Minister of National Revenue v. Allarco Developments LTD (Formerly Paris Investments Ltd), [1972] CTC 172, 72 DTC 6154

Martland, J (concurred in by Abbott, Ritchie and Laskin, JJ):—The question in issue in the present appeal is as to whether an amount of $1,000,000 paid to the respondent in October 1964 represented income received by it in the course of its trading operations.

The respondent was incorporated in the year 1954 under the provisions of The Companies Act (Alberta). One of the objects stated in its memorandum of association was:

(a) To purchase or otherwise acquire and to hold or otherwise deal in real and personal property and rights and in particular lands, buildings, hereditaments, business or industrial concerns and undertakings, mortgages, charges, contracts, concessions, franchises, annuities, patents, licences, securities, policies, book debts and any interest in real or personal property.

it engaged in a wide variety of business activities, frequently through subsidiary corporations. These included automobile dealerships, the ownership of apartment buildings, interests in construction companies, trust services, mortgages and loans, general insurance, hotel ownership, ownership of a radio station, printing, and the acquisition, development and sale of land.

In the course of its land trading activities it acquired a beneficial interest in approximately 503 acres of land in southwest Edmonton, on the Saskatchewan River, from a Mr Greniuk. The purchase price was $700,000, of which $90,000 was paid on the completion of the sale, the balance to be paid over a period of ten years. These lands were purchased subject to an agreement between Greniuk and the City of Edmonton (hereinafter referred to as the “City”), wherein he had agreed to sell approximately 130 acres to the City for parkland purposes at a price of $600 an acre. The balance of the land had been subdivided and the respondent acquired it with a view to developing it and selling lots to purchasers. These lands were described in the judgment at trial as “trading lands” and “trading inventory”.

Shortly after their acquisition by the respondent, 420 acres out of the 503 acres were rezoned by the City for use as parks, which precluded their intended use as residential properties. The respondent was unsuccessful in an attempt to persuade the City to alter the zoning to permit their use for residential purposes. An attempt to persuade the City to purchase the full 503 acres also failed.

Faced with this situation, the respondent then examined the possibility of acquiring some land owned by the City, preferably in the downtown area, in exchange for land acquired from Greniuk. Ultimately, the respondent was successful in arranging for the acquisition of a 1.23 acre parcel of land owned by the City on a hill, known as Bellamy Hill, overlooking the Saskatchewan River valley, in the central business district of Edmonton, one block south of the intersection of Jasper Avenue and 101st Street, considered as the financial core area of the City and two blocks south of the retail core area. The use to which this centrally located land could be put was limited by the fact that it consisted of a fairly steep hill, but the respondent conceived the idea of using it for a parking garage complex, entered from the hill-top level, above which there would be constructed a 23-storey hotel structure.

The agreement finally reached provided for the City exchanging this land for 215 out of the 503 acres owned by the respondent, and also for the City purchasing from the respondent an additional 217.14 acres at a price of $1,000 an acre. Before obtaining a transfer of the Bellamy Hill site from the City, the respondent was obligated to provide it with satisfactory proof that it was ready, willing and able to proceed with at least the parkade.

Before a formal agreement was executed with the City, on July 17, 1964, the respondent had been active in seeking arrangements for the financing of the proposed construction. Eventually, an arrangement was made with Great-West Life Assurance Company (hereinafter referred to as “Great-West”), which was embodied in two letter agreements, each dated July 7, 1964. One of these provided for the purchase by that company from the respondent of the Bellamy Hill site for the price of $1,000,000. This agreement also provided for a lease, to be concurrent with the land purchase, by Great-West to a corporation to be formed, providing for the improvement of the land by the lessee by a 13 split level parking garage and a 23-storey hotel building. The lease was to be for a term of 99 years at an annual rental, for the first 25 years, of $70,000, with provision for a possible rental adjustment at the end of the 25th year, and at the end of the 50th year, depending upon the appraised value of the land at that time. It was also to provide for an additional rent of 25% of net earnings from all sources in the parking and the hotel building. The purchase was subject to the lessee entering a contract for the construction of the improvements stipulated and satisfactory evidence that the improvements would be carried out.

The other agreement provided for a loan by the insurance company to the respondent of $5,000,000, carrying interest at the rate of 7 /2% on the first $4,000,000 and at 8% on the remaining $1,000,000, to be paid, over a term of 25 years, by monthly blended payments of interest and principal. This loan was to be secured by a first mortgage bond on the respondent’s leasehold estate and a chattel mortgage upon furniture, furnishings and other equipment.

The $1,000,000 purchase price was determined on the basis of an appraisal report prepared for the insurance company, the purpose of which was stated to be “to estimate the value as at the date of appraisal as security for a first mortgage loan”. The report considered the economic possibilities of the project. It stated that:

It is your appraiser’s opinion that, as a result of the unique opportunities offered by this site, the proposed hotel and parking complex will result in the highest and best use of the site.

The appraiser considered that a land residual approach was the indicated method of estimating value and placed a value on the land, by that approach, of $1,000.000.

The land was transferred directly from the City to Great-West on August 18, 1964. That company paid $1,000,000 to the respondent in October 1964. This money was used, in part, to repay to a subsidiary of the respondent the amount which it had paid to Greniuk for the purchase of the 503 acres. The balance was used for the corporate purposes of the respondent.

The respondent’s statement of profit and loss for the year ended October 31, 1964 under the heading “Real Estate Operations” showed: “Net gain on transfer of land $735,025.00.”

The appellant, in assessing the respondent in computing its taxable income for the 1964 taxation year included therein the profit from the transfer of land, which the respondent had excluded when it had calculated its taxable income. The appellant included in the respondent’s income the sum of $669,000, which sum was arrived at as follows:

Sale of Bellamy Hill property

to The Great-West Life

Assurance Company		$1,000,000
Cost of land (215 acres)
exchanged for Bellamy Hill
property	$272,600
Provision for loss on land
under option with City of
Edmonton, 217 acres
at $265	57,500	330,100
Gain		$ 669,900

The respondent appealed from this assessment. The assessment was justified by the appellant, in its Reply, on the basis that the $669,900 was a gain on the sale of the Bellamy Hill site, which was taxable income. It was stated that the respondent had arranged to acquire that land with a view to trading or dealing therein or turning it to account, the profit therefrom was income from a business or an adventure in the nature of trade, and that the respondent, at the time of acquisition of that property contemplated its resale to Great-West.

The appellant later amended its Reply as follows:

The respondent [now appellant] says in the alternative that the exchange of lands with the City of Edmonton, whereby the appellant [now respondent] acquired the Bellamy Hill property in exchange for a portion of the 503 acre parcel of land referred to in paragraph 5(i) hereof, [which land was intended by the appellant to be subdivided and sold in the course of its business] was a Sale or realization by the appellant of the portion of the said 503 acre parcel of land, and that upon that sale or realization the appellant received the Bellamy Hill property having a fair market value of not less than $1,000,000.00 and that accordingly the said sum of $1,000,000.00, being the fair market value of the Bellamy Hill property or the proceeds of realization thereof, should be included in computing the appellant’s income for 1964 as the proceeds from the sale of inventory.

In response to this, the respondent amended its Notice of Appeal to allege that:

(a) the profit on the sale was $727,400 and not $669,900, and that the $727,400 was a Capital gain and should not be included in computing the respondent’s income; and

(b) the loss on the sale of the 217.14 acres of $58,200 was an inventory loss which was deductible in computing its income.

The learned trial judge, in respect of the position taken by the appellant, prior to the amendment of its Reply to the Notice of Appeal, found as follows ([1970] CTC 390 at 394):

I find, on the evidence, that the appellant [now respondent] acquired the Bellamy Hill site for the exclusive purpose of creating thereon an income producing asset, that it carried out that purpose and that the sale to GreatWest Life was an integral part of the financing arrangement that was worked out for it by Great-West to fit in with Great-West’s preferred method of financing such an operation. Looked at another way, the acquisition from the City and the re-sale to Great-West were only part of a series of transac- tions whereby the appellant acquired an income producing asset consisting of a 99-year lease of a garage and a hotel. These transactions were clearly not transactions in the course of carrying on the trading activities of the appellant. I therefore reject the respondent’s [now appellant’s] position as set out in the Reply as originally filed.

With respect to the matter raised by the amended Reply, he said, in part (pp. 395-6 [6277-8]):

My conclusion on this aspect of the case is that there was involved in the transaction with the City a disposition by the appellant in 1964 of part of the 503 acres of land that were acquired by the appellant in 1961 as what might be described as trading lands. Any profit or loss involved in that disposition should, in my view, be taken into account in determining the appellant’s profit for the purposes of Part I of the Income Tax Act for the 1964 taxation year. I am not, however, in a position, on the evidence before me, to determine whether or not there was such a profit or loss.

I do not propose to make any finding in this appeal on the question as to what is the precise transaction giving rise to the potential profit or loss in question. It may be, as paragraph 6A of the Reply to the Notice of Appeal assumes, that there was an “exchange” of some of the trading lands for the Bellamy Hill property and that such exchange was a transaction in the course of the appellant’s trading business. I doubt that that is a correct view of the matter. In the first place, I do not think that the somewhat complicated transaction with the City can be severed into parts and I do not think that there was a simple exchange as such. In the second place, the transaction with the City was a part of the series of transactions whereby the appellant acquired its long term leasehold interest in the present hotel and garage complex and was not a transaction in the course of the appellant’s trading business at all. The better view, in my opinion, is that the appellant, in effect, removed the park lands in question from its trading inventory to use them to acquire the hotel and garage site and that, upon so removing them, it was bound, for the purpose of computing its profits from the trading business, to take into the revenues of its trading business the fair market value of the lands so removed. I think this would have been so if a trader in house properties took a house out of his inventories to use it for his private residence, and I see no difference where a trader removes trading inventories to use them as Capital assets of a producing business or as consideration for the acquisition of such assets.

However, I express that only as a tentative view because I do not think that I should decide, in the present case, any more than that there is a transaction in the trading business that ought to be considered.

My decision is that the respondent erred in taking into profit the item under attack but that the evidence that establishes that error shows that there were possible profits or losses of another kind that should have been considered and that were omitted. I cannot, therefore, merely correct the assessment by deleting the item attacked.

I recognize that the pleadings are such that the appellant might feel that he was not put on proper warning of this alternative possibility. I gave the appellant, during argument, an opportunity of electing for a further hearing but, after consideration, he decided not to accept it.

In my view, in the circumstances, there should be judgment allowing the appeal with costs and referring the assessment under appeal back for re-assessment on the basis that the item of $669,900 was not properly included in computing the appellant’s income for the 1964 taxation year, but that consideration should be given to whether there was any profit or loss arising out of the disposition of any part of the 503 acres acquired by the appellant in 1961 that should be so included.

From this judgment the present appeal is brought.

To me, the important fact in this case is that the respondent did receive from Great-West a cash payment of $1,000,000 in considéra- tion for the transfer to it of the fee simple title to the Bellamy Hill site. This money it expended, in part, to meet payments owing to Greniuk, and, as to the balance, for its own corporate purposes. It was able to obtain that transfer, and the consideration for it, by reason of its transfer to the City, in exchange, of 215 acres of the lands acquired from Greniuk which have been properly described as “trading lands”, coupled with its commitment to sell to the City an additional 217.14 acres at a price less than what it had paid.

The learned trial judge has found that the respondent acquired the Bellamy Hill site for the exclusive purpose of creating thereon an income producing asset. It should, however, be noted that the respondent’s initial purpose was to effect an exchange of the land purchased from Greniuk for a parcel of land owned by the City and preferably in the downtown area. The transfer of the Bellamy Hill site could not be obtained without a commitment as to the construction, upon it at least, of a parkade, but, when the respondent made its land exchange agreement with the City, it knew that it had the necessary financing to enable it to meet that commitment and also knew that it would receive $1,000,000 for the fee simple title to it. There was no intention to acquire that title with a view to deriving income from it. The fee simple title was obtained in order to be sold immediately to Great-West. The income producing asset was a leasehold title granted by Great-West to the respondent’s subsidiary.

It is quite true that the sale of the fee simple title to Great-West was an integral part of the financing arrangement for the construction by the respondent of the parkade and hotel, and that this arrangement was the one proposed by Great-West, but that does not alter the fact that the arrangement involved a cash sale by the respondent to GreatWest of land obtained by the respondent in exchange for its trading lands.

It is contended by the respondent that the determination of the price of $1,000,000 was arrived at by Great-West on the basis of the annual return of the property and that its fair market value was not taken into account. This, however, overlooks the fact that an appraisal of value was made on behalf of Great-West. The value of the land was determined by means of the “land residual approach”, which is a recognized method of land valuation, which is applied in cases where it is not possible to determine value on the basis of sales of comparable properties. A valuation of $1,000,000 was made and Great-West paid that amount in order to acquire title to the land.

The financing by Great-West involved the receipt by the respondent of $6,000,000, of which $5,000,000 was a loan, which earned interest for Great-West, and $1,000,000 was payment for the land, which did not earn interest for Great-West. It was not in the financial interest of Great-West to fix the land valuation higher than what is considered to be the fair market value of the land.

My conclusions, in light of all these circumstances, are as follows: The respondent, being desirous of salvaging its investment in the lands acquired by it from Greniuk, and rezoned by the City as parkland, was successful in arranging with the City for the exchange of part of its land for the Bellamy Hill site. That exchange was subject to the respondent’s using the land acquired for specified construction purposes. The respondent, through its financing by Great-West, was able to meet the requirement and to complete the exchange. The lands conveyed to the City were trading lands. The financing arrangement involved a sale of the Bellamy Hill site by the respondent to Great-West for a price of $1,000,000, which was received by the respondent. That price represented the value of the Bellamy Hill site according to Great-West’s land appraisal. In the result, the respondent obtained, by its exchange of trading lands, land which it was able to sell for a cash consideration of $1,000,000, being the value placed on the land by the purchaser. The fact that such sale was made as a part of Great-West’s arrangement for the financing of the construction of the parkade and of the hotel does not affect the nature of the receipt of moneys by the respondent, which represented a trading receipt and not a realization of capital.

In my opinion the appeal should be allowed, with costs in this Court and in the Exchequer Court, and the assessment should be restored.

Pigeon, J (dissenting):—The facts of this case are stated in the reasons of my brother Martland. With deference, I cannot agree that the important fact is that the respondent, the “Company”, did receive from Great-West a cash payment of $1,000,000 in consideration for the transfer to it of the fee-simple title to the Bellamy Hill site. The tax with which we are concerned is levied on income, not on receipts or gains of any nature. Consequently, what is essential is to ascertain the true nature of the operation in the course of which the money sought to be taxed was received or became payable.

Here, the situation was that the Company found itself prevented by the action of municipal authorities from dealing as it intended with lands acquired for trading purposes. In order to extricate itself, it arranged to exchange with the City of Edmonton a part of those lands, the “park lands”, for a downtown site to be used for a large hotel with parking facilities for 757 cars. This hotel development was clearly going to be a permanent investment, not a trading operation like the acquisition of the park lands. Great-West would not lend all of the $6,000,000 that the Company needed for this undertaking, it agreed to lend only $5,000,000 on first mortgage and required a sale and lease back of the downtown site for the other $1,000,000.

The Minister has assessed the Company as if the sum obtained by that sale was the proceeds of the sale of the park lands that were exchanged for the hotel site. In my view, this is not a fair analysis of the operation. Although the various transactions were interrelated and prearranged, the financing of the downtown development was an operation completely distinct from the disposition of the park lands. The hotel development was an investment, while the transfer of the park lands was a trade. I cannot agree with the trial judge’s “tentative view” that the operation might be treated, for income tax purposes, as if the Company had appropriated the park lands for use as a permanent investment. The exchange was a disposition of those lands in a trading transaction but that operation also included the acquisition of a capital asset for permanent investment. It is therefore necessary to ascertain what was, at the date of the trading transaction, the value of the downtown site, because that value is the trading receipt subject to tax.

It is clear that the sale of the hotel site to Great-West subject to a 99-year lease back to the Company constitutes together with the $5,000,000 mortgage a single transaction. This transaction can, in no way, be looked upon as the realization or disposition of an asset by the Company. On the contrary, its very purpose was to enable it to put the downtown site to profitable use as a revenue producing investment and the whole purpose was to obtain the funds required to that end. In order to obtain those funds, the Company had to part with the fee and take back a 99-year lease. If it had parted with the fee and taken an equity of redemption, this could not have been considered as a disposition even though, under the law of Alberta, the mortgagee would not have been entitled to sue on the covenant, only to foreclose. Here Great-West, in order to make sure that it would get a return in money for the $1,000,000 advanced to the Company, required Dr Allard’s personal undertaking to repurchase the land if the building was not duly completed as promised. Unfortunately, the Company’s accountants almost invited the Minister to assess it on the basis that the $1,000,000 were the proceeds of a disposition when they described in its accounts, the amount by which that sum exceeded the cost of the park lands as “Net gain on transfer of land”. This could not prevent the Company from proving, as it did, the true nature of the sum received.

The situation was not at all the same as if the Company had, a few days after exchanging the park lands for the hotel site, sold the latter so as to get rid of it and make a profit. In effect, the Company did not part with its property. On the contrary, it undertook to develop it as a permanent investment. It did not obtain the $1,000,000 without obligations. On the contrary, it had to accept a method of financing much more onerous than mortgage financing. It had to covenant to pay, in addition to what is called a “net net rental” comparable to interest on a loan subject to possible periodic upwards adjustments, 25% of the Income to be derived from the improvements which it obliged itself to make.

At the outset of the trial, the pleadings were amended and counsel for the Minister put in an allegation that the $1,000,000 should, in the alternative, be looked upon as the fair market value of the hotel site. In my view, this is the basis on which the question should be considered. By its agreement with the City, the Company made a disposition of a trading asset. In effect, it ceased to carry on a part of its business, the park lands operation, and it disposed of the major part of the property that was included in its inventory of lands held for trading. If this disposition of property was not otherwise to be considered as a business operation in that year, section 85E of the Income Tax Act would make it so. However, because the park lands were traded for another piece of land and not a sum of money, it is necessary to ascertain the fair market value of the thing that was obtained.

I have already indicated why it does not appear to me that the $1,000,000 obtained by the sale and lease back agreement with GreatWest should be looked upon as the proceeds of a disposition. Should this, however, be considered as evidence of fair market value? In support of this contention, great stress was laid on the appraisal report made by one G Lawrie for a purpose stated to be “to estimate the value as of date of appraisal as security for a first mortgage loan”. Here is what this appraiser said concerning the value of the site:

Land: In the case of the subject property we have a tract of land which has been acquired for development in a manner not reconcilable with normal market transactions. The land was owned by the City of Edmonton and has been zoned parkland in part at least. The site was only available to the present owners as a result of a recent plebiscite which approved the exchange of 415 acres owned by the present owners and which the City wished to acquire for parkland use.

Considering the peculiar circumstances surrounding the acquisition of the property, the unique location and physical attributes of the land, its value today must be estimated on the basis of the benefits it will aid in producing.

Your appraiser, therefore, considers a Land Residual approach is the indicated method of estimating value.

Value of land by the Residual Approach:

53,578,8 Sq Ft at $18.66 per Sq Ft — $1,000,000.00

It is obvious that the value thus arrived at was not the value of the site as delivered by the City. It was the value that would be obtained upon completion of the intended development. That this was so appears from the fact that Great-West required Dr Allard’s personal guarantee to repurchase the land if the development was not completed. This was obviously deemed necessary so as to protect the financing company against the possibility that it would be left with a piece of land worth less than the amount advanced, if the project was not completed.

There is also in the record a copy of a report submitted by the Commissioners to the City Council, March 11, 1963. This report, which was concurred in by the Council, dealt with the proposed exchange of park lands for the hotel site (then called the “Tower City” site) for the purpose of building apartments and a 100-car parking garage. Respecting the value of this land, it said:

The professionally appraised price of the Tower City site is $440,000 having in mind the nature of the proposed development.

I have italicized the words “having in mind the nature of the proposed development” because they indicate how the value of the site was influenced by the kind of development contemplated. In my opinion, it is perfectly clear in this case that the $1,000,000 value was not the fair market value in the sense of being the amount which would be obtained by selling the land. It was a value which could be reached only through an undertaking to spend several millions of dollars in a huge development. It was, in no way, a realizable value at the time when the exchange was made with the City, on the contrary, it required an additional major expenditure. It was not, therefore, the fair market value, but a prospective value dependent on the completion of the project at great cost.

Finally, consideration must be given to what took place ait the trial with respect to evidence of market value. Here is what one finds in the transcript a few pages after the beginning of the deposition of the first witness, Dr Allard, the Company’s president:

MR REGNIER (Counsel for the Company): Well, -I don’t know if this sort of arrangement will please your lordship; I was going to point it out that your lordship — at the end of the evidence is probably the best time — assuming that your lordship arrives at a conclusion after my learned friend has jumped two hurdles and he had made a prima facie case as to value, then, if your lordship pleases, we would like the case to be simply adjourned so that at a later date I can be in position to bring in expert evidence on the value of the Bellamy Hill.

THE COURT: Well, why don’t we — instead of doing that, why not make the finding that is against you and refer the matter back for reassessment? Then, you can decide whether you want to appeal on the question as to whether there should be an assessment on this basis at all or not and if you’re ultimately unsuccessful, then, you may be able to work out the evaluation question with the Department and have another appeal. It would not be any more expensive and probably more satisfactory because if you have to bring in certain evidence as to value, before you go to the Supreme Court, you may be wasting a lot of —

MR REGNIER: Well, that is the point. It is basically the same approach as you will recall, my lord. It is completely —

THE COURT: You were in the case where we worked that out with reference to trading the timber limit?

MR REGNIER: Basically the same approach.

THE COURT: Has it gone into the Supreme Court?

MR REGNIER: I have appealed, but we are working on it.

THE COURT: Let’s not get off on another case.

MR REGNIER: We are working on values, my lord.

THE COURT: But it is same problem.

MR BOWMAN (Counsel for the Minister): I think that would be a sound idea, my lord, with respect.

THE COURT: Well, then, I will forget about values.

MR BOWMAN: If your lordship comes to the conclusion, if the value is somehow relevant and the way I see the case, it may well be that your lordship will decide that value isn’t really a problem in the case at all.

THE COURT: Even if you succeed?

MR BOWMAN: Yes, yes.

THE COURT: That is right. So, I won’t worry about value.

Due to what I have just quoted, the question of fair market value was not further dealt with in the evidence at the trial. Under those circumstances, it seems to me that a finding concerning the fair market value cannot properly be made on this appeal. Although I do not agree with the trial judge’s “tentative view”, it appears to me that in the present circumstances of the case his decision to refer the assessment under appeal back for reassessment was correct. However, I would vary his direction by adding ‘said profit or loss to be determined by taking into account the fair market value of the Bellamy Hill site at the date of the exchange for a part of the 503 acres”. Success in this Court being divided, I would not allow costs.

MINISTER OF NATIONAL REVENUE, Appellant,

and TOWER INVESTMENT INC, Respondent.

Federal Court—Trial Division (Collier, J), April 10, 1972, on appeal from a decision of the Tax Appeal Board, reported [1969] Tax ABC 769.

Income tax—Federal—Income Tax Act, RSC 1952, c 148—12(1)(a)—Advertising

In conjunction with its construction of certain apartment buildings containing some 660 suites the respondent launched an advertising campaign to secure tenants and thus made outlays during the years 1963 to 1965 of $92,351, $58,596 and $2,354, respectively, to a total of $153,301. Because the benefit from this campaign was not to be immediately felt, the respondent sought to defer its deduction in a reasonable manner and so claimed $7,351 in 1963, $63,595 in 1964 and $82,354 in 1965. The Minister rejected the principle of matching revenue and expense and contended that expenditures of the kind in question must be deducted in the year in which laid out and could not be deferred.

HELD:

There was no prohibition in the Act against the matching system, which had in fact been held appropriate in Sherritt Gordon Mines, Ltd v MNR (infra) and which in the present case more accurately set forth the respondent’s true income position.

On the Minister’s second point, there were certain expenditures (eg ‘‘running expenses”) which must be deducted in the year in which made or incurred, and other expenditures which were deductible for the year “in respect of which” they were made or incurred. Among the latter were the advertising expenses in question, the respondent’s treatment of which was proper and not prohibited by the Act.

Appeal dismissed.

Paul A Boivin, QC for the Appellant.

Philip F Vineberg, QC for the Respondent.

CASES REFERRED TO:

Publishers Guild of Canada Ltd v MNR, [1956-60] Ex CR 32; [1957]

CTC 1; 57 DTC 1017;

Sherritt Gordon Mines, Ltd v MNR, [1968] Ex CR 459; [1968] CTC 262;

68 DTC 5180;

Consolidated Textiles Limited v MNR, [1947] Ex CR 77; [1947] CTC

63; 3 DTC 958:

L Berman & Co Ltd v MNR, [1961] CTC 237; 61 DTC 1150;

Rossmor Auto Supply Limited v MNR, [1962] CTC 123; 62 DTC 1080;

Associated Investors of Canada Ltd v MNR, [1967] Ex CR 96; [1967]

CTC 138; 67 DTC 5096;

Steer v MNR, [1965] Ex CR 458; [1965] CTC 181; 65 DTC 5115.

Collier, J:—This is an appeal from a decision of the Tax Appeal Board ([1969] Tax ABC 769). The Minister had reassessed the present respondent for its taxation years 1963, 1964 and 1965 and it successfully appealed to the Tax Appeal Board.

The evidence before this Court consisted of the evidence and proceedings before the Board with the addition of evidence from one witness called on behalf of the respondent.

The issue is whether the respondent must deduct in each of the years in question the actual amount laid out in that year for advertising expenses (as contended by the Minister) or whether it is entitled to defer some portion of these amounts into subsequent years in accordance with ordinary commercial principles or well-accepted principles of business and accounting practice subject, always, to any special directions in the Income Tax Act (as contended by the respondent).

The facts are really not in dispute and I adopt the following excerpts from the Reasons for Judgment of the Assistant Chairman of the Board at pages 769-70 (the “appellant” referred to in these excerpts is the taxpayer):

Appellant describes itself as a realty company and has a fiscal period ending on 31st August. Its first taxation year of activity appears to have been 1963. In that year, on farm land in a sparsely-occupied area about ten miles from the core of Montreal acquired in September, 1962, appellant proceeded with the erection of 24 apartment buildings that were to contain 660 apartments. There was also to be a “shopette” for the convenience of tenants. The whole project was duly completed in about fourteen months and became available for renting. Some of the apartments were furnished by the appellant, but the majority were not.

In order to obtain tenants, an intensive advertising Campaign was conducted; it was such as had never been waged before. About every known means of attracting prospective tenants was devised and exercised incessantly, including the singing of a jingle. Radio was the medium mostly used; no real estate agents were employed. The radio announcements were so frequent and repeated over such a lengthy period that people even began to complain of the unceasing flow of advertising that was forced upon them daily by appellant’s publicity agents. Nevertheless, good results were obtained and by October, 1964, a ninety-percent occupancy had been achieved. The cost of all this advertising was heavy, as may be supposed, and amounted to $153,301.78 in all. However, the rental income thereby generated grew to $674,328.16 in 1964. Appellant later deducted the first-mentioned sum from its taxable income in the following proportions: $7,351.01 in 1963; $63,595.87 in 1964, and $82,354.90 in 1965, in which year the entire undertaking was sold, rather unexpectedly it would appear, for over $4,425,000.00. The respondent did not approve of this procedure and considered that the appellant had improperly deferred deducting the said advertising expense at one fell swoop and, instead, had deducted such proportions thereof as it saw fit in the three years under appeal. The appellant’s right to deduct the advertising expense is not questioned; it is the method of doing so that is challenged. There is also no dispute as to the correctness of the figures involved.

I add at this point the following: the actual amounts expended for advertising were $92,351.01 in 1963, $58,595.87 in 1964; and $2,354 in 1965.

With respect to the sale of the undertaking in 1965, the Assistant Chairman said this and, again, I adopt his language (p 771):

The decision to sell having been arrived at — albeit reluctantly, where Weitzman was concerned — it became a case of “now or never” as regards deducting the balance remaining of the advertising expense and quite understandably this balance was therefore deducted from appellant’s income for the 1965 taxation year. It appears to me that his was the logical course to adopt in the circumstances disclosed.

Abe Weitzman, the first and other witness who testified, stated that he and Kenneth Wolofsky, a builder, were the appellant’s promotors and that, Originally, the firm intention had been to retain the buildings erected; not to sell them. Later, however, differences arose between the two men and, rather than continue in what he claimed was an untenable situation, Weitzman ultimately gave in. He said: Il went along with my partner and we sold.” This occurred in October, 1964, or within the appellant’s 1965 taxation year, which ended on 31st August, 1965. There is nothing in the evidence adduced to suggest that Messrs Weitzman and Wolofsky knew before October, 1964, that the sale of the project would be made; in fact, Weitzman specifically denied that there was ever any intention to sell. It was only when an unsolicited offer was received, in 1964, that proved too tempting to Wolofsky that the question of whether to sell, or not to sell, ever arose and it was Wolofsky alone who then insisted on selling.

The respondent called as a witness before the Tax Appeal Board a chartered accountant who had prepared its financial statements. This was Harry Stein who had 33 years’ experience. In his opinion the procedure adopted in this case was the most appropriate and in accordance with well-accepted accounting principles; that is, when an intensive advertising campaign is such that the benefit must reasonably be expected to extend over future years the practice is to charge a certain proportion of the expense to those years instead of deducting the whole expenditure from the income of the previous year. Mr Stein referred to accounting textbooks and other publications to support his position.

On the appeal to this Court, an independent chartered accountant, Howard Gilmour, was called on behalf of the respondent. He testified that the method used by the respondent for the years in question was in accordance with recognized accounting practice and involved the proper matching of revenue and expense. He said the essence of accrual ‘accounting was based on the matching principle and this demanded a certain amount of judgment on the part of the individual accountant or his client as to how one should proportion these advertising expenses over the subsequent years.

As was the case with Mr Stein, Mr Gilmour supported his evidence with excerpts from various textbooks on accounting and other publications.

Generally speaking, the evidence here and before the Tax Appeal Board was that on the facts of this particular case the method adopted by the taxpayer of deferring some of the advertising expense into future years was not only in accordance with generally accepted accounting principles but also more accurately reflected the truth about the taxpayer’s income position.

The appellant, both in the Tax Appeal Board and in this Court, did not adduce any evidence to challenge or contradict Mr Stein or Mr Gilmour. The appellant argues the decision of the Tax Appeal Board is wrong:

(1) The principle of matching revenue and expense has not been accepted by the Courts and is not permissible under the Income Tax Act, except under certain special provisions of the Act.

(2) As a matter of law under the Income Tax Act expenditures such as the ones here must be deducted in the year in which they are laid out and cannot be deferred.

Counsel for the appellant chose to argue this case as a matter of general principle. I propose, so far as possible, to confine my decision to the facts of this particular case.

In my view, the first contention advanced by the appellant is too broad. As was said by Thorson, P in Publishers Guild of Canada Ltd v MNR, [1956-60] Ex CR 32 at 50; [1957] CTC 1 at 17; 57 DTC 1017 at 1026:

. . . the prime consideration, where there is a dispute about a system of accounting is, in the first place, whether it is appropriate to the business to which it is applied and tells the truth about the taxpayer’s income position and, if that condition is satisfied, whether there is any prohibition in the governing income tax law against its use.

I do not find there is any prohibition in the statute against the matching system. In fact, it was held appropriate under the particular circumstances of the case by Kerr, J in Sherritt Gordon Mines, Ltd v MNR, [1968] Ex CR 459; [1968] CTC 262; 68 DTC 5180. I quote from page 481 [283, 5193] of the judgment:

I am satisfied that at least where the amount is significant in relation to the business of a company, it is in accordance with generally accepted business and commercial principles to charge, as a cost of construction, payments of interest in respect of the construction period on borrowed money expended by the company for such construction and to write such payments off over a period of years. The practice of doing so is not as common outside the public utility field as within that field but it has extended to companies outside that field.

The facts in the case referred to were quite different from the facts in the present case.

In my view, the system used here more accurately sets forth the respondent’s true income position: for instance, by its method it showed some profit for the year 1963; by the appellant’s method it would have shown a loss.

It seems to me the main argument advanced by the appellant was the second one I have referred to earlier. A number of authorities were cited but in my opinion many of them are distinguishable in that they did not involve, either directly or by analogy, the point in issue here. I shall refer to only those cases which appear to be directly on point.

In Consolidated Textiles Limited v MNR, [1947] Ex CR 77; [1947] CTC 63; 3 DTC 958, the taxpayer sought to deduct certain operating expenses incurred in 1938 from its 1939 income. That case arose under the Income War Tax Act. Thorson, P held at pages 82-83 [69]:

In my opinion, sec 6(a) excludes the deduction of disbursements or expenses that were not laid out or expended in or during the taxation year in respect of which the assessment is made. This is, I think, wholly in accord with the general scheme of the Act, dealing as it does with each taxation year from the point of view of the incoming receipts and outgoing expenditures of such year and by the deduction of the latter from the former with a view to reaching the net profit or gain or gratuity directly or indirectly received in or during such year as the taxable income of such year.

In my opinion, that case is distinguishable; without going into detail, the relevant sections considered by Thorson, P are substantially different from the relevant sections of the present Act.

In L Berman & Co Ltd v MNR, [1961] CTC 237; 61 DTC 1150, Thorson, P considered whether certain payments made by the taxpayer were proper deductions within the present paragraph 12(1)(a) of the Income Tax Act, RSC 1952, c 148. He found the payments in question there were properly deductible. The taxpayer had sought to deduct all the payments from the 1956 receipts, including some made in 1955. Thorson, P referred to the Consolidated Textiles case and held the deductions could only be claimed in the year they were laid out. He said at page 249 [1157]:

But the appellant is not entitled to deduct from what would otherwise have been its taxable income for 1956 all the payments made by it. The payments made in September and December, 1955, are not deductible. I had occasion to consider a similar question in Consolidated Textiles Limited v MNR, [1947] Ex CR 77; [1947] CTC 63. In that case the appellant, a manufacturer of lingerie fabrics, in making its income tax return for the year 1939, sought to deduct from its 1939 receipts certain operating expenses incurred in 1938. The deduction was disallowed by the Minister and the appellant appealed. I agreed with the Minister and held that Section 6(a) of the Income War Tax Act excluded the deduction of disbursements or expenses that were not laid out or expended in or during the taxation year in respect of which the assessment was made. Consequently, I hold that the appellant was not entitled to deduct from its 1956 receipts any of the payments made by it in 1955. My reasons for doing so are the same as those set out in the case to which I refer and I include them, mutatis mutandis, in these reasons.

Similarly, Thorson, P in Rossmor Auto Supply Limited v MNR, [1962] CTC 123 at 126; 62 DTC 1080 at 1082, again referred to his previous judgment in the Consolidated Textiles Limited case.

The aspect of the Rossmor case which dealt with the year in which a deduction must be claimed was commented on by Jackett, P (now the Chief Justice of this Court) in Associated Investors of Canada Ltd v MNR, [1967] Ex CR 96; [1967] CTC 138; 67 DTC 5096, in a footnote at pages 100-101 [142-3; 5098]. I set out the footnote in full here and, respectfully, adopt it:

A submission was also made that Section 12(1)(a) of the Income Tax Act, which reads as follows:

“12. (1) In computing income, no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer,”’

must be interpreted as prohibiting the deduction in the computation of profit from a business for a year of any outlay. or expense not made or incurred in that year. In support of this submission, reliance was placed on Rossmor Auto Supply Ltd v MNR, [1962] CTC 123, per Thorson, P at p 126, where he said, “As I view Section 12(1)(a), the outlay or expense that may be deducted in computing the taxpayer’s income for the year . . . is limited to an outlay or expense that was made or incurred by the taxpayer in the year for which the taxpayer is assessed” (the italics are mine). If this view were a necessary part of the reasoning upon which the decision in that case was based, I should feel constrained to follow it although, in my view, it is not based on a principle that is applicable in all circumstances. In that case, however, the loan was clearly not made in the course of the appellant’s business and the President so held. In my view, while certain types of expense must be deducted in the year when made or incurred, or not at all, (eg, repairs as in Naval Colliery Co Ltd v CIR (1928), 12 TC 1017, or weeding as in Vallambrosa Rubber Co, Ltd v Farmer (1910), 5 TC 529), there are many types of expenditure that are deductible in computing profit for the year “in respect of” which they were paid or payable. (Compare Sections 11(1)(c) and 14 of the Act.) This is, for example, the effect of the ordinary method of computing gross trading profit (proceeds of sales in the year less the amount by which opening inventories plus cost of purchases in the year exceeds closing inventories) the effect of which (leaving aside the possibility of market being less than cost) is that the cost of the goods sold in the year is deducted from the proceeds of the sale of those goods even though the goods were acquired and paid for in an earlier year. This is, of course, the only sound basis for computing the profits from the sales made in the year. Compare /RC v Gardner Mountain & D’Ambrumenil, Ltd (1947), 29 TC per Viscount Simon at p 93: “In calculating the taxable profit of a business . . . services completely rendered or goods supplied, which are not to be paid for till a subsequent year, cannot, generally speaking, be dealt with by treating the taxpayer’s outlay as pure loss in the year in which it was incurred and bringing in the remuneration as pure profit in the subsequent year in which it is paid, or is due to be paid. in making an assessment . . . the net result of the transaction, setting expenses on the one side and a figure for remuneration on the other side, ought to appear . . . in the same year’s profit and loss account, and that year will be the year when the service was rendered or the goods delivered.” (Applied in this Court in Ken Steeves Sales Ltd v MNR, [1955] Ex CR 108; [1955] CTC 47, per Cameron, J at p 119.) The situation is different in the case of “running expenses”. See Naval Colliery Co Ltd v CIR, supra, per Rowlatt, J at p 1027: . . . and expenditure incurred in repairs, the running expenses of a business and so on, cannot be allocated directly to corresponding items of receipts, and it cannot be restricted in its allowance in some way corresponding, Or in an endeavour to make it correspond, to the actual receipts during the particular year. If running repairs are made, if lubricants are bought, of course no enquiry is instituted as to whether those repairs were partly owing to wear and tear that earned profits in the preceding year or whether they will not help to make profits in the following year and so on. The way it is looked at, and must be looked at, is this, that that sort of expenditure is expenditure incurred on the running of the business as a whole in each year, and the income is the income of the business as a whole for the year, without trying to trace items of expenditure as earning particular items of profit.” See also Riedle Brewery Ltd v MNR, [1939] SCR 253; [1938-39] CTC 312. With regard to the flexibility of method permitted under the Income Tax Act for computing profit, see Cameron, J in the Ken Steeves case, supra, at pp 113-4; 54-55.

In my view, the distinctions made by Jackett, P are applicable in a case such as this. The advertising expenses laid out here were not current expenditures in the normal sense. They were laid out to bring in income not only for the year they were made but for future years.

I have therefore concluded that the treatment of the advertising expenses by the respondent in this case was proper and not prohibited by the Income Tax Act.

I refer to the judgment of Noel, J (now the Associate Chief Justice of this Court) in Steer v MNR, [1965] Ex CR 458; [1965] CTC 181: 65 DTC 5115. He said at pages 466-7 [189, 5119]:

If the problem were merely one of determining the profit from the whole life span of a business undertaking or other source of income, it would be relatively simple. When the undertaking or other source comes to an end, you add up all the receipts therefrom and deduct all the expenses thereof and the balance is the profit or loss. Under the Income Tax Act, it is not so simple because you must determine the taxpayer’s profit from a source for each taxation year. This raises problems of allocation as between various years where the life of the undertaking or other source extends over more than one year. These problems have been solved for the most part in the case of businesses and other sources that fall into common categories. The solutions adopted, however, vary greatly even within the same categories. It may well be acceptable to adopt a “cash basis” — ie, taking into account for each year any cash receipts and cash expenditures in the year — for one business and equally acceptable to adopt, for a very similar business, some quite sophisticated so-called ‘‘accrual basis”.

The appeal is dismissed with costs.