Yonge-Eglinton Building Limited v. Minister of National Revenue, [1972] CTC 542, 72 DTC 6456

Gibson, J:—This appeal involves the validity of the disallowance of the deduction for income tax purposes of the payments in each of the years 1965 to 1968 made by the appellant pursuant to clause 3(b) of a contract between it and Traders Realty Limited dated July 3, 1962 (Exhibit 8).

The circumstances giving rise to this issue are complicated and the difficulties encountered and the skill exercised in completing the transactions out of which this issue arises were substantial; but it is not necessary to attempt to describe such in order to detail sufficient facts for the determination of this issue. Accordingly, the salient and pertinent facts only are now stated.

The appellant acquired air rights from the Toronto Transport Commission above its yards at Yonge and Eglinton Streets in Toronto, Ontario and proceeded to build and built an office building and garage in or on part of the space of such air rights.

The first step taken by the appellant after acquiring these air rights, was to obtain a mortgage financing commitment from The Manufacturers Life Insurance Company in the sum of $5,250,000. This, however, proved not adequate to complete the construction and to get the premises operating viably, for various reasons, but mainly because The Manufacturers Life Insurance Company in this commitment required that it retain substantial holdbacks pending the completion of the premises and occupancy by tenants on leases. (See Exhibits 1, 2, 3 and 4.)

The appellant then sought and obtained an alternative financing commitment on an interim basis only from Traders Realty Limited. This interim financing commitment was in the sum of $6,500,000. (See Exhibits 5, 6, 7 and 8.) (Exhibit 8 is the agreement dated July 3, 1962, clause 3(b) of which is, as indicated, critical in the determination of this appeal.)

The appellant, however, only borrowed $900,000 under this commitment. Instead, it used the Traders Realty Limited contract to get interim financing by way of a revolving type of credit, from the Bank of Montreal in the sum of $5,475,000 (see Exhibits 10 and 11) and among other things, from funds borrowed from the Bank of Montreal under this arrangement, repaid the $900,000 it had borrowed from Traders Realty Limited.

But notwithstanding such repayments, the appellant was left with the obligation to Traders Realty Limited pursuant to clause 3(b) of the agreement dated July 3, 1962 (Exhibit 8).

Then finally the appellant obtained permanent debt financing for the building premises in the sum of $9,000,000, which it used to pay for the cost of building the premises, a sum in excess of $6,000,000; and it invested the balance in short-term investments.

In obtaining the said commitment for interim financing from Traders Realty Limited in the sum of $6,500,000, the appellant in its agreement with it agreed:

(a) to pay interest on moneys borrowed at the rate of 9% (see clause 3(a) of the agreement dated July 3, 1962, Exhibit 8);

(b) to pay 1% of its gross rental income for 25 years (see clause 3(b) of the agreement dated July 3, 1962, Exhibit 8); and

(c) to sell 5% of its outstanding common stock at the total price of $5 (see letter of agreement between Traders Realty Limited and the appellant dated May 4, 1962, Exhibit 7).

After repaying Traders Realty Limited the $900,000 it had borrowed, the appellant still had, and has, the liability to make the payments pursuant to clause 3(b) of the agreement dated July 3, 1962 (Exhibit 8).

In addition, Traders Realty Limited, having obtained 5% of the outstanding common stock of the appellant pursuant to the agreement dated May 4, 1962 (Exhibit 7), retained such stock as it was entitled to do, and has received dividends on this stock in the years subsequent to 1962.

Clause 3(b) of the agreement dated July 3, 1962 (Exhibit 8) reads as follows:

(b) In each calendar year in which Yonge-Eglinton earns a net profit from its operations (as certified by Yonge-Eglinton’s auditors) it shall pay to Traders as an additional interest charge an amount equal to 1% of its gross rental income (as certified by Yonge-Eglinton’s auditors) from the Project, such payments to become due and be payable 90 days after the termination of each such calendar year; the first of such payments to be payable with respect to the first calendar year after 1964 in which Yonge- Eglinton earns a net profit and such payments to continue until 25 payments have been made pursuant hereto.

The evidence was that the appellant has made the payments called for by said clause 3(b) during the years 1965 to 1968 and will be required to make the future yearly payments until the total of 25 payments are made.

The evidence also was that the recipient of these payments under clause 3(b), Traders Realty Limited, has always included these payments as income receipts in computing its income for income tax purposes.

Apparently also the receipt of the 5% of the capital stock of the appellant at the total nominal price of $5, pursuant to the letter of agreement (Exhibit 7), which is interrelated to the agreement (Exhibit 8), was and has always been considered by Traders Realty Limited as a capital receipt.

So much for the facts.

The appellant may deduct from income the payment in each of the said years it has made to Traders Realty Limited, under its obligation contained in clause 3(b) of the agreement between them dated July 3, 1962 (Exhibit 8) if the payment is (1) “interest” within the meaning of paragraph 11 (1 )(c) of the Income Tax Act; or (2) an expense incurred in the year “in the course of borrowing money used by the taxpayer for the purpose of earning income from a business or property” within the meaning of subparagraph 11 (1 )(cb)(ii) of the Act; or (3) part of a payment “repaying borrowed money used for the purpose of earning income from a business or property” within the meaning of paragraph 11(1)(d) of the Act.

In my view, first, the word “interest” in paragraph 11(1)(c) of the Income Tax Act has the same meaning of the word as in the Interest Act, RSC 1970, c 1-18.” [1]

In this case the 1% payment of the gross rental income to the year 1989 is not referable or proportionate to an amount of principal. The payments would have had to be made to Traders Realty Limited by the appellant even if the appellant, pursuant to the contracts (Exhibits 7 and 8), had borrowed no money from Traders Realty Limited.

Second, under subparagraph 11 (1 )(cb)(ii) of the Act it may be that a payment to be deductible so as to constitute an expense incurred “in the course of borrowing money” must be incurred at the time or around the time the borrowing took place (cf Riviera Hotel Co Ltd v MNR, [1972] CTC 157; 72 DTC 6142) instead of being incurred after the borrowing took place, pursuant to an obligation to make payments in the future, as is the case here. And it also may be that each of the payments in issue here is part of a so-called “commitment fee” of a type referred to in Sherritt Gordon Mines, Limited v MNR, [1968] 2 Ex CR 459; [1968] CTC 262; 68 DTC 5180, and deductible under this subsection. As to either of these propositions in relation to the facts of this case, however, I express no opinion.

Third, and last, however in my view paragraph 11(1)(d) of the Income Tax Act and subsection 7(1) are the relevant provisions in any event in the determination of the issue in this appeal. These must be read and construed together. Paragraph 11(1)(d) of the Act reads:

(d) such part of a payment

(i) repaying borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt), or

(ii) for property acquired for the purpose of gaining or producing income therefrom or for the purpose of gaining or producing income from a business (other than property the income from which would be exempt),

made by the taxpayer in the year as is by section 7 required to be included in computing the recipient’s income for a taxation year;

Subsection 7(1) of the Act reads:

7. (1) Where a payment under a contract or other arrangement can reasonably be regarded as being in part a payment of interest or other payment of an income nature and in part a payment of a capital nature, the part of the payment that can reasonably be regarded as a payment of interest or other payment of an income nature shall, irrespective of when the contract or arrangement was made or the form or legal effect thereof, be included in computing the recipient’s income.

In this case, as stated, according to the evidence, Traders Realty Limited by reason of its contracts with the appellant, Exhibits 7 (the letter of agreement dated May 4, 1962) and 8 (the agreement dated

and see Thurlow, J in Harold F Puder v MNR, [1963] CTC 445 at 447; 63 DTC 1282 at 1284, viz:

“. . .Interest, in my opinion, is essentially compensation for the use or retention of money for a period of time . . .”

and see The Dictionary of English Law by Earl Jowitt, 1959, p. 93:

“Interest also signifies a sum payable in respect of the use of another sum of money, called the principal. Interest is calculated at a rate proportionate to the amount of the principal and to the time during which the non-payment continues; . . .”

July 3, 1962) which, as also stated, are interrelated, and are inseparable), received payments which “can reasonably be regarded as being in part a payment of interest or other payment of an income nature and in part a payment of a capital nature” within the meaning of subsection 7(1) of the Act.

The part that can be regarded “as being in part a payment of interest or from payments of an income nature” are the payment of interest on the moneys borrowed at the rate of 9% pursuant to clause 3(a) of the agreement dated July 3, 1962 between the appellant and Traders Realty Limited (Exhibit 8) and the payment of 1% of the gross rental income for 25 years pursuant to clause 3(b) of the said agreement (Exhibit 8) both of which have been included to date in the income, for income tax purposes, of the recipient Traders Realty Limited.

The part that can be regarded as “a payment of a capital nature” is the receipt by Traders Realty Limited of 5% of the outstanding common stock of the appellant for the nominal total price of $5 pursuant to the letter of agreement between Traders Realty Limited and the appellant dated May 4, 1962 (Exhibit 7) which, again, as stated, is interrelated with the agreement between the said parties dated July 3, 1962 (Exhibit 8).

The payments of 1% of the gross rentals from the said premises of the appellant to the year 1989 under clause 3(b) of the agreement dated July 3, 1962 (Exhibit 8), while not “interest” as above discussed, in my view, are “other payments] of an income nature” within the meaning of subsection 7(1) of the Act. As a consequence, the deduction of these payments under paragraph 11(1)(d) of the Act are allowable.

The appeal is therefore allowed with costs.