Baker Lovick Ltd. v. MNR, 91 DTC 1041, [1991] 2 CTC 2345 (TCC)

Taylor, T.CJ.:—These are appeals heard in Toronto, Ontario, on March 27, 1991, against income tax assessments for the years 1984 and 1985, in which the Minister of National Revenue ("respondent") disallowed as a current expendi- ture an amount of $189,103 for the year 1984, characterizing it as an expenditure on capital account; and disallowed a deduction of $89,000 ($21,210 in 1984 and $67,790 in 1985), as rent paid by Baker Lovick Ltd. (“appellant”). The respondent did allow appropriate adjustments to capital cost allowance arising out of the assessment, but these are not an issue in the appeals—the determination required relates only to the amounts noted above.

The notice of appeal read in part:

In June 1984, the Appellant sublet the remaining portion of the excess office space in the Calgary Premises to Cochrane Oil & Gas Ltd. (“Cochrane”) for the period June 1, 1984 to May 31, 1989—to secure Cochrane as a subtenant, the Appellant paid $157,806 to Cochrane as an inducement to sublet its excess space.

The Appellant paid $23,324.80 in commissions in connection with the sublease of the Calgary Premises to Cochrane.

The Appellant also paid $7,972.35 in legal fees in connection with the sublease entered into by Cochrane.

— On December 1, 1984, the Appellant entered into an arm's length lease with Cadillac Fairview Corporation Ltd. (“Cadillac”) with respect to certain office space in Toronto (the “Toronto Premises").

— Before leasing the Toronto Premises, the appellant engaged A.E. LePage Ltd., a real estate company operating in Toronto, to assist in locating suitable premises in Toronto and agreed to pay certain commissions to A.E. LePage Ltd. for its services in this connection.

— To induce the appellant to lease the Toronto Premises, Cadillac agreed to pay to the appellant the amount of $89,000 in order to reimburse the appellant for commissions paid to A.E. LePage Ltd. in connection with locating the Toronto Premises.

— Cadillac reimbursed the appellant for the commissions paid to A.E. LePage Ltd. by offsetting the amount of such commissions against the first rentals due in respect of the Toronto Premises.

— The appellant submits that the inducement payment made to Cochrane and commissions and legal expenses paid by the appellant in connection with the sublease of Calgary Premises to Cochrane were made for the purpose of reducing an ongoing business expense and therefore were properly deducted by the appellant in computing income for its 1984 taxation year.

— The appellant further submits that rents in the amount of $21,210 and $67,790 paid in the appellant's 1984 and 1985 taxation years, respectively, by way of offset against amounts Cadillac agreed to pay to the appellant in connection with the lease of the Toronto Premises were ordinary business expenses. Accordingly, the appellant was entitled to deduct these amounts in computing its income for the 1984 and 1985 taxation years.

For the respondent, the reply to notice of appeal read in part:

Calgary Sublease

— the lease inducement payment was made in circumstances outside the appellant's ordinary course of business operations;

— the lease inducement payment, the leasing acent's commission of $23,324.80 and the legal fees of $7,972.35 were incurred by the appellant to secure the sublease of the Calgary premises and, as such, were incurred on capital account;

— as an inducement to enter into the Toronto lease, Cadillac Fairview Corporation Ltd. (the "landlord") paid the appellant $868,000;

— the landlord also provided the Toronto premises rent free to the appellant to the extent of $89,000 which was applied to reduce the rent expense by $21,210 in the 1984 taxation year and by $67,790 in the 1985 taxation year;

— the real estate commission paid to A.E. LePage Ltd. in the amount of $89,000 was incurred by the appellant to secure the lease of its Toronto premises and, as such, was incurred on capital account;

— the Respondent relies, inter alia, upon paragraphs 14(5)(b), 18(1)(a), 18(1)(b), 20(1)(a) and 20(1)(b) of the Income Tax Act, R.S.C. 1952, Chapter 148 as amended (the "Act") and section 1100 of the Income Tax Regulations, C.R.C. 1987, Chapter 945 as amended (the "Regulations").

Evidence and Argument

Counsel for the appellant supported the general facts of this case with testimony and documentation. There was little if any dispute about these facts

— primarily those already outlined in the pleadings — and the matter before the Court centred on the proper interpretation to be placed on them, under the circumstances and according to the Act.

The major case law referenced by the parties was:

Johns-Manville Canada Inc. v. The Queen, [1985] 2 C.T.C. 111; 85 D.T.C. 5373 (S.C.C.);

The Queen v. Oxford Shopping Centres Ltd., [1981] C.T.C. 128; 81 D.T.C.

5065 (F.C.A.);

Jack L. Cummings v. The Queen, [1981] C.T.C. 285; 81 D.T.C. 5207 (F.C.A.)*;

Queen v. The Consumers' Gas Company Ltd., [1987] 1 C.T.C. 79; 87 D.T.C.

5008 (F.C.A.) ;

Oxford Shopping Centres Ltd. v. M.N.R., [1980] C.T.C. 7; 79 D.T.C. 5458

(F.C.T.D.);

Angostura International Ltd. v. The Queen, [1985] 2 C.T.C. 170; 85 D.T.C.

5384 (F.C.T.D.);

French Shoes Ltd. v. The Queen, [1986] 2 C.T.C. 132; 86 D.T.C. 6359

(F.C.T.D.)*;

Westfair Foods Ltd. v. Canada, [1991] 1 C.T.C. 146; 91 D.T.C. 5073 (F.C.T.D.)*;

Woodward Stores Ltd. v. Canada, [1991] 1 C.T.C. 233; 91 D.T.C. 5090

(F.C.T.D.)*;

Yesac Creative Foods Inc. v. M.N.R., 91 D.T.C. 413 (T.C.C.)*;

Maison de Choix Inc. v. M.N.R., [1983] C.T.C. 2241; 83 D.T.C. 204 (T.R.B.)*:

A. Leon Co. Ltd. v. M.N.R. (1961), 27 Tax A.B.C. 289; 61 D.T.C. 517 (T.A.B.).

Analysis

The first point at issue in these appeals relates to the payment made by the appellant of $189,103 as an inducement to a sublessee, including the direct costs associated therewith. I recognize that there can be read into the record of case law (see above) some divergence of opinion on the subject of capital versus income — even recognizing that each case must be determined on its particular facts. Counsel for the appellant relied substantially on a comment from page 291 (D.T.C. 5211) of Cummings, supra, to deal with such a distinction and I quote:

As Mr. Vineberg characterized it, the $790,000 was spent to “prevent a hole in income”, said moneys being spent "to plug the hole". . . .

Accordingly, and for the foregoing reasons, I have concluded that the said sum of $790,000 was a current expenditure.

Judge's Note: These cases were considered directly relevant to the facts of these appeals, the others were only of a general interest on the question of capital or income.

Where an amount (as in Cummings above) can be clearly identified with the income-earning process—that is the operational activity of the taxpayer, there would seem to be little argument that it should be reflected in the disposition accorded such an amount for income tax purposes. I am not as easily persuaded that the simple payment of an amount alleged to be an "inducement" to obtain a signature on a lease, is automatically synonymous with purchasing or acquiring that lease, which was the general view apparently espoused by counsel. In the case of Cummings, supra, the amount of $790,000 related directly to the income-earning process of the landlord and the Court treated it as such. I have some reservation however that the description above provided by counsel in that case "prevent a hole in income", and "to plug the hole", was the main rationale for such a decision by the Court. It would be difficult to find that there was any “hole in income" in Cummings above, where no income existed before the payment. There was no existing lease from which a loss in income was about to be experienced by that taxpayer. The two contracts (the "inducement" and the "lease") could indeed be regarded as quite separate in such a set of circumstances. It seems to me that a situation could obtain in which the amount paid for the signature (perhaps a very small amount) if regarded as payment for a very valuable capital asset—the lease— would be quite an absurd conclusion. That would be ignoring the overriding legal implications and complications—for both parties—arising out of the lease itself, and suggesting that these all arose as a result of a payment made “to sign the lease".

Suffice it to say, however, that in these appeals I do not feel called upon to review that aspect of the matter any further. I have no need to decide whether the argument of counsel for the respondent, that "for the $189,103 Baker Lovick acquired a lease”, has any merit. I am simply of the view that the circumstances of these appeals point to only one conclusion—that Baker Lovick paid that amount in order to reduce its ongoing obligation to the landlord to pay rent for the excess space. There is nothing complicated about that, and it may not be related at all to the tenuous proposition of "acquiring a capital asset—a lease” nor does it run the risk of trying to show it was "to plug the hole” in the income. I would note that I favour very strongly the logic applied by the Honourable Justice Teitelbaum that is to be found in French Shoes, supra, on page 138 (D.T.C. 6363):

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.

To convert such a payment (or a receipt for that matter in the opposite set of circumstances, since I see little basic distinction to be made) into some form of capital requires very substantial leaps and twists of logic. At the same time I agree it may be possible, but I would say highly improbable. I need make no comment with regard to the effect of the recent amendment to the Act, paragraph 12(1)(x)—but it would seem to me that any new argument allegedly arising out of that amendment which would conflict with the general view I have already expressed above would be on tenuous grounds.

In relying on French Shoes, supra, I do not accord much weight to the "inventory" characterization as the basic reason for the "income" determination of the receipt therein, just as I would rely very little on the "fixturing allowance” designation in Woodward, supra. It might be contended that some moral obligation was undertaken by the recipient in French Shoes, supra, the appellant there, and by the recipient in Woodward, supra, the beneficiary there, not the appellant. But I have seen nothing of a binding legal obligation in either case requiring expenditure to be made for an "income" or a "capital" purpose. The description iven to the amount at issue by the parties might nave no bearing at all on the determination of the proper characterization to be made by the Court. It might only confuse the issue so that receipts would be regarded as on capital account, while payments might be more generally treated by taxpayers as on income account. I agree with the comment made on page 150 (D.T.C. 5076) of Westfair, supra, by the learned Justice:

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 following this principle to its conclusion I do not expect Generally Accepted Accounting Principles (GAAP) to unerringly point the way. It may be comforting if the interpretation placed on GAAP by the witnesses, provides confirmation for a conclusion reached on the facts and the law relevant to the issue. But circumstances must be rare indeed, in which GAAP, or the euphemism "fundamental business principles" can provide a determination independent of those considerations. I would note the caution to be adopted in the use of GAAP referred to in Zeiben v. M.N.R., [1991] 2 C.T.C. 2008; 91 D.T.C. 886 at 2018-19 (D.T.C. 893):

Certainly there is jurisprudence which permits, in fact advocates, the appropriate utilization of GAAP under given circumstances, and I recognize that.

It would also seem to me that the way the respondent has posed the issue in this case, such a change in the "cost" could be applicable in all similar cases where a “trade-in” is involved, indeed perhaps in any situation defining “cost”. I am not convinced that the jurisprudence regarding the use of GAAP goes that far.

While the learned Justice in Woodward, supra, found substantial support for his decision therein, in the comments made in Maison de Choix, supra, I fail to find in Maison de Choix, supra, a logic or a rationale which is persuasive given the facts of this case. I do not see any valid relationship between subsection 6(3) of the Act, and an inducement payment or receipt, where the question of capital or income in a business contractual context is at issue. Finally, in connection with the above list of case law, I do note Yesac, supra. The distinction therein is clear—the learned Judge noted:

I am of the view that the inducement payments formed part of the income from the appellant's business. That business consisted of the creation of prepackaged restaurants with a view to selling them to franchisees.

That part of these appeals will be allowed, a total of $189,103 including the commissions and legal fees associated with the direct payment to the sublessee.

I would note at this juncture that only passing reference was made by the parties to the issue of whether the deduction of $189,103 above should be all in the year 1984, or spread over a number of years. One significant comment by counsel for the appellant was:

Here, I think the appellant paid out this lease-inducement payment to receive rent over the next five years. I mean, it didn't end up working that way, I think it may have only gone for four years or three-and-a-half years based on the reduction in size or the renegotiations but the immediate effect was, I think, from three to four years but certainly the hope was that they would have ongoing benefits for five years; they got them for three to four.

So, the question is how is it appropriate to deal with that expenditure? Well, one way would be to allocate it over the three or four years and that certainly gives you an immediate matching. Another way is to deduct it immediately in the year of operation, and there's all sorts of jurisprudence dealing with when you can do that. And your Honour's aware, I think, even in the Oxford case, the taxpayers, for accounting purposes, spread the expenditure out. And the Court said no, for tax purposes, once you find its on income account, you can take it all in the first year.

And from the respondent:

One of the arguments that my friend made was he asked you to consider what was the appropriate treatment for this payment: should it be amortized over thirty years, by his calculations, or is it properly paid out in the one year? Well, with respect, I would submit that that is not the issue and that that should not be a consideration that you would make in arriving at your decision. What should be considered is what is the nature of the payment, rather than is it an appropriate treatment that it be written over thirty years or to be deducted in one year.

Since the respondent in this matter concentrated solely on the question of “capital or income”, I do not feel called upon to make any determination of this secondary question—it will be all left to be written off in the year 1984. However, I say, without hesitation, that I do not read into the case law the same direct identification with the year of payment only, apparently seen quite easily by counsel for the appellant above. In my view where there is no clear time frame which permits “matching” of the expenditure a good argument might be made for writing off the expenditure in the year of payment. However, where there is an evident term which can be related directly to the expenditure—in this case five years, or perhaps three or four years depending on what importance would be attached to the renegotiation—I can think of little, either of logic, accounting treatment, or income tax jurisprudence, which would negate using that same period of time to write off the expenditure, just as one would do with other forms of prepayment or accrual.

We turn then to the second part of the appeal, the amount of $89,000 received by Baker Lovick from Cadillac Fairview, part of which $21,210 was claimed in 1984 and the balance of $67,790 claimed in 1985. The clause in the lease dealing with that point reads:

The Lessor agrees to credit to the Lessee's rental account an amount of eighty nine thousand dollars ($89,000.00) in order that the Lessee can reimburse outside consultants for consulting services provided to the Lessee regarding its new lease. Such amount will be credited on December 1, 1984.

That situation was somewhat clouded by the fact that the respondent had allowed the claim of the appellant in reporting the $868,000 inducement "received from Cadillac Fairview" (see above) as a capital gain—in fact, according to counsel, as a “non-taxable capital gain”. Counsel gave no definition of what that might be. I make no attempt to reconcile that result in non-taxation of the $868,000 above, decided by the respondent, with the comments I have already made about "inducement", nor with my decision regarding the $189,103 payment above. It was raised by the parties, as I understand it here, because from the circumstances some possible relationship between the $89,000 and the $868,000 might be inferred. In my view, however, the $89,000 issue stands for precisely that which it is—a liability of Baker Lovick for commission or consulting services, from A.E. LePage in some way connected with the lease with Cadillac Fairview. The position of counsel for the appellant was that even though "we may have hired the real estate agent to go look at properties for us, the practice in the industry was that the tenant or purchaser doesn't bear the commission expense". The assertion of counsel of the respondent was—"the way the appellant has treated the expenditure in its books, I would submit, is inappropriate, it is incorrect, it does not reflect the true situation. It deducted amounts for rent in respect of December of 1984 and again in respect of January of 1985, amounts for rent which were clearly not paid to Cadillac Fairview —” "There was no liability, there's no proof, no evidence that Cadillac Fairview ever incurred a liability to A.E. LePage that the appellant paid for Cadillac Fairview; the liability was incurred by the appellant and I would submit that the set-off cases have no relevance as this is not truly a set-off case.”

As I comprehend the evidence the basic facts are that Baker Lovick paid to A.E. LePage the amount of $89,000 and in turn (in the appellant's view), paid no rent to Cadillac Fairview for a period of time under the lease, equivalent to that amount of $89,000. That payment of $89,000 by Baker Lovick should represent a cost to the appellant—paid to the third party (A.E. LePage) in connection with negotiation of a satisfactory lease between the two principals, Baker Lovick and Cadillac Fairview. That is quite an ordinary situation, and while it is a "cost", there is nothing about it that resembles a current expenditure. It does not reduce cost, nor does it increase income. As I see it, that is a substantial difference to be seen between a lease inducement between the two principals to a lease (i.e., $189,103 above) and a quite separate payment to a third party as in this point at issue. As noted earlier, I refrain from making any similar comparison with the $868,000 above since the determination of that amount is not before the Court. I am not persuaded that a so-called "inducement payment" between the two principal parties to a lease for the purpose of obtaining agreement on signing the lease is necessarily the same as bringing into existence the lease with all its rights and obligations. I do not see the basis for the same possible confusion in the amount at issue here. This payment is for the purpose of A.E. LePage helping to bring into existence a capital asset— the lease between the two principals, and is a capital expenditure at that level of the transaction—a simple payment by Baker Lovick to A.E. LePage for services rendered. The effort in this appeal by the appellant to convert that amount from a capital expenditure into a current expenditure in the records of the appellant, by substituting a similar amount of "free rent" from Cadillac Fairview for the commission paid to negotiate the lease is not supportable. Such conversion is not accomplished in that simple a matter—as a matter of fact I am not aware of how such a transformation from nondeductible to deductible identification can be accomplished. It is of no relevance to that matter that Baker Lovick may have received $89,000 worth of free rent—that is again an agreement between the two principals totally aside from the payment to A.E. LePage, and arises directly out of the lease itself. No rent was paid, none is deductible. And it cannot be “set-off” against an entirely unrelated amount. That issue will be dismissed.

In the end result the appeals are allowed in order that the amount of $189,103 paid by Baker Lovick to its sublessee in Calgary, Alberta should be deductible for the year 1984. In all other respects the appeals are dismissed. The appellant being substantially successful is entitled to costs.

Appeal allowed in part.