Eastern Business Management Limited v. Minister of National Revenue, [1972] CTC 2650

Roland St-Onge (orally):—This appeal is from a reassessment dated July 22, 1970 wherein a tax in the sum of $13,642.58 was levied in respect of income for the taxation year 1965. The appellant company contends that, being a management company, it should be able to deduct, in 1965, the sum of $55,094.89.

There is no contestation with respect to the figures and, at the hearing, both parties agreed that disbursements comprise fees paid for feasibility studies, and legal expenses for rezoning application. The actual payments were as follows: in 1964, $51,747.82; in 1965, $3,347.70. It seems from that admission, that the appellant paid $51,747.82 in 1964 for feasibility studies, and $3,347.70 in 1965 as legal expenses for rezoning application. The evidence also shows that the said expenses were incurred, by the appellant, with respect to a proposal to erect high-rise apartments over the Canadian National Railway right-of-way extension, approximately from Sunnyside Station to Dufferin Street in Toronto, Ontario and that the major portion of the expenses was a fee of $50,153.35 paid to A D Margison and Associates Limited.

The respondent contends that the disbursement is a capital expense and therefore not deductible according to paragraph 12(1)(b) and furthermore, if the amount of $55,094.89 was an expense incurred for the purpose of gaining or producing income, such an expense was incurred in 1964, which is not under appeal, and which is statute- barred. He further contends that the disbursements did not concern, or were not in connection with, the business carried on by the appellant.

The evidence on behalf of the appellant was adduced by its vice- president who took care of the day-to-day activities in the pertinent years. He stated that in 1959 the appellant company was incorporated in Ontario for the purpose of managing Mr Adams’ business for a fee. Mr Adams, born in Saskatchewan, was interested in real estate and hotel development and, in 1959, moved from the West to Toronto in order to expand his business. Around 1962 Mr Adams was approached by a real estate broker who had been talking to the CNR Traffic Department people about a real estate development over the CNR right- of-way. Mr Adams grabbed this opportunity and started to study what could be done in that respect. He soon realized that a tremendous residential development could be achieved on that site. The CNR right-of-way presented many advantages, namely: a great track of not expensive land in Toronto; the opportunity of getting a very panoramic view; the possibility of taking advantage of the contours of the lake and of building communicating bridges and rafts for the project. Through his management company, Mr Adams hired A D Margison and Associates Limited, Consulting Professional Engineers, who had already worked in the area and who knew the nature of the soil. Because of his personal friendship with this firm and the fact that they already knew the area, he was able to start a feasibility study at a minimum cost. A letter written on April 8, 1963 by the firm to Mr Adams of the appellant company gives a good idea of their mutual arrangement. It reads in part as follows:

Pursuant to our recent conversations, we are beginning a study of the above project. It is our understanding that you will require a comprehensive report thereon within about three months that will be of a nature to permit a decision by you and your colleagues (prior to the 31st July next) on whether or not to proceed with a commitment opposite this proposed undertaking. It is further our understanding that we should conduct our study in a manner that all significant engineering and architectural aspects are developed in sufficient measure for the above initial purpose with reporting on: (a) an overall concept to your approval; (b) preliminary estimates of cost; (c) a program for development; (d) progress on indicated approvals of authorities having jurisdiction (as far as possible); (e) total property necessary or desirable; and (f) generally all other pertinent matter of significance.

While the foregoing is a general statement of the scope of the services for this preliminary study, the following provides a description of the general nature of the services to be performed:

1. Project management in liaison with those members of your staff designated by you.

2. Collection of all necessary data from the CNR on existing conditions and the obtaining of their statements of requirements for operation under the proposed future conditions.

3. Development of structural (also mechanical and electrical) schemes acceptable to the CNR.

4. Development of an overall architectural concept for superstructures in a preliminary way and with regard for economic data, etc. already provided by you and as may be modified during the study. This concept is to provide for apartments, stores, hotels (two), parking etc., all within an imaginative scheme and with regard for the factors established in other aspects of the study on which other departments of our firm will be concurrently engaged as briefly indicated in the items following.

5. Investigation into area planning schemes; present and future traffic and road conditions; population; other transportation; utilities and services such [as] sewer and water.

6. Investigation into further land acquisition (e.g. essential minimum; desirable minimum; other).

7. Structural, mechanical and electrical systems for superstructure buildings.

8. Estimate of cost.

9. Miscellaneous related data.

We shall carry out the present study and prepare the report on a time basis charging time rates and expenses in accordance with the current Schedule of Fees of the Association of Professional Engineers of the Province of Ontario. We do not expect that there will be any significant amount for expenses (e.g. travelling, long distance calls, engagement of outside specialists, soil investigations, etc.) but, where these do occur, they will be billed to you at actual invoiced cost to us.

We propose that you set a budget of $22,000.00 for the study and the report which will constitute an amount not to be exceeded without your express approval. Should we conclude our study and submit our report at less than the above amount, you will be billed only for the lesser amount.

Mr Adams also hired a firm of lawyers to draw the application for rezoning this low-rise into a high-rise building area. Following a meet- ing with the City Council, somebody gave the news to the local newspapers, Globe and Mail, Toronto Daily Star, Telegram, Daily Commercial News, so that this first announcement caused a great deal of people to be against the project. A public hearing was held at which 200 persons attended and complained that such project would block the view of the lake. Apparently, nobody was in favour of the project except those interested financially in it, and, consequently, it was impossible for the City Council to approve such a project. It was then suggested to modify and improve the project so that the view of the lake would be less obstructed. The firm of engineers undertook at their own expense to prepare another plan which provided that the project be built by sections rather than as a whole. This supplementary report purported to show the continuing nature of the project. On the strength of this report, a second application was presented in 1965 but, because of the same opposition, the project was turned down a second time.

A letter addressed to Mr Adams relates the sad story of the project, and I would like to mention that this 3-page letter (Exhibit A-8) narrates all the details of a meeting before a committee where some 200 persons attended and is also very important because it shows that the project really became impossible in the year 1965.

According to the evidence adduced, the appellant company did not have the financial strength to build that project and, consequently, only a joint venture could undertake to erect it. The appellant company was to receive a fee, and later to become an administrator of the project but would not have any interest in it as an owner. As a matter of fact, two documents were drafted (Exhibits A-9 and A-10) between Foundation Development Limited, Compass Investments (Ontario) Limited, The Foundation Company of Canada Limited and the appellant company in order to organize a corporation for the purpose of developing the residential and commercial project over and along the CNR right-of-way. In those documents, paragraph 1(i), page 3 of Exhibit A-9, and paragraph 9(b) of Exhibit A-10 read as follows (the words “to past and future” are in one of the paragraphs and not in the other):

Foundation, Compass and Eastern shall enter into an agreement with respect to past and future office administration services in or substantially in the form of the draft agreement annexed as Schedule B.

To show the course of conduct of the appellant company, the appellant’s witness went on to relate a past experience of the appellant company to the effect that an option was obtained where the appellant company made a feasibility study, but the company interested could not get the financing, and the option was sold by the appellant company for $75,000 to Perini Company. The said amount was reported as income.

Upon cross-examination it was mentioned that the appellant company had the power to build in general, but was not incorporated for this specific project; that the appellant company was not to become one of the owners of the project, and that Mr Adams was the majority shareholder of Compass Investments (Ontario) Limited. Finally, it was agreed between counsel that the appellant company’s fiscal year was the calendar year and that its income was calculated on an accrual basis.

Counsel for the appellant argued that the expenses were incurred to earn income because the appellant company was hired to render services for a fee which was its source of income. The appellant company has carried on preliminary work and was going to act after the completion of the project as a management company for a fee. He referred the Board to A E Le Page Limited v MNR, [1969] Tax ABC 763; 69 DTC 499.

Counsel for the respondent started his argument by enunciating the well-known principle that taxation is the rule and exemption the exception: W A Sheaffer Pen Company Limited v MNR, [1953] Ex CR 251; [1953] CTC 345; 53 DTC 1223. Then, he claimed that the $51,747.82 paid to the firm of A D Margison and Associates Limited to make a study about feasibility was an undeductible capital expense. He also referred the Board to paragraph 11(1)(ab) which states:

(ab) an amount paid by the taxpayer in the year for investigating the suitability of a site for a building or other structure planned by the taxpayer for use in connection with a business carried on by him.

He contended that the taxpayer does not fall within that exemption, because the major part of the expenses claimed was paid to the engineers’ firm to make a feasibility study, which expenses are of a capital nature. According to him, these expenses were not paid in connection with the appellant’s business, but were expenses of the development companies, namely, Compass Investments (Ontario) Limited and Foundation Developments Limited. The appellant company was not in the construction business and, therefore, could not deduct the expense which should have been deducted by the development company. Finally, he stated that if deductible at all, the expense was deductible in years prior to 1965, because an expense is deductible when it is incurred and paid, and he referred the Board to British Columbia Electric Railway Co Ltd v MNR, [1958] SCR 133; [1958] CTC 21; 58 DTC 1022.

According to paragraph 11(1)(ab) it is clear that this provision applies to a development, and not to a management, company. The whole project was a joint venture, and Foundation and Compass would have owned the project whereas the appellant company was to render a service by trying to get this project off the ground. Counsel for the respondent argued that such expense is covered by paragraph 11(1)(ab) of the Act which permits the deduction by a. development company of an expense for investigation of a site. Actually, it is clear from the evidence adduced that the appellant is not a developer but a management company which has previously earned management fees in the amount of $75,000 and reported it as income. Consequently, such course of conduct is that of a management company and the expenses sought to be deducted were paid to earn income from its business. It is also obvious that the appellant is a separate company from Compass Investments (Ontario) Limited and Foundation Developments Limited, which are the developers. There is nothing in the Income Tax Act to prevent a taxpayer incorporating a management company, as long as it is a bona fide company, and the fact that the appellant had already earned a management fee of $75,000 and had reported it as income shows, without a doubt, that it is a bona fide management company. The appellant company actually learned about its loss in 1965 only when it became certain that the project was not feasible. Consequently, its loss became deductible only in the year the appellant learned about the impossibility of the project.

I have studied with much interest the Le Page case (supra) cited to me, and have noticed many similarities with the present appeal. The appellant company was not to be owner of the proposed project and its remuneration was to be received in the form of management fees for the preliminary work done in respect of the $40 million project, and additional fees to manage the project after its completion. As in the Le Page case, the expenses in the present case were incurred for the purpose of earning income and could not be termed a capital outlay. Moreover, in the circumstances and in light of Associated Investors of Canada Limited v MNR, [1967] CTC 138; 21 DTC 5096, the expenses incurred in prior taxation years became a loss in 1965 and ought to be deducted in that year. Consequently, the appeal is allowed.

Appeal allowed.