Avis Immobilièn G.M.B.H. v. The Queen, 94 DTC 1039, [1994] 1 CTC 2204 (TCC)

Rip, J.T.C.C.:—Avis Immobilien G.M.B.H. ("Avis"), a non-resident of Canada, was assessed tax for 1986 pursuant to subsection 115(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). Avis has appealed the assessment on the basis that the Minister of National Revenue ("Minister") ought to allow it to deduct a foreign exchange loss in calculating its capital gain from dispositions of property in accordance with paragraph 40(1 )(a) of the Act. [1]

Avis was formed under the laws of the Republic of Germany in November 1982 and at all relevant times was resident of Germany. The owners of the interests in Avis were Mr. Robert Vogel ("Vogel"), a citizen and resident of Germany, and Mrs. Karen Fischer ("Fischer"), Vogel's sister, a citizen of the Netherlands and a resident of Switzerland.

Prior to 1982 Vogel and Fischer had invested in Canada. They had purchased three immovable rental properties situated at 1625 Blvd. de Maisonneuve West, 2000—2100 Guy Street ("de Maisonneuve"), 3333 Queen Mary Road ("Queen Mary") and 1350 Sherbrooke Street West ("Sherbrooke") in the city of Montreal. On December 21, 1982 he and Fischer sold to Avis each of the properties for the following purchase prices:

The purchase price of $16,500,000 was payable and paid as follows:

(a) a cash payment in the amount of $10,060,268.86; and

(b) the balance of $6,439,731.14 payable as follows:

(i) the assumption of a debt in the amount of $1,039,731.14 secured by a first-ranking hypothec on the Sherbrooke property, payable to the Prudential Insurance Company of America; and

(ii) an amount of $5,400,000 payable to the vendors with interest at rates ranging from 9.1 per cent to 11.4 per cent per annum, payable monthly from January 1983 until December 1997.

Interest rates in Canada were high in 1982. To finance the purchase of the properties, Avis obtained three loans aggregating DM 21,000,000 from the Ham- ourgische Landesbank Girozentrale ("Bank") of Hamburg, Germany. At time of the loans DM 21,000,000 converted into $10,875,194.

The three loan agreements, dated December 21, 1982, provided, amongst other things, that:

(a) each loan was secured by hypothec registered on the particular property in the following amount:

(b) the principal amount of each loan was payable on 31 December 1997 with ongoing capital repayments of 1 per cent per annum;

(c) the loans bore interest at the rate of 9.5 per cent per annum;

(d) the appellant had no right to prepay the loans prior to March 30,1988; and (e) the loans were to be repaid in German currency.

The loan agreements also stated that:

. . . the borrower shall not sell further hypothecate or otherwise alienate the whole or any part of the property without the prior written consent of the lender. . . .

The three properties were the only assets of Avis.

By 1986, Avis was having difficulty with the management of the properties and the properties were in need of repair. The value of the Canadian dollar had depreciated relative to the German mark. Vogel also found Quebec taxes high compared to other jurisdictions. For these reasons Vogel decided it was best to sell the properties. Vogel had a long standing relationship with the bank which he did not want jeopardize and advised the bank.

In October 1986, the appellant agreed, subject to the bank's approval, to sell the properties to a Canadian company, MCLR Equities Inc. ("MCLR"), with whom the appellant was dealing at arm's length. The bank consented to the sales on certain conditions. First, it required Avis to repay its loans prior to the sale. The bank was prepared to finance the purchase but desired to deal only with Vogel and Fischer, according to Vogel. Arrangements were thus made for Avis first to sell the properties to Vogel and Fischer who would finance the purchase by borrowing personally from the bank DM 20,000,000. The loans were to be made on closing and were to be secured by hypothecs on each of the properties in favour of the Bank. Vogel and Fischer would then, in turn, sell the properties to MCLR subject to the hypothecs. The Bank also demanded a penalty payment from the appellant for its consent to the sale.

The properties were sold for $25,000,000 by Avis to Vogel and Fischer and by them to MCLR on December 15, 1986, as arranged. As of that date Avis had made capital repayments of DM 105,000 on the loan. The appellant also on that day paid to the bank:

(a) the full amount of the principal of the loan then outstanding of DM 20,895,000 which converted into $14,306,807; and

(b) a penalty of 5'/2 per cent of unpaid capital, equal to the amount of $786,866, in order to secure the right to prepay the loans.

The bank loaned Vogel and Fischer DM 20,000,000, to purchase the de Maisonneuve, Queen Mary and Sherbrooke properties; the loans were secured by hypothecs in different amounts on each of the properties. The deeds of loan and hypothec are dated December 15,1986 and were registered December 16, 1986. The bank granted an "acquittance" to Avis, which was dated December 18, 1986, and registered on January 12, 1987.

An income tax return (T 2 form) was filed on behalf of the appellant with respect to the 1986 taxation year within the time prescribed by the Act. The appellant declared a capital gain on dispositions of the properties of $3,866,996, calculated as follows:

The “outlay or expenses" included an amount of $3,485,996 representing the difference between:

plus, amongst other amounts, the amount of the prepayment penalty of $788,666.2 [2]

Mr. Ronald Gallay, the appellant’s chartered accountant, testified that when the return was being prepared it was his view that the $3,485,996 was an expense incurred "strictly" as a result of selling the properties and "therefore related to the sale"; this expense would not have been incurred had the properties not been sold.

By notice of assessment dated 28 September 1990, the Minister disallowed the deduction of the $3,485,996 foreign exchange loss and added back an amount of $1,742,998 representing the taxable portion of the additional capital gain. The Minister agreed the prepayment penalty of $788,666 was a cost of disposition. [3] In the Minister’s view the foreign exchange loss was neither an outlay nor an expense to the extent that it was made or incurred by Avis for the purpose of making the dispositions of the three properties contemplated by subparagraph 40(1)(a)(i) of the Act. The loss was incurred for the purpose of extinguishing the debt of the appellant to the bank: subsection 39(2).

The appellant submits that the amount of $3,485,996 it paid to the bank was an outlay or expense "made or incurred . . . for the purpose of making the disposition" within the meaning of subparagraph 40(1)(a)(i) and therefore was deductible in computing its capital gain from the dispositions of the properties.

The appellant had to repay the loan in order to sell the properties, it says, and in so doing it incurred an expense. The appellant argues that in principle and in accordance with the spirit of the Act, the calculation of the appellant's gain arising from the dispositions of the properties necessitates the deduction of all outlays and expenses incurred by the appellant for the purpose of making the dispositions, including the expenses incurred to repay the bank loans. Any other construction or interpretation of the capital gains provision of the Act would result in taking into account as a gain an amount that is more than the appellant's actual gain and such an interpretation would not comply with section 12 of the Interpretation Act, R.S.C. 1985, c. I-21.

In the alternative, the appellant argues that the amount of $3,485,996 was part of the adjusted cost base to it of the properties immediately before their dispositions.

Subparagraph 40(1)(a)(i) provides:

40 (1) Except as otherwise expressly provided in this Part

(a) a taxpayer's gain for a taxation year from the disposition of any property is the amount, if any, by which

(i) if the property was disposed of in the year, the amount, if any, by which his proceeds of disposition exceeds the aggregate of the adjusted cost base to him of the property immediately before the disposition and any outlays and expenses to the extent that they were made or incurred by him for the purpose of making the disposition. . . .

The main issue to be decided, then, is whether the foreign exchange loss was an outlay or expense and, if so, whether it was made or incurred for the purpose of selling the three properties.

Onus of proof

In the course of making his submissions, counsel for Avis raised a procedural argument that the respondent had the onus to prove the foreign exchange loss was not “for the purpose of making the disposition”. Counsel first declared the respondent's denial that the outlay or expense was made for the purpose of making the disposition is not clear from documentation sent to the appellant. He also argued that since the respondent's reply stated that in assessing Avis, the Minister proceeded, amongst other things, on the basis that:

[T]he said "foreign exchange loss" was not an outlay nor an expense but even if it were considered to be an outlay or an expense it would not have been made for the purpose of making the disposition of the properties but for the purpose of extinguishing the debt of the appellant the respondent pleaded in the alternative.

This issue, then, is whether the Minister properly and sufficiently disclosed the basic foundation of the assessment so that the appellant knew the case it had to meet: Johnston v. M.N.R., [1948] S.C.R. 452, [1948] C.T.C. 195, D.T.C. 1182, Conway Estate v. M.N.R., [1965] C.T.C. 283, 65 D.T.C. 5169 (Ex. Ct.), at page 287 (D.T.C. 5172) and M.N.R. v. Pillsbury Holdings Ltd., [1964] C.T.C. 294, 64 D.T.C. 5184 (Ex. Ct.), at page 302 (D.T.C. 5188).

Avis was not prejudiced by the pleadings of the respondent. The Minister had advised Avis in his notice of confirmation of the assessment that:

. . . the loss on foreign exchange . . . was not incurred within the meaning of subparagraph 40(1)(a)(i) . . . accordingly the allowable capital loss . . . has not been deducted from your income in accordance with the provisions of subsection 115(1). . . .

On receipt of the notice of confirmation Avis was advised it would have to meet a case under subparagraph 40(1)(a)(i). The provision states capital gain is equal to the proceeds of the property less any outlay or expense if such outlay or expense was made for the purpose of the disposition.

Hence, the taxpayer must come within subparagraph (i) to reduce the capital gain. The Minister is not limited to only one ground in assessing. If the amount is an outlay or expense it must then meet the "purpose" test. This is not pleading in the alternative as discussed in the cases cited by counsel: Fradet et al. v. The Queen, [1986] 2 C.T.C. 321, 86 D.T.C. 6411, (F.C.A.); The Queen v. Stirling, [1985] 1 C.T.C. 275, 85 D.T.C. 5199 (F.C.A.) and Gaynor v. The Queen, [1991] 1 C.T.C. 470, 91 D.T.C. 5288 (F.C.A.).

The taxpayer's notice of appeal does not lack anything which indicates, even remotely, that the taxpayer is unaware of the case it has to meet. Indeed, in its notice of appeal, the appellant's first reason for the appeal is that the foreign exchange loss was "made or incurred . . . for the purpose of making the disposition”. The vast majority of evidence led by both counsel in examination in chief and cross-examination of witnesses related to whether the foreign exchange loss was made for the purpose of making the dispositions of the properties. Indeed the facts alleged in the pleadings of the parties are not really dissimilar. It is the interpretation one is to give to those facts that is in issue. There is no shift in onus on proving any fact.

Outlay and expense

Counsel for the respondent submitted the foreign exchange loss was not an Outlay or expense. He argued that loss was not an expending of money referred to by Hugessen, J., in Demers, supra. In counsel's view the loss was notional in that Avis borrowed German marks and repaid its lender in German marks. Avis did not disburse any Canadian currency.

The Act itself does not define the terms "outlay" and "expense". An outlay or an expense may be on account of income or capital. Most of the cases considering the words “outlay” and "expense" related to the calculation of income from a business and the courts have relied in the meaning of the words their meanings in determining profits of a business: Associated Investors of Canada Ltd. v. M.N.R., [1967] C.T.C. 138, 67 D.T.C. 5096, per Jackett, P., and Canadian General Electric Co. v. M.N.R., [1962] S.C.R. 3, [1961] C.T.C. 512, 61 D.T.C. 1300.

An outlay is "the expending of a sum of money": Fradet et al., supra, at page 325 (D.T.C. 6413), per Hugessen, J. In MacMillan Bloedel Ltd. v. Canada, [1990] 1 C.T.C. 468, 90 D.T.C. 6219 the Federal Court, per Collier, J., considered, amongst other things, whether a foreign exchange loss was deductible in computing income from a business in accordance with subparagraph 20(1)(e)(ii). At page 476 (D.T.C. 6225) Collier, J., stated:

Mr. Culver [a chartered accountant called as an expert witness by the defendant], in his evidence in chief, described the foreign exchange loss as a "cost", but seemed unwilling to characterize that cost as an expense. I so characterize it; and deductible under. . . the statute.

See also, for example, Eli Lilly and Co. v. M.N.R., [1955] S.C.R. 745; [1955] C.T.C. 198, 55 D.T.C. 1139; Gaynor v. The Queen, supra, D.W.S. Corp. v. M.N.R., [1968] C.T.C. 65, 68 D.T.C. 5045, at pages 75-76 (D.T.C. 5052) per Thurlow, J., (as he then was) and Texas Co.(Australia) Ltd. v. Federal Commissioner of Taxation (1939), 63 C.L.R. 382 (Aust H.C.), at pages 426-30, 465-67, 469.

A foreign exchange loss, then, may be an outlay or expense for the purpose of determining income from a taxpayer's business. However, whether a foreign exchange loss may be an outlay or expense contemplated by subparagraph 40(1)(a)(i) has not been previously considered. It has been argued that a capital gain or loss on foreign exchange is determined only by subsection 39(2). It does not follow that a capital gain necessarily should be computed according to the same rules as income from a business or property: The Queen v. Stirling, supra, at page 276 (D.T.C 5200), per Pratte, J.I, however, shall assume that there may be circumstances when a foreign exchange loss may be an outlay or expense which may be applied to reduce a capital gain.

"For the purpose"

Appellant's counsel, Me. Du Pont, says the foreign exchange loss was incurred for the purpose of selling the properties in Montreal. Counsel argues that to deny a deduction of the loss on converting the Canadian currency to German currency on the dispositions of the properties would artificially inflate the gain. He suggested that the transactions are to be appreciated in the light of the practical and essential business purposes which they were calculated to achieve. He referred the Court to Bo water Power Co. v. M.N.R., [1971] C.T.C. 818, 71 D.T.C. 5469, at page 837 (D.T.C. 5480), per Noël, J., Fradet v. The Queen, supra, at 428 (D.T.C. 5448), per Walsh, J., and Firestone v. The Queen, [1987] 2 C.T.C. 1, 87 D.T.C. 5237 at page 12 (D.T.C. 5245), per MacGuigan J.

Counsel declared that on the face of the deeds Avis could not sell the property without the bank's consent and the bank would only consent if its loans were repaid. The appellant considered the price it was to receive for the properties and the costs of the penalty and the foreign exchange loss prior to making the dispositions and concluded the dispositions were "good deals”. In accordance with Bowater, supra, the essential business purpose to be achieved by the transactions and what the repayment of the loans was "calculated to effect from a practical business point of view" was the sale of the properties. More particularly, the foreign exchange loss was calculated to effect the sale of the properties; without agreeing to suffer that loss, the properties could not have been sold.

Appellant's counsel stated that the fact the foreign exchange loss was incurred in the course of repaying the loans does not in any way preclude a finding that the outlay was indeed made for the purpose of disposing of the properties. An outlay may oe made for more that one purpose: Fradet et al., supra, at page 324-25 (D.T.C. 6413-14) per Hugessen, J.

Me. Du Pont referred to a number of cases which considered whether particular expenses were incurred for the purpose of earning income. [4] He concluded from these cases that absent a specific statutory provision to the contrary, costs which are part of the process of disposing of a capital asset are deductible from the proceeds of disposition of the asset in computing the gain on the disposition for the year of the dispositions, provided the costs are not otherwise deductible in computing income for the year.

In counsel’s view the foreign exchange cost was no different in principle from the prepayment penalty paid to the Bank which the Minister allowed to be deducted in computing the capital gain. The phrase "for the purpose of making the disposition" has been given a broad meaning by the courts, counsel said. He referred to the following cases: Campbellton Enterprises Ltd. v. M.N.R., [1990] 2 C.T.C. 2413, 90 D.T.C. 1869 (T.C.C.), Pollard v. M.N.R., [1988] 1 C.T.C. 2138, 88 D.T.C. 1110 (T.C.C.), Collin v. M.N.R., [1990] 2 C.T.C. 92, 90 D.T.C. 6369 (F.C.T.D.), Samson Estate v. M.N.R., [1990] 1 C.T.C. 2223, 90 D.T.C. 1144 (T.C.C.), and Fradet, supra. In the last case the taxpayers sold their shares in a corporation for $7,800,000. However pursuant to the agreement of purchase or sale, on closing they were to pay to the corporation $1,402,225, the face value of a debt owed to the corporation by another company. The market value of the debt was $600,000. The taxpayers deducted the difference between the face and market values in determining their proceeds of dispositions of the shares. Pratte and MacGuigan, JJ. of the F.C.A. held the agreement, properly construed, provided the taxpayers would use part of the sale price to pay the debt owing to the corporation and they were correct in reducing the proceeds, relying on subparagraph 54(h)(i). Hugessen, J., found the difference between the market and face values of the debt was an expense or outlay incurred to dispose of the shares within the meaning of subparagraph 40(1 )(a)(i).

Counsel also submitted that if the Minister's assessment is upheld, the appellant would be taxed on an amount that is $3,485,996 more than its economic gain. Section 12 of the Interpretation Act, he said, requires that subparagraph 40(1)(a)(i):

. . . be given such fair, large and liberal construction and interpretation as best ensures the attainment of its objects.

He suggested that to interpret subparagraph 40(1 )(a)(i) in a manner that would result in taking into account as a gain an amount that is more than the appellant’s actual economic gain contravenes section 12 of the Interpretation Act. He relied on the following comments of Lord Wilberforce in Aberdeen Construction Group Ltd. v. C.I.R., [1978] 2 W.L.R. 648, [1978] 52 T.C. 281 (H.L.), at page 651 (W.L.R.):

The capital gains tax is of comparatively recent origin. The legislation imposing it, mainly the Finance Act 1965, is necessarily complicated, and the detailed provisions, as they affect this or any other case, must of course be looked at with care. But a guiding principle must underlie any interpretation of the Act, namely, that its purpose is to tax capital gains and to make allowance for capital losses, each of which ought to be arrived at upon normal business principles. No doubt anomalies may occur, but in straight-forward situations, such as this, the courts should hesitate before accepting results which are paradoxical and contrary to business sense. To paraphrase a famous cliche, the capital gains tax is a tax upon gains: it is not a tax upon arithmetical differences.

In the view of counsel for the appellant, subsection 39(2) of the Act is not relevant to the calculation of a capital gain and the rule in subsection 39(2), if it applies, does not preclude the application of subsection 40(1) on the facts of this appeal. Nothing in subsection 39(2) expressly overrides the rules laid down in section 40. Subsection 39(2), he stated, does not determine proceeds of dispositions or costs of property. What subsection 39(2) does, he added, is to deem for certain purposes and in certain circumstances the existence of capital gains or losses resulting from a fluctuation of currency of a country other than Canada.

In support of the Minister’s claim that the foreign exchange cost was not laid out or incurred for the purpose of selling the properties, Me. Roy, respondent's counsel, directed me to Pattison H.M. Inspection of Taxes v. Marine Midland Ltd., [1984] A.C. 362, 57 T.C. 219, a decision of the House of Lords. In that case Lord Templeman found that the taxpayer, a resident of the United Kingdom who carried on the business of a commercial banker, did not make any capital or other loss when it repaid with $15,000,000 in U.S. funds a loan of $15,000,000 in U.S. funds, although the U.S. dollar appreciated over sterling during the time the loan was unpaid, from £6,000,000 to nearly £8,500,000. Lord Templeman explained at page 372 (A.C.):

A profit or loss may be earned or suffered if a borrower changes the currency he borrows but that profit or loss arises from the exchange transaction and not from the borrowing.

Me. Roy submitted that by virtue of paragraph 2(3)(c) of the Act that Avis is liable to pay tax in Canada: Avis is a non-resident who disposed of taxable Canadian property. Paragraph 115(1 )(b) defines taxable Canadian property which does not include foreign currency. The provisions of subsection 39(2) are not available to non-residents of Canada.

Increase to cost base

The appellant’s counsel also submitted that in the event I hold the foreign exchange cost was not incurred for the purposes of making the dispositions the foreign exchange cost is to be included in the appellant’s adjusted cost base of each of the properties immediately prior to their dispositions. He stated the foreign exchange loss was a cost of holding and maintaining the property and is to be added to the property's original acquisition cost. He relied on the reasons of Stone, J., of the Federal Court of Appeal in Bodrug Estate v. Canada, [1991] 2 C.T.C. 347, 91 D.T.C. 5621, as authority for the proposition that the terms and scheme of the Act relating to the computation of capital gains do not limit the "cost" of a capital asset to the price of acquiring such asset. He adds that there is no support in the Act for excluding from the computation of capital gains costs incurred by a taxpayer in order to put itself in a position to acquire and dispose of an asset.

Analysis

The words "for the purpose of” are found not only in subparagraph 40(1)(a)(i) but in other provisions of the Act as well. The words are used, for example, in paragraph 18(1)(a) and counsel for the appellant has cited several cases where various expenses or outlays were deductible in computing income from a business (R. v. Lavigueur, [1973] C.T.C. 773, 73 D.T.C. 5538 (F.C.T.D); R. v. FH. Jones Tobacco Sales Co., [1973] C.T.C. 784, 73 D.T.C. 5577 (F.C.T.D.); Mosport Park Ltd. v. M.N.R., [1977] C.T.C. 2397, 77 D.T.C. 264 (T.R.B.); Frappier v. M.N.R., [1976] C.T.C. 85, 76 D.T.C. 6066 (T.D.); Eli Lilly, supra; and D.W.S. Corp., Supra.) However, one ought not to lose sight that what may be a valid proposition to determine whether an expense or outlay is deductible in computing income may have no influence in computing a capital gain. In Bodrug Estate, supra, Stone, J., stated, at page 352 (D.T.C. 5625):

In my view, the principles which apply to the determination of ordinary income for income tax purposes are not in play. We are concerned with the computation of a capital gain within a particular statutory regime.

and he rejected the argument of the Bodrug Estate that tax consequences of a damage award are dependent upon an analysis of the underlying liability. The comments of Thorson, P., in Imperial Oil Ltd. supra, at pages 370-74 (D.T.C. 1098-100), apply to disbursements or expenses laid out or incurred in the course of various operations and transactions carried on by a business and not to one particular transaction of a capital nature. See also Stirling, supra.

In 1983, Avis borrowed German marks from the Bank, changed the marks to Canadian dollars and then purchased the properties. In 1986, Avis entered into at least three transactions: it sold the properties, it converted at least a portion of the Canadian funds it received from the sales of the properties to German marks and it repaid the bank with the marks. The number of Canadian dollars Avis required to repay the bank with marks was greater than the number of dollars it received in 1983 when it converted the marks it borrowed to dollars. I accept Lord Templeman's description of the foreign exchange loss, that it arises from the exchange transaction and not from the borrowing.

If I accept the appellant's basic premise in the appeal, that the loan was repaid for the purpose of disposing of the properties—and I infer from the evidence that the loan would not nave been repaid had the sale not taken place—then its appeal must fall since no outlay or expense was incurred by him in the transaction of repaying the loan. In other words a transaction consisting of marks being repaid with marks took place and there was no foreign exchange loss flowing from that transaction.

Any outlay or expense was incurred as a result of another transaction, marks being exchanged for dollars in 1983 and then, in 1986, more dollars being reconverted into the number of marks borrowed in 1986 (ignoring the modest portion of the loan repaid over the three years). Therefore the question becomes: was the foreign exchange loss itself, independent of the repayment of the loan, made or incurred for the purpose of making the dispositions?

Notwithstanding Me. Du Font's submission that the Federal Court of Appeal in Neonex Int'l Ltd. v. The Queen, supra, (see also Riviera Hotel Co. v. M.N.R., [1972] C.T.C. 157, 72 D.T.C. 157 (F.C.T.D.)) took a restrictive approach which is inconsistent with more recent court decisions, this decision is still binding on me. The Court of Appeal held that a payment made by Neonex to return existing debt obligations in order to make a new loan could not be considered to have been incurred "in the course of borrowing of money used by the taxpayer for the purpose of earning income from a business .. . .” (subparagraph 20(1)(e)(ii)).

In his reasons for judgment in Neonex, Urie, J., stated, on page 495 (D.T.C. 6345):

In my view, the payment . . . while in a sense necessary for the fulfillment of a condition imposed in respect of a second borrowing, is more properly characterized as a bonus paid to induce the first lender. . . to forego its right to hold its first mortgage to maturity by permitting the mortgagor, . . . , to prepay it.

Appellant's counsel argued that a major difference in the facts at bar and those in Neonex, was that in the latter case the taxpayer had no obligation to repay the first loan in order to enter into the second but chose to do so as a matter of preference. However, he said, Avis had no choice but to repay the loans in order to sell the properties. I cannot agree with counsel that his client had no choice but to repay the loan. Firstly, it was the appellant's choice to sell the properties in the same way Neonex decided to make a second loan. There is no evidence anybody held a gun to the heads of Vogel and Fischer to force them to cause Avis to sell. Once Avis decided to sell it entered into negotiations with its Bank and freely accepted the bank’s conditions, as did Neonex with its first lender.

The words "for the purpose of" are susceptible of different meanings depending on whether the purpose is immediate or ultimate, direct or indirect or initial or final. Subparagraph 40(1)(a)(i) provides a rule for determining what outlays and expenses may be deducted in calculating a taxpayer's capital gain. The words "for the purpose of" in subparagraph 40(1)(a)(i) are directed to the action of making a particular disposition. The outlays and expenses in that provision are directed to a particular disposition and no other.

In the facts at bar Avis entered into two transactions prior to selling the properties; it repaid the loan and exchanged currencies. While the repayment of the loan may have been transacted in order to dispose of the properties, the exchange of currencies was transacted for the purpose of repaying the loan in German marks. In other words, it may be said that the transaction of converting the currency was made for the purpose of repaying the loan in a certain foreign currency and the repayment of the loan was made to dispose of the properties.

The words “for the purpose of" in subparagraph 40(1)(a)(i) mean "for the immediate or initial purpose of” and not the eventual or final goal which the taxpayer may have in mind. To give the words the latter meaning would permit the most indirect or most distantly related outlay or expense to reduce the amount of a gain. This could not have been Parliament's intent. We are not dealing in subparagraph 40(1)(a)(i) with the computation of income from a business, which is of a ongoing nature, but, rather, expenses or outlays made or incurred to dispose solely of capital properties. The statutory provision under consideration sets out a rule to determine a taxpayer's capital gain from the disposition of property and only expenses or outlays to be applied in reducing the gain are those incurred or made directly for the purposes of making the disposition. Subparagraph 40(1)(a)(i) does not contemplate expenses or outlays which may have merely facilitated the making of the disposition or which were entered into on the occasion of the disposition.

Foreign exchange losses are specifically dealt with in subsection 39(2) of the Act, as submitted by respondent's counsel. What the appellant appears to be trying to do is incorporate subsection 39(2) into subsection 115(1) and turn a deemed disposition of the type contemplated by subsection 39(2) into a disposition of taxable Canadian property within subsection 115(1). This attempt to rationalize the appellant’s position cannot succeed.

I also do not find merit in counsel for the appellant’s alternate argument that the foreign exchange loss is to be added to the cost base of each of the properties prior to their dispositions. I cannot find any support for Me Du Font's submission in the reasons of Stone, J., in Bodrug Estate, supra. Indeed, Stone J., added to his comments at page 352 (D.T.C.) 5625, cited above, that:

As I see it, the appellant can succeed only if it is able to bring itself within the relevant language [of the statute].

Subsection 53(1) of the Act sets out the amounts that may be added to the cost base of a taxpayer's property. I am unable to find in subsection 53(1) or elsewhere in the Act any amount of foreign exchange loss in the circumstances at bar that may reduce the capital gain.

The appeal is dismissed with costs.

Appeal dismissed.

Supermarché Dubuc & Frère Inc. v. Her Majesty The Queen (informal procedure)

[Indexed as: Supermarché Dubuc & Frère Inc. v. Canada]

Tax Court of Canada (Garon, J.T.C.C.), October 8, 1993 (Court File No. 92-2846).

Income tax—Federal—Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63)—9(1), 12(1)(x), 14(5)(b), 22(1), 248(1) "business"—Eligible capital propertyinducement

payments.

The appellant operated a grocery business in Québec. Since 1977 or 1978, the appellant had operated under the banner of Métro-Richelieu Inc. (M Inc.). On June 30, 1988, an important change occurred in the business relations between the appellant and M Inc. On that date, the appellant and M Inc. entered into an agreement whereby M Inc. agreed to pay the appellant $75,000 and the appellant undertook to operate its business under the M Inc. banner, and in particular undertook to observe certain quotas in M Inc.’s favour for the purchasing of various categories of food products. Specifically, M Inc. acquired the following four rights pursuant to the agreement. First, it acquired a priority right to purchase before any other purchaser the appellant's business or any other business it might operate in the future. Second, in the event that M Inc. did not exercise its right to purchase the business, M Inc. was the beneficiary of the appellant’s promise that the purchaser of the business would have to sign an agreement to be a member of M Inc. and give an undertaking to M Inc. to observe the rights conferred on it by the agreement for the unexpired portion of the 20 year period specified by the agreement, such period ending on June 29, 2008. Third, M Inc. was the beneficiary of the appellant’s obligation to obtain supplies from M Inc. Fourth, M Inc. was given the benefit of a general penalty clause with regard to each failure of the appellant to perform the obligations stated in the agreement. Pursuant to this clause, each of the appellant's transgressions brought a penalty of $400,000 in the first ten year period and $700,000 in the second ten year period. In its 1988 taxation year, the appellant considered the $75,000 to be the proceeds of disposition of eligible capital property and as such included the sum of $36,560 in its income. By assessment, the Minister included the full $75,000 in the appellant’s income on the basis that paragraph 12(1)(x) applied. The issue was whether the $75,000 payment could reasonably be regarded as a payment made for the acquisition by M Inc. "of an interest in" the appellant, “in its business" or “in its property" within the meaning of subparagraph 12(1)(x)(viii).

HELD:

It was beyond question that M Inc. acquired rights relating to the activities of the appellant connected with the operation of its business. The appellant’s hands were tied in several respects. In operating its business the appellant was required, under the very wording of the agreement, to obtain supplies from M Inc. and from suppliers designated by M Inc. to a very large degree. This undertaking was accompanied specifically by a penalty clause in M Inc.'s favour. The appellant also could not cease doing business by selling its operation without first giving M Inc. the right to purchase the latter within the stated deadline. It was also provided that in the event M Inc. did not exercise its right to purchase the latter the appellant had to make sure that the purchaser of the business signed a contract to be a member of M Inc. and observe the rights conferred on M Inc. for the unexpired portion of the term of the agreement. M Inc. thus held rights regarding how the appellant would cease operating its business. In the result, paragraph 12(1)(x) did not apply to the $75,000 payment because the $75,000 could reasonably be considered a payment made for the acquisition by M Inc. of rights in the appellant’s business within the meaning of subparagraph 12(1)(x)(viii). Appeal allowed.

André Lareau for the appellant.

Johanne Boudreau for the respondent.

Garon, J.T.C.C.:—This is an appeal under the informal procedure from an assessment of the Minister of National Revenue dated August 9, 1991 for the appellant’s 1988 taxation year. By that assessment the Minister of National Revenue included in the appellant’s income $75,000 received from Métro- Richelieu Inc. ("Métro"), whereas the appellant had considered that the amount was the proceeds of disposition of eligible capital property and as such had included the sum of $36,560 in its income. According to the Minister of National Revenue's confirmation notice, this addition to the appellant’s income was made pursuant to the provisions of paragraph 12(1)(x) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

There is no dispute as to the facts concerned in this appeal.

Jean-Claude Dubuc was the only person to testify for the appellant, while the respondent called Claude Brunetta, Vice-President, Expansion and Banner Development, for Métro.

Mr. Dubuc stated that he began operating a grocery business on July 1, 1973 under the trade name Dubuc & Frères Enr. A joint stock company was subsequently established to continue operating this business. The grocery business was first operated under the Trans-Québec banner and from 1977 or 1978 onwards under the Métro banner. Neither Mr. Dubuc during the period prior to the creation of the appellant nor the latter thereafter was required to purchase fruit, vegetables and meat from Métro. There was no agreement, even oral, between them and Métro.

On June 30, 1988 an important change occurred in the business relations between the appellant and Métro. On that day the appellant on the one hand, and Métro-Richelieu Inc. and Épiciers Unis Métro-Richelieu Inc. ("Épiciers") [1] on the other, entered into an agreement in the form of a letter which covered several aspects of the appellant's business. This letter, from which I omit the introductory part and the final portion where the signatures of the parties to the agreement appear, is set out below:

For good and valid consideration and as a further security beside the other securities and undertakings already given, and notwithstanding the terms and conditions of any agreement, contract, settlement or other transaction by which we may be bound to Métro-Richelieu Inc. ("Métro") or Épiciers Unis Métro-Richelieu Inc. ("Épiciers"), we hereby undertake jointly and severally to continue firmly and irrevocably our membership of Métro and Épiciers for a minimum period of 20 years ending on June 29, 2008 ("the period”). It is agreed that during the period we shall operate the food business located at 887 Marie-Victorin, Deschaillons ("the business") under the Métro banner or any other banner acceptable to Métro and Épiciers.

We further hereby agree that during the period Métro and Épiciers shall have a right of first refusal over the business or any other food business at present operated or to be operated by ourselves, directly or indirectly, under one of the Métro or Épiciers banners during the period, in the event of receipt of a purchase or sale offer for the said business(es) or for 20 per cent or more (in one or more transactions) of the issued shares of the capital stock of the company operating the said business(es), so that Métro and Épiciers shall have a priority right to purchase the said businesses) or the said shares over any other purchaser.

In this regard, before accepting any purchase or sale offer pursuant to the aforementioned right of first refusal, we shall send Métro and Épiciers a copy of the said offer and Métro or Épiciers shall have a priority right to purchase the said business(es) or shares on the same terms and conditions as specified in the said offer, within 30 days of receipt of a copy of the offer.

If Métro or Épiciers does not exercise its priority purchase option within this 30- day deadline, we shall then proceed within the next six months to the sale contemplated by the offer received on the terms and conditions initially stated in the said offer, failing which Métro and Épiciers shall retain their priority purchase right.

We further agree that in the event that Métro or Épiciers does not exercise their priority purchase right as stated above, any purchaser, successor or assignee of our rights in the said business(es) and any shareholders of such purchaser, successor and assignee shall sign with Métro and Épiciers, before any such assignment, an agreement making them members of Métro or Épiciers and shall similarly give an undertaking to Métro and Épiciers to observe the rights herein conferred for the unexpired portion of the period, failing which any such assignment shall be null and void.

We further agree to obtain our supplies of all goods and products required from Métro or Épiciers or from suppliers designated by either one, so that the sum of our purchases^ from the Épiciers warehouses and by direct deliveries authorized and billed by Épiciers during its fiscal year shall be at least 68 per cent of our retail sales of grocery products, 68 per cent of our retail sales of meat and 56 per cent of our retail sales of fruit and vegetables.

Métro and Épiciers shall at the end of their fiscal year determine whether we have observed the required minimum fidelity ratios and we undertake to repay to Métro or Épiciers on demand an amount equivalent to five per cent of the difference between the amount of actual purchases and the minimum purchases required under the above rule if the amount of actual purchases is less than the amount of deemed purchases in each of the aforementioned categories of product.

We further undertake to use the supplier designated by Métro for purchasing, renting and laundering uniforms.

We further hereby agree that Métro and Épiciers shall have a priority right to purchase our rights in the lease held by us for operation of the aforementioned businesses in the event that the premises so occupied are relinquished. In this regard we shall inform Métro and Epiciers in writing before notifying our lessor of such relinquishment. Métro and Épiciers shall then have a priority option to purchase our rights and interest in one or more of the said leases within 30 days following receipt of the aforementioned notice. If Métro or Épiciers then decides to purchase our rights, a fair and equitable determination of the consideration to be paid for assignment of the said lease or leases shall then be made by the partie within the next 30 days.

Please take note that in the event of your acceptance hereof the undertakings given herein shall be considered an integral part of other undertakings already given or to be given in accordance with the policies of Métro or Épiciers. However, the termination of the undertakings given herein shall not have the effect of terminating all other undertakings, contracts or agreements which may then exist between Métro, Épiciers and the undersigned.

It is agreed that we may not assign or transfer the rights and obligations conferred on us hereunder without the prior written consent of Métro and Épiciers. Further, all costs, charges and expenses incurred by Métro and Épiciers as a consequence of acts or omissions of the undersigned and, without limiting the generality of the foregoing, all costs accruing to Métro or Épiciers as the result of any legal proceeding of any kind whatever brought by them to assert their rights and remedies or to collect money owed hereunder and interest thereon shall be assumed by us.

Without prejudice to the other rights and remedies of Métro and Épiciers in the circumstances, we jointly and severally agree that in the event of our default hereunder we shall pay Métro and Épiciers, and for each such default as a penalty and in addition to any other amount which may then be owed to them, the sum of $400,000 for the first ten-year term and the sum of $700,000 for the second ten- year term, the said money to be payable when such default occurs, without prejudice to the other rights of Métro and Épiciers resulting from law or from other agreements.

It is hereby agreed that any notice, demand or communication to be given or made hereunder shall be given or made in person or sent by registered mail to the following address:

(a) Métro or Épiciers:

11 011, boulevard Maurice Duplessis

MONTREAL, Québec

H1C 1V6

Attention: Vice-President, Administration

(b) to ourselves:

SUPERMARCHE DUBUC & FRERE INC. (M0577)

887, Marie-Victorin

DESCHAILLONS, Québec

GOS 1G0

Attention: Messrs. Jacques and Jean-Claude Dubuc

or to any other address that one or other of the parties shall from time to time indicate to the other party in writing. Any such notice, demand, acceptance or other communication shall be deemed to have been received when delivered in person or, if sent by registered mail, on the fifth day after mailing. In the event of a postal strike or disruption any notice, demand or communication shall be given in person or by telegram.

These presents and the guarantees given therein by ourselves to Métro and Épiciers shall not constitute a novation or derogation from our existing obligations to Métro and Épiciers.

[Translation.]

This agreement was signed in the atmosphere of goodwill that had existed for many years between Mr. Dubuc and the appellant on the one hand and Métro on the other. The agreement was also signed at a time of keen competition between Québec food wholesalers. These wholesalers were seeking, by means of agreements concluded by them with grocers, to establish permanent links with the latter so they could rely on having a definite volume of sales. The agreement was described as a purchasing fidelity agreement.

However, so far as Mr. Dubuc was concerned the appellant’s purpose was to operate a food business. The appellant was quite satisfied to operate this business under the Métro banner. Mr. Dubuc saw concrete advantages to be gained from his association with Métro. In this connection he mentioned in particular the Métro name, the prestige connected with this banner and the advertising done by Métro. He explained that he signed this agreement on the appellant's behalf because he had confidence in Métro. In this regard the Court learned that another Métro competitor had had preliminary discussions with Mr. Dubuc. However, no amount was offered to the appellant by this competitor during these initial negotiations.

Mr. Dubuc recognized that the payment of $75,000 by Métro, repayment of which could not be required, was an important if not conclusive factor leading him to sign the agreement at issue here. This sum of $75,000 was paid to the appellant by Métro immediately after the agreement of June 30, 1988 was entered into. The payment of this money was not covered by any clause in the agreement. This failure to mention the payment in the agreement was not explained either by Mr. Dubuc or by Mr. Brunetta.

Mr. Dubuc also noted that the agreement required the appellant to inform Métro if it wished to sell its business, in view of the right of first refusal given to the latter by the appellant in the aforementioned agreement. Furthermore, if it sold to anyone else but Métro, the appellant undertook that the purchaser would sign an agreement to become a member of Métro and would also observe the rights conferred on Métro for the unexpired period. In passing, as it was established that the appellant was owner of the real property where it operated its business, I note that the clause regarding Métro's right in the event of a lease could not be applied in the present situation.

Special reference was also made to the various ratios which the appellant had to observe in obtaining supplies of fruit and vegetables, meat and grocery products. In the case of grocery and meat products the percentage of the appellant’s purchases had to be at least 68 per cent of its retail sales for each of these two categories, whereas for fruit and vegetables the appellant’s purchases were to be 56 per cent of its retail sales. Mr. Dubuc fully understood that if the appellant, for example, were to purchase food products elsewhere it would be required to pay a penalty. That penalty would consist of repayment of five per cent of the difference between the actual purchases and purchases not made, pursuant to the agreement at issue in the instant appeal.

In his testimony Mr. Dubuc also noted that the agreement provides for a penalty of $400,000 for the first ten-year term and $700,000 for the second ten-year term for each failure by the appellant to perform the obligations stated in the agreement. From a practical standpoint there was no possibility of the appellant, for example, offering to do business with IGA or Provigo unless a wholesaler was prepared to pay the amount of the penalty in question. Mr. Dubuc also added that if the appellant sold its business it would be obliged to sell it at a price below what it could have obtained if it had not signed the agreement at issue here. He stated that if the business was sold to someone already associated with Métro the latter would receive no benefit and would accordingly offer no incentive payment, since no sales volume increase would necessarily result for Métro. If on the other hand the business was sold to a Métro competitor a substantial penalty would have to be paid, as already indicated.

Mr. Dubuc further stated that it is in practice almost impossible for a retailer to do business without being associated with a wholesaler by a fidelity agreement. He also added that he could not do business under another banner or by associating with another wholesaler as a result of the obligation imposed on the appellant to pay a very high penalty.

The Court learned from Mr. Brunetta’s testimony that Métro has been a public joint stock company since about 1985. Merchants are required to hold a number of class B shares. These shares are given as security to ensure Métro that the retailers would pay for their food product purchases from Métro. A personal undertaking is also signed by the shareholders themselves of the joint stock companies operating a business. This commercial practice on the part of wholesalers to require undertakings from most food retailers began somewhere around 1985. As a result of the policy adopted by one of the three large food chains in Québec to give monetary incentives to certain merchants to induce them to join a particular banner, Mr. Brunetta indicated that Métro decided to do likewise and establish ties with retail merchants, either by a “fidelity agreement" or by a lease under which the merchant agreed to assign his principal lease to Métro, which in turn made a sublease to the merchant for 10, 15 or 20 years, as the case might be. Under a fidelity agreement Mr. Brunetta noted that Métro secured two important benefits: a long-term connection with a food merchant and a better concentration of purchasing of its products.

The Court further learned that Métro had established a program known as "corvée-rénovation" (required renovation). Under this program Métro made available to its merchants amounts of money varying from $15,000 to $35,000, which were given to them to expand or renovate their premises. Other commercial agreements could also be entered into by Métro and merchants covering, for example, rebates, transportation costs and observance of advertising standards.

Mr. Brunetta also mentioned in his testimony that although the amount of $75,000 paid to the appellant was not under any circumstances repayable, the Métro management required that the amount oe invested in the business. He also stated that the fidelity agreement was connected to the operation of a business on a given site. The Court learned that only 10 to 12 per cent of merchants buying goods from Métro have not signed fidelity agreements with the wholesaler. Mr. Brunetta stated that the fidelity agreement was not equivalent to a franchise, it was a form of affiliation: Métro did not interfere in the running of a business. Mr. Brunetta also mentioned certain internal regulations of Métro which prohibit a shareholder from doing business under any other banner. Mr. Brunetta also noted that as regards the five per cent penalty mentioned above on purchases not made, Métro itself made a kind of adjustment if the merchant did not pay this penalty by exercising its rights under the security it had over the shares held by the merchant in question. There were also other internal procedures for penalizing a merchant who obtained supplies from other wholesalers: for example, the retailer would receive a lower rebate at the end of the year.

Appellant’s arguments

The appellant argued that as a result of the fidelity agreement of June 30, 1988 between the appellant and Métro, the latter had acquired rights over the appellant in accordance with subparagraph 12(1 )(x)(viii) of the Act. These rights are summarized by counsel for the appellant as follows in a submission attached to the notice of objection referred to in the notice of appeal. Part of that submission reads as follows:

The taxpayer considers that at the time the company signed the fidelity agreement with Métro-Richelieu (the debtor), the latter had acquired rights over the taxpayer. These rights may be summarized as follows:

— The company had for a given period alienated its freedom to change its banner by adopting another which might possibly be in competition with Métro- Richelieu.

— The debtor thus acquired a right over the company, so much so that in order to buy back this right and terminate its agreement to the debtor it would have to pay $1,100,000, namely $400,000 for the first ten-year term and $700,000 for the second, also of ten years.

— The debtor also acquired a right over the company's purchasing policy for the next twenty years, as the company had to maintain a fixed ratio of purchases from Métro-Richelieu.

— With respect to this clause, the debtor also joins [sic] a right of supervision of the company's affairs and continuance of the right so acquired is protected by a five per cent penalty on the difference between the agreed ratio and the results actually obtained. That penalty and the ratios required however have no connection with the volume discount or other discounts currently in use.

— Right of first refusal over the sale of the business or shares of the company, right to a possible lease of the premises of the food market.

The taxpayer considers that the sale of these rights constitutes the sale of eligible capital property because it is specifically excluded from the definition given to inducements in subparagraph 12(1)(x)(viii) and that this treatment corresponds to the economic substance of this transaction.

The purpose of paragraph 12(1)(x) is to include in the taxpayer’s income any amount received (as a reimbursement, contribution, allowance or assistance) in the ordinary course of its business, which has not reduced the cost or capital cost of the property related to the amount received (related property) or which has not reduced the amount of the expense related to the amount received (related expense).

In the instant case the payment made by Métro-Richelieu was made to induce the taxpayer to conclude the fidelity agreement:

— This payment was not associated with the purchase of property, whether equipment, rental improvements or otherwise.

— This payment was not associated with expenses incurred or to be incurred by the taxpayer.

— The taxpayer had absolute control over the amount received.

— The taxpayer was not required to use the said amount for specific purposes.

This is accordingly not a case of the kind contemplated by the legislature when it introduced paragraph 12(1)(x).

The taxpayer accordingly considers that the Department erred in making the reassessment which is the subject of this objection and asks the Department to consider the amount of $75,000 received from Métro-Richelieu as the proceeds of an eligible capital property and reassess it accordingly.

[Translation.]

Respondent's arguments

It was argued on behalf of the respondent that the amount received from Métro-Richelieu is an inducement pursuant to paragraph 12(1 )(x) of the Act. Counsel for the respondent added that all the conditions for application of that paragraph are present. In particular, she noted that the exception mentioned in subparagraph 12(1 )(x)(viii) does not apply here as Métro-Richelieu did not acquire any right over the appellant or the way in which the latter’s business was conducted.

Counsel for the respondent argued that it is clear that in consideration of an inducement payment made to a taxpayer the payer will ordinarily require the recipient of the payment to perform certain undertakings and obligations, but she added that subparagraph 12(1 )(x)(viii) cannot be applied to each undertaking and each right as otherwise paragraph 12(1 )(x) would be devoid of all practical meaning. She also put forward the proposition that the appellant did not dispose of anything whatsoever in the instant case and the payment in question is not the proceeds of disposition of an eligible capital property.

Alternatively, the respondent argued that the amount of $75,000 should be included in the appellant’s income for 1988 "as business income pursuant to subsections 9(1) and 248(1)".

Analysis

It became clear in the course of the argument by counsel for the parties to this case that the issue turned on the meaning to be given to subparagraph 12(1 )(x)(viii) of the Act. It was not disputed by counsel for the appellant that the payment of $75,000 received by the appellant should be included in the appellant’s income were it not for the existence of subparagraph 12 (1 )(x)(viii). To further clarify the specific question involved in this appeal, it is worth reproducing below the text of paragraph 12(1 )(x) in its version applicable to 1988:

12(1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:

(x) 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 be 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,

(vi) except 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. . . .

As can be seen, paragraph 12(1)(x) requires notably that there be included in a taxpayer's income from a business or property any amount received in a given year from a person, government or public authority if the amount may reasonably be considered to have been received as an inducement of any kind. This is the gist of the general rule stated in subparagraph 12(1 )(x)(iii). Subparagraph 12(1)(x)(iv), for its part, also requires the inclusion of an amount which it is reasonable to consider was received "as a reimbursement, contribution, allowance or as assistance" in various forms "in respect of the cost of property or in respect of an expense".

It seems clear in the instant case that the $75,000 payment received by the appellant does not fall into this latter category established by subparagraph 12(1 )(x)(iv), but rather into the first category covered by subparagraph 12(1 )(x)(iii), the so-called inducements category.

The Court must therefore determine whether the $75,000 payment received by the appellant from Métro during its 1988 taxation year can reasonably be regarded, on the facts of the instant case, as a payment made for the acquisition by Métro "of an interest in" the appellant, "in [its] business" or "in [its] property".

The first question is as to the rights acquired by Métro from the appellant when the agreement of June 30, 1988 was concluded.

Analysis of this agreement indicates that the most important rights acquired by Métro were of four types.

1. A priority right to purchase before any other purchaser the appellant's business or any other business it might operate in the future or the shares of the company operating that business “in the event of receipt of a purchase or sale offer for the said business(es) or for 20 per cent or more (in one or more transactions) of the issued shares of the capital stock of the company operating the said business(es), so that Métro and Épiciers shall have a priority right to purchase the said business(es) or the said shares over any other purchaser". It is a first refusal option.

It was further stated in the agreement as regards this right of purchasing the business or shares of the company operating the business that Métro “shall have a priority right to purchase the said business(es) or shares on the same terms and conditions as specified in the said offer, within 30 days of receipt of a copy of the offer". It was further added:

If Métro or Épiciers does not exercise its priority purchase option within th is 30- day deadline, we shall then proceed within the next six months to ‘ne sale contemplated by the offer received on the terms and conditions initially stated in the said offer, failing which Métro and Épiciers shall retain their priority purchase right.

[Translation.]

2. In the event that Métro does not exercise its right to purchase the business or shares in the situation mentioned in paragraph 1 above, Métro is the beneficiary of the appellant’s promise that the purchaser of the business or shares in question will have to sign an agreement to be a member of Métro and give an undertaking to Métro to observe the rights conferred on it by the agreement for the unexpired portion of the 20-year period specified by that agreement, ending on June 29, 2008.

3. Métro is the beneficiary of the appellant’s obligation to obtain supplies from Métro or from suppliers appointed by the latter for grocery products, fruit and vegetables and meat, in proportions indicated in the agreement of the retail sales made by the appellant for each class of product. This right of Métro to "fidelity ratios" to be observed by the appellant is subject to a penalty clause requiring the appellant to repay "on demand an amount equivalent to five per cent of the difference between the amount of actual purchases and the minimum purchases required under the above rule if the amount of actual purchases is less than the amount of deemed purchases in each of the aforementioned categories of product". The agreement provides in this regard that Métro “shall determine at the end of its fiscal year whether we have observed the required minimum fidelity ratios".

4. Finally, Métro was given the benefit of a general penalty clause with regard to each failure of the appellant to perform the obligations stated in this agreement of June 30, 1988. This clause is again reproduced for convenience' sake:

Without prejudice to the other rights and remedies of Métro and Épiciers in the circumstances, we jointly and severally agree that in the event of our default hereunder we shall pay Métro and Épiciers, and for each such default as a penalty and in addition to any other amount which may then be owed to them, the sum of $400,000 for the first ten-year term and the sum of $700,000 for the second ten- year term, the said money to be payable when such default occurs, without prejudice to other rights of Métro and Épiciers resulting from law or from other agreements.

[Translation.]

I have not mentioned in this list of the most important rights conferred on Métro by this agreement the ''priority right to purchase our rights in the lease held by us for operation of the aforementioned businesses in the event that the premises so occupied are relinquished", as according to the evidence this right had no consequences, at least until the date of the hearing of this appeal, since the appellant was owner of the premises where the business is operated. I have also made no mention of the fact that Métro was the beneficiary of the appellant’s obligation to "use the supplier designated by Métro for purchasing, renting and laundering uniforms". This right seems to me to be a secondary aspect of the instant case.

The question is whether these rights conferred on the appellant by the agreement of June 30, 1988 represent the acquisition by Métro of rights over the appellant, in its business or in its property.

I am inclined to believe that the acquisition of a right “in [its] property" mentioned in subparagraph 12(1 )(x)(viii) implies the acquisition of real rights over the property of a taxpayer. First, the use of the preposition "in" seems to me unsuited to describing personal rights or the rights of a creditor in legal terminology. Second, in the context of a right pertaining to property the preposition "in" designates a close relationship to that property, a jus in rea. I consider that when associated with the word "property" the preposition "in" is equivalent to the preposition "on". [2] In this regard it is worth looking at the terminology used by Article 405 of the Civil Code of Lower Canada — the Code now in effect — which reads as follows:

On peut avoir, sur les biens, ou un droit de propriété, ou un simple droit de jouissance, ou seulement des servitudes a prétendre.

A person may have on property either a right of ownership, or a simple right of enjoyment, or a servitude to exercise.

[Emphasis added.]

For example, Article 2016 of the Civil Code of Lower Canada defines hypothec in part as “a real right upon immoveables made liable for the fulfilment of an obligation" [emphasis added].

Similarly, in the new Code [3] , it is stated that ‘’a hypothec is a real right on a movable or immovable property" [emphasis added].

In the second edition of his text Vocabulaire juridique [4] the writer Gérard Cornu discusses the word "réel" [real] as follows:

Relating to a thing (corporeal) or a right over a thing. E.g. real action, real subrogation. Ant. personal.

[Translation.]

The same writer goes on to discuss the word "réel" [real] in the phrase "droit réel" [real right] as follows:

Right bearing directly on a thing (jus in re) and procuring for its holder all or part of the economic utility of that thing. E.g. ownership is the most complete real right. V. usufruct, servitude, use, right to follow, right of first refusal, collateral right, estovers. Cf. right to claim.

[Translation.]

In the instant case it is clear that Métro did not acquire any real rights over the appellant’s property. It only acquired a personal right or right to claim. A first refusal option in particular is clearly not a real right.

As to the part of subparagraph 12(1)(x)(viii) which mentions the acquisition "of an interest in the taxpayer", it seems to me that this part of the subparagraph cannot apply if the taxpayer is an individual. This kind of language can only be understood if it applies to a joint stock company. In civil law terminology, at least, there can be no question of a right "in" a natural person. In the case of an artificial person the subparagraph can be applied to a person owning shares in a joint stock company. If in the instant case Métro had by this agreement acquired the appellant’s shares it could be said that Métro had acquired rights in the artificial person represented by the appellant. However, that is not the situation in the facts at issue here.

It remains to consider the part of subparagraph 12(1 )(x)(viii) which refers to the acquisition “of an interest in [the] business". The concept of a business involves the activities themselves, the operations associated with the management and functioning of an economic entity. Further, subsection 248(1) describes the word "business" in part as follows:

"business" includes a profession, calling, trade, manufacture or undertaking of any kind. . . .

This word "business" does not include the property used in operating the business: see e.g., subsection 22(1) of the Act.

In view of the nature of the concept of a business, I think it is beyond question that Métro acquired rights relating to the activities of the appellant connected with the operation of its business. The appellant’s hands were tied in several respects. In operating its business it was required, under the very wording of the agreement, to obtain supplies from Métro and from suppliers designated by Métro to a very large degree. In other words, the appellant had to meet certain quotas or "fidelity ratios" in purchasing the classes of product covered by the agreement. This undertaking by the appellant is accompanied specifically by a penalty clause in Métro's favour. The appellant also could not cease doing business by selling its operation without first giving Métro the right to purchase the latter within the stated deadline. It was also provided that in the event Métro did not exercise its right to purchase the latter the appellant, as we have seen, had to make sure that the purchaser of the business signed a contract to be a member of Métro and observe the rights conferred on Métro by the aforesaid agreement for the unexpired portion of the term of that agreement. Métro thus held rights regarding how the appellant would cease operating its business in the circumstances I have just indicated.

Moreover, compliance with all the obligations imposed on the appellant by the agreement of June 30, 1988 — and not only those I have just mentioned — is guaranteed by a very severe penalty clause applying to each failure to perform any of those obligations.

I therefore consider that the amount of $75,000 received by the appellant can reasonably be considered a payment made for the acquisition by Métro of rights in the appellant’s business within the meaning of subparagraph 12(1 )(x)(viii) of the Act.

Counsel for the respondent did not discuss at any great length the alternative argument that the payment to the appellant of the $75,000 constituted income within the meaning of subsection 9(1) of the Income Tax Act. It seems clear to me that this $75,000 payment was a payment on a Capital account. In consideration for this payment the appellant undertook by an agreement which was to last twenty last years to operate its business under the Métro banner, and in particular undertook to observe certain quotas in Métro's favour for the purchasing of various categories of food products. The appellant also gave Métro a first refusal option to purchase the appellant’s business and the snares of a company operating that business. Other obligations were imposed on the appellant by this agreement. Thus, the agreement substantially altered the conditions under which the appellant would be operating its business. The association between the appellant and Métro created by this agreement was something fundamental and permanent.

Although I do not have to decide this point, I am inclined to think that the expense represented by this $75,000 payment is an eligible capital expense within the meaning of paragraph 14(5)(b) of the Act.

For these reasons the appeal is allowed with costs and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that paragraph 12(1)(x) does not apply to the $75,000 payment received by the appellant from Métro during its 1988 taxation year. Neither is this payment income within the meaning of subsection 9(1) of the Act.

Appeal allowed.