Elwood Smith Limited v. Minister of National Revenue, [1981] CTC 2208, 81 DTC 132

M J Bonner:—The appellant appeals from assessments of income tax for its 1972 and 1975 taxation years.

In assessing tax for 1972 the respondent proceeded on the basis that certain buildings owned by the appellant and situated in the Town of Listowel, Ontario, were ‘’rental properties” as defined in subsection 1100(14) of the Income Tax Regulations and that subsection 1100(11) of those Regulations therefore operated to limit the deduction otherwise permitted by subsection 1100(1) of the Regulations. Accordingly, on assessment the respondent disallowed $7,687 in capital cost allowance forming part of a claimed rental loss of $13,275.

The appellant’s pleaded position in this regard was that the management of the buildings by the appellant in 1972 was part of its business and consequently all the revenue earned by it from the buildings was business revenue and not rent and, in further consequence, none of its buildings was a rental property within the meaning of subsection 1100(14).

One of the buildings, a hotel, was sold by the appellant in 1975. The Minister assessed tax for that year on the basis that the building was a “rental property” within the meaning of subsection 1100(14) of the Regulations; that it fell within a Class 3 of Schedule B [New Schedule II] to the Regulations separate from another Class 3 of other properties belonging to the appellant by virtue of subsection 1101 (1ae) of the Regulations; and that, as a result, amounts of recaptured capital cost allowance were, by virtue of subsection 13(1) of the Income Tax Act, to be included in the computation of the appellant’s income for the year.* [1]

The appellant’s pleaded position was that the hotel was not a rental property for the same reasons as set forth for 1972. It therefore did not fall into a separate Class 3. The undepreciated capital cost of the Class 3 assets which included the hotel and all its other buildings described in Class 3 was greater than the proceeds of disposition and thus no amount fell to be included in income by virtue of subseciton 13(1) of the Act.

Finally, the appellant contended that the undepreciated capital cost of the class of property which included the hotel was higher than found by the Minister on assessment.

Elwood Smith was controlling shareholder of the appellant company. He operated a grocery store in Listowel, initially in rented premises. In 1946 he bought a hotel building at the corner of Main Street and Argyle Avenue. He then moved his grocery store to premises forming part of the hotel building. He also commenced to operate a hotel business in the remainder of the building.

In 1955 the appellant was incorporated and took over the grocery business. Mr Smith retained title to the hotel property and he leased the store premises to the appellant. Further property at the rear or north of the hotel was acquired. Additions were made to the structure of the hotel building, the first being for the expansion of the grocery store and the second being for purposes of a cocktail lounge. A further block of land was acquired to the north of the cocktail lounge for customer parking. The cocktail lounge addition was constructed in 1969.

The supermarket operated by the appellant today is situated in the city block lying to the north of the block in which the hotel, its additions and parking area are located. In the early 1960’s the first part of the present supermarket building was constructed and the appellant moved its grocery operations into the new structure.

The portions of the hotel building formerly occupied by the supermarket were then divided and leased to a bank and to the operator of a men’s wear store.

Following the move of the supermarket to the north block four additions to the building were made. Almost all the property in the north block was purchased by the appellant for purposes of parking, warehousing or building expansion. The property purchased in the north block included certain houses which, at the relevant times, were rented to tenants but which were acquired with a view to the expansion of the supermarket building. The supermarket building, during the relevant years, contained a small area rented out for purposes of stores and offices.

By 1962 all thought of making further use of the hotel for purposes of the operation of the grocery store was abandoned.

In September of 1969 during the appellant’s 1970 taxation year the hotel building, including the first addition but excluding the cocktail lounge, was sold by Mr Smith to the appellant for an amount equal to the undepreciated capital cost to Mr Smith. The appellant leased back to Mr Smith the portion of the building containing the hotel rooms and dining room. As well, it leased the cocktail lounge to Mr Smith upon completion of construction.

On December 31, 1971, Mr Smith sold the business which he carried on in the dining room, lounge and hotel rooms to Tri-City Holdings Limited, a company owned by his children. Thereafter, until the sale in 1975, the hotel property (save for the area leased to the bank) was leased by the appellant to Tri-City.

Mr Ward argued that the hotel could not fall into the definition of “’rental property” because 99% of the food sold in the dining room was bought from the appellant. He relied on that portion of subsection 1100(14) following the words, “but, for greater certainty”. There was no evidence of any agreement containing the requisite undertaking. Mr Ward suggested that in a non-arm’s length situation no written agreement was necessary. Subsection 1100(14) does not require a written agreement, but it does require an agreement. Further, there was no evidence which could reasonably lead to a conclusion that the hotel was leased in the ordinary course of the appellant’s business of selling groceries. This argument must therefore fail.

Mr Ward argued further that the principal purpose for which the hotel property was used in 1972 and 1975 was not that of gaining or producing gross revenue that is rent. He argued that the evidence demonstrated an interconnection of all of the properties arising from the overall business of the company. The evidence does demonstrate an interconnection.

Subsection 1100(14) looks to “use” by the taxpayer of the property “in the year”. The word “used” in the context of the subsection does not mean “occupied”. However, neither in 1972 nor in 1975 did the company use the properties in question, that is to say, the hotel and houses, save for the earning of rent. As to the pleaded argument, the fact that the rent received by a landlord may, in some circumstances, form part of income from a business does not, in logic, lead to the conclusion that the gross revenue is not rent.

A further argument was advanced on behalf of the appellant in relation to the quantum of recapture arising from the 1975 sale of the hotel. It was that the respondent, in computing the “total depreciation allowed to the taxpayer for property of that class before that time” under subparagraph 13(21 ) (f) (iii) of the Act was not entitled to include depreciation allowed as a deduction to Mr Smith during the period of his ownership of the hotel (ending in 1969). The reasoning which lay behind this argument was that the separate class of Class 3 property into which the rental properties fell arose from the introduction of subsection 1101(1ae), effective January 1, 1972, and that in respect of that class there had never been a claim. It was submitted further that nothing is deemed to have been claimed in respect of the property.

Reference was made to paragraph 13(5)(b) of the Act. In my view subsection 13(5) is not relevant. Subsection 1101 (1 ae) does not effect a transfer. It effects a separation. The undepreciated capital cost to the appellant of the hotel at the time of its sale is simply its historical cost to Mr Smith by operation of paragraph 20(4)(a) of the former Act less, by operation of the same provision, capital cost allowance claimed and allowed to Mr Smith and less, as well, capital cost allowance claimed and allowed to the appellant following its purchase of the hotel. It would be inconsistent with the scheme of the Act if, in determining the paragraph 13(21)(f) figure, one were to have regard to the cost of property falling into a class for purposes of subparagraph (i) and, at the same time, to fail to have regard to depreciation previously allowed in respect of that same property for purposes of subparagraph (iii). Nothing in the words of the paragraph justifies such an interpretation. In the circumstances of this case subsection 20(4) of the former Act continues to apply by reason of subsection 20(1.3) of the Income Tax Application Rules, 1971.

For the foregoing reasons the appeals are dismissed.

Appeal dismissed.