Armour Group – Federal Court of Appeal finds that a lump sum paid on the acquisition of a property subject to a ground lease to the purchaser group coupled with the ground lease surrender did not generate a lease termination deduction

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, in addition to making a cash payment, 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). Without the encumbrance of the ground lease, the property had a fair market value of $14 million. Accordingly, it likely would have been clear that on exercise of the option by Armour, it would have acquired a capital property with a cost of $2.4 million.

However, Armour calculated that the present value of the remaining ground lease rentals was $2.24 million. This meant that if it were able to have $2.24 million of the $2.4 million to be paid by it characterized as a fully-deductible lease termination payment, this could reduce the capital expenditure to only $0.16 million. What it did was to assign the option to an affiliate (“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. Armour then took the view that the $2.4 million liability of the Province which was extinguished at closing on the exercise of the option should be viewed as the payment by it of a $2.24 million deductible lease termination payment, and the payment by ADL of a $0.16 million option exercise price, to the Province.

Webb JA found that these transactions did not generate the targeted $2.24 million deduction. It was difficult to see how these largely internal transactions had the effect of transforming the $2.4 million paid (by way of set-off) to the Province into a lease termination payment rather than payment of the exercise price for the option.

Neal Armstrong. Summary of Armour Group Limited v. Canada, 2018 FCA 134 under s. 18(1)(b) – capital expenditure v. expense – contract cancellation.