Urbandale Realty Corporation Limited v. Minister of National Revenue, [1993] 1 CTC 2132, 93 DTC 154

Bonner, T.C.C.J.:—The appellant carries on the business of a land developer, that is to say, it buys raw land, subdivides it into building lots, services the lots and sells them to construction companies. In its 1986 taxation year it paid a development charge of approximately $2.9 million to the regional municipality of Ottawa-Carleton. In computing its income for the year it sought to deduct the entire amount paid. In assessing tax for the year the respondent disallowed the deduction and this appeal resulted. The appellant takes the position that the amount paid was”. . . property taxes . . . payable by (it) in respect of land . . . to a . . . Canadian municipality . . ." within the meaning of subsection 18(2)(b) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") and deductible thereunder. In the alternative it takes the position that the charge is deductible in the computation of profit for purposes of section 9 of the Act.

The charge was paid in respect of lands owned by the appellant and located on a draft plan of subdivision known as Bridlewood Phase III. The lands were located in the city of Kanata. That city forms part of the regional municipality of Ottawa-Carleton (hereinafter the Region"). None of the lands within the draft plan of subdivision was sold by the appellant before the end of its 1986 taxation year. Indeed some of them have not yet been sold.

At the hearing of the appeal evidence was given by Alan Cohen, a lawyer specializing in municipal development and planning law. He identified the policies and practices of the various levels of municipal government involved in the development process. His evidence was fair and balanced and I have no hesitation in relying on it.

Prior to the imposition of regional development charges developers were required as a condition of the subdivision agreement to install at their own expense services such as sewers and water within the boundaries of the subdivision plan. As well developers were forced to dedicate lands for roads and parks located within the plan and otherwise to bear the costs directly and immediately linked to the subdivision itself. However many general costs of urban expansion were borne by existing rate-payers. The regional development charge was a one-time payment designed to reduce the impact on the existing tax base of the indirect capital costs of new development. The charge was intended to raise funds to finance capital expenditures related to general urban expansion as opposed to costs linked directly to a single newly developed subdivision. Examples of the costs intended to be defrayed include costs of regional road improvements, health care facilities, transit ways, main sewers, pollution control plants, water distribution systems and water purification plants. The charge was uniform in nature, that is to say it was calculated by multiplying a per capita rate by the average number of persons expected to inhabit dwellings of the type permitted by the zoning applicable to each lot or block on a registered plan of subdivision. When collected by the region the development charge was to be distributed among reserve funds set up for each of the categories of expenditure intended to be defrayed by the charges. Thus the development charge did not constitute a recovery of costs which could be tied in a direct and immediate way to the provision of service required by an individual plan of subdivision.

It was the policy of the region to enter into agreements with local municipalities within the region requiring the municipality to refrain from issuing a building permit for a residence unless it was established that the regional development charge had first been paid. The appellant paid the development charge now in question well before the building permit deadline. It did so in order to avoid an anticipated increase in the rate.

In its audited financial statements for 1986 the appellant treated the charge as part of its "administrative-overhead" costs and deducted the entire amount thereof in computing income. The land which was sold by the appellant in the year and which generated the land sales revenues reported by it in its financial statements did not include any part of the land in respect of which the charge was paid.

Opinion evidence with regard to the accounting treatment of the development charge was given by Leonard Cogan, C.A., a member of the firm of accountants which audited the appellant's financial statements for 1986 and expressed the opinion that they fairly presented the financial picture of the company in accordance with generally accepted accounting principles. Mr. Cogan stated that the facts taken into account in determining the accounting treatment for the development charges included:

The company has consistently followed a policy of recording interest, taxes and other carrying costs on land which is being held for development as an expense on its financial statements. It believes that this is a conservative approach and prevents the overstatement of assets on the balance sheet and properly matches revenue from land sales with costs incurred during the year as a result of conducting its land development business.

Mr. Cogan stated that the handbook of the Canadian Institute of Chartered Accountants was silent on the subject of the accounting treatment for carrying costs on land held for development. Accordingly, Mr. Cogan turned to the American Financial Accounting Standards Board ("FASB") and relied on Financial Accounting Standards Statement No. 67 of that body which reads in part as follows:

Cost incurred on real estate, property taxes and insurance shall be capitalized as project costs only during periods in which activities necessary to get the property ready for its intended use are in progress. Cost incurred for such items after the property is substantially complete and ready for its intended use shall be charged to expense as incurred.

Mr. Cogan noted that the Canadian Institute of Public Real Estate Companies ("CIPREC") has recommended that carrying costs on land held for development be treated as part of land costs and therefore be “ apitalized”. However Mr. Cogan did not agree with that recommendation and asserted that CIPREC does not represent an independent impartial body because its members are in the main, public real estate companies which act as a lobby group.

One of the factual premises on which Mr. Cogan's opinion was based was that the land on which the development charge was paid had only received draft plan approval and therefore no land development had taken place prior to the end of the taxation year. It was Mr. Cogan's opinion that development of land does not commence until work is physically done on the land to make it ready for its intended use.

Mr. Cogan expressed the view that the development charge amounts to nothing more than a tax on developers calculated by reference to the number of lots for which building permits are to be issued. He stated that the payment of the charge does nothing to enhance the value of the land. He reasoned further that the inventory of land held for development cannot be compared to the inventory of a company which manufactures merchandise. In the latter case, according to Mr. Cogan, the selling price is calculated by taking into account direct and indirect costs and the addition thereto of a mark-up. Thus, he reasoned, the value of an inventory of merchandise will almost always be greater than the cost incurred. He stated that, in contrast, in the land development business, it is the market which determines the selling price and a markup of the costs incurred will not provide a formula for determining selling price. Thus Mr. Cogan concluded that the "capitalizing" of taxes and interest would overstate the profit from land development and that the accounting principles followed by the company accurately reflect the nature of its ongoing activities.

The respondent called D. Neil McFadgen, C.A., a partner in charge of national auditing services with the firm of Price, Waterhouse chartered accountants. He was eminently Qualified to give evidence as to the proper accounting treatment of land development business operations. Mr. McFadgen expressed the opinion that the appellant's treatment of the development charge was not in accordance with generally accepted accounting principles. He characterized the regional development charge as:

. . . a one-time fee related to each lot for which a building permit is issued. Therefore it is different from a carrying charge which normally is a cost which is expected to recur over a period of time, such as interest or realty taxes. It does not have the normal characteristics of an overhead cost. Overhead cost in the real estate industry usually consist of salaries and benefits including development personnel ana executives, traveland automotive costs, stationery and office expenses, directors’ fees, insurance costs, computer facility costs, subscriptions, capital and business taxes and donations. In essence, the regional development charge can be likened to a cost of obtaining zoning. It is a necessary cost that must be paid prior to issuance of building permits for the lots. Accordingly, it is a laid- down cost in the production of building lots.

Mr. McFadgen cited paragraph 202.01 of the handbook published by the Canadian Institute of Public Real Estate Companies (CIPREC).

The principle of matching costs and revenue requires that carrying costs on land held for development or sale should form part of its cost. These costs include: direct and allocated interest, real estate taxes and an appropriate portion of general and administrative expenses as outlined in paragraph 201.03.

While I have no difficulty with what is said I note that the development charge cannot realistically be viewed as a carrying cost and indeed Mr. McFadgen did not so view it. Mr. McFadgen relied on a text, Canadian Edition of Intermediate Accounting by D.E. Kieso, et al. for the proposition that:

Charges directly connected with the bringing of goods to the place of business of the buyer and converting such goods to a saleable condition are accepted as proper inventoriable costs.

Mr. McFadgen concluded that:

. . . generally accepted accounting principles in Canada require development costs to be capitalized. Such development costs should be expensed as cost of sales with the related revenue.

In considering the deductibility of the development charge it should be noted at the outset that the issue before the Court relates to deductibility in the computation of income from a business. Thus, section 9 of the Act is the starting point. It provides that income from a business for a year is the" profit” therefrom for the year. The word profit" is not defined by the Act. The courts have consistently held the profit is to be computed in accordance with ordinary commercial principles, subject always to the dictates of any applicable provision of the Act. The question is one of law for the Court. In consequence the evidence of experts is not conclusive. The position is, in my respectful view, neatly and accurately summarized in the following passage from the reasons for judgment of Jackett, P. in Associated Investors of Canada Ltd. v. M.N.R., [1967] 2 Ex. C.R. 96, [1967] C.T.C. 138, 67 D.T.C. 5096 at pages 101-2 (C.T.C. 143-44, D.T.C. 5099):

Profit from a business, subject to any special directions inthe statute, must be determined in accordance with ordinary commercial principles (Canadian General Electric Co. v. M.N.R., [1962] S.C.R. 3, [1961] C.T.C. 512, 61 D.T.C. 1300, per Martland, J. at page 12 (C.T.C. 520)). The question is ultimately “one of law for the court”. It must be answered having regard to the facts of the particular case and the weight which must be given to a particular circumstance must depend upon practical considerations. As it is a question of law, the evidence of experts is not conclusive. (See Oxford Motors Ltd. v. M.N.R., [1959] S.C.R. 548, [1959] C.T.C. 195, 59 D.T.C. 1119], per Abbott, J. at page 553 (C.T.C. 202), and Strick v. Regent Oil Co., [1965] 3 W.L.R. 636 per Reid, J., at pages 645-6 (H.L.). See also M.N.R. v. Anaconda American Brass Ltd., [1956] A.C. 85, [1955] C.T.C. 311, 55 D.T.C. 1220 at page 102 (C.T.C. 319).

My first task is therefore to determine the proper treatment of the amounts in question in accordance with ordinary commercial principles. Having ascertained that, I must consider whether any different treatment is dictated by any special provision of the statute.

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 my view the generally accepted accounting principles espoused by Mr. McFadgen more closely accord with ordinary commercial principles than those espoused by Mr. Cogan. I have arrived at that conclusion for several reasons. The primary reason is that deduction in 1986 would depress 1986 profits by charging against the revenues of that year an amount which in reality is a cost of earning the revenues of the later years during which the Bridlewood III building lots will ultimately be sold. The 1986 payment of the development charge was quite unrelated to the process of earning the appellants 1986 revenues. The charge cannot reasonably be regarded as an administrative or overhead cost or as a "running expense" of the business as a whole as described by Rowlett, J. in Naval Colliery Co. v. 1.R.C. (1928), 12 T.C. 1017 (H.L.). The outlay was not made to satisfy a recurrent demand arising from the operation of the business as a whole. It is obvious that the direct and immediate result of the payment of the charges was an increase in the value of the appellant's inventory of building lots within Bridlewood Phase III all of which were on hand at the end of 1986. It must be remembered that before the payment was made no building permit could issue in respect of these lots. By making the payment the appellant eliminated an obstacle which would otherwise have prevented the appellant's customers from getting the product they sought, that is to say, a lot on which a housing unit could be built.

The appellant's economic position was not worsened by the payment of the charge. As a result of the payment it had less cash but it had lots that were worth a great deal more. In expressing the opinion that payment of the charge did not increase the value of the land Mr. Cogan moved from matters of accounting in which he was qualified by training to express an opinion into areas in which he was not so qualified. Plain common sense is relevant in matters such as this. In Ostime v. Duple Motor Bodies Ltd., [1961] 2 All E.R. 167, Viscount Simonds said at page 171:

Stock-in-trade and work in progress are brought into account because, fictitiously but as a matter of plain common sense, they are treated as a receipt of the year's trading.

[Emphasis added.]

Ostime v. Duple stands as a warning against accounting methods that would create a risk of overstating profit. At pages 170-171, Viscount Simonds stated :

My Lords, I think that, in this dilemma, the prevailing consideration must be that the taxpayer should not be put to any risk of being charged with a higher amount of profit than can be determined with reasonable certainty. He may concede that stock-in-trade and work in progress must, for tax purposes, be regarded as a receipt. On that, professional accountants appear to be universally agreed . . . .

That warning is to be taken seriously but it is in my view clear that the disallowance of the appellant's claim would not result in an overstatement of the appellant's income for 1986. The lots will be carried in inventory at the lower of cost or market in accordance with the general rule and the possibility of a fall in market value to a figure less than cost will thus be reflected at the appropriate time.

Finally I will comment briefly on Financial Accounting Standard No. 67 relied on by Mr. Cogan. For convenience I will repeat it.

Cost incurred on real estate, property taxes and insurance shall be capitalized as project costs only during periods in which activities necessary to get the property ready for its intended use are in progress. Cost incurred for such items after the property is substantially complete and ready for its intended use shall be charged to expense as incurred.

That statement cannot be read as preventing the deferral of the deduction of the development charge by reflecting the amount as a cost of inventory. Mr. Cogan's view that progress in“ "activities necessary to get the property ready for its intended use” commences only when construction activities commence on the lands is quite untenable. The appellant is a developer. The assertion that activities leading to draft plan approval and from that stage to final approval and registration of a plan of subdivision do not form part of the development process cannot rest on a realistic view of the ambit of the development process. Equally the payment of the development charge forms part of the development process. In my view, although the outlay now in issue was made in the course of the appellant's current business operations and must, therefore, be taken into account in computing the profits from such operations, it can only be taken into account at the proper time. That time is the time of sale of the inventory in respect of which the charge was imposed.

I turn next to Mr. Weinstein's argument that the development charge is a property tax within the meaning of subsection 18(2) of the Act and is deductible under that provision even if it is not deductible under section 9 of the Act. Subsection 9(1) provides “. . . a taxpayer's income for a taxation year from a business . . . is his profit therefrom . . ." The plain language of subsection 18(2) makes it clear that it operates to restrict the deduction of amounts which might otherwise be deductible in the computation of income or profit. That conclusion is made inescapable by the statutory language". . . in computing the taxpayer's income . . . from a business . . . no deduction shall be made. . . ." Thus the appellant, having failed in relation to section 9, cannot look to section 18 for relief. For the foregoing reasons the appeal will be dismissed.

Appeal dismissed.