Canderel Limited v. Her Majesty the Queen, [1994] 1 CTC 2336, 94 DTC 1133

Brulé, J.T.C.C.:—The appellant is appealing a reassessment in respect to its taxation year ending June 30, 1986. In that year the appellant deducted $1,238,369 for the purpose of inducing various tenants to its office building known as Churchill Office Park ("COP"). The Minister of National Revenue ("Minister") disallowed the deduction in 1986 and this appeal resulted.

Issue

The sole issue involved is whether or not the appellant is allowed to deduct the sum involved as tenant inducement payments ("TIPs") in 1986 or whether the sum must be amortized over the life or the respective leases.

Evidence

The facts are generally not in dispute but the essential matters are set out to appreciate the situation. Most of the fact evidence was given by Jonathan Wener, the sole owner of Canderel. Approximately 90 per cent of the appellant's business consisted of managing and developing commercial real estate while the balance was industrial development and management. The appel- lant began an independent commercial existence in 1980 when it began operating for itself in various co-ventures, primarily in Montreal and Ottawa. Mr. Wener testified that, in the co-ventures, the guarantee of the appellant was generally required.

The appellant’s head office was located in Montreal with small regional offices in Toronto and Ottawa. It employed 75 to 100 people most of whom were located in Montreal and Ottawa. The appellant’s income statement for 1986 indicate that its income was as follows:

As of 1986, the appellant had developed ten projects. The development in issue, COP, is located in the fringe of the west-end of Ottawa where rents were generally about 30 per cent less than downtown Ottawa. A similar office tower, Carling Executive Park, had been built by the appellant’s competition earlier. The general concept in the area was to provide private sector buildings, thus centralizing an area of business outside of downtown. Because the tax and rentals were lower, it was anticipated that tenants could be obtained from existing downtown areas.

On February 3, 1984, Mount-Batten Properties Ltd. entered into an agreement (the “development agreement") with the appellant to develop property located at 1600 Carling Avenue which eventually became COP In the development agreement, the appellant assumed development duties typical of its modus operandi. As part of its pre-development duties, the appellant was required, among other things, to prepare construction budgets, to coordinate design development, to obtain permits and licences, to select the architect, the engineers and the general contractor, to supervise the subcontracts, to coordinate the acquisition of land, to plan schedules, to execute construction and to conceptualize the marketing plans for the project.

As part of its development duties, the development agreement required the appellant to adjust the construction budget as required, to provide ongoing design input and coordination, to provide accounting and budget control, to acquire permits and licences not secured in the pre-development stage, to supervise the general contractor, to supervise and coordinate tenant improvements and negotiate leases subject to written approval and execution by the owners. In addition, the appellant was responsible for marketing plans, advertising budgets and brochures and other promotional activities relating to project marketing and the coordination of real estate community brokers and agents.

The development agreement provided for a payment of $350,000 as a redevelopment fee ana $450,000 as a development fee, payment of part of which was contingent on 90 per cent leasing. In consideration for management services, the appellant was to receive various management and development fees pursuant to a separate management agreement ("management agreement") signed contemporaneously with the development agreement. The fees pursuant to the management agreement were 3 /2 per cent of gross revenue or $90,000 (whichever was greater) for the first three years and 3Ÿ2 per cent of gross revenue for the balance. The management agreement provided that the appellant would act as the property manager of COP and that its duties were, among other things, to furnish management services for the efficient operation of COP, to negotiate leases and their renewals and to take various legal actions as required.

Mr. Wener testified that the projects were generally financed with mortgages to minimize equity and cover the cost with mortgage debt. It was also his evidence that the co-ventures did not supplement the cash-flow of less successful projects. Therefore, each project was required to succeed on its own merits. Consequently, an early positive cash-flow was imperative and the key to the success of a project was leasing velocity.

A co-ownership agreement also dated February 23, 1984 showed that the land cost was $1,505,000. The co-ownership agreement provided that Mount-Batten's initial capital was $2,135,000 and the appellant’s initial capital was $1,423,000. The co-ownership agreement provided that title to the project was held by 129,143 Canada Inc. as agent on behalf of Mount-Batten and Canderel as co-tenants with Mount-Batten having a 45 per cent interest and the appellant having a 55 per cent interest. Subject to provisions for special advances, the co-ownership agreement provided that co-owners were required to pay operating costs in the same proportions. Ultimately the appellant held 47.5 per cent, Mount-Batten held 45.0 per cent, Oakley Semple held 5 per cent and Develocar Investment held 2.5 per cent.

The appellant submitted an "Executive Summary of Carling Churchill Project" dated January 18, 1984. It was Mr. Wener's testimony that this document was used to create and administer a construction budget by allocating projected expenses and costs. The summary projected among other things a "downside" view of capitalized losses by velocity of lease-up. The analysis indicated a total capitalized loss of $1,541,478 for year one of the project and $493,126 for year two. Therefore, an allowance of $2,034,604 was made to cover projected losses. The estimated time for the project to break even was in the ninth to tenth month of year two. Mr. Wener testified that it was possible to readjust the budget created based on these forecasts to change the flow of allocated funds.

There was testimony that, for the development stage, short-term "bridge financing" was arranged in essentially demand loan form. Mr. Wener said that once the building was 75 per cent to 85 per cent leased, permanent financing would be obtainable. He also testified that if it took more than three years to obtain permanent financing, the co-venture risked seizure of the debt.

Evidence was given that the circumstances surrounding COP were as follows: At the time the development of COP commenced, there were two other large projects undertaken by the appellant in Montreal. There were no commitments to lease when COP was commenced due to an aberration in the Ottawa market wherein the prospective tenants generally required substantial completion before they would enter into leases.

The market had been analyzed by the Royal LePage Annual Report Market Survey upon which the appellant relied and submitted. This survey indicated that there are three classes of building: "A" high quality new buildings; "B" older "A" buildings or slightly lesser quality buildings; and, "C" very old or poor quality buildings. COP was classified as "A" space. For the 1983 market, the figures for downtown Ottawa indicated that there was a 1.67 vacancy of "A" space. For 1982, it was indicated that there was 3.42 per cent vacancy of "A" space. At the time construction was started, the downtown market was rapidly becoming in short supply. However throughout construction and at completion, the amount of available office space in all three classes of building was rising. The appellant relied on the downtown figures because COP was to compete directly with downtown.

Canderel completed its own survey and concluded that the Royal LePage survey was accurate. At the time that construction of COP commenced, it was anticipated that the project would reach the “break-even oint” by the time it opened. Mr. Wener also testified and gave examples that, in general, the appellant’s previous experience with similar projects was very successful.

When COP opened, only 2.3 per cent of the building was leased. Construction was started in March 1984 and it ended in June 1985 and the total cost to build was approximately $25,000,000. Simultaneously, two other projects of 200,000 square feet each were undertaken by the appellant in other areas. At the time that COP was entered into, other properties were being developed in the same area by competitors. These buildings included three downtown buildings and three buildings in the west-end. This created intense competition for tenants.

Six to eight months after they started construction, the appellant's management realized that there were problems with the market. By 1984, the vacancy rate for "A" space was 11.2 per cent. In 1986 it went up to 14 per cent. Although the 1987 rate was .07 per cent, this was due to a "federal grab" of low rates. Therefore the absorption in the west suburbs of downtown clients came later than the appellant had anticipated. The prime competition was Carling Executive Park.

Mr. Wener testified that these developments caused management to evaluate the effect of allocating budgeted losses to lease inducement payments and to in fact reallocate the budget. Four or five key Montreal leasing people came to Ottawa for a one week leasing blitz and the resulting leads were followed- up by the Ottawa office. James Stien a former Montreal employee, was relocated to Ottawa. These steps were successful. By the end of June 1986 COP was 59 per cent rented and, by June 1987, it was 85 per cent rented.

The Toronto Dominion Bank had provided interim financing by a $1,500,000 operating loan and mortgage of $22,000,000. According to the evidence presented to the Court Canderel had to find tenants at project completion or shortly thereafter or several adverse consequences would occur, namely:

(a) the operating and financing costs which approximated $2.9 million (amortized) would have to be entirely borne by the joint venturers, significantly reducing COP’s prospective cash yield; and

(b) permanent financing would not be obtained leaving the joint venturers with a demand full recourse loan funding a long-term asset with floating interest rates;

(c) the project could become known as not having gained market acceptance, thus reducing the likelihood of attracting stable credit-worthy tenants that, in essence, would ensure the financial viability of a project.

On June 17, 1989, the appellant’s agent acquired a Sunlife permanent financing commitment.

The average amount paid for rent was $25 per square foot per annum. Tenant inducements ranged from $12 to $56 per square foot. It was Mr. Wener's testimony that inducements did not vary with the length of lease and that similar inducements were paid by competitors. He testified that the lease inducement payments did not artificially drive up the leases because Carling Executive Suite set the rate.

It was Mr. Wener's testimony that lease inducement payments affected the quality of the terms, the attraction to other tenants to lease and the timing of entrance. Because the figures showed varying lengths of leases inconsistent with the inducement payments, it was not possible to correlate the lease inducement payments and the length of the leases.

Under cross-examination, Mr. Wener testified that the only relevancy of lease length was the prevention of losses over a longer term and that the primary goal was to avoid initial losses by attracting tenants in the first year. Mr. Wener testified that he assumed that if there were no lease inducement payments, the tenants would lease the premises much later. He also testified that if the building was empty, operating losses of the building would escalate and such costs were not recoverable because tenants pay only their proportionate share of the costs of maintaining the building.

The auditor's report of January 1986 showed an operating loss of $1,219,000 and the notes to the balance sheet show that the TIPs were treated in the appellant’s books as being capitalized. By 1986, $4,000,000 had been capitalized and amortized. For 1986, income was minus $800,000 (before amortization). The return shows that the TIPs were deducted from income in the year of payment. The reconciliation shows that the appellant changed the treatment from capitalization to write off in the current year.

The appellant submitted the expert report of Russell Andrew Goodman who testified viva voce as an expert witness in the area of accounting. His testimony and expert evidence essentially can be summarized in the following manner. In his opinion, Canadian GAAP, as applicable in the relevant period, contemplated three alternative and acceptable accounting methods, each of which was in general usage at the time, in respect of TIPs made to tenants of a commercial real estate project. Under Canadian GAAP, the owner was entitled to consider these payments as:

1. operating expenses fully chargeable to the results of operations in the financial year in which they were made or incurred;

2. capital expenditures to be added to the cost of the building and depreciated thereafter; or,

3. deferred expenses to be amortized over the life of the relevant leases.

He was also of the opinion that the preferable method under Canadian GAAP was for the appellant to account for the TIPs as operating expenses for the period during which they were incurred because the expenditures were incurred in the ordinary course of its revenue generating business. The main benefit was the immediate reduction of Canderel's start-up operating losses that would otherwise have been incurred; and, current expensing of these payments in speculative ventures such as COP would best reflect Canderel's true financial operating results and financial position.

He was further of the opinion that the CICA Handbook is normally the only source of GAAP. There was no express reference to the accounting treatment for lease inducement payments in the CICA Handbook to a relevant time. Therefore, Mr. Goodman turned to generally accepted practice pronouncements by authorities, bodies elsewhere in the world, analogies and text books. He described the principle of "matching" as being the principle that expenses are matched to revenue when it is recognized. He described "conservatism" as the principle that when there is uncertainty the judgment should be conservative to avoid overstatement of assets and understatement of liabilities. In his opinion the inducement payments in question formed an integral part of the operating expenses during the lease up because immediate expensing was a generally accepted practice; it closely followed the underlying Canadian GAAP principal of "matching"; and, it closely followed the underlying Canadian GAAP principal of "conservatism". In his view, the payment should be “matched” to the immediate reduction of operating costs and the ability to pay the demand loan.

Furthermore it was his opinion that the immediate expensing of the TIPs did not constitute a deliberate understatement of assets nor an overstatement of expenses because there were financial uncertainties due to the initial slow lease up, the highly leveraged financial position, the demand nature of the construction financing, the guarantee to repay 40 per cent of the construction financing, and the less than triple "A" status of some of its initial tenants.

The second expert report submitted by the appellant was the affidavit of Mr. Peter David Chant who also testified viva voce as an expert witness in the area of accounting. It was his opinion that the three methods cited by Mr. Goodman were applicable under Canadian GAAP. He concurred with Mr. Goodman's opinion that guidelines published by the Canadian Institute of Real Estate Companies ("CIPREC") did not preclude the existence of an equally acceptable alternative policy because CIPREC was not a "standard setter" or a source of GAAP. It was his opinion that TIPs could have been reported as an income item in the period of receipt under Canadian GAAP until the publication by the Emerging Issues Committee of the CICA of Abstract No. 21 in 1991. In selecting the best treatment, in his opinion, the concept of matching the expense with the future revenue stream did not apply because of the circumstances in which the payments were made. He further stated: “in my opinion the speculative nature of the property development, the development's initial losses and the nature of the times, made the shortterm objectives of Canderel of considerable significance in assessing the appropriateness of the policy at the time". Consequently, in his opinion, the expensing of the TIPs was the preferable accounting policy. Neither expert witness submitted by the appellant correlated TIPs and lease length.

The respondent submitted the expert report of Mr. Philip Boname whose opinion focused on the role of TIPs. His testimony was that TIPs were used to attract tenants and maintain a high revenue stream. The Ottawa market, in his opinion, dictated varied measures of inducements for the purpose of inducing leases. His report indicated that TIPs allowed the landlord to create a particular stream of rental income over the life of the lease and that there was direct correlation between tenant inducements and higher rents.

The respondent submitted the expert opinion of Mr. J.P. Enns a chartered accountant whose written and viva voce evidence was in rebuttal to Mr. Goodman. In his report he commented on Mr. Goodman's interpretation and application of the matching principal in computing profit and on his view that Canderel was able to immediately reduce current operating losses by paying various tenant inducements.

Relying on the definition of the "matching principal" in section 1000.51 of the CICA Handbook, it was Mr. Enns' opinion that the critically important financial benefits referred to by Mr. Goodman could not reasonably and properly be considered as revenues and therefore could not be the subject of "matching". With respect to Mr. Goodman's assertion that there was an immediate reduction of operating losses, it was Mr. Enns’ opinion that the operating losses for the period would be increased if the inducement payments were treated as operating expenses. As well operating losses would be reduced only if the lease inducement payments were amortized over the length of the leases.

In part his report read as follows:

This opinion is based upon the computations in Appendix I of my report which show that:

(i) According to Mr. Goodman's analysis (in Exhibit 2 of his affidavit) at zero per cent occupancy the joint venture would have sustained annual operating losses of $2,950,000. Therefore for the eight month period from May 1, 1985 to December 31, 1985 it can be assumed that the loss would have been $1,966,677 had no inducements been paid and had the building remained unoccupied;

(ii) by treating the tenant inducement expenses as current operating expenses, operating results for the joint venture for the eight month period ended December 31, 1985 would have been a loss of $4,115,456 (as opposed to a loss of $1,960,000 had no inducement been paid and no consequent revenue generated);

(iii) if, on the other hand, tenant inducement costs were amortized, the joint venture would sustain losses of $1,118,343 for the eight month period ended December 31, 1985.

The third expert report submitted by the respondent was that of Mr. R.W. Maclean. His report and viva voce evidence considered whether, in 1985 and 1986, GAAP prescribed the particular method for the treatment of TIPs and, if not, how it has evolved since to resolve any differences in treatment. He also considered if, in computing the appellant's income, whether expensing the entire amounts to the year of payment or whether over the terms of the leases was preferable. The third issue considered was whether TIPs can be considered to be period costs or "running expenses".

In his view during 1985 and 1986 there was no authoritative guidance in Canadian GAAP but the preferred method was to amortize TIPs over the duration of the leases to which they relate. His opinion was that amortizing a TIP results in a better matching of the expense to the revenues generated by the lease and therefore results in a more accurate measure of income. It was his opinion that the principle of "conservatism" did not prevent the deduction of the inducement due to the subsequent resolution by CIPREC in favour of matching against revenue. It was furthermore his evidence that these payments are not running costs because they are casually linked with the rental income from the leases. I do not accept his testimony on the evolution of GAAP after 1985 and 1986 as it is irrelevant.

Also called for the respondent was Mr. Peter Dardarian, a director of Sunlife Mortgage Investment who was involved in preparing the commitment letter for financing and who acted as a liaison for Sunlife Internal Department.

He was questioned as to a property investment minute for COP dated May 14, 1986 recommending granting a first mortgage. He testified that the negotiations required some direct meeting and discussion with the borrower and the broker resulting in a formal application which summarized information issued to the Board of Directors and was accompanied by a more detailed memo. These documents were typically written by field officers as a recommendation to the Head Office regarding investments. Mr. Dardarian was one of the people who evaluated it. He testified that he was looking for physical security, location and area, site and lot, leasing availability, quality of tenants in terms of leases, the quality of the borrower, and covenants supporting the mortgage.

He testified that the importance of leasing was that the building was 79.4 per cent leased and that the average term was 7.1 years. The company was generally more comfortable with longer term leases which provided for longterm cash flow. On the review of the criteria it was his testimony that if the loans were short-term as opposed to long-term this would probably not affect the satisfactory nature of the project.

The most important criteria was the reproductive value of the project. It was also his testimony that, if the leases were significantly shorter than seven years (for instance two years), available financing would be on onerous terms. Moreover it was his testimony that cash inducements to be paid must be done before the loan is paid out or the lending institution would hold back money to meet these obligations.

On cross-examination, Mr. Dardarian indicated that the lease inducement payments did not result in artificiality of the rents. It was his testimony that if there were no leases there could be situations where financing would not be available and that if all leases were short-term then they may finance with different terms. It was also his testimony that, if the building was vacant, the terms of the financing would generally not be acceptable to the average developer and that generally the minimum was 40 per cent or more lease up. On redirect examination he testified that, if COP had two-year leases, he would not have advanced the money because of the other factors.

A Mr. Holtz testified under subpoena regarding the change in Revenue Canada’s administrative policy and its relationship and former reliance on CIPREC. I did not find this evidence to be relevant to the question in issue.

Statutory provisions

The relevant statutory provisions are section 3, subsection 9(1), paragraph 18(1 )(a) and subsection 18(9) which read, in part, as follows:

3. The income of a taxpayer for a taxation year for the purposes of this Part is his income for the year determined by the following rules:

(a) determine the aggregate of amounts each of which is the taxpayer's income for the year. . . including . . . his income for the year from each . . . property . . .;

(c) determine the amount, if any, by which the aggregate determined under paragraph (a) plus the amount determined under paragraph (b) exceeds the aggregate of the deductions permitted. . .; and

(d) determine the amount, if any, by which the amount determined under paragraph (c) exceeds the aggregate of all amounts each of which is his loss for the year from . . . [a] property . . .

and the amount, if any, determined under paragraph (d) is the taxpayer’s income for the year for the purposes of this Part.

9 (1) Subject to this Part, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.

(2) Subject to section 31, a taxpayer’s loss for a taxation year from a business or property is the amount of his loss, if any, for the taxation year from that source computed by applying the provisions of this Act respecting computation of income from that source mutatis mutandis.

18 (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) 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;

(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

(i) as consideration for services to be rendered after the end of the year,

(ii) as, on account or in lieu of payment of, or in satisfaction of, interest, taxes

. .. rent or royalty in respect of a period after the end of the year, or

(iii) as consideration for insurance in respect of a period after the end of the year. . .;

(b) such portion of each outlay or expense made or incurred as would, but for paragraph (a), have been deductible in computing a taxpayer’s income for a taxation year shall be deductible in computing his income for the subsequent year to which it can reasonably be considered to relate; and. . . .

Appellant’s position

The main thrust of the appellant’s arguments can be summarized in four points. Firstly, Canderel submits that the TIPs are deductible in the year they were incurred because they constitute current expenditures made for the purpose of gaining or producing income. Secondly, Canderel argues that they are fully deductible as there is no provision in the Act obliging the appellant to amortize the payments. Thirdly, the appellant contends that matcning is available but only at the taxpayer's option; as a result, it cannot be imposed by the Minister absent statutory provisions to that effect. Fourthly, the appellant argues that even if it is required in law to match, the expenses should be matched against the immediate and current benefits generated by these inducements.

Respondent's position

The respondent argues that the appellant should not be permitted to use the expensing method, but should amortize the TIPs over the terms of the particular leases. Since the payments were incurred to generate revenues over the entire terms of particular leases, in order to arrive at the true profit of the company, only a portion of the TIPs should be deducted in the year of payment. In addition, the respondent submits that the law provides no choice to the appellant and is required to amortize the TIPs because it results in a better matching of revenues and expenses and a "truer picture" of its income. Lastly, the respondent contends that the TIPs must be matched to revenues and not to any other intangible benefits.

Analysis

While over 50 cases were cited to the Court by both counsel, some by each, reference is only made to certain of these below which the Court feels are significant. In addition cases other than those cited to the Court are mentioned.

The first point in the appellant’s argument was that TIPs can be deducted in the year incurred. On the other hand the respondent stressed that such was not correct but rather amortization of TIPs over the terms of the leases was proper. There is no question that TIPs were expenses and incurred by the appellant for the purpose of gaining or producing income from the business, but the issue to be considered is when they may be deducted.

The courts have consistently held that an expense is deductible although there is no directly resulting income. The genesis of this principle is found in Vallambrosa Rubber Co. v. Farmer, [1910] S.C. 519, 5 T.C. 529 (Scot. Ct. of Sess.) wherein the Lord President stated at page 534 (T.C.):

The junior counsel for the Crown . . . wished your lordships to accept this proposition, that nothing ever could be deducted as an expense unless that expense was purely and solely referable to a profit which was reaped within the year. I think that proposition has only to be stated to be defeated by its own absurdity.

The second point in the appellant’s argument involves the matter of the timing of the deduction. The Court must ascertain whether the TIPs are running expenses and whether or not there should be matching which is discussed in the appellant's third point of argument.

The subject of running expenses was discussed in the case of Naval Colliery Co. v. C.I.R. (1928), 12 T.C. 1017 (H.L.) wherein it was held that running expenses are not matched to revenue, but are deductible in full in the year incurred. In essence, running expenses are expenses that cannot be directly linked to corresponding items of receipt. Rowlatt, J., said at page 1027:

. . . and expenditure incurred in repairs, the running expenses of a business and so on, cannot be allocated directly to corresponding items of receipts, and it cannot be restricted in its allowance in some way corresponding, or in an endeavour to make it correspond, to the actual receipts during the particular year.

This definition was approved in Oxford Shopping Centres Ltd. v. The Queen, [1980] C.T.C. 7, 79 D.T.C. 5458 (F.C.T.D.), whereby Thurlow, A.C.J., held that a running expense was one that is not referable or related to any particular item of revenue. The treatment of running expenses was also explained in this case. Unlike other current expenses, running expenses are deductible in the year incurred and not matched with the revenues generated. Rowlatt, J., in Naval Colliery Co., supra, dealt with the issue at the same page 1027 as follows:

If running repairs are made, if lubricants are bought, of course no enquiry is instituted as to whether those repairs were partly owing to wear and tear that earned profits in the preceding year or whether the will not help to make profits in the following year and so on. The way it is looked at, and must be looked at, is this, that that sort of expenditure is expenditure incurred on the running of the business as a whole in each year, and the income is income of the business as a whole for the year, without trying to trace items of expenditure as earning particular items of profit.

In Cummings v. The Queen, [1981] C.T.C. 285, 81 D.T.C. 5207 (F.C.A.), Heald, J.A., held that the "pick-up" expenses of the existing lease of a tenant constituted running expenses. He also declared in obiter that the payment to a prospective tenant of a rent-free period as an inducement to enter a long-term ease would also qualify as a running expense. Heald, J.A., stated at page 291 (D.T.C. 5211):

It seems clear to me that subject expenditure was a “running expense" and in the same category as for example, an extensive advertising campaign to obtain tenants or an offer to a prospective tenant of a rent-free period as an inducement to enter into a long-term lease or a finder’s fee for obtaining tenants and leases.

Also in Cummings, Heald J.A., cited with approval the case of Oxford Shopping Centres Ltd., supra, as set out below.

The recent judgment of the Federal Court in Toronto College Park Ltd. v. The Queen (as yet not published), dealt with the deduction of a TIP. There Simpson, J., deciding on the propriety of a TIP deduction and also that of matching, set out at page 4 the following:

The Crown also argued that Cummings is not a binding authority because it is limited to a consideration of lease pick-up costs. Accordingly, comments referring to other types of tenant inducements and running expenses are obiter dicta. This is true but, in my view, Cummings does serve as authority for three general propositions. Firstly, certain tenant inducements may be classified as running expenses. Secondly, running expenses may, in some cases, be deducted in the year of the expense and, thirdly, the matching principle does not apply to running expenses.

Further at page 7 the learned Justice said:

It is clear that there is no obligation imposed by the case law or by the Act to defer in the case of a current running expense.

In answer to the appellant's argument the respondent said that TIPs were incurred for profits over the whole terms of the leases and therefore to arrive at true profits each lease should have the TIPs amortized over its terms. Reference was then made to Neonex International Ltd. v. The Queen, [1978] C.T.C. 485, 78 D.T.C. 6339 (F.C.A.), wherein Urie, J.A., dealt with the concept of matching as it related to inventory accounting. Up until the taxation years in controversy, the taxpayer had treated the costs of uncompleted signs as progress inventory at year-end. In the taxation years in controversy, though retaining the same method for financial statement purposes, Neonex, supra, deducted the full costs in computing its income in the taxation years in question. The Court rejected Neonex’s computation of its income because it did not take into account the value of the uncompleted signs at year-end while the expenditures were fully deducted. This was an application of matching to the purchase of sale of inventory.

The present case, however, is quite different on its facts. Neonex is not an example of a running expense situation.

In the very recent Supreme Court of Canada case of Symes v. Canada, [1994] 1 C.T.C. 40, 94 D.T.C. 6001, lacobucci, J., noted the decision of Wilson, J., in Mattabi Mines Ltd. v. Ontario (Minister of Revenue), [1988] 2 S.C.R. 175, [1988] 2 C.T.C. 294. There in considering a taxation situation Wilson, J., came to a conclusion at page 189 (C.T.C. 301) as follows:

The only thing that matters is that the expenditures were a legitimate expense made in the ordinary course of business with the intention that the company could generate a taxable income some time in the future.

lacobucci, J., then said at page 57 (D.T.C. 6013) of his judgment:

In making this statement, and in proceeding to discuss an interpretation bulletin reference to the "income-earning process" (at pp. 189-90), Wilson J. . . . was rejecting both the need for a causal connection between a particular expenditure and a particular receipt, and the suggestion that a receipt must arise in the same year aS an expenditure is incurred. Her reference to the "ordinary course of business” is merely a reflection of these other conclusions.

Indeed, in this regard, it is instructive to note Wilson, J.’s reference to the "intention" of the taxpayer.

The third point in the appellant’s argument concerning the timing of the deduction was that while matching is available it is at the taxpayer's option. The respondent's counsel put forward that matching gives a better picture of the appellant's true income and should be used. Counsel for the appellant submitted that matching is not a rule of law but an accounting method.

Much expert evidence was submitted on the question of generally accepted accounting principles and whether amortization or immediate expensing is within “GAAP”. The role of expert evidence in such areas was discussed in M.N.R. v. Anaconda American Brass Ltd., [1955] C.T.C. 311, 55 D.T.C. 1220 (A.C.), wherein it was stated by Viscount Simonds at page 321 (D.T.C. 1225):

. . . that new theories of accountancy though they may be accepted and put into practice by business men, do not finally determine a trading company’s income for tax purposes.

Counsel for the respondent referred to several cases to stress his position. A passage from Associated Investors of Canada Ltd. v. M.N.R., [1967] C.T.C. 138, 67 D.T.C. 5096, is found at page 143 (D.T.C. 5099) as follows:

Ordinary commercial principles dictate, according to the decisions, that the annual profit from a business must be ascertained by setting against the revenues from the business for the year, the expenses incurred in earning such revenues.

In M.N.R. v. Tower Investment Inc., [1972] C.T.C. 182, 72 D.T.C. 6161 (F.C.T.D.), the Court held that the expenses were not "current expenditures" and that amortization was in accordance with GAAP. It also found that it most accurately reflected the true economic position of the taxpayer. The Court held that the use of the matching principle was appropriate in the circumstances because the expense had been incurred for the purpose of gaining income in future years. Therefore, the taxpayer was, entitled to amortize.

The company in Neonex, supra, deducted the cost of unfinished signs for income tax calculations but matched this expense with income earned for its financial statements. One issue was the proper treatment of this amount. The Court held that the application of GAAP was a question of law. The Court accepted uncontroverted evidence that the matching principle requires costs to be recorded as expenses when the revenues with which they are associated are recorded in the income statement. It held that the next question to be asked is whether the Act requires or permits a different accounting treatment for income tax calculation than that applicable for shareholders and creditors. The Court held that the principle of matching expenses with revenue under GAAP applied because the expense was incurred to earn future income and the Act did not expressly allow otherwise.

The respondent's counsel said that the Neonex case, supra, was similar to the present one as well as the Tower case, supra. I suggest that the facts and reasoning behind the deductions are quite different from the action by the appellant here. While the matching principle may have its usefulness, especially for accounting purposes, such is not necessarily the case for income tax purposes.

The fourth argument of the appellant was to the effect that even if the law in many cases said that expenses should be matched such should be matched against current benefits, as did the appellant in claiming the deduction. In response to this the respondent referred to Neonex, supra, while the appellant's counsel defended the Court's decision in that case reiterating what was said in Oxford, supra, that this was not the introduction of a more general principle. In Oxford, supra, at page 18 (D.T.C. 5466-67) the Court held as follows:

. . . for income tax purposes, while the "matching principal" will apply to expenses related to particular items of income, and in particular with respect to the computation of profit from the acquisition and sale of inventory . . . it does not apply to the running expense of the business as a whole even though the deduction of a particularly heavy item of running expense in the year in which it is paid will distort the income for that particular year. Thus while there is in the present case some evidence that accepted principles of accounting recognize the method adopted by the plaintiff in amortizing the amount in question for corporate purposes and there is also evidence that to deduct the whole amount in 1973 would distort the profit for that year, it appears to me that as the nature of the amount is that of a running expense that is not referable or related to any particular item of revenue . . . the amount is deductible only in the year in which it was paid. All that appears to me to have been held in the Tower Investment case, supra . . . is that it was nevertheless open to the taxpayer to spread the deduction there in question over a number of years. It was not decided that the whole expenditure might not be deducted in the year in which it was made, as the earlier authorities hold. And there is no specific provision in the Act which prohibits the deduction of the full amount in the year it was paid. I do not think, therefore, that the Minister is entitled to insist on an amortization of the expenditure or on the plaintiff spreading the deduction in respect of it over a period of years.

It is interesting to note the comments made by Mogan, J., in I.B.M. Canada Ltd. v. M.N.R., [1993] 2 C.T.C. 2860, 93 D.T.C. 1266, where he recognized that TIPs had more than one purpose and benefit. At page 2866 (D.T.C. 1270) the following was said:

It is too simplistic to say that the tenant is paid to sign the lease because, upon signing, the tenant acquires both rights and obligations. So does the landlord. . . . In other words, a landlord does not have to induce a tenant to acquire a right which the tenant will acquire in any event under the lease by paying the rent. There may be circumstances, however, when a landlord is required to induce a tenant to accept an obligation (i.e., to pay a certain quantum of rent) which the tenant may otherwise be unwilling to accept.

It is noteworthy that Mogan, J., characterized lease inducement payments as a finder's fee or commission. He made the following comments, also at page 2866 (D.T.C. 1270):

A lease inducement payment is something like a finder's fee or agent's commission paid to a third party to bring the tenant to the landlord. If it were such a fee or commission, it would be income to the third party for services rendered to the landlord. But when the amount in question is paid directly to the tenant and not to a third party, what is the character of that amount in the hands of the tenant, and what consideration flows from the tenant to the landlord for that amount?

There were four main benefits generated from the TIPs by the appellant. These were:

1. to “prevent a hole in income" otherwise caused by maintaining a vacant building;

2. to satisfy the underlying requirements of its interim financing and to obtain permanent financing;

3. to meet its competition, maintain its market position and reputation;

4. to earn revenues through rentals, management, and development fees.

Conclusion

The underlying question to determine the issue is one of timing of the deduction of these payments. In light of the facts, the evidence and the arguments given above it is my opinion that the expenses deducted by the appellant were running expenses, that matching is not in this case the appropriate method for tax purposes, and that the appellant should be allowed to adopt the expensing method.

In addition there is no requirement under the law for consistency in accounting methods between financial statements and income tax calculation. In fact, since financial statements and income tax returns are used for two separate and distinct purposes, it is my opinion that it may not always be proper to use precisely the same methods for both. There is no requirement in law for this Court to follow GAAP. In fact, if this Court was to follow GAAP without question, the Canadian Institute of Chartered Accountants would be de facto legislating the development of tax law through the CICA Handbook. However GAAP may still be a useful tool to analyze.

The appeal is allowed and the matter is referred back to the Minister for reconsideration and reassessment. Costs are awarded to the appellant and should be submitted to the Court in accordance with the usual Tax Court practice.

Appeal allowed.