, Gulf Canada Square was not used by GCL principally for the purpose of producing rent and was therefore not "rental property" within the meaning of that term in subsection 1100(14) of the Income Tax Regulations.

Counsel for the Minister made a number of arguments, each of which I will deal with briefly.

1. Subsection 1100(14) speaks of use “in the taxation year" and therefore intentions at the time or construction are irrelevant.

I agree that use in the taxation year is relevant. But in order to determine whether use in the taxation year was principally for the purpose of producing rent or otherwise, other considerations may also be relevant. In this case, it is relevant that GCL's intention at the time of construction was to house all Gulf Calgary operations, including those that subsequently came under GCRI, in Gulf Canada Square.

2. It is not appropriate to look behind the corporate veil.

It is true that GCRI is a separate entity from GCL. However, in applying subsection 1100(14), it is the principal use of the property by its owner that is relevant. Having regard to the fact that an owner wishes to have a wholly- owned subsidiary housed at its own property is not lifting the corporate veil. Indeed, under IT-195R4, the leasing of a service station by an oil company to an arm's length dealer constitutes circumstances in which a property would normally not be "rental property". If it is appropriate to have regard to circumstances in which there is a lease between arm's length parties, I do not see why it is less appropriate to have regard to the arrangements between a parent and a wholly-owned subsidiary to ascertain the parent's purpose with respect to the use of the property occupied by its subsidiary.

3. GCL incorporated GCRI to avoid paying Ontario capital tax. It should not now be able to ignore the separate existence of GCRI in order to claim full CCA on Gulf Canada Square.

Indeed, this is an issue I myself raised with counsel for GCL. He argued, quite appropriately, that I should have regard to the relevant statutory provisions and be guided by them. I think this is the correct approach. The liability to pay Ontario capital tax arises under a specific statutory scheme of Ontario legislation. The intention of that legislation and its scheme are not related to the scheme under subsection 1100(14) of the Income Tax Regulations. To draw relationships between two different unrelated statutory regimes of two different jurisdictions serves no useful purpose.

4. GCRI made discrete payments which counsel for the Minister described as rent.

It is true that discrete monthly payments were made by GCRI to GCL. However, the fact that such payments were made is only one consideration of many that help to determine whether or not GCL's use of GCRI space was for the purpose of producing rent. The other relevant considerations, to which I have referred earlier, are all far more persuasive in convincing me that the use of the GCRI premises by GCL was not for the purpose of producing rent.

5. It is use by the taxpayer and not purpose that is important.

The simple answer is that all the words must be given meaning. When this is done, there is no strain on the language to conclude that Gulf Canada Square was not” "rental property" in 1980.

6. The Court should have regard only to the actual or functional use of the GCRI space. Once it was given to GCRI for some consideration, that must inevitably lead to the conclusion that the purpose to which the space was put was to produce rent.

This is a very narrow approach to the language of the subsection. The necessary assessment required under subsection 1100(14) cannot be carried out solely by a test based on whether or not rent was paid. Indeed, if counsel for the Minister was correct, I do not see how IT-195R4 could explain subsection 1100(14) as allowing an oil company full CCA with respect to a service station that it leases to a dealer. All the relevant circumstances must be considered.

7. Subsection 1100(12) of the Regulations creates an exemption whereby a corporation that has as its principal business the rental or sale of real estate, is not limited in its ability to deduct CCA. Counsel for the Minister argues that GCL's position in this case inappropriately relies on the "principal business" concept.

The principal business exception in subsection 1100(12) creates a specific exemption allowing full CCA deduction for taxpayers in the business of the rental or sale of real estate even where the purpose of such taxpayers in owning a building is to produce rent. That is not the case here and there is no reliance by the plaintiff on the principal business exception. This is simply a case in which the use to which GCL put Gulf Canada Square in 1980 was not principally for the purpose of producing rent.

8. The benefit of having GCRI in Gulf Canada Square was a “spin-off benefit" which should be disregarded.

I do not view the presence of GCRI in Gulf Canada Square as a spin-off benefit. GCL's intended benefit to having GCRI in Gulf Canada Square was to consolidate all Gulf Calgary operations in one building and to achieve efficiencies therefrom. That was the principal benefit and not a spin-off benefit.

Conclusion

In 1980, Gulf Canada Square was not “rental property" as that term is defined in subsection 1100(14) of the Income Tax Regulations.

In view of my disposition of this matter, it is not necessary for me to address the other question raised by counsel for the plaintiff — whether the payments made by GCRI to GCL were rent".

The appeal from the Minister’s assessment in respect of Gulf Canada Square for the taxation year 1980 is allowed and the matter is referred back to the Minister for reassessment in accordance with this decision.

The plaintiff is awarded costs of the action.

Counsel for both parties advised me that certain other matters in dispute between them had been settled and requested a consent order to cover these other matters. That order will be granted.

A judgment carrying out the effect of this decision, including provisions which are the subject of consent by the parties, will be circulated to counsel for comment as to form before it is signed.

Appeal allowed.