Her Majesty the Queen v. Stanley a Vineberg, Val Royal Corporation and Harlaw Investments LTD, [1974] CTC 41, 74 DTC 6055

Addy, J:—This is an appeal by way of trial de novo from a finding of the Tax Review Board who found in favour of the taxpayers herein. The three cases were ordered to be tried together.

The facts in issue can best be summarized by reproducing hereunder the agreed statement of facts which was filed by consent of all parties at the outset of the trial. In addition, at trial, a list of documents was filed on consent. The statement of facts reads as follows:

1. The Defendants own various apartment buildings in St Laurent, collectively operated and administered by them under pooling agreements and commonly known as Norgate Housing Development.

2. Each Defendant entered into an agreement with Central Mortgage and Housing Corporation (CMHC) for rental insurance;

3. As a result of vacancies in the leasing of various of the apartment units, rental insurance payments aggregating $407,579.95 that were paid by CMHC to Defendants were included in the taxable income of the Defendants in the years paid and were taxed accordingly;

4. The tenants were concentrated in certain units and vacancies in other units, this method of operating called “stacking” caused some buildings to be filled and others to be left partially empty, resulting in greater rental insurance payments by CMHC (in view of the minimum co-insurance for each unit of apartments) than would have been the case if all vacancies had been spread more or less uniformly amongst all the building units; the Defendants contended that this was a more efficient way to operate the buildings;

5. Under the terms and provisions of these contracts, the Defendants received the following substantial payments of rental insurance from Central Mortgage and Housing Corporation in relationship to vacancies in the apartments:

Buildings	Rental Limit	Total payments	Excess paid
4-R1-33	$ 37,864.00	$ 53,486.70	$ 15,622.70
4-$1-34	37,864.00	97,033.17	59,169.17
4-R1-35	37,864.00	64,559.39	26,695.39
4-$1-36	37,864.00	114,118.99	76,254.99
	151,456.00	329,198.25	177,742.25
			(178,187.00)
	38,054.00	78,381.70	40,327.70
	$189,510.00	$407,579.95	$218,069.95
			($219,524.00)

6. After various discussions between the parties relative to the respective rental insurance agreements, the CMHC served notice on the Defendants under the terms of the said rental insurance agreements, had the notices registered in the Registry Office and deposited with the notary the necessary cheques representing the price set in the rental insurance agreements for the purchase of the properties;

7. Negotiations ensued between the parties and eventually there was a settlement under which it was agreed that the owners would pay to Central Mortgage and Housing Corporation an amount of $105,000.00;

8. The said amount of $105,000.00 was a compromised figure resulting from proposals and counter-proposals made by the parties during the normal process of negotiation [sic];

9. The issue in the present case relates to the tax treatment of the 105,000.00;

10. The parties agree that the issue shall be resolved on the basis of the present agreed Statement of Facts and on the basis of the documents which have been produced. It is agreed that all the documents speak for themselves and there are no facts to controvert them;

11. The Parties agree that if the Court shall be of the opinion that the payments of instalments on account of the $105,000.00 under the settlement were non-deductible payments in calculating the income of the Defendants, then the Appeal shall be maintained with costs; and if the Court is of the opinion that the payments of instalments on account of the $105,000.00 under the settlement is deductible, then the Appeal shall be dismissed with costs.

The twofold test for determining whether a particular expenditure is deductible from income seems to be well settled. One first has to determine whether, in accordance with paragraph 12(1)(a) of the Income Tax Act, RSC 1952, c 148, the expense or outlay was made or incurred by the taxpayer for the purpose of gaining or producing income from a property or a business. Counsel for the plaintiff readily conceded this. Having determined this first part, one must then address oneself to the question as to whether the payment is allowable as an income expense or a capital outlay, since a capital outlay, even if made to produce income, is not deductible as an income expense. See British Columbia Electric Railway Company Limited v MNR, [1958] CTC 21 at 31 ; 58 DTC 1022 at 1027-8:

Since the main purpose of every business undertaking is presumably to make a profit, any expenditure made “for the purpose of gaining or producing income” comes within the terms of Section 12(1)(a) whether it be classified as an income expense or as a capital outlay.

Once it is determined that a particular expenditure is one made for the purpose of gaining or producing income, in order to compute income tax liability it must next be ascertained whether such disbursement is an income expense or a capital outlay. The principle underlying such a distinction is, of course, that since for tax purposes income is determined on an annual basis, an income expense is one incurred to earn the income of the particular year in which it is made and should be allowed as a deduction from gross income in that year.

I fully agree with the statement of the law and with the authorities quoted by my brother Cattanach, J in Mandrel Industries, Inc v MNR, [1965] CTC 233 at 241-2; 65 DTC 5142 at 5147:

In order to determine whether a particular outgoing represents an outlay of capital, several tests have been proposed, one of which is that of Lord President Clyde in Robert Addie & Sons’ Collieries Ltd v CIR, 8 TC 671 at 676.

“Is it an expenditure laid out as part of the process of profit earning? Or, on the other hand, is it a capital outlay? Is it expenditure necessary for the acquisition of property or of rights of a permanent character, the possession of which is a condition of carrying on its trade at all?”

The most notable and frequently cited declaration as to what constitutes a capital outlay is that of Viscount Cave in British Insulated and Helsby Cables Limited v Atherton, [1926] AC 205 at 213:

. . But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.”

In Vallambrosa Rubber Co Ltd v Farmer, 5 TC 529, Lord Dunedin said in part at page 536:

“I do not say 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 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.”

In applying the foregoing classical tests to the present case, I cannot but think that the payment here in question was an outlay on account of capital. What the appellant did here was to make a payment once and for all, with a view to bringing into being an advantage for the enduring benefit of the trade. There is no question that the payment was made once and for all.

See also Atherton v British Insulated and Helsby Cables, Ltd, 10 TC 188 (HL), per Viscount Cave, LC at pages 192-3 where he stated that a useful criterion to determine whether an outlay was a capital expenditure is to ask oneself whether it is going to be spent once and for all or whether it is likely to recur every year. (This, of course, is not a final test.) He added, however, that, where an expenditure, in addition, is made with a view to bringing into existence an asset or an advantage of enduring benefit there would normally be “very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating it as an expenditure properly attributable not to revenue but to capital”. This test was specifically approved by the Supreme Court of Canada in British Columbia Electric Railway Company Limited v MNR (supra), not as an exhaustive test but as a useful guide.

The defendants relied on an agreement, filed at the trial and mentioned in paragraph 7 of the agreed statement of facts above, wherein the sum of $105,000 paid by the defendants to the plaintiff herein was expressed to be paid “by way of rental insurance [re]fund”. It was argued that this simply meant that it was a rebate of payments made in lieu of rental, which payments, when originally received by the defendants, were obviously taxable as income; the rebate would therefore be deductible. It was further argued on behalf of the defendants that, since the agreement was a formal one and was obviously entered into in good faith and was also the expression of an arm’s length transaction, the agreement must speak for itself and the Court should not look behind and indeed could not at law look behind the actual words used in the agreement in order to try to determine any other reason, motive or purpose for the payment being made. See Commissioners of Inland Revenue v Fleming & Co (Machinery), Ltd, 33 TC 57 at 63 as per Lord President (Cooper):

As was demonstrated in the Duke of Westminster, 19 TC 490, [1936] AC 1, it is not legitimate to look behind the form and strict legal effect of a transaction to its so-called “substance” in order to impose upon a taxpayer a liability not otherwise enforceable against him . . . .

The original contract of rental insurance provided that, after a fixed amount was paid, the plaintiff would have an option to purchase the lands and premises of the defendants for a price determined by a fixed formula, and that, in order to exercise that option, the plaintiff was to register a notice. This was done and, according to the original contract of insurance, the plaintiff then became entitled to a conveyance of the absolute title to it of the lands and premises in question. Finally, after negotiations the agreement on which the defendants relied was executed.

The original contract of rental insurance, the notice exercising the option and the memorandum of agreement were undoubtedly executed bona fide and were intended to be acted upon by the parties and were not documents used as a cloak to conceal a different transaction. Therefore, the memorandum of agreement must be given its fair meaning and cannot be ignored or treated as operating in a different way than as expressed by the parties. I also fully agree with counsel for the defendants to the effect that in such a case the substance of the transaction is to be found only by a proper construction of the agreement and that it should be construed by what appears on the face of the document and not by evidence or documents en dehors the instrument and not embodied in it or referred to in it. See the Duke of Westminster v CIR, 19 TC 490 at 521, 524 and 528.

However, in construing the meaning of any document and therefore in determining its purpose and effect, and, in this particular case, the reason for payment of the sum of $105,000, two'basic principles must be borne in mind: firstly, the whole of the agreement must be considered and not only any particular word or sentence isolated from the remainder of the document and, secondly, one must also consider the contents and legal effect of any documents actually referred to in the agreement and pursuant to which the agreement is expressed to have executed (in this case: the original rental insurance agreement, which granted the right to an option and the registered notice, by which the plaintiff purported to exercise the option to assume ownership).

Dealing with the two last-mentioned documents first, the rental insurance agreement clearly gives an absolute option to purchase the property after a fixed amount had been paid by way of rental assurance payments, this option is not expressed in any way to be by way of security for moneys advanced, because the moneys advanced under the contract are not a loan but, on the contrary, the owner of the real estate has an absolute right to these moneys and may retain them. The relevant portions of clause 3 of the original rental insurance agreement read as follows:

3. (a) In consideration of the payment of the said annual premium, and when claim is established in the manner hereinafter provided, in respect of any operating year, the Corporation shall pay to the Builder the amount by which the gross rentals are less than the insured rentals. Such insured rentals are the rentals set out in Schedule “A” to this Contract increased or decreased for any operating year by an amount equal to the amount by which the taxes and rates (whether general, special, municipal, ecclesiastical or school) levied upon or charged against the project for such operating year is greater or less than the sum of Six thousand one hundred and fifty Dollars ($6,150.00) . . . .

This clearly provides for an absolute obligation on the part of the plaintiff to pay. Clause 7 of the rental insurance agreement reads as follows:

7. At any time after the sum of Thirty-seven thousand Eight hundred and Sixty-four Dollars ($87,864.00) has been paid by the Corporation under this contract, the Corporation shall have the right and is hereby given an option to purchase the project on sixty days’ notice in writing to the owner of the project, at a price of Three hundred thousand ($300,000.00) less 2 /2 per centum per annum thereof from the first day of December 1949 to the date upon which the purchase is completed and title to the project is transferred to the Corporation, and less the sum required to discharge or radiate all mortgages, privileges, hypothecs, liens and other charges outstanding against the project, and the owner shall convey the project to the Corporation free and clear of all mortgages, privileges, hypothecs, liens and other charges, except a first mortgage or hypothec made under Section 8B of the Act, and shall execute all such documents and perform all such acts as may be requisite to such conveyance.

When title to the project has been transferred to the Corporation, the Corporation shall have no further obligation under this Contract.

It is provided that if the said option to purchase is not exercised by the Corporation within two years after the date when it first becomes exercisable, the option shall be suspended until the builder makes a claim after such two-year period, in which event the option to purchase may be exercised at any time.

It is therefore also clear from this clause that the option is an absolute one, if exercised according to its terms: it is absolute in a sense that it does not purport to be security for the payment of an advance and it is absolute also in a sense that it grants an absolute and irrevocable right to the property when exercised, the only remaining obligation being that of the defendants to execute the required documents to perfect the plaintiff’s title, from a conveyancing standpoint.

As to the notice of exercising the option it is common ground that it was given and was properly served and registered. From that moment the plaintiff had the absolute right to title and the only duty or Obligation remaining on any of the parties was the defendants’ duty to execute the required formalities to give effect to the agreement.

After negotiations, which do not form part of and are not mentioned in the agreement and therefore should not, when interpreting the agreement, be taken into consideration, the agreement itself was signed. In addition to the statement that the $105,000 is to be paid “by way of rental insurance refund” in five yearly instalments, it also provides among other things the following: an acknowledgment that the plaintiff herein is entitled to become the absolute owner of the properties and to a deed of sale thereto, an undertaking on the part of the corporation not to exercise its right to obtain the final title if the owners pay as provided for in the agreement and in such event also an undertaking on the part of the plaintiff to cancel the notices exercising the option and to renounce its acquired right; finally, the agreement provided for certain variations of certain provisions of the original insurance rental agreements.

These are the only considerations for the payment of the $105,000 flowing from the plaintiff to the defendants [sic] to be found anywhere in this agreement or any of its incorporated documents. Taking the agreement at its face value, as urged to do by counsel for the defendants, I cannot come to the conclusion that the payment of the $105,000 was paid for anything but to “bring into existence an advantage for the enduring benefit of the defendants’ business”; it was money paid for the reacquisition of “permanent rights—the possession of which is a condition of carrying on its trade or business”, and was paid “with a view to bringing into existence an asset or an advantage for an enduring benefit of a trade”. It was not paid as an income expense for the purpose of increasing income for that or any particular year nor was it laid out as a part of the income earning process.

Whether a payment is in the nature of an income payment or a capital expenditure depends on the nature of the payment and the purpose for which it was made and not merely the nomenclature which the parties, however innocently, happen to attach to it, providing of course in the case of a bona fide agreement such true purpose can be gathered from the agreement itself. Had the agreement in this case simply recited that there had been an overpayment of rentals and that the plaintiff was entitled to a refund, the result would have been otherwise, but the document, when read by itself and also when read with the other supporting documents to which it refers and in pursuance to which it purports to have been executed, clearly establishes that it could not in truth be an insurance rental refund as the word refund is normally used, that is, in the sense of a replacement, a payment back, a reimbursement of insurance money. It is to be noted that there is not even any mathematical formula or calculation or indication to establish how many months of insurance premiums are purported to be refunded or the manner in which the sum was arrived at.

From the documents themselves I am therefore driven to the conclusion that the payment of the $105,000 was clearly and essentially and solely a lump sum payment for the reacquiring by the defendants of lost property rights and it is therefore a capital expenditure. The plaintiff is therefore entitled to succeed and will have judgment with its costs. There shall be but one set of costs throughout except for disbursements.