Westfair Foods Ltd. v. The Queen, 91 DTC 5073, [1991] 1 CTC 146 (FCTD), aff'd 91 DTC 5625 (FCA)

Reed, J.:—The issue in this case is whether certain sums ($880,000 and $1,000,000) paid to the plaintiff, in the years 1983 and 1984 respectively, on account of the early termination of leases should be treated for tax purposes as capital gains or as business income.

The plaintiff is a corporation with its head office in Winnipeg, Manitoba. It is a subsidiary of Kelly Douglas & Company which is in turn a subsidiary of Loblaw Companies Ltd. (‘ Loblaws”). The plaintiff is in the business of distributing and selling food, both at wholesale and retail, throughout western Canada. The retail aspect of the business involves selling food through stores which it operates, using a trade name such as“ Loblaws”, or through stores operated by a franchisee using a trade name such as "Super Valu”. In 1983 the plaintiff directly operated 48 stores and had 421 stores under franchise. In 1984 these numbers were 50 and 455 respectively.

In the case of some of these stores the plaintiff owns the property on which they are situated. It is not entirely clear from the evidence, in my view, whether it is the plaintiff, Westfair Foods, or a wholly owned subsidiary, Westfair Properties, which actually holds title. In any event, this does not matter. The plaintiff also holds, as lessee, leases relating to some of the retail and wholesale establishments.

Some of the premises which the plaintiff owns are operated by it; some are leased to franchisees or independents. Some of the premises on which the plaintiff holds leases are operated by it; some are subleased to franchisees or independents. More precisely the plaintiff, at the relevant time, had leased 14 of the properties it owned to franchisees or independents. It had subleased 11 of the properties for which it held long-term leases to franchisees or independents. The rent paid to the plaintiff, in either case, might include an amount calculated by reference to the percentage of sales which the franchisee or independent made. In the case of the subleases, the plaintiff's headlease could exist as the result of an assignment to the plaintiff by Loblaws of a lease which had originally been held by Loblaws. Alternatively, it could exist as a result of the plaintiff having negotiated directly with the owner or developer of a shopping centre for the lease.

One of the two leases in question in this case (for premises in the Chinook Shopping Centre in Calgary) had been sublet by the plaintiff to a franchisee, Ferraro Ltd., who operated under the name Super Valu. The other (for premises in the Polo Park Shopping Centre in Winnipeg) pertained to premises in which the plaintiff itself was operating a retail store, under the name Loblaws. It is necessary to recount the chain of title pertaining to both leases.

The first (the Chinook lease) originated as a lease from Oxford Leaseholds Ltd. to Loblaws signed in January 1965. That lease was for 25 years with a right of renewal for an additional ten years. On December 30, 1973, this lease was assigned by Loblaws to the plaintiff. Three years later the plaintiff subleased the premises to Ferraro's Ltd. which, as has already been noted, operated a retail store on those premises under the name Super Valu.

The second lease (the Polo Park lease) originated as a lease from Fairview Corporation Ltd. to Loblaws in October 1967. That lease was for a term of 25 years with two ten-year renewal terms possible. On December 30, 1973 Loblaws assigned that lease to the plaintiff. The plaintiff, thereafter, operated a food store on those premises under the name Loblaws.

In both cases it was the plaintiff's landlords who took the initiative in seeking to terminate the leases. In the case of the Chinook Shopping Centre premises, the landlord (Cambridge Leaseholds Ltd.—successor to the original landlord Oxford Leaseholds Ltd.) sought termination of the lease so that a Safeway Store could be moved into the space. In the case of the Polo Park lease, the landlord (Cadillac-Fairview—successor to the original landlord Fairview Corporation) sought termination of the lease to enable it to renovate and redevelop the whole shopping centre. The plaintiff was paid $880,000 with respect to the cancellation of the first lease and $1,000,000 with respect to the second.

In evaluating the acceptability of the $825,000, which the plaintiff had originally been offered for the first lease, the plaintiff assessed how much profit would be lost by it as a result of the early termination of that lease, i.e., calculated by reference to the difference between what it was paying to the landlord and the amount of rent it was receiving from Ferraro. In the case of the $1,000,000, a similar type of assessment was made but since the plaintiff itself was using the leased premises, this assessment was calculated by reference to the difference between what the plaintiff was paying to the landlord and what it would cost to rent similar premises if a lease had to be negotiated at that time (i.e., the market value of the lease).

The plaintiff included the sums of $880,000 and $1,000,000 in its income tax returns for the years 1983 and 1984 respectively as capital gains. The defendant takes the position that the amounts should have been included as business income.

The plaintiff relies on certain statements made by the representative of the defendant during the course of discovery:

Q. I mean, do they [the Plaintiff] enter into a lease as a tenant with the intention of making money or some day being able to dispose of that lease? Is that one of their—

A. Oh, no. As a tenant I would say our, the Department's position would be that no, as a tenant they would enter into the lease to minimize their cost.

Q. Yes, and their purpose—was it the Department's position that their purpose of entering into the lease as a tenant was to sell food through that premises?

A. To gain access to a location, I would have to say yes.

Q. Yes, okay. And so, in making the assessment the Department assumed that the leases were not items of trade when entered into by the Plaintiff?

A. I would say correct.

Q. And that can come about, it seems to be, from two different ways: either the leases are inventory items, or the leases are capital items but it’s part of the Plaintiff's business to change leases? Which is the, which assumption did the Department take?

A. I would say we, the position that we're taking now is that they're capital items but part of the Plaintiff's business.

Counsel for the plaintiff argues that those admissions end the matter. He argues that since the proceeds received by the plaintiff are proceeds received on the disposition of capital assets (the leases) the receipts are capital receipts.

Counsel for the defendant argues the contrary. He argues that since the plaintiff is in some circumstances a landlord, receiving rental income is a part of the ordinary course of the plaintiff's business. He notes, as well, that the disposition of the two leases in question did not affect the income-earning situation of the plaintiff. Accordingly, it is argued that the money received on cancellation of the leases was more of an income receipt than a capital receipt.

The defendant's argument is difficult to follow. A great number of cases were cited which deal with the characterization of a payment made on early termination of a trading contract or an agency agreement. Courrier M.H. Inc. v. The Queen, [1976] C.T.C. 567; 76 D.T.C. 6331 (F.C.T.D.); Pe Ben Industries Co. v. The Queen, [1988] 2 C.T.C. 120; 88 D.T.C. 6347 (F.C.T.D.); H.A. Roberts Ltd. v. M.N.R., [1969] S.C.R. 719; [1969] C.T.C. 369; 69 D.T.C. 5249 (S.C.C.); Edgerton Fuels Ltd. v. M.N.R., [1970] C.T.C. 202; 70 D.T.C. 6158 (Ex. Ct.); Packer Floor Coverings Ltd. v. The Queen, [1981] C.T.C. 506; 82 D.T.C. 6027 (F.C.T.D.); Short Bros. Ltd. v. C.I.R. (1926), 12 T.C. 955 (C.A.); Bush, Beach & Gent, Ltd. v. Road, [1939] 3 All E.R. 302; 22 T.C. 519 (K.B. Div.); Wiseburgh v. Domville, [1956] 1 All E.R. 754 (C.A.); Kelsall Parsons & Co. v. C.I.R. (1938), 21 T.C. 608 (Ct. Sess.).

These cases indicate that a payment made as a result of the early termination of an agency or trading contract may be characterized as either an income receipt or a capital receipt. Which characterization is appropriate will depend on the particular circumstances of the case. The question to be answered is whether the amount is being paid as a replacement for the loss of a capital asset or as a replacement for income. The degree of dislocation caused to the income-earning structure of the taxpayer is one factor which is relevant to the consideration. If the cancellation of the contract results in a significant degree of dislocation to that structure, then, it is more likely to be classified as a capital receipt than as an income receipt.

Counsel for the defendant argues that, in the present case, since the contract cancellations did not cause a significant dislocation to the plaintiff's income-earning structure, the termination payments should be characterized as income receipts. In my view, the cases cited are not relevant to the present situation. The leases which were terminated in this case were neither trading contracts nor agency contracts. Cadillac-Fairview and Cambridge Leaseholds Ltd. are not customers of the plaintiff nor did those companies hire the plaintiff to sublease properties for them. I am not persuaded that the cases listed above have any relevance for the present purposes, except to the extent that they set out the principle that you look to the nature of the subject matter for which the payment is a replacement in order to characterize it.

Counsel for the defendant also cites the decision in French Shoes Ltd. v. The Queen, [1986] 2 C.T.C. 132; 86 D.T.C. 6359. In that case, Mr. Justice Teitelbaum was faced with characterizing an amount paid to a retailer to enter into a lease with the owner of a shopping centre. The owner had tried repeatedly to persuade French Shoes to open a store in the mall. French Shoes refused on the ground that the customers served by the mall were not ones which would likely purchase the type of shoes sold by French Shoes. The mall owner, finally, in desperation, asked the proprietor of French Shoes what it would take to persuade him to open a store in the mall. The proprietor answered, in jest, $50,000 in cash. The mall owner produced the cash. French Shoes reported the $50,000 amount on its tax returns as windfall gain. The department took the position that it should have been included in income. Mr. Justice Teitelbaum agreed. In coming to that conclusion, he said at page 138 (D.T.C. 6363-64):

Was the payment unrelated to the taxpayer's business activities? At first glance one would have to answer in the affirmative, it was not related to the taxpayer's business activity of selling shoes. This would be true if I would only be restricted to looking at the business activity of plaintiff as only selling shoes to the public.

It is important, as part of plaintiff's business activity, to sign leases for stores under the best possible conditions, that is, the cheapest rent, the least amount of expenditures for start-up costs, etc. In the present case, there was an additional benefit, a single payment of $50,000 in addition to the other benefits already described.

I also believe that the plaintiff, after signing the lease, had a right to legally claim the $50,000 promised and moreover had, according to the lease, an obligation to apply the sum to its inventory.

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.

[Emphasis added.]

I am not convinced that that decision helps the defendant. The amount paid in that case could legitimately be characterized as compensation for income. It was described as imposing on the taxpayer "an obligation to apply the sum to its inventory”. Also, as I read that case, no argument seems to have been made as to whether the amount might be classified as a capital gain. In any event, it is not sufficient to say, as counsel would have me conclude on the basis of that case, that merely because the signing of leases is related to the plaintiff's business, a termination payment, in the circumstances of the present case, should therefore be characterized as an income receipt. Such a rule would wipe out all distinction between capital assets and income. All capital receipts and capital expenditures are related to the taxpayer's business in some way or other.

The plaintiff does not dispute the fact, that, the negotiation of leases for premiums and the sublease to franchisees is part of its business. The plaintiff agrees that the leases are related to the food distribution and sales business. However, it points out that it is not in the business of buying and selling leases. It 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.

In Golden Horseshoe Turkey Farms Ltd. v. M.N.R., [1968] C.T.C. 294; 68 D.T.C. 5198 (Ex. Ct.), it was held that the character of an abatement is to be assessed by reference to whether it is an abatement of a capital liability or an abatement received in the course of the appellant's normal trading operations. In Consumers' Gas Co. v. The Queen, [1987] 1 C.T.C. 79; 87 D.T.C. 5008 (F.C.A.) it was held that amounts received by Consumers' Gas as payment for the relocation of gas lines (the average number of relocations in a taxation year being 225) were capital receipts. Pacific Northern Gas Ltd. v. Canada, [1990] 1 C.T.C. 380; 90 D.T.C. 6252 (F.C.T.D.) dealt with a similar issue. The principle I deduce from these cases is that in characterizing a termination payment as exists in this case, one must look to the nature of the subject matter for which it is paid.

In my view, the amounts paid as compensation for the termination of the two headleases in the present case were paid as replacement for capital assets. They are therefore capital receipts.

Counsel for the defendant also referred to the decision in Re Pacific Mobile Corp., [1982] C.A. 501; 44 C.B.R. (N.S.) 190 (sub nom. Pacific Mobile Corp., Re; American Biltrite (Canada) Ltée. v. Robitaille). In my view, that case has no relevance to the present situation. It deals with bankruptcy law. It deals with the meaning of the term "ordinary course of business” for the purposes of determining the limitations on a debtor's activity after becoming insolvent. That case does not address the meaning of what constitutes profit arising from a taxpayer's ordinary course of business for the purpose of reporting income under the Income Tax Act.

For the reasons given the plaintiff's claim will be allowed. The plaintiff shall be entitled to its costs of the action.

Appeal allowed.