Bowman T.C.J.:
1 These appeals are from loss determinations made under the Income Tax Act for the 1981, 1982 and 1983 taxation years. The narrow question is whether the cost of “acquiring” zoning from a landowner across the street that would permit a greater density is a cost of land or building or, if neither, whether it is an eligible capital expenditure.
2 In 1979 Sun Life acquired 4 parcels of land on the north east and north west corners of University Avenue and King Street in Toronto. The purpose of the acquisition was to construct two high-rise office buildings. The existing zoning on the two lots permitted an 8 times density.
3 After the acquisition it became aware that, across King Street, St. Andrews Church had commercial density that it did not need and that if it could acquire increased density from the church it could construct a larger office building. A memorandum describing the economic effect of the acquisition of increased density rightswas put in evidence and it sets out the business considerations that went into the decision to approach St. Andrews Church and to attempt to acquire from it its increased density. The memorandum is worth reproducing in full:
Air Rights St. Andrew's Church
Location
St. Andrew's Church is located on the northern portion of a city block bounded by King Street, Simcoe Street, Wellington Street and Emily Street (see attached Appendix B).
The site is believed to contain about 40,000 square feet.
Air rights
Under the Official Plan of the City of Toronto, there is a new procedure which makes it possible to transfer building densities from one property to another subject to meeting certain prescribed conditions and obtaining the specific approval of City Council. Transfer of densities can be undertaken only between properties that are located within 150 metres of each other. Office density can be transferred only if residential premises are to be built on the property fro which the office density is transferred. The property receiving the additional density is not to exceed 1 acre in size. The total coverage of a property receiving additional office density may not be raised above 12 times.
The first application involving the transfer of office density under the new procedure is now before City Council, hence there is no established series of precedents to indicate how Council may act on transfer applications. While St. Andrew's Church is not in a position to build the residential premises normally required, it has been advised that the Planning Department of the City of Toronto is prepared to support the sale of the Church's air rights. Although both the East and West Sites exceed an acre in size, it may be possible to obtain additional building density if the City is basically sympathetic to the Church's desire to sell the air rights.
Cost of Air Rights
For purposes of this analysis, it is assumed that it would be possible to acquire sufficient air rights to bring the density on the East Site to 11 times and on the West Site to 10 times. The allocation of this additional density would be as follows:
| East Site | 156,000 square feet |
| West Site | 94,000 square feet |
| 250,000 square feet |
As the result of recent negotiations with the Church through an intermediary, it is believed that the additional rights can be obtained at a cost of $15 per square foot. This would lead to the following allocation of costs between the two sites| East Site | $2,400,000 |
| West Site | 1,400,000 |
| $3,800,000 |
Payment for the rights would be made only to the extent that City Council approved their use on one or more of our development sites.Increased Development Potential
East Site
As mentioned earlier, at 8 times coverage the East Site could be developed with an office building having a gross area of 416,000 square feet and a net rentable area of 365,000 square feet. At 11 times coverage, the gross area would become 572,000 square feet with a net rentable area of 500,000 square feet. The relative cost of the two project sizes on the East Site would be as follows:
| 8 Times Coverage | 11 Times Coverage | |
|---|
| Land Assembly Costs | $21,000,000 | $21,000,000 |
| Development Costs | 27,400,000 | 37,600,000 |
| Air Rights | - | 2,400,000 |
| $48,400,000 | $61,000,000 |
| Average Cost Per Rentable Square Foot | $133 | $122 |
West Site
At 8 times coverage, the West Site could be developed with an office building having a gross area of 373,000 square feet and a net rentable area of 330,000 square feet. At 10 times coverage, the gross area would become 466,000 square feet with a net rentable area of 410,000 square feet. The relative cost of the two project sizes on the West Site would be as follows:
| 8 Times Coverage | 11 Times Coverage | |
|---|
| Land Assembly Costs | $12,700,000 | $12,700,000 |
| Development Costs | 24,700,000 | 30,900,000 |
| Air Rights | - | 1,400,000 |
| $37,400,000 | $45,000,000 |
| Average Cost Per Rentable Square Foot | $113 | $110 |
Timing
It is believed that if City Council is prepared to transfer building density from St. Andrew's Church to the East and West Sites, it would do so within the next 12 months. For purposes of this analysis, it is assumed that we would pay for the air rights in the first quarter of 1981.
4 It must be recognized that zoning, or density, is not a commodity that can be bought and sold on the open market. The transfer of density rights from one landowner to another involves an agreement between landowners whereby one surrenders a “higher” zoning or higher density and the other obtains what the former gives up. Such trades must necessarily involve the municipality which is the authority that can grant such changes in zoning in respect of a particular parcel of land.
5 St. Andrews Church was agreeable to the transfer and on April 25, 1980 an agreement was entered into between it and Sun Life. The relevant portions read as follows:
We are writing to confirm the agreement we have reached in connection with the exchange of densities between parcels of land which we respectively own having frontages on King Street West.- 1. Our agreement is premised on the following facts:
A. Section 3A.5 (f) of the Official Plan for the City of Toronto permits, at the discretion of the City Council and subject to the satisfaction of certain conditions including the passage of a by-law, the transfer of commercial density from one lot to another and the exchange therefor of density for conventional housing units, (“residential density”).
B. You hold the fee simple estate in a parcel of land (the “Church Lands”) bounded in part by King Street West, Simcoe Street and Emily Street on which parcel stands St. Andrew's Church and other buildings.
C. We hold the fee simple estates in parcels of land in the city blocks bounded by King Street West, Simcoe Street, Pearl Street and University Avenue (the “West University Block”) and by King Street West, York Street, Pearl Street and University Avenue (the “East University Block”) (both of which blocks are collectively referred to as the “University Lands”).
D. You and we contemplate the making of an application for the passage of a by-law or by-laws the effect of which would be to transfer commercial density from the Church Lands to the University Lands and to transfer in exchange residential density from the University Lands to the Church Lands. This would permit the construction of buildings on the University Lands with greater commercial gross floor areas than would otherwise be permitted by the Official Plan.
2. Accompanying this letter is a cheque in the amount of $50,000.00. You will have no obligation to refund this amount to us except in the circumstances referred to in paragraphs 3, 8 and 11 in which case it will be refunded without interest thereon or deduction therefrom. In consideration of this amount and subject to the terms and conditions contained herein, including the additional payment provisions referred to in paragraphs 6 and 9, you agree to (and by execution of the acknowledgement copy of this letter you do) sell, assign and transfer to us all commercial density applicable to the Church Lands which was unused on 1st February, 1980 and which by virtue of the by-laws referred to in paragraph 4 hereof we are permitted to use. (For purposes of this agreement, unused commercial density means the remaining number of square feet of commercial gross floor area that may be built on a parcel of land). As part of the consideration for the assignment of the commercial density aforesaid, we agree to transfer and assign to you the appropriate amount of residential density from the University Lands.
3. We understand that to accomplish the density transfers proposed herein, you desire to obtain division of the Church Lands into two separate lots, the Church to stand on one lot (the “Church Lot”), the other buildings on the other (the “South Lot”). If consent to severance is obtained and such consent is not subject to conditions which are in your opinion prejudicial to your interest, you and we agree that the applications will request the transfer of commercial density from the Church Lot to the East University Block and from the South Lot to the West University Block, although in our sole discretion we may request a transfer from the Church Lot to the West University Block and from the South Lot to the East University Block. If for any reason we are unable to effect a transfer of commercial density to either of or both the East University Block and the West University Block, we shall be entitled, in our sole discretion, to substitute another parcel or other parcels of land within the required radius in a new application for commercial density transfers. You represent that you will proceed with all due diligence with, and make your best efforts to obtain approval of, an application to the Committee of Adjustment of the City of Toronto to divide the Church Lands into two lots. If that application is not successful, and if the application proves to be necessary for the accomplishment of the objectives set out in paragraph 1(D) and we ourselves are unable to obtain Committee of Adjustment consent, we acknowledge your right to re-examine your position and to terminate the agreement at your option. Provided that upon such termination you will return to us all amounts paid to you by us under this agreement and you shall not prior to the 30th June, 1982 enter into an agreement with a party other than us, the object of which is the passage of a by-law which will accomplish a transfer of commercial density in a similar manner as contemplated herein.
4. Subject to the qualifications contained later in this paragraph, you and we agree to apply to the City for the passage of by-laws implementing transfers of density which will yield the maximum number of additional square feet of commercial gross floor area the municipal authorities will permit to be built on the University Lands as a result of such transfers, and to accept from you all of your commercial density which the City will permit to be transferred to our parcels. The parties recognize that each of the two city blocks which together constitute the University Lands exceeds one acre in area and that, accordingly, it may be necessary for applications to be made in respect of parcels which, in each case, constitute less than the entire city block so that each parcel which is the intended recipient of a density transfer (the “recipient parcels”) is no larger than one acre. In such circumstances before calculating the maximum number of square feet of commercial gross floor area that could be transferred from the Church Lands to the intended recipient parcels constituting part of the University Lands, there may, in our sole discretion, first be added to the intended recipient parcels the number of square feet of commercial gross floor area that may be contributed to the intended recipient parcels by adjacent parcels within the same city block that are owned by the applicant and any portion of the lane on the East University Block in respect of which an application to stop up and convey is being made.
5. You are we agree to make our best efforts to obtain from all necessary municipal and provincial departments, committees and authorities approval of by-laws permitting the transfer of commercial densities from the Church Lands to the University Lands (or to parcels substituted pursuant to paragraph 3) and we agree to co-operate fully with each other and with municipal authorities with a view to obtaining quick passage and approval of the necessary by-laws but you must approve any proposed by-law affecting the Church Lands to the extent that it may be prejudicial to you and we must approve any proposed by-law affecting the University Lands (or parcels substituted pursuant to paragraph 3) to the extent that it may be prejudicial to us.
6. Immediately following final approval by the Ontario Municipal Board and by any other government agency or official, if required, and otherwise following passage of the necessary by-laws validly permitting the transfer of unused commercial density from the Church Lands to the University Lands (or to any parcels substituted therefor pursuant to paragraph 3), we shall pay you an additional amount for the commercial density rights acquired from you. This additional amount will be determined by deducting $50,000.00 (plus the sum of all payments, if any, made pursuant to paragraph 9) from the product obtained by multiplying, subject to paragraph 11, the actual number of additional square feet of commercial gross floor area which, pursuant to the necessary site-specific by-laws, may be built on the University Lands (or on parcels substituted therefor pursuant to paragraph 3) as a result of the transfer thereto of unused commercial density from the Church Lands, by $14.50.
6 The exchange of density was in fact accomplished and the two buildings that are now situated at the corner of King Street and University Avenue were erected. For the exchange Sun Life paid St. Andrew's Church $4,124,803. It seeks to include this amount in the computation of its capital cost of the buildings for the purpose of claiming capital cost allowance. The respondent says that the expenditure is more properly attributed to the cost of the land.
7 I have no difficulty in concluding that the purpose of the expenditures to obtain the higher density on the appellant's lands was to enable it to put up larger buildings which would, of course, generate increased revenues. To a businessman I can well imagine that this could be seen as part of the cost of the building. Mr. Geoffrey W. Clarkson, F.C.A., a distinguished senior chartered accountant, testified that in his opinion the appropriate accounting treatment would be to treat the expenditure as part of the cost of the building rather than as a cost of the land. He stated that the Canadian Institute of Chartered Accountants (“C.I.C.A”) Handbook does not deal with the point but in 1990 the Accounting Practices Handbook of the Canadian Institute of Public Real Estate Companies (the “CIPREC” Handbook) states:
The cost of air rights or payments in lieu increase the density of a project and hence the amount of rentable area permissible in a building to be constructed. Air rights would be acquired or payments in lieu made generally only when there was a specific use for those rights. Accordingly, they are considered to be a part of the project and should be capitalized. Although air rights are separate from the underlying land and can be traded independently thereof, they are generally subject to amendments in the official plan or other changes in zoning at the discretion of a municipality. As a result, practice has been to record the cost of air rights as part of the building rather than as land or as a separate asset.
8 Mr. Clarkson stated in his report:
14. In 1980 and 1981, in assessing the proper method of accounting for the cost of the “density rights”, the accountant would have relied on professional judgment and basic concepts and principles. I have been advised that Sun Life management based its decisions on whether to purchase the “density rights” on its ability to add more floors to the building and thus increase revenue from the building. In my opinion, the attachment of the related costs to the building is required by the fundamental “matching principle” of accounting. In the foremost Canadian accounting reference text “Accounting Principles -- A Canadian Viewpoint”, R.M. Skinner stated:
Costs recorded in the accounts should be matched with revenues for the purpose of determining income of individual accounting periods in a manner which best reflects the “cause and effect” relationship between costs and revenues... (Page 69).
Sun Life had purchased the land which was zoned for high rise office towers. The Official Plan of the City of Toronto contemplated that density rights could be transferred, and the business decision made by management was whether the cost of the density rights in order to be able to add the additional floors to the building was a justifiable cost which would be recovered from the revenue generated from these additional floors. They concluded it would be. Thus there was a clear “cause and effect” relationship between the cost to acquire the density rights and revenue for the additional floors of the buildings. Under these circumstances, in order to properly determine the annual net profit, the cost of the density rights should be amortized over the projected revenue from the additional floors, so the appropriate judgment of the accountant within GAAP would have been to capitalize the cost of the density rights to the buildings and the costs of the density rights would have been amortized against the revenue from these additional floors through the annual depreciation charge.15. One of the questions which I have been requested to answer is whether there has been any change in accounting for density rights between 1980 and today. As noted above, there is very little accounting literature on this topic. In addition, since 1990 there have been very few, if any, transactions in density rights in Canada because of the significant downturn in construction in Canada. Based on my experience there has not been any change in accounting for density rights under GAAP between 1980 and today.
Conclusion
16. I understand the payment of $4,124,803 for density rights was made for the specific purpose of adding more floors to the buildings and thus increasing revenue. In my opinion, under GAAP, in order to properly determine the annual net income of Sun Life, the matching principle is appropriate in this circumstance, so the $4,124,803 should be capitalized to the buildings and depreciated over the lives of the buildings. I am not aware of any change in accounting for density rights under GAAP between 1980 and today.
The 1990 CIPREC Handbook supports the capitalization of the cost of density rights to buildings and this Handbook prescribes the accepted business (accounting) practice followed by the real estate industry.
9 Mr. Clarkson was an impressive witness and I accept that it would not be an inappropriate accounting treatment to capitalize the cost of acquiring different zoning as part of the cost of the building. Moreover, I accept that the matching principle has acquired virtually the status of a rule of law. I do not, however, think that the answer lies in the accounting treatment. See IKEA Ltd. v. R. (1993), 94 D.T.C. 1112 (T.C.C.); aff'd(1996), 96 D.T.C. 6526 (Fed. C.A.); cf. Sherritt Gordon Mines Ltd. v. Minister of National Revenue (1968), 68 D.T.C. 5180 (Can. Ex. Ct.). No doubt, irrespective of how this or a higher court decides the issue of law, the accounting profession will continue to treat such costs as Mr. Clarkson has indicated.
10 The question is whether as a matter of law the cost of acquiring zoning that permits a landowner to construct a larger or different building on the land is part of the cost of the land or the building.
11 Counsel for the appellant invited me to reconsider my decision in Cadillac Fairview Corp. v. R., [1996] 2 C.T.C. 2197 (T.C.C.). That case has been appealed to the Federal Court of Appeal, but it is uncertain whether it is intended to pursue the branch of the appeal dealing with the acquisition of zoning rights.
12 One difference between that case and this one is that while Cadillac Fairview“acquired” for about $11,000,000 density rights from Holy Trinity Church for the purpose of constructing Phase II of the Eaton Centre, it never did proceed with the construction. Here at least we have a building.
13 Since many of the legal considerations that applied in Cadillac Fairview apply here, the simplest thing is to repeat what I said there at pages 2211-2214:
To begin with, we should be clear on just what “density rights” are and what the appellant was getting for its $11,227,444. We may start from the proposition that in the absence of legislative or other legal restrictions a landowner is free to do what it wants on its land. It can farm it, build highrise apartments or office buildings, or build the Tower of Babel. Its rights inhere in the ownership of the land. The exercise of those rights can, however, be restricted, regulated or prohibited by legislation. In this case the authority having that jurisdiction is the province and it delegates the power to the municipal authorities.
The power of municipal zoning is conferred upon the municipality by the Planning Act. Section 34 of the Planning Act of Ontario R.S.O. 1990, c. P-13 reads in part as follows:
(1) Zoning by-laws may be passed by the councils of local municipalities:1. For prohibiting the use of land, for or except for such purposes as may be set out in the by-law within the municipality or within any defined area or areas or abutting on any defined highway or part of a highway.
2. For prohibiting the erecting, locating or using of buildings or structures for or except for such purposes as may be set out in the by-law within the municipality or within any defined area or areas or upon land abutting on any defined highway or part of a highway.
3. For prohibiting the erection of any class or classes of buildings or structures on land that is subject to flooding or on land with steep slopes, or that is rocky, low-lying, marshy or unstable.
4. For regulating the type of construction and the height, bulk, location, size, floor area, spacing, character and use of buildings or structures to be erected or located within the municipality or within any defined area or areas or upon land abutting on any defined highway or part of a highway, and the minimum frontage and depth of the parcel of land and the proportion of the area thereof that any building or structure may occupy.
(3) The authority to regulate provided in paragraph 4 of subsection (1) includes and, despite the decision of any court, shall be deemed always to have included the authority to regulate the minimum area of the parcel of land mentioned therein and to regulate the density of development in the municipality or in the area or areas defined in the by-law.
The origin of that section is S.O. 1983, c. 1.
Presumably the zoning by-laws of Toronto were enacted by it under the authority of a predecessor to that section, possibly section 39 of the Planning Act, R.S.O. 1980, c. 379 which is substantially the same as that contained in R.S.O. 1990. It is important to recognize that zoning does not constitute a conferral of a right but rather a restriction of the otherwise unlimited right of a landowner to do what it wishes with its land. It is less accurate to describe a change in zoning to allow a further use of land as the conferral of a right than to describe it as a lifting or relaxation of a restriction on the otherwise unrestricted use of the property. It follows that the right to use property, whether restricted by zoning by-laws or not, is a right that inheres in the ownership of the property. It is part of the bundle of rights that a landowner has by reason of ownership of property. The cost of a modification of the restrictions of the rights that a landowner has with respect to the use of land is a part of the cost of the land. The cost of lifting restrictions on the exercise of those rights clearly relates to the cost of the bundle of rights that ownership entails. Density rights have to do with what the owner can do with the land. If a landowner is successful in improving the zoning of a parcel of land, and then sells it, it is inconceivable that the revenue authorities could demur at the inclusion of the cost of that rezoning in the cost of the land sold.
The position was put with clarity by the New York Court of Appeals in a decision MacMillan, Inc. v. CF Lex Associates (sub. nom. MacMillan v. Cadillac Fairview Corporation) (1982), Ct. App., 452 N.Y.S. 2d 377. It said at p. 380:
Moreover, air rights, at the heart of the concept of zoning lot merger, have historically been conceived as one of the bundle of rights associated with ownership of the land rather than with ownership of the structures erected on the land. Air rights are incident to the ownership of the surface property -- the right of one who owns land to utilize the space above it. This right has been recognized as an inherent attribute of the ownership of land since the earliest times as reflected in the maxim, “[ c] ujus est solum, ejus est usque ad coelum et ad inferos” [“to whomsoever the soil belongs, he owns also to the sky and to the depths”] (Butler v. Frontier Tel. Co., 186 N.Y. 486, 491, 79 N.E. 716; 2 Blackstone's Comm., p. 18; see Ball, Vertical Extent of Ownership in Land, 76 U. of Pa.L.Rev. 631 in which the maxim is attributed to the early 14th century scholar Cino da Pistoia).
The decision is of course not binding, but it is persuasive. The cost of modifying rights relating to what one can do with land are in my view a cost attributable to the land. They inhere in the land, whether or not a structure is erected on the land. In this case the proposed Phase II has not been erected. It requires something of a leap of faith to claim capital cost allowance under Class 3 on a building that does not exist and may never exist. The land however does exist, along with all of the rights that inhere in it. The rights do not exist independently of the ownership of the land. If the ownership of the land is transferred, the rights follow it.
Although one speaks colloquially of “acquiring” density rights from an adjoining landowner, this process involves persuading that landowner to accept on its land a “lower” zoning and, armed with that concession, persuading the municipality to give to that adjoining land a lower zoning and a correspondingly higher zoning to the neighbouring land. It is not a simple transfer of rights between owners. Zoning is not a commodity that can be bought and sold on the open market. It is something that the municipality confers on, or takes away from, the land itself.
Accordingly it is not necessary for me to consider the alternative argument that the costs are eligible capital expenditures. Since I have concluded that the cost of obtaining zoning that permitted a higher density on the land is a cost of land, it follows that it cannot, by reason of paragraph 14(5)(c)(i), be an eligible capital expenditure.
14 Counsel for the appellant in a very thorough and articulate argument suggested that possibly I went too far in Cadillac Fairview and that since there was no building erected there I could have disposed of the matter on the basis that one cannot claim capital cost allowance on a non-existent building. It would not have been quite as simple as that, because I still had to decide between the cost of land and eligible capital.
15 Is it appropriate to say that where there is in fact a building erected on the land the cost of acquiring zoning that would permit that construction is part of the cost of the building, whereas if no building is erected the cost is attributable to the land? I asked Mr. Clarkson what the appropriate accounting treatment would be if for some reason Sun Life had not proceeded with the construction. He stated that the expenditure would probably be put in a suspense account and the matter would be reviewed periodically. This may well be the appropriate accounting treatment but it does underline the difficulty, indeed futility, of attempting to find in accounting practices solutions to what are essentially legal questions.
16 Counsel for the appellant contended that the acquisition of the density rights bore directly on the economics of the operation in the sense that a larger building could be constructed and increased rents would be received. This is, I think, evident from the memorandum quoted above. Counsel also contended that density rights and zoning by-laws have to do essentially with buildings. In support of this he pointed to the City of Toronto Official Plan in which a number of the definitions of density appear to focus on the size of building that may be put on a lot.
17 I do not necessarily disagree with these observations but, notwithstanding Mr. van Banning's very able argument, I do not think that they are determinative of the issue. In analyzing the question one must determine the true nature of zoning. While I have no reluctance about reconsidering my own judgment in Cadillac Fairview, or in distinguishing it, I am not persuaded that I reached the wrong conclusion in that case. Nor can I see any rational basis for reaching a different conclusion depending on whether a building is constructed on the land.
18 I continue to be of the view that since zoning determines what a landowner can do with land it is an attribute of the land and that costs associated with obtaining a change in zoning are part of the cost of land. Density rights have to do with what an owner can do with land. They are, therefore, an integral component in the value of land. They exist independently of their exercise and independently of any present or future building. They would continue to exist even if the building were demolished and the land were left vacant or another building erected. In light of this, it cannot be said that they form part of the cost of this particular building. The obtaining of higher zoning, or increased density rights, may well affect the economics of the intended commercial operation but this results from the fact that the landowner has obtained the right to do more with the land. On one view of the matter one could say that the cost of purchasing the land is an integral part of the economics of the proposed commercial operation yet one could not include the cost of the land in the cost of the building. Possibly one way of testing the conclusion would be to envision the situation where the previous owner, before selling the land to Sun Life, had negotiated with the church and, for a price, obtained a higher density or more favourable zoning and as a result charged a higher price for the land. The increased price for the land could not be attributed to the building even though, in a sense, it relates to the type of building that can be constructed on the land.
19 This case may be distinguished from Stursberg v. Minister of National Revenue, [1990] 1 C.T.C. 2335 (T.C.C.). In that case Mogan J. of this Court held that certain municipal levies that were payable only upon the issuance of a building permit were not related to holding or acquiring land but were more appropriately treated as part of the cost of the building. Here I think the cost of the increased density is part of the cost of the land.
20 In light of this conclusion, I need not consider the alternative argument that the costs are eligible capital expenditures.
21 The appeals are therefore dismissed with costs.
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