Ibm Canada Ltd. v. Minister of National Revenue, [1993] 2 CTC 2860

Mogan, T.C.C.J.:—During 1984, the appellant (as tenant) received lease inducement payments from different landlords with respect to seven leased locations. The issue in this appeal is whether the amounts received are capital or income.

The appellant, a 100 per cent controlled subsidiary of IBM (US), is engaged in the information handling business, manufacturing computers and related equipment. It offers a full range of hardware and software products and services. The appellant owns manufacturing plants at Don Mills, Ontario and at Bromont, Quebec. It also owns a research facility at Don Mills. In 1992, the appellant had over 10,000 employees in Canada. Approximately 4,000 were engaged in manufacturing and research and 6,000 were in marketing and service activities. In 1984, the appellant maintained about 120 sales offices (either sales or customer service centres) across Canada, in every province and in the territories. The sales offices were not owned by the appellant but were leased. Therefore the appellant had about 120 leases in 1984. The appellant had a real estate department comprising about 60 persons who performed many functions: (i) short-term and long-term planning — trying to determine where sales offices would be needed and how much space would be required; (ii) design layout for work stations and cubicles in the various offices; (iii) procuring desks and other furniture; and (iv) one person who negotiated leases on a full-time basis. About ten persons in the real estate department were maintenance staff who looked after the headquarters building in Don Mills.

The sales offices across Canada are essential to market and service the appellant's products. Therefore, the negotiation of the many leases for those sales offices is incidental to the appellant's principal business. During 1984, the appellant received lease inducement payments from landlords with respect to

seven different lease locations: one in Vancouver, one in London (Ontario), one in Halifax and four in Toronto. Exhibit A-1 is a list of the seven lease locations showing the respective inducement amounts and the amount which the appellant expended for leasehold improvements at each respective location. Exhibit A-1 is set out below:

The Minister of National Revenue added the amount $1,583,220 to the appellant’s reported income for 1984 but there is now some doubt as to whether there was a duplication error of $203,401. The appellant claims that its leases are capital assets; that the total of all lease inducement payments was received on capital account and no portion of that total should be included in the computation of income.

The negotiation and recording of lease inducement payments was explained by Ms. Debera Tomalty who is a Certified Management Accountant and the appellant's Manager of Taxes. The leasing manager (Ms. Audrey Courts) would identify a need for either new space or expanded space. She would speak with existing landlords for expansion or look for new locations. In the negotiating process, the landlord would either offer an inducement or the appellant would ask for it. As a typical example, the appellant produced Exhibit A-2, documents relating to the appellant's leased space in the Royal Trust Tower of the Toronto-Dominion Centre. A brief letter dated April 26, 1984 from Cadillac Fairview Corporation to the appellant's leasing manager simply stated:

In consideration of IBM signing leases with Toronto-Dominion Centre Ltd. covering a total of 8,643 square feet on the 10th and 14th floors in the Royal Trust Tower, we will grant an inducement allowance in the amount of $129,645.

The above letter refers to the inducement amount shown as item 3 in Exhibit A-1 above. Similarly, Exhibit R-1 contained documents relating to the appellant's lease at 195 Dufferin Street, London. A letter dated March 26, 1984 from Oxford Development Group to the appellant's leasing manager contained the following paragraph:

TENANT INDUCEMENT:

If tenant accepts this proposal, landlord shall, as an inducement for tenant to execute the lease, pay to tenant 60 days after the later of the commencement date and the date tenant first begins to conduct business in all of the premises an amount equal to $2 for each of 29,085 square feet of space contained in the premises excluding storage space.

The resulting amount of $58,170 (two times $29,085) is item 6 in Exhibit A-1. In each leasing situation, the tenant inducement provision was incorporated into the lease itself (transcript page 24, lines 18-20).

Ms. Tomalty stated very clearly in cross-examination that the lease inducement payments were not in any way tied to leasehold improvements which the appellant in its own discretion might decide to construct or install. The following is a portion of her cross-examination (transcript pages 46-47):

Q. Now, with respect to all of the payments that arose out of the agreements or the written proposal letters, the only requirement was that IBM enter into the contract; is that correct?

A. There was no strings attached to them; that’s right.

Q. But you had to enter into the lease contract to get the payment?

A. Yes.

Q. In other words, no lease, no payment?

A. Right.

Q. And once the payment was received by IBM, IBM was entitled to use it as it pleased?

A. That's right.

Q. And in all of these leases, the premises were rented from the landlord on an "as is’’ basis; is that correct?

A. Yes.

Q. So whatever the premises were like, that's how you got them?

A. That’s how we took them, yes, and any changes had to be done by us subsequent to the lease.

Q. So, any improvements or fixtures that IBM put in were completely at IBM's discretion?

A. Yes. I do not know of any requirements by the landlords to do anything specific.

Notwithstanding the appellant's unfettered discretion with respect to the use of the lease inducement payments, the appellant followed a consistent policy of recording these payments in a special manner. The amount of a particular lease inducement payment was set up in the appellant’s internal accounting system as a capital improvement account with an appropriation number for the particular leased location. When the appellant incurred costs for tenant improvements at that location, such costs were charged against that appropriation number. In most circumstances, the amounts actually expended by the appellant on tenant improvements at a particular location would, in the aggregate, exceed the lease inducement payment received by the appellant with respect to that location. This statement is borne out by Exhibit A-1.

For accounting purposes, the appellant netted the amount of the lease inducement payment against the cost of any tenant improvements to the premises and so, on the appellant’s books, the cost of tenant improvements at a particular location was reduced by any lease inducement payment received with respect to the lease for that location. For income tax purposes, there was no netting of the lease inducement payment. Therefore, the cost of tenant improvements was shown at the gross amount when computing capital cost allowance. The appellant was consistent for both accounting and income tax purposes in excluding from revenue the amount of any lease inducement payment. Although there was no expert evidence with respect to generally accepted accounting principles, Ms. Tomalty stated that the appellant's method of recording the lease inducement payments was reviewed by the appellant’s outside auditors (a national firm of chartered accountants) who approved it.

The appellant argues that its leases (approximately 120 in 1984) are capital property because they provide the premises from which the appellant markets its products and services. The appellant does not buy or sell leases or otherwise trade in them. The leases provide a flexible base from which the appellant can operate in all ten provinces and the territories. Counsel for the appellant relied on the decisions in The Queen v. Canadian Pacific Ltd., [1977] C.T.C. 606, 77 D.T.C. 5383 (F.C.A.); Consumers’ Gas Co. v. The Queen, [1984] C.T.C. 83, 84 D.T.C. 6058 (F.C.A.) for the proposition that a third party payment to reimburse the recipient for the cost of capital property should not be deducted from the cost of that property for income tax purposes. He further relied on the decision in Consumers’ Gas Co. v. The Queen, [1987] 1 C.T.C. 79, 87 D.T.C. 5008 (F.C.A.) for the proposition that such a third party payment should not be included in income. Those are important decisions of the Federal Court of Appeal and must be reviewed with care.

The relevant issue in Canadian Pacific was a claim for capital cost allowance. Canadian Pacific would receive a request to modify its railway facilities so that a third party could carry out a project of its own. The third party would reimburse Canadian Pacific for all or part of the cost of the modifications. Canadian Pacific deducted capital cost allowance on the assumption that its original cost of the modifications was not to be reduced by any amount received from a third party as reimbursement. Revenue Canada claimed that such original cost must be reduced by any reimbursement amount. The Federal Court of Appeal applied the decision in Birmingham Corp. v. Barnes, [1935] A.C. 292 (H.L.) and held that a reimbursement amount received from a third party did not reduce the original cost of the modifications for purposes of capital cost allowance.

Consumers' Gas carries on the business of natural gas production and distribution. It has about 17,000 kilometres of pipelines to service its customers. Each year, it receives many requests from third parties to relocate a portion of its pipelines to accommodate the various projects of such third parties. In those circumstances, Consumers' Gas would enter into a contract with each third party requiring the payment of a donation, grant or other contribution from the third party to reimburse Consumers' Gas for all or a significant portion of the cost of relocating its pipeline. In Consumer's Gas, the issue was whether the corporation was required to reduce the cost of the new relocated pipelines (property in Class 2 of Schedule II to the Income Tax Regulations) by the amount of any donations, grants or contributions received from such third parties. The Federal Court of Appeal held that the issue was indistinguishable from the Canadian Pacific case; and the corporation was not required to reduce the cost of new relocated pipelines by the amount of any contribution from third parties.

In Consumers’ Gas (1987), the issue was whether the amount of any donation, grant or contribution received from a third party in the same circumstances should be included in computing income. Finding in favour of the corporation, Hugessen, J.A. delivered the judgment of the Federal Court of Appeal and stated at page 82 (D.T.C. 5011):

It is common ground here that the cost of pipeline relocations is a capital outlay and that the receipts from third parties in respect thereof need not be taken into account in determining undepreciated capital cost for the purposes of calculating capital cost allowance. The mere fact that this results in such receipts not being reflected in income does not make them income. Absent some provision of the statute specifically bringing them into income, they continue to be treated, as required by generally accepted accounting principles, as capital receipts.

The Canadian Pacific case was about tangible capital property, modified railway facilities. Consumers’ Gas was also about tangible capital property, relocated pipelines. In this appeal, we are not concerned with tangible capital property but with the intangible rights and obligations which arise under a lease. It is true that any tenant improvement which the appellant may construct or install within particular leased premises would become tangible capital property of the appellant (Schedule ll, Class 13) but we are not concerned here with the cost of such depreciable property or a claim for capital cost allowance. The issue in this appeal is the character of the lease inducement payments received by the appellant as tenant.

If it were obvious from the leases and related documents that the purpose of the lease inducement payments had been to reimburse the appellant for tangible capital property like specific tenant improvements within the leased premises, the facts and issue in this appeal would be closer to the situation in Consumers’ Gas No. 2 and the Woodward decision which will be discussed below. The evidence was clear, however, that any amount received as a lease inducement payment was conditional only upon signing the lease and, when received, its disposition was within the appellant's unfettered discretion. The appellant's decision to set up an appropriation account was a matter of free choice and internal policy. Ms. Tomalty explained this in cross-examination (transcript pages 52-53):

Q. Now, you've described in your evidence the procedure whereby there would be an appropriate [sic] number and then there would be this other internal record, and you referred to it as internal control?

A. Yes.

Q. I take it you mean by IBM?

A. Yes, yes.

Q. And you said that approval was needed to spend any money?

A. Yes.

Q. You mean by IBM?

A. Yes.

Q. So that what you've described and the records that you've provided to the Court, these are all internal records of IBM?

A. That's right.

Q. They have nothing whatsoever to do with the landlord?

A. No, nothing.

In my opinion, the decisions of the Federal Court of Appeal in Canadian Pacific and Consumers’ Gas have no application to this appeal because (i) the payments received in those cases were clearly intended by the payor and the recipient to reimburse the recipient for costs incurred to modify or relocate a portion of the recipient's tangible capital property; (ii) the payments received in those cases had a capital character imposed upon them by their clearly intended purpose; and (iii) there was no direct evidence in this appeal that the lease inducement payments received by IBM were intended to reimburse the appellant for any costs at all, either of a capital or revenue nature. I am left to infer from all of the surrounding circumstances the intent or purpose of the lease inducement payments.

A lease is a special kind of contract in which a landlord grants to a tenant the right to possess a certain interest in real property for a fixed term. In this appeal, a typical lease granted to the appellant the right to possess a certain area on one or more floors of a commercial office building for a term usually measured in years. Like any contract, a lease brings into existence both rights and obligations as, for example, the landlord’s right to receive rent and the tenant's right to possession, and the landlord's obligation to grant quiet enjoyment and the tenant's obligation to pay rent. A lease does not, in itself, transfer ownership of any property.

The essence of a lease is the transfer of possession of the leased premises for a fixed term in exchange for the periodic payment of rent over that term. The rent is on revenue account for the landlord. See paragraphs 12(1)(g) and 212(1)(d) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). And unless the rent is paid for a personal residence or for some other non-commercial purpose; it is on revenue account for the tenant. See paragraphs 18(1)(a) and (d) of the Act. In this case, it was established that all of the rent paid under the many leases was deducted on a current basis in computing the appellant's income. In 1984, the total rent deducted by the appellant was approximately $29 million. The tenant's right to possess the leased premises may be capital property to the tenant but the tenant's obligation to pay rent is a revenue obligation.

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?

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. Assuming that there is consideration flowing from the tenant to the landlord for the lease inducement payment, that consideration must be found among the rights and obligations which are brought into existence by the signing of the lease. As a matter of common sense, the tenant's consideration for the lease inducement payment cannot be the tenant's right to possess and use the leased premises (and the landlord's parallel obligation to transfer possession and to grant quiet enjoyment of the leased premises) because that is the precise consideration which the tenant receives in exchange for paying the rent. 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.

If a landlord makes a lump sum payment to a tenant, upon signing, to induce the tenant to accept its obligations under the lease, the logical question arises: why does the landlord not keep the lease inducement payment and simply reduce the rent by a proportionate amount? In this appeal, there was no evidence with respect to the policy or practice of lease inducement payments in the commercial leasing industry but one could speculate on possible reasons for such payments. First, the financing of a commercial office building may be conditional upon the landlord receiving a minimum gross monthly rent. Second, the market for commercial office space will usually dictate leasing practices. If there is an abundance of space, a landlord may have to offer a bigger inducement to acquire a prestigious tenant. And third, to reduce bargaining and negotiations with prospective tenants, a landlord may want to maintain the posted rent for all tenants within a particular bank of floors so that the small non-prestigious tenant who is about to lease only 4,000 square feet can be told that he is paying the same rent per square foot as the large prestigious tenant who is about to lease 40,000 square feet. In those situations, it is unlikely that the small tenant would be able to obtain a lease inducement payment. Without further speculation, I am satisfied that there are bona fide practical reasons (including tax-motivated reasons) for the policy of making lease inducement payments.

In the circumstances of this appeal, and in particular the appellant's denial that any lease inducement payment was conditional upon the appellant's acquisition of any tenant improvements, I infer that part of the consideration for each lease inducement payment was the appellant's acceptance of its obligation to pay the rent which had been negotiated in each respective lease. In my view, there is a real commercial link between the single lease inducement payment flowing from the landlord to the tenant and the periodic rental payments flowing from the tenant to the landlord.

In business language, a person will often refer to a contract as an asset, like property. In that sense, the reference is usually to rights under the contract. This is particularly true if the right has become more valuable like a long-term contract for the purchase of raw materials at a fixed price when the price in the open market has increased. By the same token, a contract may be referred to as a liability if the obligation to pay for goods is fixed when the open market price for those goods has declined. In McLean v. M.N.R., [1966] C.T.C. 530, 66 D.T.C. 5003 (Ex. Ct.) (sub nom. Jaimet (Estate) v. M.N.R.), Gibson, J. held that a leasehold interest, as property, may have a plus value or a minus value or no market value depending upon the economic rental of similar space at a point in time (i.e., fair market value) in relation to the rent required to be paid under the lease.

The appellant's counsel may be correct in arguing that its leases (comprising bundles of rights and obligations) are capital property if one looks only at the appellant's rights to possess the leased premises from which it carries on its marketing operation in all ten provinces and the territories. I refer to the definition of "property" in section 248 of the Income Tax Act which includes a right but does not mention an obligation. If the appellant were to assign its rights under the leases, any proceeds from such assignment would probably be on capital account. The amounts in issue, however, were not received in connection with the assignment of any of the appellant's rights under its leases. On the contrary, these amounts appear to have been received more in connection with the appellant's acceptance of its obligations to pay rent under the seven leases.

Although each lease, as a contract, brings into existence both rights and obligations, it is maintained by the monthly payments of rent which are, of course, deductible expenses in the computation of profit or income. Each lease inducement payment was received in connection with and as a direct consequence of the appellant accepting its obligation to make these monthly payments of rent. The appellant, therefore, has a difficult hurdle in claiming that a lease inducement payment is a capital amount (in effect, a windfall, although the appellant does not use that term) when it is received in connection with the appellant's incurring an obligation to pay a series of income expenses.

Unlike the decisions in Canadian Pacific and Consumers' Gas, there are other cases which are concerned with payments by landlords to tenants. In French Shoes Ltd. v. The Queen, [1986] 2 C.T.C. 132, 86 D.T.C. 6359 (F.C.T.D.), the corporation operated 22 retail shoe stores all in leased premises. In 1977, it received $50,000 as an inducement to sign a lease for a retail store in a proposed shopping centre at Cowansville, Quebec. The lease itself contained the provision: "Lessee shall receive the sum of $50,000 to be applied against its inventory”. The only issue was whether the amount of $50,000 should be included in computing the corporation's income. When dismissing the corporation's appeal, Teitelbaum, J. stated at page 135 (D.T.C. 6361):

. . . a very important part of the company's business is in the negotiation of leases. The better the conditions, that is, rent, extra charges, etc., the more the profit will be from any individual store. There is no doubt that the main business of the plaintiff is the selling, at retail, of shoes.

and further at page 138 (D.T.C. 6363):

Was the payment unrelated to the taxpayer's business activities? At first glance one would have to answer in the affirmative, it was not related to the taxpayer's business activity of selling shoes. This would be true if I would only be restricted to looking at the business activity of plaintiff as only selling shoes to the public.

It is important, as part of plaintiff's business activity, to sign leases for stores under the best possible conditions, that is, the cheapest rent, the least amount of expenditures for start up costs, etc. In the present case, there was an additional benefit, a single payment of $50,000 in addition to the other benefits already described.

I also believe that the plaintiff, after signing the lease, had a right to legally claim the $50,000 promised and moreover had, according to the lease, an obligation to apply the sum to its inventory.

I am not so convinced as to believe that such a payment could not have happened again. It is my belief that there was a good possibility of its happening again for plaintiff because of plaintiff's outstanding reputation. Plaintiff was a very desirable tenant and, as such, could arrange for such an inducement if an owner of a shopping centre really wanted plaintiff as a tenant.

I am satisfied that the $50,000 received by plaintiff is part of its revenue. When a taxpayer receives an inducement to sign a lease, then those moneys received must form part of the taxpayer's revenue for the year in which the inducement was received. An inducement is not a“ "windfall", it is an incentive, a reason for doing something. Taxpayers and lessors use inducements as a form of doing business. For the lessor, it rents out space and for the taxpayer it is a benefit received. In the end, the receipt of the benefit helps to make a profit. It is part of the taxpayer's revenue that is derived because of, and is part of, its business activity.

I quote extensively from the reasons of Teitelbaum, J. because, in my view, so much of what he says has a direct application to the appellant herein. All of the 22 retail stores of French Shoes were in leased premises and the negotiation of leases was a very important part of the corporation's business. The appellant herein conducts the whole of its marketing operation (products and services) from a network of approximately 120 separate leased premises from coast to coast across Canada. The negotiation of leases is obviously an important part of the appellant’s business. Within its real estate department, there is one person who negotiates leases on a full-time basis. When Teitelbaum, J. states his belief that French Shoes has a "good possibility” of receiving another similar payment because of its “ outstanding reputation”, it is a fact that IBM in this appeal received seven lease inducement payments in 1984 alone. There was also evidence that the appellant received lease inducement payments in the preceding and following taxation years (1983 and 1985). One can easily imagine the owner of a commercial office building wanting to have the appellant as a prestigious tenant.

Although the actual lease in French Shoes contained a clause stating that the $50,000 was to be applied against inventory, that fact does not seem to have had a significant influence on the decision. Teitelbaum, J. was influenced more by the fact that negotiating many leases was very important to and incidental to the corporation's method of carrying on its business.

The decision in Nesbitt Thomson Inc. v. M.N.R., [1991] 2 C.T.C. 2352, 91 D.T.C. 1113 (T.C.C.) also involved lease inducement payments. In that case, Bonner, J. of this Court dismissed the corporate taxpayer's appeal and stated at page 2355 (D.T.C. 1115):

It is significant that Mr. Usher-Jones admitted that the appellant received inducements to enter into leases both before and after 1985 and, further, that the payment of such inducements was a common practice.

The payments cannot in my view be seen to be windfalls. They were neither unusual nor unexpected, and in this regard I refer to The Queen v. Cranswick, [1982] C.T.C. 69, 82 D.T.C. 6073 (F.C.A.). The payments were the subject of bargaining between the landlords and the appellant and were, when settled, made the subject of enforceable provisions in the leases or agreements for leases. The word windfall is, I think, totally inappropriate to describe payments of the sort under review.

I would apply the above statement of Bonner, J. in Nesbitt Thomson to this appeal because the appellant had about 120 leases to negotiate or renegotiate from time to time; the opportunity to obtain a lease inducement payment was part of the negotiation process; the landlord's obligation to make a lease inducement payment became a term of the lease itself; and the receipt of such payment was neither unusual nor unexpected. In this appeal, the appellant's receipt of lease inducement payments was frequent.

There is a significant decision of the Federal Court-Trial Division subsequent to French Shoes which reached a different conclusion and appears to support the appellant's argument. In Woodward Stores Ltd. v. Canada, [1991] 1 C.T.C. 233, 91 D.T.C. 5090 (F.C.T.D.), the corporation operated 24 large department stores in British Columbia and Alberta. Daon was constructing shopping centres in Red Deer and Calgary and wanted Woodward as an anchor tenant. Woodward signed two long-term leases with Daon which provided: (i) for the Red Deer location, Daon paid to Woodward a "fixturing allowance” of $3,000,000; (ii) for the Calgary location, Daon paid to Woodward a "fixturing allowance” of $750,000; (iii) Woodward took possession of bare space comprising perimeter walls, concrete ceilings and concrete floors; and (iv) the tenant improvements required under the leases were considerable. In fact, Woodward expended $6,658,228 at Calgary and a further $4,991,174 at Red Deer. The Minister of National Revenue assessed on the basis that both amounts ($3,750,000) received from Daon were income in the hands of Woodward. When deciding in favour of Woodward, Joyal, J. very clearly characterized the amounts paid by Daon as reimbursements for capital outlays. He stated at page 244 (D.T.C. 5098):

. . . an analysis of the contract documents submitted to me does not convince me that the terms incorporating such allowances are other than what they clearly appear to be, namely capital payments earmarked for capital purposes.

And he had previously stated at page 243 (D.T.C. 5098):

. . .it could be said that the benefit received by the plaintiff is no more than the benefit it would otherwise have enjoyed if the developer, as part of the lease conditions, had undertaken to provide leasehold improvements at the lessee's specification to a maximum of $3,750,000.

Once the amounts received by Woodward are characterized as reimbursements for the cost of tangible capital property, the Woodward decision is brought under the umbrella of Consumers' Gas No. 2. As I have already stated, that case is quite different from the appeal herein because the lease inducement payments received by IBM were not tied to any fixturing costs, tenant improvements or other tangible capital property. The only consideration which I can find for such payments is the appellant's ongoing obligation to pay rent after the various leases have commenced.

Counsel for the appellant relied on three other decisions of the Federal Court: Suzy Creamcheese (Canada) Ltd. v. Canada, [1992] 1 C.T.C. 242, 92

D. T.C. 6291 (F.C.T.D.), Pacific Northern Gas Ltd. v. Canada, [1990] 1 C.T.C. 380, 90 D.T.C. 6252 (F.C.T.D.); aff'd [1991] 1 C.T.C. 469, 91 D.T.C. 5287 (F.C.A.) and Westfair Foods Ltd. v. Canada, [1991] 1 C.T.C. 146, 91 D.T.C. 5073 (F.C.T.D.); aff'd [1991] 2 C.T.C. 343, 91 D.T.C. 5625 (F.C.A.). In Suzy Creamcheese, Collier, J. described the 18 new retail stores (all in leased premises) opened by the corporation between August 1980 and January 1984. He then stated at page 243 (D.T.C. 6292):

Out of the 18 new stores, earlier referred to, the plaintiff received leasehold inducements, or allowances, in respect of 12 or 13 of them.

The payments were paid either as a fixed sum or on a square footage basis. They were applied to the leasehold improvements or fixtures in accordance with the terms of the lease. The total cost of the improvements made by the plaintiff, always exceeded the allowances, or payments, made by the landlords.

[Emphasis added.]

In a very brief judgment, Collier, J. followed the decision in Woodward and allowed the appeal. I would distinguish the decision in Suzy Creamcheese on the same basis as Woodward.

The relevant issue in Pacific Northern Gas involved pipelines to the customers' premises and, as tangible capital property, the case could not be distinguished from Consumers’ Gas No. 7 but can be distinguished from the appeal herein for the reasons given above.

In Westfair Foods, the taxpayer corporation was in the retail food business in leased premises and its leases were part of its capital assets. The corporation received two substantial amounts from two different landlords as compensation for the early termination of two of its leases. The Minister of National Revenue had included these two substantial amounts in the corporation's income. Reed, J. allowed the appeal of Westfair Foods and held that the amounts received were on capital account for the loss of capital property. The decision in Westfair Foods is easily distinguished from the appeal herein because, although the appellant's rights under its 120 leases are capital property to the appellant, the amounts in issue were not received in connection with the disposition or loss of those rights. The contrary is true. The amounts in issue were received as a consequence of the appellant entering into seven different leases.

During argument, counsel for the appellant suggested that the introduction of paragraph 12(1)(x) of the Income Tax Act in 1986 changed the law, and that inducement payments received by the appellant in 1984 (the taxation year under appeal) should therefore be regarded on capital account. This argument was considered in French Shoes and in Woodward. In French Shoes, Teitelbaum, J. relied on the Interpretation Act, R.S.C. 1970, c. 1-23, to find that the new paragraph 12(1)(x) did not change the law. Although Joyal, J. in Woodward expressed some doubt as to whether he could agree with Teitelbaum J. on that point, he did state at page 246 (D.T.C. 5100):

Some persons may take this particular subsection to mean that inducement payments may, even in the absence of paragraph 12(1)(x), be included in income, presumably by section 3 or subsection 9(1) of the Act. This was the case in French Shoes for example. However, insofar as inducement payments of a capital nature are now included in income by paragraph 12(1)(x), I think that paragraph 12(1)(x) has changed the state of the law.

For the purposes of this appeal by IBM, the above statement of Joyal, J. begs the question because he speaks only of "inducement payments of a capital nature”. The only issue in this appeal is to determine the character of the inducement payments in the hands of the appellant as being either capital or income.

Prior to the enactment of paragraph 12(1)(x) in 1986, the decisions in Canadian Pacific (1977) and Consumers' Gas (1984) had established the principle that an amount received to reimburse the recipient for the cost of tangible capital property did not reduce the cost of that property for the purpose of computing capital cost allowance. But the question of whether such amount should be included in computing the income of the recipient was not decided by the Federal Court of Appeal until 1987 in Consumers' Gas No. 2. In my view, the decisions of the Federal Court of Appeal in Canadian Pacific, Consumers' Gas No. 1 and Consumers' Gas No. 2 apply only to payments which are intended to reimburse the recipient for the cost of tangible capital property. If the seven leases are capital property of the appellant, those leases (comprising bundles of rights and obligations) have no capital cost for which the lease inducement payments may be regarded as reimbursement. The only costs incurred by the appellant in connection with the leases, as such, are the monthly payments of rent which are on revenue account. The appellant's costs of its tenant improvements are costs of tangible capital property which, as property, is quite different from the intangible property represented by the leases themselves.

In Everett's Truck Stop Ltd. v. Canada, [1993] 2 C.T.C. 2658, 93 D.T.C. 965 a recent (July 14, 1993) decision of this Court, Bowman, J. stated at page 2662 (D.T.C. 968):

Paragraph 12(1)(x) is an unnecessarily convoluted provision. I understand that one of its important original purposes was to subject to taxation inducement payments made by landlords to prospective tenants. It casts, however, a much wider net and covers many types of payments that should in all likelihood be taxable on general principles.

Although Bowman, J. applied paragraph 12(1)(x) and dismissed the appeal by Everett's Truck Stop, he observed in a footnote that the amount in dispute would probably be income under section 9. This is the problem faced by IBM when the lease inducement payments are received in a commercial context and relate to obligations which are purely on revenue account and are incidental to the appellant’s business. I think that the enactment of paragraph 12(1)(x) in 1986 did not "change the law” with respect to the issue which is before me in this appeal. I do not find the introduction of paragraph 12(1)(x) persuasive for either side in this appeal.

Lastly, it was suggested that the hearing might be reconvened to consider evidence and argument with respect to generally accepted accounting principles (GAAP) if I should consider that such principles are relevant. I have concluded that the character of the lease inducement payments in the hands of the appellant must be determined by the underlying purpose for those payments and not by GAAP. Ordinarily, one would expect to find the underlying purpose within the leases themselves. The Royal Trust Tower lease (Exhibit A-2) states: “In consideration of IBM signing leases . . . we will grant an inducement allowance in the amount of .. .”. And the Dufferin Street lease (Exhibit R-1) states: Landlord shall, as an inducement for tenant to execute the lease, pay to tenant .. .”. Neither one of these documents (and they were presented to the Court as typical of the seven leases) indicates that the underlying purpose for the payments was reimbursement for any costs of tangible capital property as in Canadian Pacific, Consumers' Gas No. 1, Pacific Northern Gas and Woodward.

Taken at face value, the underlying purpose for the payments was to induce the appellant to sign the seven leases. But that face value purpose is too simplistic because each lease brings into existence both rights and obligations. In the circumstances of this case, I find that the primary consideration granted by the appellant for the lease inducement payments was the appellant's acceptance of its obligations under the various leases to pay rent during the terms of those leases. Those obligations were on revenue account. Having regard to the appellant's denial that any lease inducement payment was conditional upon the appellant's acquisition of any tenant improvements, I find that the inducement payments flowing from the various landlords to the appellant are just as much revenue payments as the periodic rental payments flowing from the appellant to its landlords. The inducement payment comes first in each lease but its primary purpose is to persuade the appellant to commit itself to a subsequent stream of rental payments. The appeal is dismissed subject to verification within 60 days after the date of these reasons as to whether the Minister of National Revenue made a duplication error of $203,401 or some other amount when he added the amount of $1,583,220 to the appellant's reported income for 1984.

Appeal dismissed.