Randy Remington v. Her Majesty the Queen, [1993] 2 CTC 2252, 93 DTC 1020

Beaubier, T.C.C.J.:— This matter was heard in Calgary, Alberta, on April 20 and 21, 1993. It is an appeal pursuant to the general procedure of this Court respecting the appellant's 1985 taxation year.

In paragraph D. 14. of the appeal, the appellant describes the issues to be decided as follows:

Is the inducement:

(a) a non-taxable receipt, as alleged by the appellant? or

(b) alternatively, an amount which is a rebate of rent for the period of the Head Lease, a proportionate amount of which is a reduction of what would otherwise be the rental expense of the appellant in his 1985 taxation year? or

(c) an amount includable in the rental income of the appellant from a business as alleged by the respondent.

In paragraph B. 11 of the reply, the respondent describes the issues to be decided as follows:

The Deputy Attorney General of Canada submits that the issues to be decided in this Appeal are as follows:

(a) whether the payments receivable from R.E.I. Management Inc. by the appellant in 1985 as inducements for the appellant to enter into the lease were income from a business carried out by the appellant;

(b) whether the payments receivable from R.E.I. Management Inc. by the appellant in 1985 as inducements for the appellant to enter into the lease were income from a property owned by the appellant;

(c) whether this Honourable Court has jurisdiction to change the fiscal period of Randy Remington Holdings as requested in paragraph 21 of the notice of appeal;

(d) whether the appellant can claim a reserve for a doubtful debt in 1985 of

$100,000 for the money the appellant alleges was owed to him by R.E.I.

The only witnesses were the appellant and Anthony James Murray, C.A., an expert called by the appellant.

The appellant is 44 years old. He was born in Cardston, Alberta, and went to the University of Calgary for three years where he studied English Literature. Thereafter he sold real estate in Calgary. Then he moved to Lethbridge where he and Bryan Sheer became equal shareholders in Philadon Developments Ltd. ("Philadon") which constructed buildings. Corporations in which he is interested build specific purpose industrial buildings, primarily in Alberta. Mr. Remington also has a 25 per cent interest in Remuda Ranch Ltd. ("Remuda") which is a family corporation engaged in the cattle ranching and trucking business.

In March or April of 1985 Amherst Real Estate Ltd. ("Amherst") of Calgary approached Messrs. Remington and Sheer to interest them in selling or trading properties the two men had some kind of interest in, apparently through a corporation or corporations, in Lethbridge, Alberta.

On April 23, 1985, Remuda offered to purchase lots 3 and 4, block 130, Plan South Industrial Park, Calgary 7811365 ("Lots 3 and 4") for $5,050,000 from the owner, Central Trust Company (Exhibit R-8). Shortly thereafter R.E.I. Management Inc. ("R.E.I.") proposed to the appellant that Remuda withdraw its offer to purchase (Exhibit R-8) and R.E.I. would buy lots 3 and 4 and lease 23,000 square feet of the Intergraph building located on lots 3 and 4 to the appellant. (The 23,000 square feet netted out at 20,482 square feet.) R.E.I. offered to pay a lease inducement of $900,000. The appellant was frank to state that he would not have entered into the lease without such an inducement. All of the lease offers which followed went through Amherst.

The appellant signed an offer to lease (Exhibit A-2) with a higher rate of rent on the basis of a $1,000,000 lease inducement on April 29, 1985. On May 16, 1985 the appellant signed a further offer to lease (Exhibit A-3) with the higher rent and a $900,000 lease inducement. R.E.I. signed Exhibit A-3 on May 22, 1985. On that same date the $900,000 was paid, the lease (Exhibit A-4) was signed, and the appellant received a letter (Exhibit A-5) from R.E.I. which reads:

May 22, 1985

Mr. Randy Remington

% #1 7503 33st. S.E.

Calgary, Alberta

Dear Sir:

RE: Government of Canada Bonds

REI Management Incorporated will purchase Government of Canada Bonds in the name of Randy Remington that mature in five years in four equal monthly bonds of Twenty-Five Thousand Dollars ($25,000) each to total One Hundred Thousand Dollars ($100,000). The bonds will be purchased on the following dates:

May 28, 1985

June 28, 1985

July 28, 1985

August 28, 1985

Trusting this meets with your approval.

Sincerely yours,

R.A. Fry

The $100,000 referred to in the letter is the rest of the $1,000,000 lease inducement in question. Exhibit A-6 was filed which states that Exhibit A-5 is conditional upon the lease between Randy Remington and R.E.I. becoming formalized and in full effect.

Schedule G to the lease (Exhibit A-4) is a schedule of“ special clauses” to the lease. Clauses (h) and (i) read:

(h) As a one-time only inducement to the lessee to enter into this lease, the lessor covenants and agrees to pay to the lessee the sum of NINE HUNDRED THOUSAND DOLLARS ($900,000) concurrent with the execution of this lease.

(i) The tenant shall perform, within a reasonable period of time, leasehold improvements on at least ten thousand (10,000) square feet of the demised premises equal in standard to the present improvements in the building.

The appellant stated that he was prepared to improve the entire 23,000 square feet, thus the 10,000 square feet of improvements referred to in Clause

(i) could have been left out. He does not recall any ratio being discussed as to the amount of inducement in relation to the area of improvements.

Once the lease was entered into the appellant sublet the entire premises to Philadon and to Helix Management Systems Ltd. ("Helix"). The projections of these subleases were for a profit. No profit resulted because Helix was in financial difficulty within months of entering into the sublease.

The $900,000 paid on May 22, 1985 as a tenant inducement was arranged as follows:

1. R.E.I. borrowed $900,000 from Northland Bank.

2. R.E.I. paid Mr. Remington $900,000 as a lease inducement.

3. Mr. Remington deposited the $900,000 with his bank, Canadian Imperial Bank of Commerce ("C.I.B.C.").

4. C.I.B.C. issued a letter of credit for $900,000 to R.E.I. which was drawn on account of Mr. Remington. Mr. Remington had to keep the $900,000 on deposit with C.I.B.C. against the letter of credit.

5. R.E.I. deposited the C.I.B.C. letter of credit for $900,000 with Northland Bank as security for its loan of the $900,000 tenant inducement money to R.E.I.

In its letter of commitment to R.E.I. dated May 14, 1985 which set out the terms of its $900,000 loan to R.E.I., Northland Bank stated:

It is also agreed that in the event of a sub-lease being entered into by the tenant that on approval of the owner regarding the validity of the sub-lease the L/C will be reduced on a pro-rated basis determined by the number of square feet sub-let. Such approval will not be unreasonably withheld (Exhibit R-13, Exhibit "A").

The Philadon and Helix subleases were approved by R.E.I. and assigned to R.E.I. by Mr. Remington. Mr. Remington only recovered the C.I.B.C. Letter of Credit by commencing an action for an injunction against the Curator of the Northland Bank. That injunction was ordered on December 19, 1985 (Exhibit R-14).

Mr. Remington also had to sue R.E.I. for the $100,000 in bonds. He was paid the $100,000 on August 7, 1986 when R.E.I. sold Lots 3 and 4 to Philadon (Exhibits R-15 and R-16). The agreement respecting the payment of $100,000 is contained in Exhibit R-16 which reads as follows:

AGREEMENT BETWEEN:

RANDY REMINGTON of the City of Calgary in the Province of Alberta (hereinafter referred to as Remington”) OF THE FIRST PART

- and -

PHILADON DEVELOPMENT CORPORATION of the City of Calgary in the Province of Alberta (hereinafter referred to as" Philadon")

WHEREAS Philadon has agreed to purchase the Intergraph Building from R.E.I. Management Inc.; and

WHEREAS as part of the consideration to R.E.I. Management Inc. from Philadon, Philadon has agreed to assume R.E.I. Management Inc. outstanding obligations to pay to Remington the balance of the lease inducement owed to Remington by R.E.I. Management Inc.

NOW THEREFORE THIS AGREEMENT WITNESSETH:

1. In consideration of Remington releasing R.E.I. Management Inc., Philadon hereby covenants with Remington to pay to Remington $100,000 representing the face value of the Government of Canada Bonds under terms of an agreement between R.E.I. Management Inc. and Remington dated May 22, 1985.

2. Remington hereby accepts as payment in full of said obligations a Demand Promissory Note without interest payable from Philadon to Remington in the amount of $100,000.

3. Remington hereby releases R.E.I. Management Inc. of all further obligations and responsibilities in this regard.

IN WITNESS WHEREOF, the parties hereto have executed this agreement as of the 7th day of August, A.D. 1986.

Randy Remington

PHILADON DEVELOPMENT CORPORATION

With respect to this payment of $100,000, the assumption of the Queen contained in subparagraph 9(n) reads:

(n) as part of the purchase and sale transaction Philadon credited the appellant's shareholder loan account with $100,000, such moneys being alleged to be owed from R.E.I. to the appellant.

On August 7 Randy Remington and Philadon also agreed that Mr. Remington's lease on the Intergraph Building (Exhibit A-4) was cancelled. The cancelling clause of the agreement signed by Mr. Remington and Philadon reads as follows:

In consideration of $1 paid by Philadon to Remington, receipt whereof is hereby acknowledged, the parties hereto agree that said lease of 20,482 square feet is hereby cancelled (Exhibit R-17).

The appellant did not report the $1,000,000 in his income tax return for 1985. His 1985 notice of confirmation stated that $785,733.06 was included in his income pursuant to section 3 and subsection 9(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). This sum was calculated as follows:

(Reply, Subparagraphs 9(p) and (q))

The evidence is that this is the only head lease/sublease deal that the appellant ever entered into personally. Thus, the appellant stated in paragraphs 16, 17 and 18 of his notice of appeal:

16. The appellant was not in the business of leasing commercial premises for subletting to tenants.

17. The appellant entered into the head lease for the purpose of earning income from property in the form of rental income.

18. The inducement does not form part of the rental revenue of the appellant from subletting the premises since it was not paid to the appellant by a subleasee [sic].

Paragraph 18 was admitted by the respondent. Paragraphs 16 and 17 were denied.

The respondent pleaded assumptions 9(p) and (q) and pleaded paragraph 10 which read as follows:

9(p) the $1,000,000 in lease inducement payments receivable in 1985 by the appellant were income from a business conducted by the appellant.

(q) the appellant incurred expenses of $217,266.94 in legal fees and leasehold improvement expenses in the business.

10. Further, the Deputy Attorney General pleads, as a material fact, that Randy Remington was involved in 1985 in a partnership with Bryan Sheer and that the business of the partnership was the leasing of space in buildings owned by the partnership.

The appellant and Mr. Sheer operated a number of corporations which built and leased buildings. The appellant also had a holding corporation which leased property.

Anthony James Murray, CA, qualified as an expert witness respecting generally accepted accounting principles. He testified that a lease inducement payment is accounted for by deducting its proceeds from the cost of improvements it is used to purchase or develop in the leased premises; in this way it affects the net accounted for costs or income of the leased premises. The concluding paragraph of Mr. Murray's letter of opinion dated March 26, 1993 respecting this matter reads as follows:

CONCLUSION

In the situation at hand, the receipt by Mr. Remington of $1,000,000, constitutes an inducement payment which, in our opinion, would be amortized to income over the period of the lease, or if linked to the leasehold improvements over the useful life of such improvements (Exhibit A-11).

In both examination-in-chief and in cross-examination Mr. Murray took the position that any cash payment by way of inducement should be accounted for as a reduction of rental expense over the term of the lease. Therefore, his view was that it should not be taken into income in the year of receipt, rather it should be used to reduce the expenses of the primary lease and thereby it would increase the net income from the lease transaction. If there were no term of lease and no improvements, then it would all be included in one year.

Crown counsel argued that the determination [of] what the $1,000,000 constitutes and how it is to be dealt with is a question for the Court.

The Court is satisfied that the lease itself was a capital asset insofar as the appellant is concerned. The appellant was not in the business of trading in leases. The evidence is that various corporations in which the appellant was interested were in the leasing business, but the appellant himself was not. Rather, the appellant entered into this lease transaction for the purpose of earning income from property in the form of rental income. At the time that the lease was signed it was known that the appellant would sublease and there is no evidence of any secondary intention.

The manner in which the $1,000,000 inducement was to be used by the appellant was not specified. The evidence is that both the $900,000 and the $100,000 were paid to the appellant for his free use and enjoyment.

In Woodward Stores Ltd. v. The Queen, [1991] 1 C.T.C. 233, 91 D.T.C. 5090 (F.C.T.D.), Joyal, J. of the Federal Court of Canada canvassed the law respecting lease inducement payments thoroughly, including the statute, the cases decided, and the Interpretation Bulletins issued by the Minister of National Revenue, including Interpretation Bulletin No. IT-359R2, paragraph 9 of which reads:

9. A payment received by a tenant from a landlord as an inducement to enter into a lease will be considered in the hands of the tenant as

(a) a non-taxable capital receipt where the payment is a reimbursement of part or all of the tenant's capital cost of leasehold improvements within the meaning of Regulation 1102(4);

(b) a reduction of those expenses where the payment is a reimbursement of other expenses incurred by the tenant;

(c) income where the negotiation of leases is a regular part of the tenant's business operations (e.g. a chain store);

(d) a reduction of what would otherwise be the rental expense of the tenant where the payment is a rebate of rent for a period of the lease;

(e) a non-taxable capital receipt in other cases.

Unlike the inducement described in Woodward Stores Ltd. v. The Queen, supra, the inducement in this case was not to be a fixturing allowance. Unlike the inducement described in French Shoes Ltd. v. The Queen, [1986] 2 C.T.C. 132, 86 D.T.C. 6359 (F.C.T.D.), the inducement in this case was not specified to be used for inventory.

There is no indication that R.E.I. required the appellant to do anything with the $900,000 once he received it. There is no evidence that the amount of rent charged was related to the $900,000. There is no evidence before the Court as to the relative rents available in Calgary and whether or not the rent paid by the appellant to R.E.I. was "rock bottom”, or was higher than the market rate for equivalent space. From the beginning of negotiations, R.E.I. had always offered the $900,000 to the tenant as an inducement. There was no negotiation over that figure and it had never been asked for by the appellant. It was, in essence, a' given", once the appellant signed the lease. The Court finds that the $900,000 was not income from property. In these circumstances the Court finds that the $900,000 payment by R.E.I. to the appellant constituted a“ non- taxable receipt".

With respect to the $100,000 lease inducement payment, the evidence is different. The oral evidence of Mr. Remington is that he solicited the extra $100,000 and R.E.I. agreed to pay it in consideration for an increased rent rate. The $100,000 was formally agreed to by R.E.I. in a document separate from the lease (Exhibit A-5). Finally, Philadon paid the $100,000 in full satisfaction on August 7, 1986 pursuant to Exhibit R-16. In these circumstances the $100,000 is a reduction of what otherwise would be a rental expense of the appellant and constitutes a rebate of rent for the period of the lease.

No evidence was led as to whether the appellant was on a cash basis or an accrual basis respecting his income in 1985. Certainly, it is obvious from the evidence that if the appellant was on an accrual basis, the $100,000 lease inducement payment was at best a doubtful debt at the end of 1985, since R.E.I. and the appellant were litigating about its payment in 1985. The $100,000 was in fact received by the appellant on August 7,1986 on the same day that the lease was terminated. In these circumstances the $100,000 constitutes income to the appellant which was paid to him and received by him as income in his taxation year ending December 31,1986.

In view of these findings, no other matters raised in the pleadings or defined in the issues need be dealt with by this Court.

For the foregoing reasons this matter is referred back to the Minister of National Revenue for reconsideration and reassessment.

The appellant is granted his party-and-party costs.

Appeal allowed.