Damon Developments Ltd. v. Minister of National Revenue, [1988] 1 CTC 2266, 88 DTC 1128

Brulé, T.C.J.:—The present appeals, heard at Regina on September 28, 1987 are from reassessments for the appellant's 1977, 1978 and 1979 taxation years by appeal 83-798 and for the appellant's 1980, 1981, 1982 and 1983 taxation years by appeal 85-1101. These appeals, heard on common evidence with appeals (of F.D. Hinkson) 83-781 and 85-1351, raise several distinct issues which shall be dealt with separately.

Capital Outlay v. Expense

The appellant is a corporation which, during the years under appeal, operated a hotel business in Regina. By its returns for the taxation years in question, it sought to deduct as business expenses outlays made in relation to the business. Some of the outlays were made specifically to renovate a beverage room on the hotel premises and other outlays were used to replace equipment used in relation to the operations of the hotel. The expenditures that do not specifically relate to the renovation of the beverage room shall be dealt with first. Among these in appeal 85-1101 is a $9,495 expenditure made in the 1980 taxation year for the replacement of draperies and the replacement of washer and dryer equipment in 1981. In appeal 83-798 the appellant claimed as business expenses the following:

Analysis

Counsel for the appellant stated that the Court should allow the expenses on the ground that 1982 minutes of settlement and consent to judgment covering the years 1973, 1974 and 1975 allowed similar expenditures. Suffice it to say it is now well settled law that the Minister is not bound by past assessing practices (see Hencott Houses Limited v. M.N.R., 24 Tax ABC 402; 60 D.T.C. 405 and Admiral Investments Limited v. M.N.R., [1967] C.T.C. 165; 67 D.T.C. 5114).

In dealing with the issue of capital expenditures v. expenses great care must be taken when drawing general principles from particular cases. Although not speaking in a judicial capacity, the former Chief Justice of the Federal Court, the Honourable Wilbur Jackett, referring to cases dealing with the capital v. expense issue, stated at the Corporate Management Tax Conference (1981) found at pages 288-9 in the report:

Having regard to the complexity of cases concerning capital transactions, I hesitate to do so. I can say that it seems to me to be a line of jurisprudence where lawyers and judges have, only too frequently, fallen into the trap of taking reasoning out of particular cases and erecting it into general principles.

This warning is particularly appropriate when reading the case of M.N.R. v. Haddon Hall Realty Inc., [1961] C.T.C. 509; 62 D.T.C. 1001 in which the Supreme Court finds the replacement of Venetian blinds, refrigerators and stoves in an apartment building to be a capital expenditure. One might be tempted to draw the conclusion that the replacement of such items in any business constitutes a capital expenditure. The Court must however consider the particular facts involved in each issue before it.

Speaking on the point at issue, Noël A.C.J. stated in Bowater Power Company Limited v. M.N.R., [1971] C.T.C. 818 at 836; 71 D.T.C. 5469 at 5480:

The Chief Justice of the Supreme Court, in dismissing the appeal from the decision of the President in M.N.R. v. Algoma Central Railway, (supra) at page 162, referred with approval to the following statement by Lord Pearce in B.P Australia Ltd. v. Commissioner of Taxation of the Commonwealth of Australia, [1966] A.C. p. 224, at page 264:

The solution, to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer.

The solution therefore, "depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process"*. [1] The question of deductibility of expenses must, therefore, be considered from the standpoint of the company, or its operations, as a practical matter.

In the present case, the equipment was purchased to replace similar items used in the operation of a hotel business. Because of the nature of the business, the case before us must be distinguished from that of M.N.R. v. Haddon Hall Realty (supra). The replacement of such items as drapes must, because of the type of business, occur at a different rate than that of similar items in an apartment rental business. Appliances have shorter useful lives when used in the operation of a hotel business than when used by tenants in an apartment building.

Chief Justice Jackett, in the case of Shabro Investments Limited v. M.N.R., [1979] C.T.C. 125 at 128; 79 D.T.C. 5104 at 5106 said:

I know of no single test to distinguish between

(a) "repairs", the cost of which is a revenue expenditure in the year during which they are carried out, and

(b) additions or improvements, the cost of which is an outlay on account of capital.

Generally speaking, replacement of worn or damaged parts, even though substantial, are repairs and are to be contrasted with changes designed to create an enduring addition or improvement to the structure.

Later Urie, J. suggested at page 131 (D.T.C. 5106) the following test to determine the nature of a particular expenditure:

Perhaps the starting point in the determination of whether an expenditure is a capital one or an income one is the expression used by the Lord President in the case of Valambrosa Rubber Company, Limited v. Farmer, 5 TC 536 where he said: —

Now I don’t say that this consideration is absolutely final or determinative, but in a rough way I think it is not a bad criterion of what is capital expenditure

— as against what is income expenditure — to say that capital expenditure is a thing that is going to be spent once and for all, and income expenditure is a thing that is going to recur every year.

As observed by Rowlatt, J. in Dunsworth v. Vickers, Limited, [1915] 3 KB 267 no stress is placed on the words "every year". Rather "the real test is between an expenditure which is made to meet a continuous demand for expenditure, as opposed to an expenditure which is made once for all, to put it shortly”. Thus it is a question of fact in each case and often a question of degree.

Chief Justice Jackett’s comments may be read in conjunction with those of Lord Reid in the case of Strick v. Regent Oil Co. Ltd. (1964), 43 T.C. 27 at pages 35-36 where he rejects "the supposed rule . . . that any lump sum paid for a benefit enduring for more than one year must be treated as capital outlay".

It is clear from the evidence presented by the appellant that expenditures for the hotel such as the replacement of drapes, washers and dryers occur regularly at relatively short intervals and are therefore made to "meet a continuous demand for expenditures". The evidence given by the appellant also indicates the items were purchased to replace similar items and did not constitute what, in the Shabro case, Chief Justice Jackett (as he then was) referred to as "something that is essentially different in kind". The purpose was not to bring in [to existence] a capital asset.

The expenditures in question must also be examined in the light of President Jackett’s (as he then was) comments in Canada Steamship Lines Ltd. v. M.N.R., [1966] C.T.C. 255 at 257; 66 D.T.C. 5205 at 5207.

There is, of course, in other types of cases, a problem as to whether the thing replaced is, from the relevant point of view, an integral part of a larger asset or a distinct capital asset, that must be, from a businessman's point of view, treated separately. In deciding a problem of this kind, the amount of the expenditure for replacement in relation to the cost of the larger asset and in relation to past expenditures for repairs of the larger asset may well be significant.

Considering the appellant's past expenditures and the relation of the amounts of the outlays in relation to the value of the sum of the capital assets involved, I come to the conclusion that many of the items which were replaced such as drapes, washers and dryers, televisions and mirrors were not distinct capital assets but were part of larger assets used to produce income from the operation of the hotel business. The Court therefore allows the appeals on this point.

Beverage Room Renovations

The above reasoning relative to outlays made to replace items used in the operation of the hotel business does not apply to outlays incurred in renovating the beverage room.

The evidence indicates the changes made were so extensive as to in fact bring into existence a new capital asset. In his testimony, Mr. Graham, purchaser of the hotel, describes the beverage room before the renovations as out of style and in need of repair. He testified the renovations were so extensive one could see at a glance that very little remained of the old beverage room. Items such as panelling, banquettes and light fixtures were replaced. The design of the room changed and, according to Mr. Graham, the clientele changed as a result of the renovations.

The Minister has examined the outlays the appellant sought to deduct and has allowed in part certain amounts. In the 1982 taxation year for example, the appellant claimed as an expense $4,191 for the beverage room design and the Minister capitalized $2,056.96. The appellant also claimed as an expense for that same year $19,545 for replacing tiles in the beverage room and $10,172 for electrical repairs and replacement. Of these the Minister capitalized $8,012.50 and $2,671.96 respectively.

The facts here resemble those in the case of Alexandra Hotel (1960) Ltd. v. M.N.R., [1971] Tax ABC 1135; 71 D.T.C. 767. In his judgment the Chairman, W.O. Davis, Q.C. described at page 1137 (D.T.C. 768) of the report the changes made to a beverage room:

The second item to be considered deals with a number of changes, some of a structural nature, made to the hotel premises upon the suggestion or recommendation of the Alberta Liquor Control Board.

One such change consisted of lowering the ceiling in the men’s beverage room and at the same time installing new acoustic tiles and ceiling lights. The existing arborite panelling on the walls was replaced by new and more attractive wood panelling in order to make the general appearance of the room more attractive and the old wooden moulding was replaced with new, chrome moulding.

At the same page Chairman Davis reaches the following conclusion:

After considering the evidence in respect of this phase of the appeal, I have formed the opinion that these changes and alterations were too extensive and substantial in their nature to be looked upon as merely routine repair and maintenance of the premises. The walls and ceiling were not merely restored to their original condition, but were altered and improved both visually and from the point of view of durability. The cost of these alterations should therefore, in my opinion, be capitalized, and written off by means of capital cost allowances.

In the case of Shabro Investments Limited v. The Queen, [1979] C.T.C. 125; 79 D.T.C. 5104 Jackett, C.J. gives examples of outlays that should be capitalized. He concludes at page 130 (D.T.C. 5108):

In each of such cases there has been, in the "replacing" operation, a substitution for some part of the building something that is essentially different in kind from what was there before and constitutes an improvement to the building rather than a mere repair thereto.

The evidence indicates that the expenditures the Minister chose to capitalize in relation to the beverage room were what Jackett, P. (as he then was) described in Canada Steamship Lines Ltd. v. M.N.R., [1966] C.T.C. 255 at 258; 66 D.T.C. 5205 at 5207 as:

money laid out to upgrade such an asset to make it something different in kind from what it was . . .

Such expenditures are capital in nature. I would borrow the words of Christie, C.J.T.C. (as he then was) in Sydney Harold Healey v. M.N.R., [1984] C.T.C. 2004 at 2014; 84 D.T.C. 1017 at 1025:

The difference is of such magnitude that I should be very surprised that, if anyone examined exhibit A-2(7) and A-5 without knowledge of the history of the property, he or she would conclude that they are photographs of the same premises. In my opinion what was done was to effect changes so fundamental in character that they cannot possibly be regarded as "repairs", the cost of which was an expenditure on account of revenue.

The appeals concerning the following amounts capitalized by the Minister in relation to the 1981, 1982 and 1983 taxation years fails as either they constituted capital renovations to the beverage room or no evidence was adduced to indicate they would be more appropriately characterized as expenses.

Reclassification of Assets

In paragraph (6) of the notice of appeal in appeal no. 85-1101, the appellant submits that if the following outlays, made in 1982, are found to be capital expenditures they should be classified as Class 8 instead of Class 3 assets under Part XI of the regulations to the Income Tax Act, as previously filed and assessed by the Minister. The appellant lists the expenditures as follows:

No evidence was adduced and no argument was presented by the appellant to justify such a finding by the Court. Therefore the appeal on this point fails.

For the same reason, the reclassification of assets from Class 8 to Class 3, referred to in the notice of appeal at paragraph 5 of the conclusions, must be denied.

No evidence was adduced to justify the finding requested in paragraph 3 of the conclusions that the sum of $161,114 referred to in paragraph 3 of the facts of the notice of appeal previously filed as capital expenditures should be allowed as a current expenditure. The appeal on this point fails.

Club Membership

The appellant sought to deduct membership fees paid in 1980, 1981 and 1982 to the Saskatchewan Roughrider Football Club in order to allow its senior management personnel access to the Club. The appellant told the Court that the Club was used to take guests there for promotional purposes.

The Court is satisfied the Club falls within the scope of subparagraph 18(1)(l)(ii) of the Income Tax Act. Having reached this conclusion, it is immaterial, in light of the Federal Court of Appeal's decision in The Queen v. Jaddco Anderson Limited, [1984] C.T.C. 137; 84 D.T.C. 6135, whether or not the expense was incurred to gain income from the appellant's business. The appeal fails on this point.

Re-Allocation of Proceeds of Sale

During its 1982 taxation year the appellant sold the Plains Hotel for the sum of $2,625,000. In reporting its income for that taxation year the appellant allocated the proceeds of the sale in the following way:

In its notice of appeal (appeal no. 85-1101) the appellant states this allocation was unreasonable and that a larger proportion of the proceeds should have been allocated to the sale of the land.

Although the agreement of purchase and sale produced as Exhibit A-6 contains the same allocation of the proceeds of sale as that found in the appellant's return for the 1982 taxation year, Mr. Hinkson, the appellant's shareholder and administrator, testified the allocation overstated the furni- ture's value and understated the land’s value. The appellant called as an expert witness Mr. Hosie who testified as to the value of the land in question.

Analysis

An issue similar to the one before the Court was determined by Taylor, T.C.J. in the case of H. Baur Investments Limited v. M.N.R., [1988] 1 C.T.C. 2067; 88 D.T.C. 1024. After reviewing the pertinent case law and particularly the decision of the Supreme Court in the case of The Queen v. George Golden et al., [1986] 1 C.T.C. 274; 86 D.T.C. 6138 Taylor, T.C.J. refused to rely on the appellant’s appraisal report as to the value of the land but found the allocation made in an agreement executed by the parties to the sale to be conclusive. Taylor, T.C.J. agreed with the view, arising out of the case of Herb Payne Transport Limited v. M.N.R., [1963] C.T.C. 116; 63 D.T.C. 1075, that the matter must be considered from the viewpoint of both the purchaser and vendor, taking into account all relevant circumstances surrounding the transaction. Taylor, T.C.J. found that in the circumstances, reliance on the appellant's appraisal of the property being sold would be paramount to ignoring the viewpoint of the purchaser and to substituting therefore the sole viewpoint of the vendor. At page 2071 (D.T.C. 1027) the judge states:

It is quite clear from the documentation and testimony that both parties to the transaction signed the "Amendment" (Exhibit A-3) of which this is the clause most critical to these appeals. It may well be that this clause represented some "tradeoff", or last minute accord, or reflected particular circumstances, as now portrayed by the appellant in this matter. But that does not alter the basic fact that the Court must take into account the known view of the other party. The case law regarding section 68 does not dictate that an "agreement" on such allocation is the only or even the most important factor to be taken into account by the Court in usual circumstances. However, in this case, because it is the so/e reflection of the purchaser's view, it cannot be overlooked and, in my opinion, must be the deciding factor for the Court. As I see the situation, it would be completely unreasonable for either the Minister, or this Court, to accept as an appropriate allocation any other breakdown of the selling price.

I am in complete agreement with the view expressed above and this would be sufficient to decide the matter. Moreover, in the present case another factor strongly presents itself.

Contrary to what had occurred in the case of H. Baur Investments Limited (supra), the appellant in the present case has relied on the allocation made in the sales agreement to file his return. The Minister has assessed the appellant in accordance with the return. The appellant now claims the allocation found in his return was made by mistake. The purchaser, as well, indicated he acted on the agreed allocation.

It is well settled law that an appellant may appeal an assessment that reflects the taxpayer's return when the return contains an error or omission. In 1887 Mr. Justice Stephen stated in Ho/born Viaduct Go. v. The Queen (1887), 2 T.C. 228:

Now, are these people aggrieved by the assessment? The real cause why they are aggrieved, according to them, is that their return was made by a mistake. No doubt it was made by a mistake. . . . But it seems to me that could have done them no harm if it had not been for the assessment based on that return. Therefore, what they ought to have done would have been, when they found out their mistake, to have appealed against the assessment, upon the ground that it proceeded upon an erroneous return. That, I think, would have been the proper course.

In Frederic J.A. Davidson v. The King, [1945] C.T.C. 189; 2 D.T.C. 718 Thorson, J. stated at page 198 (D.T.C. 722):

The taxpayer's own return of his income, while not binding upon the Minister, may be the basis of the assessment made by him. It is reasonable that this should be so since the taxpayer knows better than anyone else what his income is. . . . The taxpayer may make an error in his return by including as income that which may really be capital or by failing to claim a deduction to which he may be entitled, and he may be able on appeal, in the manner prescribed by the Act, to show such error and have the assessment set aside but there is a vast difference between an assessment that is invalid as being erroneous and one that is invalid as being made without jurisdiction to make it.

In the present case however it cannot be said the allocation was arrived at because of a mistake or error made by the appellant. The allocation was arrived at following negotiations between the parties to the sale. It was the allocation deliberately chosen by the appellant as representing the value of each item sold, one which he considered reasonable. The error the appellant refers to was not made in arriving at the allocation but subsequently in evaluating the impact such an allocation would have on his tax liability.

It may well be that for reasons of public policy a taxpayer may in certain situations successfully appeal an assessment based on his own return even when the statements contained in the return were not made by mistake or error but reflected a choice made by the taxpayer. In the present circumstances however the Court will not rely on evidence provided by the appellant to set aside the allocation of the proceeds of the sale arrived at deliberately after negotiation between the purchaser and the vendor and relied on by them in preparing their returns.

The appeal fails on this point.

Legal Expenses, Taxes and Utilities

In paragraph 2(a) of the "Grounds for appeal" the appellant states that certain costs incurred in connection with the purchase and maintenance of a property at 2700 Regina Avenue should be added to the cost base of that property. Mr. Hill, the appellant's accountant itemized the expenses as follows:

The appellant claims these expenses should be added to the cost base of the property and that the taxable capital gain resulting from the sale of the property in 1983 should therefore be reduced by half of these amounts.

The Court is satisfied the amounts in question were in fact expended in relation to the Regina Avenue property and should therefore be included in the property's cost base. The appeal is allowed on this point.

Capital Loss

The appellant also requested in paragraph 2(b) of the "Grounds of Appeal" in the notice of appeal, that the capital loss incurred in connection with the forfeited deposit concerning the purchase of a business in the 1982 taxation year be carried forward to the 1983 taxation year. In view of the Court's dismissal of the appeal concerning the reallocation of the proceeds of sale of the hotel in the 1982 taxation year and the fact that the capital loss in question was allowed against the taxable capital gain in that year, the appeal fails on this point.

Re: Cottage Expenses

During some of the years under appeal, the appellant owned a summer cottage which was used every summer by a principal shareholder and officer of the corporation. Although the shareholder estimated he and his family used the cottage for approximately 60 days a year, the evidence indicates it was at the shareholder's disposition throughout the year. The appellant sought to deduct various cottage-related repairs and maintenance outlays.

The Court has concluded after the analysis set forth in the judgment of F. D. Hinkson for cases number 83-781 and 85-1351, heard on common evidence with the present case, that the cottage was not purchased to gain or produce income but to provide a personal benefit to the shareholder qua shareholder. In light of these conclusions the appeals must fail on this point.

The appeals are allowed in part and the assessments are referred back to the Minister for reassessment in accordance with the terms of these reasons for judgment. No order is made as to costs.

Appeals allowed in part.