REASONS
FOR JUDGMENT
Paris J.
[1]
This is an appeal of a reassessment of the
Appellant’s taxation year ending December 31, 2003, by which the Minister of
National Revenue (the “Minister”) disallowed the deduction of $2.24 million claimed by the Appellant
as a lease cancellation fee.
[2]
The Appellant is an investment and real estate
company having its principal place of business in Halifax, Nova Scotia. The
transactions giving rise to the Appellant’s claim were carried out by Founders Square
Limited (“FSL”), a wholly-owned subsidiary of the Appellant. FSL acts as a bare
trustee, holding all of its assets for the benefit of the Appellant. All of the
relevant transactions undertaken by FSL were, therefore, reported in the
Appellant’s tax filings.
[3]
The Minister reassessed the Appellant on the
basis that FSL did not pay a lease cancellation fee of $2.24 million in 2003.
The Minister viewed the amount as having been paid by FSL to acquire an
interest in real property and therefore laid out on capital account, the
deduction of which is prohibited by paragraph 18(1)(b) of the Income
Tax Act (the “Act”).
[4]
The issue in this appeal, therefore, is whether
the $2.24 million amount is deductible by the Appellant in calculating its
business income for its 2003 taxation year.
[5]
Should I find that the amount is not a capital
expenditure, the Respondent says, in the alternative, that the $2.24 million
amount was a pre-payment of rent, the deduction of which is prohibited by
subsection 18(9) of the Act.
[6]
The Appellant called one witness at the hearing
of the appeal: Mr. Douglas MacIssac, the President of the Appellant since 1995
and its CFO since 2009.
Facts
[7]
During the 1970s, the Province of Nova Scotia (“the Province”) acquired certain land and historic buildings located in downtown
Halifax. This property was known as Founders Square.
[8]
In 1983, FSL entered into an agreement to lease
Founders Square from the Province on a long term basis and to redevelop the
property for use as office space. The agreement between FSL and the Province
included the following:
−
the Province would be the owner of the land, the
historic buildings and any new buildings constructed on the land (together “the Property”);
−
the Province would enter into a Ground Lease of
the Property with FSL until 2064. The rent payable by FSL would be $100,000 per
year for the first 10 years and a percentage of gross revenue for the remaining
70 years of the term;
−
the Province would have a reversionary interest
in the Property that would materialize in 2064;
−
FSL would build a new development on the site
which, combined with the existing buildings, would contain a total rentable area
of 200,600 square feet, and
−
the Province would rent 50,000 square feet of
office space from FSL for a period of 30 year.
[9]
In July, 1984, the Ground Lease was signed
between the Province and FSL, reflecting the 1983 Agreement. Thereafter, FSL
constructed the new office component of Founders Square and the Province leased
50,000 square feet of that space from FSL.
[10]
In the early 1990s, the space leased by the
Province from FSL fell below 50,000 square feet and FSL brought an action in
the Supreme Court of Nova Scotia to enforce the 1983 Agreement. FSL was
ultimately successful in that action. In Minutes of Settlement dated February
21, 2003, the parties reached an agreement on the damages owing by the Province
to FSL and how that amount would be paid.
[11]
The Minutes of Settlement provided that:
−
the Province was liable to FSL in the amount of
$4,456,250 (inclusive of HST);
−
the Province would pay FSL $2,056,250 in cash
within 7 days of the settlement;
−
the Province would grant an irrevocable
assignable option (the “Option”) to FSL or its assignee to purchase the Lands and buildings known as
Founders Square, together with an assignment of the Ground Lease in favour of
FSL and all rights of reversion in the said Lands and buildings, all for
$2,400,000,
−
the fair market value of the Lands was $2.4
million;
−
if FSL or its assignee did not exercise the
Option, that the Province would pay FSL a lump sum of $2,400,000.
[12]
The Province granted the Option to FSL on March
20, 2003.
[13]
On June 10, 2003, FSL entered into a Transfer
Agreement with Armour Developments Limited (“ADL”), another wholly-owned
subsidiary of the Appellant, whereby FSL assigned to ADL the Option to purchase
the Lands. A condition of the assignment of the Option was that ADL, “upon becoming the owner of the Lands”, would grant FSL a new Ground Lease of the Lands to run until 2064.
The new Ground Lease was to be granted on the same terms and conditions as
those contained in the Ground Lease between FSL and the Province, except that
the rent payable by FSL to ADL would be $10 per year.
[14]
Under the Transfer Agreement, FSL agreed to
transfer a $160,000 portion of the $2.4 million amount it was entitled to
receive from the Province under the Minutes of Settlement to ADL, and ADL
agreed to provide a promissory note payable to FSL in the amount of $160,000.
[15]
On June 11, 2003, FSL and ADL delivered the
following notices to the Province:
- a Notice that FSL
had assigned to ADL its rights under the Option “to acquire title to the lands”
described in the Option, but not the Ground Lease, which FSL stated was “being
canceled concurrent with delivery of the deed” to the Property to ADL.
- a Notice that FSL
was exercising “the option to purchase the Property referred to in the Option
except the interest transferred to ADL.”
- a Notice that
ADL, as assignee from FSL, was electing “to purchase the lands referred to in
the Option.”
[16]
In the letter accompanying the Notices, the
Appellant advised the Province that the Ground Lease would be surrendered
simultaneously with the transfer of the Property to ADL.
[17]
On June 20, 2003, the Province confirmed with
the Appellant that the Option had been appropriately exercised.
[18]
On July 22, 2003, the Province, FSL and ADL
entered into the following transactions:
-FSL surrendered
the Ground Lease to the Province (the “Surrender Agreement”);
-the Province
deeded and transferred the fee simple interest in the Property to ADL; and
ADL and FSL
entered into a new ground lease of the Property to run until July 31, 2064, on
the same terms and conditions as the Ground Lease with the Province except that
the rent was reduced to $10 per year, (the “New Ground Lease”).
[19]
The closing agenda for the July 22, 2003
transactions provided that all documents in respect of the transactions would
be held in escrow until all documents were delivered, at which time the escrow
would terminate, the documents would be released from escrow simultaneously and
the closing would be deemed to have been completed.
[20]
According to the Surrender Agreement entered
into between FSL and the Province, the consideration provided by FSL to the
Province for the surrender was “$10.00
and other good and valuable consideration”. The
Surrender Agreement also provided that “the Surrender and the Conveyance (of the lands) shall be released
from escrow simultaneously and that the delivery of this Surrender and the
Conveyance shall in no way constitute a merger of the fee simple title and the
leasehold title in the Lands.”
[21]
Mr. MacIsaac gave two reasons why FSL chose to
surrender the Ground Lease to the Province. First, he said that it was preferable
in terms of creditor‑proofing that FSL not exercise the Option entirely
itself, since this would have resulted in a merger of the lease and
reversionary interest. Mr. MacIsaac explained that it is common practice for
the Appellant to keep the ownership and leasehold interests in its properties
in two separate companies and to obtain leasehold mortgages in order to finance
its operations. By keeping the ownership and leaseholds interest in separate
companies, the leasehold mortgagor would be precluded from seizing the freehold
interest in their real property in the event of default. Mr. MacIsaac said
that, in the case of the Founders Square Property, the mortgagor would not have
been able to seize the reversionary interest held by ADL, should FSL ever
default.
[22]
The second reason given by Mr. MacIsaac for the
surrender of the lease was to make the office rents for the Property more
competitive. He said that the subtenants of the Property were responsible to
pay a share of the operating costs for the buildings, and that those costs
included a proportionate share of the underlying Ground Lease payments.
Therefore, by transferring the reversionary interest to ADL and reducing the
lease payments from $100,000 to $10 per year, the operating cost of the
Founders Square buildings dropped considerably. This was intended to have a
positive effect on attracting tenants and increasing the stability of the
tenant base.
[23]
Mr. MacIsaac said that he determined the amount
of the lease cancellation payment, and that he did so by discounting the
present value of lease payments over the remaining of the 63 years of the
Ground Lease. He said that this calculation yielded a value of $2,263,362.
[24]
Mr. MacIsaac testified that the value of the
reversionary interest in the Property was diminished by the fact that the
holder of the reversionary interest had no right of possession until 2064, by
which time the buildings of Founders Square would have been approximately 80
years old, and by the fact that the holder of the reversionary interest was
obliged to pay the municipal property taxes on the Property. Mr. MacIsaac also
testified that the value of the reversionary interest was low because the rent
that FSL had agreed to pay until 2064, $10 per year, was low.
[25]
Mr. MacIsaac said that the Province was adamant
that the $2.24 million value not be stated on the Surrender of Lease and that
it be replaced with the phrase “other
good and valuable consideration”. He also said
that the dollar amount of the “other
consideration” was not made explicit, in part,
because of the strained relationship between the Province and the Appellant.
[26]
Finally, Mr. MacIsaac testified that ADL paid
the Municipal Deed Transfer Tax on a declared value of $160,000 for the
property it received from the Province and that the declared value was never
challenged by the municipal government.
Relevant Statutory Provisions
Income Tax Act
9(1) Subject to this Part, a taxpayer’s
income for a taxation year from a business or property is the taxpayer’s profit
from that business or property for the year.
18(1) In computing the income of a taxpayer
from a business or property no deduction shall be made in respect of
(a)
General limitation - an outlay or expense except to the extent that it was made
or incurred by the taxpayer for the purpose of gaining or producing income from
the business or property.
(b)
Capital outlay or loss – an outlay, loss or replacement of capital, a payment
on account of capital or an allowance in respect of depreciation, obsolescence
or depletion except as expressly permitted by this Part;
…
(9)
Notwithstanding any other provision of this Act,
(a) in
computing a taxpayer’s income for a taxation year from a business or property
(other than income from a business computed in accordance with the method
authorized by subsection 28(1)), no deduction shall be made in respect of an
outlay or expense to the extent that it can reasonably be regarded as having
been made or incurred
…
(ii) as,
on account of, in lieu of payment of or in satisfaction of, interest, taxes
(other than taxes imposed on an insurer in respect of insurance premiums of a
non-cancellable or guaranteed renewable accident and sickness insurance policy,
or a life insurance policy other than a group term life insurance policy that
provides coverage for a period of 12 months or less), rent or royalties in
respect of a period that is after the end of the year,
…
(b) such
portion of each outlay or expense (other than an outlay or expense of a
corporation, partnership or trust as, on account of, in lieu of payment of or
in satisfaction of, interest) made or incurred as would, but for paragraph 18(9)(a),
be deductible in computing a taxpayer’s income for a taxation year shall be
deductible in computing the taxpayer’s income for the subsequent year to which
it can reasonably be considered to relate;
Appellant’s Position
[27]
The Appellant argues that the evidence confirms
that $2.24 million was the amount paid by FSL to the Province by way of set-off
(in addition to $10) as consideration for the surrender of the Ground Lease. It
is the Appellant’s position that the “other good and valuable consideration” referred to in the Surrender was, in fact, the $2.24 million paid
by way of set-off against the credit owing to FSL by the Province according to
the Minutes of Settlement.
[28]
The Appellant submits that this position is
supported arithmetically. After the deduction of the $160,000 value of the
reversionary interest, $2.24 million was the remaining amount of the $2.4
million credit available to FSL under the Minutes of Settlement with the
Province. The Appellant argues that consideration for the surrender of the
Ground Lease therefore had to be $2.24 million as nothing else could be charged
against the $2.4 million credit. The amount was not paid by FSL to acquire any
interest in the Property from the Province.
[29]
The Appellant asserts that the Province did not challenge
the values determined by FSL for the leasehold and reversionary interests in
the Property, and points to the fact that the Province confirmed that the
Option had been appropriately exercised by FSL and ADL. The Appellant also says
that the value declared for Municipal Deed Transfer Tax purposes supports a
finding that the only property transferred to ADL was the reversionary
interest.
[30]
The Appellant further submits that the evidence
shows that the amount of the lease cancellation payment was determined with
reference to rental payments foregone by the Province. Therefore, the $2.4
million setoff against the amount owing by the Province to FSL was clearly
compensation to the Province for its loss of its right to generate income from
the Ground Lease until 2064. The Appellant argues that by accepting the
surrender of the Ground Lease, the Province gave up or conceded the benefit of
an income stream valued at $2.24 million and that the amount of the loss
to the Province was accurately reflected in the equivalent dollar reduction of
liability of the Province to FSL per the Minutes of Settlement. The Appellant
says that the value of the Ground Lease that FSL surrendered to the Province
supports its position that the true consideration given to the Province for the
surrender was $2.24 million.
[31]
Therefore, the Appellant states that the $2.24
million lump-sum payment (by way of credit set-off) was incurred as a lease
cancellation payment to compensate the Province for its loss of its right to
generate income from the Ground Lease until 2064. As a lease cancellation
payment, this amount was deductible as a business expense under section 9 and
paragraph 18(1)(a) of the Act.
[32]
Drawing from the test as enunciated by Strayer
J. in Canadian National Railway Co. v. Minister of National Revenue,
1988 DTC 6340 (FCTD), the Appellant maintains that the effect of the $2.24
million payment was to replace income, not capital because the effect of the
amount was paid to relieve FSL of the obligation to pay anything more than nominal
rent thereafter. Since the rent that had been payable to the Province was a
deductible expense to FSL, the payment made to relieve it of the obligation to
pay rent is also a deductible expense.
[33]
Consequently, the Appellant submits that the
expense of $2.24 million incurred by FSL was a deductible cost and necessary to
provide an accurate picture of profit.
Analysis
[34]
I will deal firstly with the question of whether
FSL gave consideration of $2.24 million to the Province for the surrender of
the lease. In my view, the Appellant has failed to meet the onus on it to show
that such consideration was provided.
[35]
In order to determine the consideration given
for the surrender, it is necessary to interpret the terms of the Surrender
Agreement entered into between FSL and the Province. The Appellant maintains
that the phrase “other good and
valuable consideration” used in the Agreement,
should be interpreted to mean $2.24 million.
[36]
In interpreting a contract, the goal is to
discover the objective intention of the parties at the time they entered into
it, and evidence of a party’s subjective intention is not relevant or
admissible. Also, if words in a contract are ambiguous, the court may consider
extrinsic evidence.
[37]
Where the question of interpretation relates to
the consideration agreed to by the parties, the following principles apply:
Extrinsic evidence is admissible to prove
the actual consideration where no consideration or nominal consideration is
stated in the contract; where the consideration is ambiguous; or where
substantial consideration is stated, but additional consideration exists.
However, the additional consideration must not be inconsistent with the terms
of the written contract…
Fawcett v. Western Canadian Coal Corp., 2010 BCCA 70, at para. 26.
[38]
According to the Surrender Agreement, the
surrender was given in exchange for payment of $10 and other good and valuable
consideration by FSL to the Province. It is reasonable to conclude in this case
that the express monetary consideration of $10 is nominal. It is also clear
that the expression “other good and valuable consideration” is ambiguous.
Therefore I accept that extrinsic evidence concerning any additional
consideration that may have been agreed to by the parties is admissible in this
case.
[39]
Mr. MacIsaac was the only witness called to
support the Appellant’s position that monetary consideration in excess of $10
was given for the surrender. The substance of his testimony was that FSL alone
determined a value for the surrender and that FSL sought the Province’s
agreement to show this amount as the consideration for the surrender. However,
according to Mr. MacIsaac, the Province insisted that the agreement not show
consideration of $2.24 million for the surrender. I infer, then, that the
Province did not agree to the consideration suggested by the Appellant.
[40]
The Appellant did not call anyone from the
Province to testify, and no explanation for the failure to call any such
witness was provided by counsel. In J. Sopinka, S.N. Lederman and A.W. Bryant, The
Law of Evidence in Canada, 3rd ed. (Toronto: Butterworths, 2009) the
authors state at page 377:
In civil cases, an unfavourable inference
can be drawn when, in the absence of an explanation, a party litigant does not
testify, or fails to provide affidavit evidence on an application, or fails to
call a witness who would have knowledge of the facts and would be assumed to be
willing to assist that party. In the same vein, an adverse inference may be
drawn against a party who does not call a material witness over whom he or she
has exclusive control and does not explain it away. Such failure amounts to an
implied admission that the evidence of the absent witness would be contrary to
the party’s case, or at least would not support it.
[41]
In this case, I draw the inference that the
testimony of the officials of the Province who were involved in the relevant
transactions would not have been favourable to the Appellant on the issue of
consideration given for the surrender. Given that FSL and the Province had
reached a settlement of the prior litigation between them in 2003, it is not
apparent to me that the officials of the Province would have been hostile to
the Appellant in these proceedings, or that any strained relationship that may
have existed at the time the transactions occurred would have affected the
willingness of those officials to testify about any additional consideration
for the surrender that the parties may have agreed to at the time.
[42]
I therefore find that the Appellant has not
shown that it gave consideration of $2.24 million to the Province for the lease
surrender.
[43]
While this conclusion alone is sufficient to
dispose of the appeal, I would also add that I am satisfied that FSL paid the
$2.24 million to the Province in order to permit ADL to acquire the fee simple
interest in the Property, and that the payment was therefore on capital account.
[44]
While the Appellant argued that ADL acquired
only the reversionary interest in the Property from the Province and that the
value and consideration given for this interest was $160,000, I reject this
characterization of what took place.
[45]
In the Transfer Agreement between FSL and ADL
(concerning the transfer of the Option to purchase the Property), the parties
state that ADL “upon becoming
owner of the lands will grant” FSL a ground
lease identical to the existing ground lease with the Province, except that the
annual rental would be only $10. In order for ADL to be able to grant the New
Ground Lease to FSL, it was necessary for ADL to acquire the entire fee simple
interest in the Property beforehand. If it had acquired only the reversionary
interest from the Province, it would not have been able to give the New Ground
Lease to FSL, because one cannot give what one does not own (Friedberg v.
Canada, 92 DTC 6031 (F.C.A.) at paragraph 9). Likewise, the Province could
not have given ADL the unencumbered fee simple title to the Property if it held
only the reversionary interest prior to the transfer.
[46]
Regardless of the provision in the Surrender
Agreement that “the delivery of
this Surrender and the Conveyance shall in no way constitute a merger of the
fee simple title and the leasehold title in the Lands”, the surrender of the Ground Lease to the Province caused it to
merge with the fee simple title by operation of law.
[47]
This view of what took place in law is also
supported by the Warranty Deed given to ADL by the Province. According to the
Deed, the Province conveyed the fee simple title to the Property to ADL, free
and clear of any encumbrances.
[48]
Given that the Province and FSL had agreed in
the Minutes of Settlement that the fair market value and purchase price of the
Property was $2.4 million, it would appear that all of the $2.4 million credit
owing to FSL by the Province provided for in the Minutes of Settlement was set
off against the purchase price of the Property, rather than just $160,000.
[49]
I would attach little weight to the fact that,
for municipal tax purposes, ADL reported a value of $160,000 for the property
it received from the Province. While the Appellant maintained that this value
was accepted by the municipality, there is no evidence that the details of the
transactions between FSL, ADL and the Province were ever examined or analyzed
by the municipality.
[50]
In my view, upon the proper construction of the
agreements that are before me, FSL used the $2.4 million credit under the
Minutes of Settlement to pay for the transfer of the Property to ADL. Since,
under the Transfer Agreement, FSL transferred to ADL the option to acquire the
fee simple interest to the Property, it appears to me that FSL paid the $2.4
million purchase price on ADL’s behalf.
[51]
In exchange, ADL gave FSL the right to enter
into a new long-term ground lease of the Property with ADL at a minimal rent.
[52]
A leasehold interest, such as that given in the
New Ground Lease, is a capital asset. In T. Eaton Company Limited v. The
Queen, 99 DTC 5178, the Federal Court of Appeal stated that:
…A leasehold interest in land also
represents a capital asset, the value of which depends on both the terms of the
lease and market conditions. For example, a tenant whose rent obligation is
one-half the market rate has a valuable asset which can be sold by way of
assignment, subject to any restriction protecting the interests of the landlord…(at
para 36)
[53]
It seems clear to me that the leasehold interest
that FSL obtained from ADL at a nominal rent under the New Ground Lease was a
capital asset and therefore that the payment made by FSL by offset on behalf of
ADL was on capital account.
Conclusion
[54]
For all of these reasons, the appeal is
dismissed, with costs to the Respondent on a party and party basis.
Signed at Vancouver,
Canada, this 24th day of April 2017.
“B.Paris”
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