Date:
20070919
Dockets: A-295-06
A-296-06
A-297-06
A-298-06
Citation: 2007 FCA 294
CORAM: NOËL
J.A.
NADON J.A.
PELLETIER
J.A.
BETWEEN:
A-295-06
SERAFINO SPEZZANO
Appellant
and
HER MAJESTY THE QUEEN
Respondent
BETWEEN:
A-296-06
ANTONIO SPEZZANO
Appellant
and
HER MAJESTY THE QUEEN
Respondent
BETWEEN:
A-297-06
FRANCESCO BUETI
Appellant
and
HER MAJESTY THE QUEEN
Respondent
BETWEEN:
A-298-06
VINCENZO BUETI
Appellant
and
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
NOËL J.A.
[1]
These are
four appeals from a decision of Miller J. of the Tax Court of Canada (“the Tax
Court Judge”), who confirmed the Minister of National Revenue’s (“the Minister)
reassessments issued with respect to the appellants’ 1995 taxation year, on the
basis that, a lease termination payment which they received during that year
was to be treated on an income account.
[2]
The appellants
maintain that the amount in question ought to have been characterized as a
capital receipt and that the Tax Court Judge committed a variety of errors in
holding otherwise.
[3]
The four
appeals were consolidated by order of this Court dated September 22, 2006 and
file A-295-06 was designated as the lead file. Pursuant to this order, these
reasons will be filed in Court file A-295-06 and copy thereof will be filed as
reasons for judgment in the three other appeals.
RELEVANT FACTS
[4]
On March
23, 1994, the four appellants acquired beneficial ownership in a property,
located at 1376 Grant avenue in Winnipeg (“the property”), at a cost of
$1,050,000 and assumed a mortgage with Co-Operators Life Insurance Company
(“Co-Operators life”), valued at $941, 047. The property had been built to
specification for a particular tenant, who was to occupy the premises under a
10 year lease.
[5]
According
to the appellants, the property was acquired as a long-term, bond like
investment with one sole triple-A tenant, Co-Operators General Insurance
Company (“Co-Operators General” or “the tenant”). Co-Operators General paid
$15.00 per square foot rent under a 10 year lease of which two years had
passed. The tenant was also responsible for paying all the costs of operating
and maintaining the premise.
[6]
By letter
dated July 8, 1994, the appellants were advised that Co-Operators General had
entered into a conditional sublease agreement with an entity called Ranger
Unicity. The
letter sought the approval of the landlords. This was the first indication that
the appellants had that their tenant wished to leave.
[7]
By letter
dated July 14, 1994, before the appellants could respond to the request for the
sublease, Co-Operators General presented an offer to terminate the lease.
[8]
On July
21, 1994, Francesco Bueti acting for himself and the other appellants refused
both offers. The appellants did not consent to the sublease because they did
not view Ranger Unicity as a quality tenant, the rental value was lower than
the existing rent, they were concerned about lowering the value of the building
and the fact that considerable renovations would be necessary to accommodate
the new tenant, although Co-Operators General would have been responsible for
the necessary changes.
[9]
With
respect to the offer to terminate the lease, the appellants responded with a
counter-offer, according to which they would surrender the head lease on
payment of $1,015,941. Mr. Bueti’s letter characterized the payment as the “net
tenant commitment” outstanding under the lease. The amount was calculated based
on the amount of minimum rent, additional rent, property tax and utilities
owing under the lease, less an amount allowed for sub-tenant recoveries. This
counter-offer was not accepted.
[10]
On
September 16, 1994 the tenant attempted once again, unsuccessfully, to obtain
the appellants’ consent to the sublease.
[11]
On October
5, 1994, the appellants and tenant entered into a settlement agreement, which
required Co-Operators General to pay rent and perform all other obligations
under the lease until December 31, 1994 and to pay $500,000 to the landlord on
or before December 31, 1994.
[12]
However,
the October 5, 1994 settlement did not proceed as the mortgagee (the tenant’s sister
company, Co-Operators Life Insurance) requested that the termination payment be
paid to it rather than to the appellants. The mortgagee made this request
relying on an assignment of rents agreement which gave it a security interest
in all rents and other monies (collectively referred to as “Rental Income”) due
under the lease.
[13]
Around
this time, the appellants looked into the possibility of selling the building. They
received a purchase offer of $825, 000 but an environmental report derailed the
offer and so, a second offer was made for $750,000. This offer was accepted by
the appellants subject to the condition that they obtain an acceptable lease
termination payment from Co-operators General.
[14]
This
occurred on August 31, 1995, at which time the appellants agreed with
Co-Operators General and the mortgagee, Co-operators Life, to a termination of
the lease, effective September 30, 1995 as follows:
2. In consideration of
termination of the Lease effective September 30, 1995, the Tenant covenants and
agrees:
(a) to pay the sum of
Seven Hundred and Sixty-Two Thousand Five Hundred Dollars ($762,500.00) Dollars
(plus applicable GST) to the landlord on the 30th September 1995 and
(b) subject to paragraph
3 thereof, to pay minimum rental pursuant to Article 3.00 of the Lease and
Operating Costs pursuant to Article 4.00 of the Lease during the period August
31, 1995 to September 30, 1995 as if the Lease was in full force and effect
And in accordance with
the Mortgage and the Assignment, the Landlord hereby irrevocably authorizes and
directs the Tenant to make payment of $762,500.00 directly to the mortgagee and
all such payments shall for all purposes hereof constitute payment to the
landlord
[15]
Mr.
Dabolins, who acted as leasing agent for Co-Operators General, testified that
from the perspective of his client, the purpose of the payment was to reduce the
tenant’s obligation in terms of rent and operating costs and property costs.
[16]
The sale
of the property took place for the agreed amount of $750,000. Thereby
triggering a $300,000 loss on the property which the appellants had purchased a
year earlier for $1,050,000.
[17]
In filing
their tax return for their 1995 taxation year, the appellants reported their
share of the capital loss and took the position that their respective portion
of the lease termination payment was a capital receipt. The Minister subsequently
issued reassessments whereby the appellants’ share of the termination payment
was added to their income.
[18]
Upon the
appellants challenging these reassessments before the Tax Court of Canada, the
Minister’s reassessments were confirmed.
TAX COURT OF CANADA DECISION
[19]
The Tax
Court Judge identified the issue at hand as being the correct characterization
of the lease cancellation payment made in September 1995 (Reasons, para. 10).
Applying the surrogatum principle (Tsiaprailis v. Canada, [2005] 1
S.C.R. 113, para. 7), he concluded that the tenant’s purpose in making the
payment was to relieve itself of its obligation to pay the outstanding rent
through the life of the lease (Reasons, para. 18). Similarly, he found that the
appellants’ purpose in accepting this payment was to recover the rent they were
having to forgo (Reasons, para. 27).
[20]
The Tax
Court Judge accepted that the termination of the lease had a negative impact on
the value of the property. However, he rejected the appellant’s contention that
the purpose of the payment was to compensate for this decrease in value. There
was no evidence to suggest that the compensation was based on the reduced value
of a building. Further, there was no link between the payment and the reduced
value (Reasons, para. 18).
[21]
At the end
of his reasons, the Tax Court Judge asked whether the effect of the payment (as
opposed to its purpose) might not have been, in part, compensation for the
reduced value of the property. He said (Reasons, para. 19):
I floated one possible
scenario to both counsel, and that was that, in accordance with the idea of two
effects to the payment, would either side consider the possibility that
$300,000 of the payment is attributable to capital, as it restored the value of
the property to its fair market value as a single-tenant occupied building,
with the balance to income as compensation for forgone rent. Neither side bit
on what I thought was a logical supportable resolution and I will, therefore,
not pursue this further, but will decide on the all-or-nothing approach
demanded by both sides.
[22]
The Tax
Court Judge went on to reject the four appeals with one set of costs.
ALLEGED ERRORS IN DECISION UNDER APPEAL
[23]
The
appellants submit that the long term lease was a capital asset. It follows in
their view that the payment which they received to terminate the lease is to be
treated on account of capital. They maintain that the Tax Court Judge failed to
take into account the importance of the lease and its impact on the value of
the property.
[24]
The
appellants further submit that even if a lease is not a capital asset, the decrease
in the value of the building was so severe so as to significantly affect their “business
structure”. They rely by analogy on Westfair Foods Ltd. v. Her Majesty the
Queen (1990) 40 F.T.R. 207 (“Westfair Foods”), T. Eaton Co.
Limited v. Her Majesty the Queen [1999] 3 C.F. 123 (“T. Eaton”),
numerous cases cited within this decision (Commissioner of Inland Revenue v.
Fleming & Co. (Machinery) Ltd. (1951), 33 T.C. 56 (“Fleming”); Pe
Ben Industries Co. v. the Queen, London and Thames Haven Oil Wharves,
Ltd. v. Attwooll, [1967] 2 All. E.R. 124(C.A.); Joffe v. Minister of National
Revenue, [1972] C.T.C. 2543) as well as R. Reusse Constrution Co. Ltd.
v. Her Majesty the Queen (1999), 99 D.T.C. 823 (T.C.C) (“R. Reusse”)
and Farb Investments Limited v. M.N.R. [1985] 58 D.T.C. 91.
[25]
In the
alternative, the appellants ask that this Court give effect to the Tax Court
Judge’s suggestion at the conclusion of his reasons (para. 19) that part of the
payment (i.e., $300,000) could be treated on capital account.
ANALYSIS AND DECISION
[26]
The appeal
cannot succeed. While there are a variety of circumstances where a long term
lease will be viewed as a capital asset in the hands of lessee, I am aware of
no case where a lease was given this characterization from the perspective of
the landlord.
[27]
The capital
asset which the appellants purchased back in 1994 is the income producing property.
It is true that the lease in place at that time provided for an income stream
throughout the life of the lease. However, income producing asset was the property
and not the lease.
[28]
I can see
no error in the Tax Court Judge’s conclusion that the sole capital asset acquired
by the appellants was the building and that the long term lease was but a means
of exploiting that asset (Reasons, para. 11).
[29]
Nor can I
detect any error in the Tax Court Judge’s conclusion that the payment in issue
was intended to replace rents otherwise payable under the long term lease. As
was stated by the Supreme Court in Tsiaprailis v. Canada [2005] 1 S.C.R.
113, para. 7:
[i]n
assessing whether the monies will be taxable, we must look to the nature and
purpose of the payment to determine what it is intended to replace. The
inquiry is a factual one. The tax consequences of the damage and settlement
payment is then determined according to this characterization. In other words,
the tax treatment of the item will depend on what the amount is intended to
replace. The approach is known as the surrogatum principle.
[30]
Tax Court
Judge correctly identified and applied this principle (Reasons, paras. 15 and
18). His conclusion, “that the lease cancellation payment was a payment
replacing the rent commitment under the lease”, is a finding of fact, which
cannot be overturned absent a palpable or overriding error (Housen v. Nikolaisen
[2002] 2 S.C.R. 235).
[31]
In coming
to this conclusion, the Tax Court Judge considered four factors to be
particularly persuasive:
1) The
Appellants' response of July 21, 1994 to the tenant's counsel, calculating the
tenant commitments, being primarily rent, less subtenant recoveries and seeking
such amount as compensation for the surrender of the lease;
2) Mr.
Dabilons' testimony that Co-Operators General was not concerned with the value
of the building, but simply to get out from under the lease paying as little as
possible;
3) The
lease termination agreement itself which makes no mention of any money being
paid on account of capital; and
4) The
Assignment of Rents agreement with Co-Operators Life entitling Co-Operators
Life to receive money that is on account of rent under the lease. Pursuant to
such agreement, Co-Operators Life received the full amount of the payment
(Reasons, para. 15)
[32]
In my
view, the Tax Court Judge was on solid grounds in identifying the purpose of
the payment as he did. The lease reflects no particular provision making the
tenant responsible for a loss in value of the rented property or providing for
compensation in the event of such a loss. The tenant’s fundamental obligation
under the lease was to pay the rent throughout the life of the lease. On the
other hand, it could terminate the lease by paying the rents which would have
accrued over the life of the lease, less a proper adjustment, to account for
the early payment. This is what it did in this instance.
[33]
The
extensive case law relied upon by the appellants in support of their view that
the payment was intended to compensate for the crippling effect of the early
termination on their property is of no assistance because even if I was to
assume the appellants’ property was permanently damaged, the Tax Court Judge
found as a fact that the purpose of the payment was intended to compensate
something else, i.e., the outstanding rents.
[34]
Finally,
the appellants ask that this Court consider attributing part of the termination
payment to capital as suggested by the Tax Court Judge at the end of his
reasons. In making this suggestion, the Tax Court Judge focussed on the effect
of the payment, as opposed to its purpose, and reasoned that part thereof
($300,000) although intended to replace the rent commitment may be looked upon
as having “… restored the value of the property to its fair market value …”
(Reasons, para. 19).
[35]
As noted
earlier, the surrogatum principle places the focus on “the nature and
purpose of the payment to determine what it is intended to replace” (Tsiaprailis,
supra, para. 7). It does not hinge on the effect of the payment. In this
case, the Tax Court Judge found that the purpose of the payment was to
compensate for the loss rents from the perspective of both the appellants and
the tenant. In my view, there is no basis in law for apportioning to payment on
some other basis.
[36]
I would
dismiss the four appeals with one set of costs in file A-295-06.
“Marc
Noël”
“I
agree
M. Nadon J.A.”
“I
agree
J.D. Denis Pelletier J.A.”
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