The Queen v. Remington, 94 DTC 6549, [1995] 1 CTC 9 (FCA)

Mahoney J.A.:-This is an appeal from a reported decision of the Tax Court of Canada ([1993] 2 C.T.C. 2252, 93 D.T.C. 1020). The issue is whether $1,000,000 received by the respondent as an inducement to enter into a lease was taxable to him as income in 1985. The learned Tax Court judge found that $900,000 was not taxable and that $100,000 was taxable but in 1986, not in 1985.

The appellant submits that the judge erred and that the entire $1,000,000 was taxable as income in 1985. The respondent submits that the judge erred in finding that the $100,000 was taxable and, in the alternative, that he did not err in finding it was not taxable in 1985 and, in the further alternative, that, if it was taxable in 1985, he was entitled to an offsetting reserve since its collectibility was doubtful December 31, 1985.

The The facts

The Tax Court judge described the respondent’s real estate related activities as follows:

The appellant is 44 years old. He was born in Cardston, Alberta, and went to the University of Calgary for three years where he studied English literature. Thereafter he sold real estate in Calgary. Then he moved to Lethbridge where he and Brian Sheer became equal shareholders in Philadon Developments Ltd. ("Philadon") which constructed buildings. Corporations in which he is interested build specific purpose industrial buildings, primarily in Alberta. Mr. Remington also has a 25 per cent interest in Remuda Ranch Ltd. ("Remuda") which is a family corporation engaged in the cattle ranching and trucking business.

That is a most incomplete account of his business activity and involvement in real estate prior to the transaction in issue as disclosed by the respondent in his testimony and in the financial statements of the various enterprises which were received in evidence.

On leaving university, the respondent worked for about two years, 1974-75, in residential real estate sales. In 1977, he joined in the formation of Philadon and thereafter owned 50 per cent of its shares. Brian Sheer owned the other 50 per cent. Philadon built a commercial building in Calgary to the specification of a proposed lessee and leased half of the building to that lessee. At its fiscal year end, November 30, 1985, it appears to have only the one direct real estate investment however it had, among others, investments in the following affiliated companies: 321591 Alberta Ltd., 1311 Holdings Ltd., Calidore Holdings Ltd. and Remington/Sheer partnership. In addition it held the assets of that partnership in trust for the partners.

The respondent also owned 33 1/3 per cent of 1311 Holdings Ltd. along with Sheer and Jack Richardson. Its business was to construct buildings pre-leased by Richardson. 321591 Alberta Ltd., 50 per cent owned by each of the appellant and Sheer, was also incorporated to pre-lease and build a building. The Remington-Sheer partnership owned and operated a 39-suite apartment building in Lethbridge built for it by Philadon.

The respondent, through a holding company, owned 25 per cent of the shares of Remuda Ranch Ltd., a family company. Remuda owned a condominium/warehouse it had bought from Philadon. The undepreciated value of its ranching assets as at December 31, 1985, was $541,083; that of the condominium/warehouse was $6,152,025.

The respondent was also president of Calidore Holdings Ltd. Calidore owned the following real estate, all in Lethbridge: the McFarland building, a two-storey, multi-tenant, office building; the single storey Canbra warehouse; the McGrath building, a two- tenant office building; a 5,000 square foot office/warehouse, occupied by Philadon; the Belvedere building, which was not otherwise described, and a house on 12th Ave. S.

In March or April 1985, the respondent and Sheer were approached on behalf of Amherst Real Estate and REI Management to interest them in either selling properties they owned in Lethbridge or trading them for other properties in Calgary. The subject of the partly occupied Intergraph building came up. Amherst and REI were trying to arrange financing for it with the Northland Bank and were about to give up the effort in frustration. The respondent discussed it with his father and an offer was made by Remuda and accepted by REI April 23 (Exhibit R-8). Included in the agreement was a personal commitment by the respondent to Remuda to take a five-year head lease on the vacant space in the building at $9 per square foot.

A few days later Amherst and REI again approached the respondent with the news that Northland was ready to fund them and asking him to cancel the sale/purchase and accept a lease of the building with an inducement. On April 29, the respondent personally offered to lease the vacant space in the Intergraph building from REI for five years at an annual rental of $9.50 per square foot, REI to provide an inducement of $900,000 (Exhibit A-l). Northland’s offer to finance depended on an acceptable head lease at $11 per square foot. On May 16, the respondent made another offer to REI to lease for five years at an annual rental of $11 per square foot (Exhibit A-3). The offer provided for the same $900,000 inducement but a side deal provided for an additional $100,000. The offer was accepted by REI on May 22, 1985. The lease was signed the same day and the $900,000 was paid to the respondent.

Payment of the inducement to lease

A. The $900,000

The arrangement respecting the $900,000 may be summarized as follows:

A. REI borrowed $900,000 from Northland Bank.

B. REI paid the respondent.

C. The respondent deposited the $900,000 with the Canadian Imperial Bank of Commerce.

D. CIBC issued a $900,000 letter of credit to REI drawn against the respondent’s deposit.

E. REI gave the letter of credit to Northland as security for the loan.

F. Northland undertook to reduce the security of the CIBC letter of credit pro rata as the leased space was sublet by the respondent.

The entire premises were sublet. What was evidently the last portion was sublet to Philadon, by sublease dated October 1, 1985 (Exhibit A-9). The subleases were duly accepted by and assigned to REI and the respondent became entitled to the return of the letter of credit and release of the $900,000. By then, however, Northland was in receivership. The respondent recovered the letter of credit from Northland’s curator pursuant to a court order obtained December 19, 1985.

B. The $100,000

By a letter dated May 22, REI undertook to buy $100,000 Government of Canada bonds in the appellant’s name in $25,000 instalments on the May 28, June 28, July 28 and August 28, 1985. The only condition precedent to their delivery was that the lease have been entered into. It was but the bonds were not delivered by REI in 1985. The respondent sued.

Sometime in 1986, Philadon purchased the Intergraph building from REI. As part of the consideration, Philadon assumed the obligation respecting the bonds. The respondent accepted Philadon’s interest free demand promissory note for $100,000 in satisfaction of the obligation on August 7, 1986 (Exhibit R-16). The same day, the respondent surrendered the lease to Philadon for a payment of $1 (Exhibit R-17).

The assessment

While lessee during parts of 1985 and 1986, the respondent operated the leasehold premises as a sole proprietor, reporting its rental income and expenses and a loss in each year in his personal return. He did not include the lease inducement in income in either year. In reassessing, the Minister of National Revenue included the entire $1,000,000 in 1985 income, allowing deduction of the respondent’s legal expenses and the cost of leasehold improvement he had paid for. The Minister pleaded that he had reassessed on the express assumption that the $1,000,000 was income from a business. [1]

The trial judgment

The Tax Court judge concluded:

The Court is satisfied that the lease itself was a capital asset insofar as the [respondent] is concerned. The [respondent] was not in the business of trading in leases. The evidence is that various corporations in which the [respondent] was interested were in the leasing business, but the [respondent] himself was not. Rather, the [respondent] entered into this lease transaction for the purpose of earning income from property in the form of rental income. At the time the lease was signed it was known that the [respondent] would sublease and there is no evidence of any secondary intention.

The manner in which the $1,000,000 inducement was to be used by the [respondent] was not specified. The evidence is that both the $900,000 and the $100,000 were paid to the [respondent] for his free use and enjoyment.

There is no evidence that the amount of rent charged was related to the $900,000.... From the beginning of negotiations, REI had always offered the $900,000 to the tenant as an inducement. There was no negotiation over the figure and it had never been asked for by the [respondent]. It was, in essence, a "given", once the [respondent] signed the lease. The Court finds that the $900,000 was not income from property. In these circumstances the Court finds that the $900,000 payment by REI to the [respondent] constituted a "non- taxable receipt".

The $100,000 was distinguished from the $900,000 because it was paid as consideration for an increased rental rate.

The Tax Court judge erred in approaching the issue as though the inducement had been received on disposition of the lease, a capital asset. Neither trading in leases not secondary intention had anything to do with it. The inducement was paid to him for entering into the lease, in other words, as consideration to induce him to acquire a capital asset, and, since no strings were attached, for nothing else.

The findings that there had been no negotiation over the $900,000 and that it had not been asked for by the respondent are inconsistent with the documentary evidence. The figure was included in the offers to lease made by the respondent to REI, not vice versa. If, indeed, it had not been the subject of negotiation, then it was plainly asked for by the respondent.

The Tax Court judge did not examine the facts from the point of view of their source possibly being a business. [2] That failure was an error in law.

Conclusion

It seems to me that this is a classic example of a taxpayer embarking, with success, on an adventure in the nature of trade. From the moment the respondent undertook to lease the vacant premises in the Intergraph building at $9 per square foot from the family company, Remuda, as a term of its offer to buy the building, he had signalled his intention of engaging in the business of subleasing those premises. Had that arrangement been carried out, his business profit would have been realized entirely from the difference between $9 and the rates he was able to secure from sublessees. When the deal was changed and he offered $9.50, his business profit was expected to be realized from that differential, and, all else being the same, would obviously be less without the inducement. His business profit was then expected from the lease inducement and, since no strings were attached to his use of the inducement, the return on its investment, as well as the rent differential.

The $1,000,000 lease inducement was taxable to the respondent as income from a business. $900,000 of it was properly assessed as income received in the respondent’s 1985 taxation year.

The $100,000 was not received in 1985. It was received in 1986. The Tax Court judge found, and I agree, the record does not permit a determination whether the respondent was reporting his business income on a cash basis or an accrual basis in 1985 and 1986. If he was on a cash basis, then the $100,000 was properly to be included in his taxable income in 1986 as held below. If he was on an accrual basis, it ought to have been included in his taxable income in 1985 but, it is clear, it was a doubtful debt as at December 31, 1985, and the respondent ought to be allowed a reserve in respect of the entire $100,000 pursuant to subparagraph 20(l)(l)(i) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the ’’Act”). [3]

It has not been suggested that there is any practical difference in the distinction. It is a subject on which the parties should be able to agree. That said, it is the respondent’s 1985 reassessment that is subject of this proceeding.

I would accordingly allow the appeal with costs here and in the Tax Court and refer the matter back to the Minister of National Revenue for reassessment on the basis that the entire $1,000,000 was properly included in the calculation of the respondent’s taxable income for 1985 but that a reserve of $100,000 should be allowed him.

Appeal allowed with costs.