Iacobucci J.:
1 This appeal was heard together with those in Canderel Ltd. v. R. (S.C.C.)and Ikea Ltd. v. R. (S.C.C.)reasons for which are being released simultaneously herewith, and raises precisely the same issue as that in Canderel: for income taxation purposes, may a tenant inducement payment (“T.I.P.”) be deducted from the taxpayer's income entirely in the year made or incurred, or must it be amortized over the term of the lease to which it relates? Applying the reasoning in Canderel to this case, I have concluded that it was open to the taxpayer to deduct the entire payment immediately.
I. Facts
2 In 1983, Toronto College Park Ltd. (“T.C.P.L.”), a corporation engaged in the business of development, sale, and rental of real estate, suffered start-up rental losses in the amount of $4,853,000 in respect of a new commercial building which it owned in Toronto. The building was ready for occupancy but no tenants had been secured. Also in 1983, T.C.P.L. made two tenant inducement payments (T.I.P.s): one in the amount of $3,569,419, which was paid directly to Maclean Hunter Ltd. and expressed to be for the purpose of leasehold improvements (although there was no obligation on Maclean Hunter to use it for that purpose), and another in the amount of $1,723,289, paid to contractors employed by the Ministry of Government Services of Ontario (the “Ministry”), for the benefit of the Ministry. It was agreed by the parties that the payments were made in the ordinary course of T.C.P.L.'s business and for the purpose of earning income. Certain other payments and financial concessions were made to these recipients as well, including rent-free periods and lease pick-up costs, and T.I.P.s were also made to other, smaller tenants.
3 T.C.P.L. deducted the entire cost of the T.I.P.s from its 1983 business income, but its tax return was reassessed to disallow the deduction on the basis that the payments were capital in nature. It was later conceded by the Minister of National Revenue (the “Minister”) that the payments were indeed on income account, but the Minister then took the position that they were not deductible in the year paid and instead should have been deferred and amortized over the life of the respective leases: in the case of Maclean Hunter, a 25-year amortization, reflecting the agreed-upon 20- year lease plus a five-year renewal period, and in the case of the Ministry, a period of 11 years and five months, the entire term of its lease. T.C.P.L. appealed the reassessment to the Federal Court–Trial Division, arguing that it was entitled to deduct the payments in full from its business income in the year in which they were made.
4 The Federal Court-Trial Division allowed T.C.P.L.'s appeal, but this decision was reversed by a unanimous panel of the Federal Court of Appeal.
II. Relevant Statutory Provisions
Income Tax Act, S.C. 1970-71-72, c. 63 (now R.S.C., 1985 (5th Supp.), c.1)
9. (1) Subject to this Part, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.
18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of(9) Notwithstanding any other provision of this Act,
(a) in computing a taxpayer's income for a taxation year from a business or property (other than income from a business computed in accordance with the method authorized by subsection 28(1)), no deduction shall be made in respect of an outlay or expense to the extent that it can reasonably be regarded as having been made or incurred
(i) as consideration for services to be rendered after the end of the year,
(ii) as, on account or in lieu of payment of, or in satisfaction of, interest, taxes ..., rent or royalty in respect of a period after the end of the year, or
(iii) as consideration for insurance in respect of a period after the end of the year....;
(b) such portion of each outlay or expense made or incurred as would, but for paragraph (a), have been deductible in computing a taxpayer's income for a taxation year shall be deductible in computing his income for the subsequent year to which it can reasonably be considered to relate;...
III. Judicial History
1. Federal Court-Trial Division (1993), 71 F.T.R. 30 (Fed. T.D.)
6 Simpson J. began by reviewing the decision in Cummings v. R. (1981), 81 D.T.C. 5207 (Fed. C.A.), where the Federal Court of Appeal decided that a lease pick-up payment made by the taxpayer was made on income account and constituted a “running expense” which was fully deductible in the year in which it was made. Also in that decision, Heald J.A. referred to certain T.I.P.s as analogous to lease pick-ups. Simpson J. rejected the Minister's contention that Cummings was predicated on the impossibility of matching the payments there considered with future lease revenues because the property in question had been sold, and that the case should therefore serve as a precedent only in situations where matching cannot occur, noting that nowhere in his reasons did Heald J.A. make any reference to the impossibility of matching as a factor. As for the argument that Cummings should be restricted only to lease pick-up cases, Simpson J. acknowledged that the comments regarding other types of T.I.P.s were obiter dicta, but identified three general propositions for which she took Cummings to stand: (1) T.I.P.s may in some cases be classified as running expenses; (2) running expenses may, in some cases, be deducted in the year of the expense; and (3) the matching principle does not apply to running expenses.
7 Thus, Simpson J. was of the opinion that the proper approach in this and similar cases was first to determine whether the expense in question was a running expense, which could not be allocated to a specific item of revenue. If so, then it must be decided whether the expense was on current account or whether the benefit extended beyond the year of payment even though it could not be matched. If it so extended, then the taxpayer would have the option either to deduct the expense from income in the year it was made, or to defer the deduction if such deduction were in accordance with generally-accepted accounting principles (“G.A.A.P.”) and would yield a truer income picture.
8 In the circumstances of this case, Simpson J. found the T.I.P.s to be running expenses, as there was no evidence that the final rent charged included specific amounts attributable to such payments. Further, because their primary objective, the inducement of tenants to rent space in the building, was achieved in the year of the expenses, the T.I.P.s were to be considered current expenses. Therefore, because she saw no obligation imposed either by the case law or by the Income Tax Act (the “Act”) to defer the deduction of a current running expense, Simpson J. allowed the complete deduction of the expense in the 1983 taxation year.
9 Although the parties had agreed that no argument would be directed at which method of accounting provided a truer picture of income, Simpson J. found that “the search for a truer picture is not relevant in the case of a running expense which the taxpayer does not elect to defer.”
2. Federal Court of Appeal (Robertson J.A., for the Court), [1996] 3 F.C. 858 (Fed. C.A.)
10 Robertson J.A. began by noting that two years after the trial decision in the instant case, the Federal Court of Appeal rendered its decision in Canderel, supra. In that case, it was decided that T.I.P.s are not running expenses, as they relate to a particular source of income and, therefore, can and must be matched to such income for tax purposes. He pointed out at para. 2 that in Canderel, the court distinguished Cummings, supra, “on the basis that the characterization therein of a lease pick-up payment as a running expense was obiter.”
11 The Minister argued that, applying the law as stated in Canderel, T.C.P.L. was clearly not entitled to deduct the entire amount of the T.I.P.s in the year in which they were paid. In response to T.C.P.L.'s argument that Canderel was wrongly decided because the effect of s. 18(9) of the Act (which requires the amortization of certain prepaid expenses but not T.I.P.s) was not considered, Robertson J.A. began by considering T.C.P.L.'s understanding of the law as it stood before Canderel. T.C.P.L. had maintained that prior to this decision, taxpayers were not, as a general rule, required to defer and amortize current expenses, that the general rule was one of full deductibility in the year the expense is incurred and made, and that this general rule was now codified in s. 18(9), which also enumerates specific exceptions thereto. However, Robertson J.A. rejected the submission that if amortization of T.I.P.s were automatically required under Canderel, s. 18(9) would become redundant. Specifically, he disputed the suggestion that the provision was intended to codify this “general rule”, finding instead that it was a specific clarification by Parliament of certain prepaid expenses which are required to be amortized.
12 Additionally, in the view of Robertson J.A. at para. 10:
...it does not follow that the promulgation of a judicial exception to a rule has the effect of rendering the statutory exceptions redundant. At most, it could be said that Canderel had the effect of adding another exception to the statutory list of expenses which require amortization.
13 Robertson J.A. acknowledged that, if T.C.P.L.'s argument was premised on the assumption that the prepaid expenses specified in s. 18(9) and the T.I.P.s here at issue fell into the same category, i.e., “non-running expenses”, then it could be argued that Canderel therefore stood for the proposition that expenses which can be matched must be amortized and, in this light, that there would have been no need for s. 18(9) to list specific expenses which met this criterion. However, he did not accept that the expenses dealt with by the statutory provision could be classified as non-running expenses. Indeed, in his view (at para. 11), “simply because an expense can be amortized does not mean it can be matched” and the expenses enumerated in s. 18(9), prepaid rents and prepaid service contracts, were good examples of non-matchable expenses which could nonetheless be amortized. Accordingly, he found that the decision in Canderel did not render s. 18(9) meaningless.
14 As to the argument that the Minister failed to establish that the deferral and amortization of the T.I.P.s provided a truer picture of T.C.P.L.'s net income than immediate deduction, a burden of proof which was said to arise from the Minister's initial characterization on of the payments as capital expenses for the purposes of the reassessment, Robertson J.A. observed that the analysis in Canderel did not require a determination of which of the various acceptable options under G.A.A.P. was most accurate. Rather, it established that if an expense can be matched with a specific source of revenue, then it must be amortized. In that case, the court held that T.I.P.s could be so matched and, according to Desjardins J.A. at p. 270, that “[t]he amortization method is the only method acceptable for income tax purposes.” This proposition was wholly unaffected by any expert evidence as to which would be the preferable method of accounting under G.A.A.P., as the calculation of “profit” for income tax purposes is a question of law.
15 Finally, Robertson J.A. held that in amortizing the T.I.P. paid to Maclean Hunter over the period of its lease, the relevant period would be the initial period of the lease, not including the renewal period. Because the option to renew was within the exclusive control of the tenant, it would be mere speculation as to whether the renewal option would ever be exercised and therefore the T.I.P. should be matched with revenues only for the term during which the tenant had an existing obligation to pay rent.
16 Therefore, the appeal was allowed and the matter remitted back to the Minister for reconsideration and reassessment.
IV. Issue
17 Was it open to the taxpayer to deduct the entire amount of the T.I.P.s from its taxable business income in 1983, or should the payments have been amortized over the terms of the leases to which they related?
V. Analysis
1. General principles of profit computation
18 In Canderel, I set out an analysis of the general method to be followed by taxpayers in computing their income for a particular taxation year. I do not propose to repeat that discussion here. For ease of reference, however, I reproduce here the summary provided therein at para. 53 of the general principles of profit computation:
(1) The determination of profit is a question of law.
(2) The profit of a business for a taxation year is to be determined by setting against the revenues from the business for that year the expenses incurred in earning said income: Minister of National Revenue v. Irwin, supra, Associated Investors, supra.
(3) In seeking to ascertain profit, the goal is to obtain an accurate picture of the taxpayer's profit for the given year.
- (4) In ascertaining profit, the taxpayer is free to adopt any method which is not inconsistent with
(a) the provisions of the Income Tax Act;
(b) established case law principles or “rules of law”; and
(c) well-accepted business principles.
(5) Well-accepted business principles, which include but are not limited to the formal codification found in G.A.A.P., are not rules of law but interpretive aids. To the extent that they may influence the calculation of income, they will do so only on a case-by-case basis, depending on the facts of the taxpayer's financial situation.
(6) On reassessment, once the taxpayer has shown that he has provided an accurate picture of income for the year, which is consistent with the Act, the case law, and well-accepted business principles, the onus shifts to the Minister to show either that the figure provided doesnotrepresent an accurate picture, or that another method of computation would provide amoreaccurate picture. [Emphasis in original.]
19 In Canderel, this Court set aside the Federal Court of Appeal's decision in Canderel because of its inappropriate treatment of the matching principle of accounting as a rule of law. As this Court made clear in its reasons, it is for Parliament, not the courts, to make such rules of law. Therefore, the analytical framework employed by the Court of Appeal in the instant case, to the extent that it applied the matching principle without regard to its actual effect on the portrayal of the taxpayer's income, was clearly erroneous. The crucial question in a case such where the method of profit computation is at issue is whether the method adopted by the taxpayer yielded an accurate picture of its profit for tax purposes. If so, then the onus shifts to the Minister to prove the propriety of the alternative method contended for, as above.
20 In light of this analysis, then, I now turn to consider the particular circumstances of the instant appeal.
2. Application of general principles to this case
21 As in Canderel, it is clear that the method of computation adopted by T.C.P.L. in this case was not inconsistent with any express provision of the Act, and was also in accordance with the treatment of T.I.P.s in the case law: see Cummings supra; see also Minister of National Revenue v. Tower Investment Inc., [1972] F.C. 454 (Fed. T.D.).
22 As to the question of conformity with well-accepted business principles, it is, in my opinion, determinative that the trial judge in the instant case found that the primary purpose of the T.I.P.s was to achieve a benefit which was realized entirely in 1983: the inducement of prospective tenants to lease space in the building. This being the case, and I can find no reason, on the evidence, to dispute this finding, the amortization of the payments over the terms of the various leases would seem to make little sense. The most that can be said in favour of the matching principle is that in cases where expenses can be related directly to specific items of future revenue, it may yield a more accurate picture of income to offset the expenses against the future revenue, notwithstanding that the actual expenditures were made or incurred in another year. This is not always the case, however, and the matching principle certainly should not be applied in a case such as the present one, where no linkage to future revenue has been found.
23 Indeed, this is even a stronger case for immediate deduction than Canderel, where the trial judge found several different benefits yielded by the T.I.P.s, some of which were realized in the year of the expenditure and some over the term of the lease. Matching is simply not an issue when all benefits related to an expenditure are realized in the year in which the expenditure is made.
24 In light of the decision of this Court in Canderel, I obviously cannot agree with the Court of Appeal's holding that the matching principle is to be applied irrespective of accounting evidence or of the search for an accurate picture of the taxpayer's income. With respect, the accuracy of the income picture is the only issue to be considered, once it has been established that the method used by the taxpayer to arrive at this picture is consistent with the provisions of the Act, with the judicial interpretation thereof, and with the well-accepted business principles, including but not limited to G.A.A.P., which are found to be applicable in the particular case. While accounting evidence is not determinative of the legal question of profit, it is certainly relevant and may in many cases be highly persuasive. The approach taken by the Court of Appeal is, in my view, unsupported by any previous authority other than its own decision in Canderel, which has now been set aside.
25 I have not been persuaded by the Minister that the amortization of the T.I.P.s would present even as accurate a picture of income as the method adopted by T.C.P.L., let alone a more accurate picture. Therefore, I conclude that T.C.P.L. was entitled to deduct the payments entirely in 1983, the year in which they were made.
26 In light of this conclusion, it is unnecessary to consider the question of what the appropriate term of amortization would be. However, I would nonetheless indicate my agreement with the holding of Robertson J.A. in this regard. Because the renewal period was speculative and exercisable at the sole option of the tenant, it would not be proper to include it as part of the period over which the T.I.P. was to be amortized. Only the initial term of the lease, to which both parties were contractually bound, should be taken into account for the purposes of amortization.
VI. Disposition
27 For the foregoing reasons, I would allow the appeal, set aside the judgment of the Federal Court of Appeal, and restore the judgment of the Federal Court–Trial Division. The appellant shall have its costs throughout.
Email this Content