Trans Canada Glass Ltd. v. MNR, 93 DTC 1260, [1993] 2 CTC 2941 (TCC)

Rowe, D.T.C.C.J.:- The appellant appeals from an assessment of income tax for its 1985 taxation year. In May, 1985, the appellant, as tenant, made an offer to lease certain premises in Burnaby, British Columbia, and that offer was accepted on May 10, 1985 by the landlord. As a term of that offer, the appellant received the sum of $400,000 as an inducement to enter into the lease. The respondent, on August 26, 1987, reassessed the appellant for the 1985 taxation year by including the $400,000 receipt into income. The appellant takes the position that the amount is not income and is a non-taxable capital receipt.

An agreed statement of facts was filed as Exhibit A-1 and a book of documents, tabbed 1 through 10, was filed as Exhibit A-2. The agreed statement of facts is as follows:

1. The appellant, Trans Canada Glass Ltd. (the "appellant"), was incorporated under the B.C. Company Act and in 1990 was continued under the Canada Business Corporations Act and changed its name to TCG International Inc.

2. The appellant and its subsidiaries carry on a retail and wholesale auto glass business in Canada and the U.S.

3. The appellant maintains its head office in British Columbia.

4. Until July 1985, the appellant had its head office in New Westminster, British Columbia.

5. In May 1985 the appellant, as tenant, made an offer to lease (“offer”) with (a copy of which is attached) Metrotown Place Holdings Ltd ("Metrotown"), as landlord, to lease the 20th floor of Metrotown Place located at 4330 Kingsway, Burnaby, British Columbia (" premises”). Metrotown accepted the offerte lease on May 10, 1985. The premises were used as the appellant's new head office.

6. As a term of the offer, the appellant received a $400,000 cash incentive as an inducement to enter into the lease ("inducement"). The relevant paragraph of the offer states:

2. CASH INCENTIVE

The landlord will pay to the tenant the sum of $400,000 upon the tenant having executed the building lease. The funds shall be held in escrow with the tenant's solicitors, with interest to the tenant, until the occupancy of the premises, at which time the total funds held shall be released to the tenant.

7. The appellant was entitled to do with the inducement as it, in its sole discretion, determined.

8. The lease over the premises commenced dated July 1, 1985.

9. The $400,000 inducement was paid by the landlord and received by the solicitors for the appellant on May 10, 1985.

10. For accounting purposes, the $400,000 inducement was credited as follows:

(i)	Leasehold Improvements
	— New Westminster	$ 44,039 **
	— Burnaby (the premises)	217,314
(ii)	Moving Expense	6,259
(iii) Rent Expense		132,388
	TOTAL	$400,000

** This was the unamortized portion of the leasehold improvements incurred in New Westminster.

11. In reviewing the audited financial statements for the appellant for the 1985 year, the auditors determined the accounting treatment of the inducement payment was not in accordance with generally accepted accounting principles; however, no change to the financial statement was required because the amount in issue was not, in their opinion, material.

12. The lease of the premises and the leasehold improvements made by the appellant to the premises were capital assets of the appellant.

13. For tax purposes the appellant treated the inducement as a non taxable receipt.

14. On August 26, 1987, by notice of reassessment (the “ reassessment”), the Minister of National Revenue reassessed the appellant for the taxation year ended December 31, 1985 by including the $400,000 inducement in income.

15. In October, 1987, the appellant filed a notice of objection to the reassessment on the basis that the inducement was a non taxable capital receipt.

Thomas Skidmore testified he is a businessman, serving as Vice-Chairman of Finance and Investments, and CEO of the Communications Group. He has been with the appellant company, founded by his father, since 1969, which now carries on business under the name, TCG International Inc. In 1985, he was the Vice-President of Corporate Development for Trans Canada Glass Ltd., in charge of overseeing investments, acquisitions of similar operations, and real estate. The appellant was carrying on the business of replacement of automobile glass, operating in most cities in Canada and in the western states in the U.S., with a total of 150 stores. In 1985, the appellant's lease on premises used for head office at New Westminster, British Columbia was drawing to an end, and Thomas Skidmore stated he was approached by various agents for landlords seeking to secure the appellant as a tenant. For example, Marathon Realty Ltd. was offering various lease inducements to potential tenants and that was well-known within the business community and had been communicated to the appellant by Marathon. At that time, the appellant had approximately 1,000 employees and had been in business for many years during which time it had remained at one head office for 35 years and then at the New Westminster head office for four and one-half years. In February, 1985, the appellant received a proposal from Polyglon Properties Ltd. regarding office space in Metrotown Place, a 19 storey, 217,526 square foot concrete office building, located within the Metrotown core of the District of Burnaby. The appellant's head office housed employees involved in administration and, together with the executives, numbered 75. The computer network of the appellant functioned from the head office. Thomas Skidmore stated that he sent the Polyglon proposal to the corporate solicitors for advice and comment. At Tab 1, in Exhibit A-2, the landlord offered to lease premises to the appellant for $13.50 per square foot for five years with the next five years at a market rate. The proposal contained no provision for rent abatement or for a cash inducement. On March 4, 1985 the appellant offered to pay $13.50 per square foot for the first five years and $14.50 for the next five years. In paragraph 8 of this offer (tab 2 of Exhibit A-2) the appellant sought a lease inducement of $419,013. On April 18, 1985 the landlord wrote a letter to the appellant (tab 3 of Exhibit A-2) setting out current rental rates and offering rent at $18 per square foot for ten years with a rent abatement of $1.50 per square foot for the first five years together with an inducement of $380,000. Another offer to lease was prepared on May 2, 1985 and this time the cash inducement was $400,000 and was accepted by the appellant on May 10, 1985 leading to the execution of a lease agreement (tab 7 of Exhibit A-2) on July 1, 1985. In addition, an agreement was entered into between the appellant and the landlord concerning rent abatement and the method of paying same. Thomas Skidmore stated that the inducement of $400,000 was a significant factor in entering into a lease as it could be used in whatever manner the company desired without any restrictions being placed thereon by the payor-landlord and was not a reimbursement of a leasehold expense. The appellant had never been in the business of buying, selling or trading in leases of property.

In cross-examination, Thomas Skidmore stated that he always regarded the $400,000 payment as tax-free. Metrotown had approached the appellant and raised the concept of the inducement which the appellant's executives knew could be obtained from most landlords in view of the soft market existing in 1985. The payment, being the subject of the appeal, was the only such inducement ever received by the appellant. The amount of payment per square foot was not tied to receipt of the inducement. In the course of negotiations with Metrotown and its agents, the inducement payment offers began at $419,043, was reduced to $380,000 and ended up at $400,000. As for the rent abatement agreement, the landlord, for its own purposes, wanted the rental per square foot to appear at a certain level, and then rebated a certain amount pursuant to a private agreement with the appellant.

Ronald Sowerby, chartered accountant, is the Comptroller and Chief Financial Officer of the appellant. He received his B.Comm. degree from the University of British Columbia in 1969 together with a C.A. designation and has been employed with the appellant since 1970. In 1985, he was the Executive Vice-President of Finance, Chief Financial Officer and Corporate Secretary. He stated the appellant has never been engaged in property development business. In referring to the corporate T-2 income tax return for the 1985 taxation year (Tab 10 of Exhibit A-2) he stated the receipt of the $400,000 inducement was regarded as a non-taxable capital receipt but used a particular accounting method which had the effect of “backin it out of income”. The head office was the site of all Board meetings, and the accounting department, financial administration and executives were located there but no retail sales took place from that location.

In cross-examination, Ronald Sowerby agreed that a terminal loss had been claimed on unamortized leasehold improvements on the former head office premises at New Westminster.

James Kerr testified he has been a chartered accountant since 1971. He was consulted on the matter of the inducement payment and prepared a report which was filed as Exhibit A-3. He was referred to an abstract of issues discussed, dated January 21, 1991, flowing from a meeting of the Emerging Issues Committee of the Canadian Institute of Chartered Accountants (Exhibit R-1). The consensus of the Committee was that any cash payments from the lessor to the lessee should be accounted for as reductions of rental expense over the term of the lease and that this method should be applied prospectively. In the resent appeal, using this method of accounting, the sum of $217,314 should have been credited to leasehold improvements and the balance deferred and amortized over the 10 year term of the lease. However, in 1985, there were no recommendations in the C.I.C.A. Handbook on the accounting for lease inducements. However, it would be incorrect to include such an amount in income in the year of receipt as there would not be a proper matching between receipt and the future economic benefit. In his opinion the appellant's accounting treatment of the leasehold inducement payment was not in accordance with GAAP but in the circumstances would not have been regarded as material and therefore would not have warranted a change in the financial statements.

Counsel for the appellant submitted that the appellant was, and is, in the retail and wholesale auto glass business and that the premises in question were only the third head office in the history of the company. Another potential landlord had offered a lease inducement payment to the appellant and it had never been in the business of buying, selling or otherwise trading in leases. Further, no business, other than administrative or head office functions were carried out at the leased premises. The lease inducement was not a reimbursement of leasehold costs or any other expenses and the amount of rent payable was not related to the inducement. Prior to May 23, 1985, there was no specific provision in the Income Tax Act to tax lease inducement payments, which oversight was corrected by the passage of paragraph 12(1)(x) of the Income Tax Act to bring lease inducement payments into income in the year of receipt. Counsel submitted that the present appeal should be decided in accordance with the decision in Woodward Stores Ltd. v. Canada, [1991] 1 C.T.C. 233, 91 D.T.C. 5090 (F.C.T.D.) and other cases which followed that line of reasoning in holding such inducement payments to be a non-taxable capital receipt. Counsel noted that the administrative policy of Revenue Canada, as set out in paragraph 9 of IT-359R2, dated December 20, 1983 remained unchanged as at 1986 when it maintained the same position with regard to lease inducement payments as stated at the Revenue Canada Round Table Conference.

Counsel for the respondent submitted the correct approach is to be found in the decision of Teitelbaum, J. of the Federal Court of Canada-Trial Division in the case of French Shoes Ltd. v. The Queen, [1986] 2 C.T.C. 132, 86 D.T.C. 6359 and that the inducement should fall into income in the appellant's 1985 taxation year.

In French Shoes, supra, Teitelbaum, J. of the Federal Court-Trial Division dealt with the issue of the appellant having received a $50,000 payment as an inducement to enter into a lease. At pages 138-39 (D.T.C. 6363-64) of his judgment, Teitelbaum, J. stated:

I am satisfied that the $50,000 received by plaintiff is part of its revenue. When a taxpayer receives an inducement to sign a lease, then those moneys received must form part of the taxpayer's revenue for the year in which the inducement was received. An inducement is not a "windfall" it is an incentive, a reason for doing something. Taxpayers and lessors use inducements as a form of doing business. For the lessor, it rents out space and for the taxpayer it is a benefit received. In the end, the receipt of the benefit helps to make a profit. It is part of the taxpayer's revenue that is derived because of, and is part of, its business activity.

In the present case, the money, $50,000, received by plaintiff is part of its business revenue.

Although each case must be judged on the facts of that particular case, I am of the opinion that incentive payments, inducements, generally form part of the revenue of the taxpayer. The payment is received as a result of the business activity carried on by the taxpayer and would not have otherwise been received.

Plaintiff contends that the defendant, in 1986, amended the Income Tax Act by adding article 12(1)(x) which states:

12(1)(x) payments as inducement or as reimbursement etc.— any amount (other than a prescribed amount) received by the taxpayer in the year, in the course of earning income from a business or property, from

(i) a person who pays the amount (in this paragraph referred to as "the payor”) in the course of earning income from a business or property or in order to achieve a benefit or advantage for himself or for persons with whom he does not deal at arm's length, or

(ii) a government, municipality or other public authority where the amount can reasonably be considered to have been received,

(iii) as an inducement, whether as a grant, subsidy, forgivable loan, deduction

from tax, allowance or any other form of inducement, or

(iv) as a reimbursement, contribution, allowance or as assistance whether as a grant, subsidy, forgivable loan, deduction from tax, allowance or any other form of assistance, in respect of the cost of property or in respect of an expense to the extent that the amount,

(v) was not otherwise included in computing the taxpayer's income for the year or a preceding taxation year, except

(vi) as provided by subsection 127(11.1), does not reduce, for the purposes of this Act, the cost or capital cost of the property or the amount of the expense, as the case may be,

(vii) does not reduce, pursuant to subsection 13(7.4) or paragraph 53(2)(s),

the cost or capital cost of the property, as the case may be, or

(viii) may not reasonably be considered to be a payment made in respect of the acquisition by the payor or the public authority of an interest in the taxpayer, his business or his property.

thus admitting that before the amendment, inducement payments such as received by plaintiff was not revenue.

I do not agree, article 37(2) of the Interpretation Act, R.S.C. 1970, c. 1-23 states:

37(2) The amendment of an enactment shall not be deemed to be or to involve a declaration that the law under such enactmentwas or was considered by Parliament or other body or person by whom the enactment was enacted to have been different from the law as it is under the enactment as amended.

Therefore, the amendment of the Income Tax Act does not imply a change in the law; it, in this case, clarifies the law with regard to inducement payments.

However, a different conclusion was reached by 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 (EC.A.) and by Joyal, J., both of the same Court, in Woodward, supra, a case in which the appellant had received two amounts totalling $3,750,000 by way of "fixturing allowances” and were in essence payments intended to induce it to enter into two long-term leases in two shopping centres. James Kerr, who testified in the present appeal, gave opinion evidence before Joyal, J. that to include those amounts into income would not be in accordance with GAAP. At pages 243-44 (D.T.C. 5099) (F.C.T.D.), Joyal, J. stated:

Does it follow, as the Crown contends, that the plaintiff was running a leasing business and moneys received from the developer represent current income? On the facts before me, I should not think so. As in the Westfair Foods case, the leasing of property to conduct a general merchandising business may be said to be part of the plaintiff's business, but the plaintiff is not in the business of buying or selling leases and to quote Hugessen, J.A. In Consumers’ Cas v. R., [1987] 1 C.T.C. 79, 87 D.T.C. 5008 (F.C.A.) the mere fact that certain receipts are not reflected in income does not make them income.

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

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

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

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

The Crown urges me to adopt the reasoning of Teitelbaum, J. in the French Shoes case, supra. No doubt, the learned judge's analysis of the facts before him invite a similar analysis of the facts before me. With respect, however, I should prefer to follow the line of reasoning of our colleague Reed, J. in the Westfair Foods case, supra, who did point out at page 150 (D.T.C. 5075) that the inducement paid to the taxpayer in the French Shoes case was "to apply the sum to its inventory" and not to capital improvements.

Reed, J. also stated at page 150 (D.T.C. 5075-76) that merely because the signing of leases is related to a taxpayer's business, it does not follow that termination payments should therefore be characterized as income receipts. “All capital receipts and capital expenditures”, she said, "are related to a taxpayer's business in some way or other".

It is common ground that paragraph 12(1)(x) was introduced to the Income Tax Act in 1986. This new provision constitutes a departure from generally accepted accounting principles and, for policy reasons, specifically categorizes inducement payments as income receipts. In the French Shoes case, the learned judge relied on the Interpretation Act to find that this new provision did not amena the law but merely clarified it.

With all respect, I am not at all sure that I should agree with my colleague on that point. Inducements were obviously a matter of concern to the Crown and, if one looks at the legislative history of paragraph 12(1)(x) of the Income Tax Act, the change it brought about certainly had elements of substance in it.

As for the effect of paragraph 12(1)(x) of the Income Tax Act and the view of that new provision as seen by Teitelbaum, J. In French Shoes, Joyal, J., at pages 245-46 (D.T.C. 5100), stated :

The existence of this transitional provision would seem to rebut, in my view, any presumption that the legislator merely intended to clarify the existing state of law when paragraph 12(1)(x) was enacted. However, paragraph 12(1)(x) also provides in subparagraph (v) that inducement payments shall be included in income to the extent that they are not otherwise included in computing the taxpayer's income for the year.

Some persons may take this particular subsection to mean that inducement payments may, even in the absence of paragraph 12(1)(x), be included in income, presumably by section 3 or subsection 9(1) of the Act. This was the case in French Shoes for example. However, insofar as inducement payments of a capital nature are now included in income by paragraph 12(1)(x) I think that paragraph 12(1)(x) has changed the state of the law.

Subsection 37(2) of the Interpretation Act, R.S.C. 1970, c. 1-23 [now subsection 45(2)] simply states that there is no presumption that a legislative amendment indicates a change in the law. This cannot mean that an amendment can never be interpreted as reflecting a change in the law, especially when there is external evidence to that effect.

In Nesbitt Thomson Inc. v. M.N.R., [1991] 2 C.T.C. 2352, 91 D.T.C. 1113 (T.C.C.), the Honourable Judge Bonner of the Tax Court of Canada considered the issue of an inducement payment. He found the appellant, as a holding company, held shares of the subsidiaries, derived income therefrom, provide certain other services required by them including the provision and fitting out of needed space and that it was in the course of doing so that it entered into the leases and received the inducement payments. At page 2355 (D.T.C. 1115), Judge Bonner stated:

The payments cannot in my view be seen to be windfalls. They were neither unusual nor unexpected, and in this regard I refer to The Queen v. Cranswick, [1982] C.T.C. 69, 82 D.T.C. 6073 (F.C.A.). The payments were the subject of bargaining between the landlords and the appellant and were, when settled, made the subject of enforceable provisions in the leases or agreements for leases. The word windfall is, I think, totally inappropriate to describe payments of the sort under review.

This case is distinguishable from that of a businessman who receives an isolated inducement payment in connection with the negotiation of a lease of space which he intends to occupy. He is establishing or extending his business organization or possibly moving the location thereof and not, as the appellant was, performing the day to day tasks involved in operating that business itself.

The present case is not analogous to that under consideration in Westfair Foods v. Canada, [1991] 1 C.T.C. 146,91 D.T.C. 5073; aff'd [1991] 2 C.T.C. 343, 91 D.T.C. 5625 (F.C.A.). That case is one in which Reed, J. held at page 150 (D.T.C. 5076) that the taxpayer:

. . . does not trade in leases. The headleases in its hands are capital assets. It needs physical premises from which to conduct its food distribution and sales business and these are obtained either by outright ownership of the premises or by way of long-term leases.

The decision of the Federal Court-Trial Division in Woodward Stores Ltd. v. Canada, [1991] C.T.C. 233, 91 D.T.C. 5090, is also distinguishable. There the taxpayer received payments characterized as fixturing allowances as inducements to enter into two long-term leases of space for use by it in conducting its general merchandising business. The payments were related to tenant improvements, that is to say the cost to the tenant of finishing space within the bare concrete perimeter walls, ceiling, and floor,

In the present case, although the space leased by the appellant was bare, the payments were not shown to be intended to defray fixturing costs. All that was shown was that the payments were not intended to be made until after tenant's work was completed or until time of move-in. Indeed, in the case of the Calgary premises, the inducement payments exceeded fixturing costs.

However, nothing, in my view, turns on the dedication or non-dedication of the payments to expenditures made in fitting out the premises. What is significant is that the payment to Woodward related to leases taken by it in expanding the structure of its business and not, as here, to leases taken as part of the day-to-day operation of the business.

In the present appeal, it is obvious that the appellant was not in the business, directly or indirectly, of buying, selling, trading or otherwise engaging in dealing with leases. The only concern was to relocate to a premise suitable for a head office, and even that relocation was only the second in the history of the corporation. The offer of the payment as an inducement to enter into the lease was common at that time and was a result of negotiations between the appellant, as tenant, and a landlord eager to have space occupied by a stable, financially solid tenant. There were no strings attached to its use. As a matter of interest, however, it should be noted that the appellant donated the sum of $250,000 to Canada Harbour Place Corporation, a federal Crown Corporation, as sponsors of the Canada Pavilion for Expo 86 in Vancouver. In my view, there is nothing before me which would call for a conclusion other than that which is supported by the weight of the authorities referred to, with the exception of the judgment of Teitelbaum, J. in French Shoes.

The appeal is allowed with costs on a party-party basis. The matter is referred back to the Minister for reconsideration and reassessment on the basis that the sum of $400,000 received as an inducement payment by the appellant in the 1985 taxation year be deleted from income.

Appeal allowed.