Armour Group – Tax Court of Canada finds that structuring to deduct most of the cost of land (or a ground leasehold interest therein) was unsuccessful
An investment company (“Armour”), which was the lessee under a long-term ground lease from the Province of Nova Scotia, had constructed a building on the property and leased the building back to the Province. The Province then breached terms of the building lease and, in the subsequent settlement agreement, the parties agreed that the Province owed $2.4 million to Armour and that Armour, in consideration for $2.4 million to be paid by way of set-off, would be granted an irrevocable option to acquire the Province’s freehold interest (with the ground lease being terminated). There was no stated exercise price for this “option,” so that effectively this appeared to be an agreement that in consideration for $2.4 million, Armour could acquire the ownership of the freehold at a time of its choosing (and, by the way, when this occurred, the ground lease would terminate.)
At that point, Armour calculated that the present value of the remaining ground lease rentals was $2.24 million which, given that the settlement agreement agreed that the value of the whole property was $2.4 million, meant that the reversionary freehold interest of the Province had an FMV of $0.16 million. Armour then assigned the option to a wholly-owned subsidiary (“ADL”) along with the right to $0.16 million of the $2.4 million owing by the Province, with ADL agreeing as a condition of the assignment that it would provide a long-term ground lease of the property to Armour for nominal rents. Thus, at closing, Armour and ADL paid $2.24 million and $0.16 million, respectively, to the Province by way of set-off against the same amounts owing to them by the Province.
Armour took the position that the $2.24 million paid by it was fully deductible as consideration for the ground lease termination. Paris J instead found that what should be considered to have occurred was that Armour used all of the $2.4 million credit owing to it by the Province (which was not allocated under any of the agreements with the Province) to acquire the fee simple interest to the property on behalf of ADL and that, in exchange for that $2.4 million, Armour acquired the new (nominal-rent long-term) leasehold interest in the property from ADL Thus, the $2.4 million was a capital expenditure to acquire a capital asset (being such leasehold interest – which presumably would not be treated by CRA as a Class 13 asset).
A better result might have been achieved if most of the $2.4 million had been paid to ADL as prepaid rent.
Neal Armstrong. Summary of Armour Group Ltd. v. The Queen, 2017 TCC 65 under s. 18(1)(b) - capital expenditure v. expense.