Huang and Danczkay Limited v. Minister of National Revenue, [1993] 2 CTC 2301, 93 DTC 1028

Hamlyn, T.C.C.J.:— The appellant entered into three separate development agreements with three separate limited partnerships to provide, inter alia, with variants, land, planning, supervision, construction, completion, initial services, management, start-up leasing and financial services for three multiple unit residential building projects ("MURBS"). In return for the undertaking to provide these services the appellant received purchase money notes for all three projects and wrap around mortgages for two of the projects. The purchase money notes and the wrap-around mortgages incorporated the appropriate development agreements as part of the respective notes and mortgages.

The payments for the services rendered under the development agreements were paid to the appellant by way of the purchase money notes and the wrap-around mortgages.

The question before this Court is when, in the computation of profit, is the proper timing of the inclusion of income in relation to the payments made pursuant to the purchase money notes and the wrap-around mortgages.

The appellant's position at the end of the hearing was the uncollected portions of the purchase money notes and the wrap-around mortgages should only be included in the computation of income for tax purposes when the appellant was entitled to payment and the appellant claims that it was only entitled to payment when certain services were provided in accordance with the development agreements.

The Minister of National Revenue's (the"Minister") position is that the total sums under the respective notes and mortgages were recognized by the appellant as receivable for the financial statement purposes, therefore such sums must be included in the computation of income under the Act when the respective notes and mortgages were received.

At the outset the appellant's counsel submitted the following:

One of the issues will not be litigated today, Your Honour. The question of discounting the mortgages taken back by HDL will be conceded by the appellant . . . .

Apart from this concession, the appellant appeals from the assessments concerning its 1980, 1981, 1982, 1983 and 1985 taxation years, (the “taxation years”).

In his pleadings, the Minister admitted the following facts from the notice

specifically:

1. The appellant, an Ontario corporation, incorporated in 1971, is a Canadian- controlled private corporation ("C.C.P.C.") owned equally by Michael Huang and Bela Danczkay.

2. The appellant carries on the practice of consulting engineer and the business of real estate development and property management.

3. In 1979, the Silver Creek-Cedarwood partnership ("Silver Creek-Cedarwood"), a limited partnership, constituted under the laws of Alberta, was formed by B.P.M. (Mill St.) Developments Ltd., a wholly-owned subsidiary of the appellant, as general partner, and Michael Huang and Bela Danczkay as limited partners ("the promoters”). In 1979, 350 additional units were issued to the public for $10,000 per unit payable $1,500 at closing and the balance of $8,500 byway of a promissory note payable in yearly instalments of $2,500, $2,500, $1,000, $1,000, $750 and $750, together with interest on the unpaid balance at the rate of 11 /2 per cent per annum calculated and payable yearly.

4. Silver Creek-Cedarwood was organized to acquire certain lands and to construct, own and operate apartment projects on such lands (the "projects"). By an agreement dated November 29, 1979 (the "transfer agreement") Silver Creek- Cedarwood acquired the projects in consideration for it assuming the liability of $1,700,500 owing by the vendor to the appellant.

5. By agreement dated November 29, 1979 (the"development agreement") among Silver Creek-Cedarwood, the appellant and the promoters,

(i) the appellant agreed to complete the projects for $9,522,976 and provide certain initial services essential to Silver Creek-Cedarwood as described in paragraph 6 below, and

(ii) the promoters and the appellant agreed to provide certain covenants and guarantees in connection with the projects.

6. Pursuant to the development agreement, the appellant agreed to provide to Silver Creek-Cedarwood initial services described in the table below for the consideration set out therein.

	Silver Creek Cedarwood		Total Total
CMHC mortgage insurance fee	$ 79,300	$ 66,536 $ 145,836
CMHC mortgage application fee	7,350	7,735	15,085
Interest during construction and lease-up	1,493,823	1,217,282	2,711,105
Mortgage guarantee fee	80,291	67,368	147,659
Mortgage brokerage fee	64,233	53,894	118,127
Legal fees relating to mortgage financing
and other documentation	25,000	25,000	50,000
Landscaping	100,000	50,000	150,000
Administration and leasing services	362,000	243,300	605,300
Cash flow guarantee	171,525	145,349	316,874
	$2,383,522	$1,876,464	$4,259,986

7. The total cost of the project and initial services to Silver Creek-Cedarwood was $14,920,000. In accordance with the development agreement, Silver Creek- Cedarwood issued to the appellant a promissory note in the amount of $3,107,300 (the "purchase money note”). The terms and conditions of the purchase money note provide for the principal to be paid over a period of six years, together with interest at the rate of 112 per cent per annum. In addition, the purchase money note includes a right of set-off in the event the appellant defaults on its obligations under the development agreement.

8. In 1980, the Stonehill partnership, a limited partnership, constituted under the laws of Alberta, was formed by 444222 Ontario Ltd., a wholly-owned subsidiary of the appellant, as general partner, and Michael Huang and Bela Danczkay as limited partners. In 1980, 450 additional units were issued to the public for $10,000 per unit, payable $2,500 at closing and the balance of $7,500 by way of promissory note payable in yearly instalments of $2,500, $1,500, $1,500, $1,000 and $1,000, together with interest on the unpaid balance on the rate of 12 per cent per annum calculated payable yearly.

9. The Stonehill partnership was organized to acquire, complete and operate two apartment projects in Scarborough, Ontario (the Stonehill project"). On June 30, 1980, Stonehill partnership acquired from the appellant land upon which the Stonehill project was to be constructed, and partially completed buildings for an agreed purchase price of $7,000,000.

10. By agreement dated June 30, 1980 (the “Stonehill development agreement") among the Stonehill partnership, the appellant and the promoters,

(i) the appellant agreed to complete the Stonehill project and provide certain

initial services essential to the Stonehill partnership for a fixed price, and

(ii) the promoters and the appellant agreed to provide certain covenants and guarantees in connection with the Stonehill project.

11. Pursuant to the Stonehill development agreement, the appellant agreed to provide to the Stonehill partnership initial services described in the table below for the consideration set out therein.

	100	Springdale
	Wingarden	Place	Total Total
CMHC mortgage insurance fee	$ 71,875 $ 48,125 $ 120,000
CMHC mortgage application fee	10,500	5,250	15,750
Interest during completion of
construction and lease-up	736,430	477,720	1,214,150
Mortgage guarantee fee	217,958	145,938	363,896
Legal fees relating to mortgage financing
and other required documentation with
respect to operations	12,000	8,000	20,000
Landscaping	90,000	60,000	150,000
Leasing services	300,000	150,000	450,000
Cashflow guarantee	448,260	293,880	742,140
Administrative services	90,000	60,000	150,000
Mortgage brokerage fee	48,000	32,000	80,000
	$2,025,023	$1,280,913	$3,305,936

12. The total cost of the Stonehill project and initial services to the Stonehill project was $17,264,000. In accordance with the Stonehill development agreement, the Stonehill partnership issued to the appellant a promissory note in the amount of $4,044,000 (the “ purchase money note”), and agreed to deliver to the appellant mortgages for the remainder of the cost. The terms and conditions of the purchase money note provide for the principal to be paid over a period of seven years, together with interest at the rate of 12 per cent per annum calculated and payable yearly. In addition, the purchase money note includes a right of set-off in the event the appellant defaults on its obligations under the Stonehill development agreement.

13. In 1981, the Burnhill partnership, a limited partnership, constituted under the laws of Ontario, was formed by Lachesis Developments Ltd., a wholly-owned subsidiary of the appellant, as general partner, and Michael Huang and Bela Danczkay as limited partners. In 1981, 400 additional units were issued to the public for $10,000 per unit, payable $1,250 at closing and the balance of $8,750 by way of promissory note, payable in yearly instalments of $2,200, $1,150, $1,150, $1,300, $1,450 and $1,500, together with interest at the rate specified by formula.

14. The Burnhill partnership was organized to acquire, construct and operate a 238 suite apartment project in Scarborough, Ontario (the "Burnhill project”). On October 21, 1981, Burnhill partnership acquired from the appellant beneficial title to the land upon which the Burnhill project was to be constructed for an agreed purchase price of $1,190,000.

15. By agreement dated October 21, 1981 (the"purchase and development agreement") among the Burnhill partnership, the appellant and the promoters,

(i) the appellant agreed to construct the Burnhill project and provide certain

initial services essential to the Burnhill partnership for a fixed price, and

(ii) the promoters and the appellant agreed to provide certain covenants and guarantees in connection with the Burnhill project.

16. Pursuant to the purchase and development agreement, the appellant agreed to provide to the Burnhill partnership initial services described in the table below for the consideration set out therein.

Total

project

CMHC mortgage insurance fee	$ 77,826
CMHC mortgage application fee	14,400
Interest during construction and lease-up	1,429,976
Mortgage guarantee fee	96,688
Realty taxes, insurance and other	119,000
Legal fees relating to mortgage financing	20,000
Landscaping	154,700
Leasing Services	261,800
Cash flow guarantee	450,924
Administrative services	238,000
Mortgage brokerage fee	63,070
Mortgage rate buydown fee	1,221,797
Purchase money note rate buydown fee	359,093
	$4,507,274

17. The total cost of the Burnhill project and initial services to the Burnhill partnership was $13,996,000. In accordance with the purchase and development agreement, the Burnhill partnership issued to the appellant a promissory note in the amount of $3,599,000 (the"purchase money note"). The terms and conditions of the purchase money note provide for the principal to be paid over a period of six years, together with interest at the rate specified by formula. In addition, the purchase money note includes a right of set-off in the event that the appellant defaults on its obligations under the purchase and development agreement.

18. As part of the purchase and development agreement, the appellant undertook to obtain condominium registration for the Burnhill project by January 1, 1984, failing which it agreed to reduce the purchase price by $1,589,000.

19. The appellant was unable to comply with certain municipal requirements for condominium registration and as a result the purchase price of the Burnhill project was reduced by $1,589,000, in accordance with the purchase and development agreement.

FROM THE ADMITTED PLEADINGS THE STEPS THE APPELLANT TOOK IN COMPUTING ITS DEDUCTIONS FROM INCOME FOR THE TAXATION YEARS IN QUESTION

20. In computing its net income for the 1980, 1981, 1982 and 1983 taxation years, the appellant deducted the uncollected portion of the Silver Creek-Cedarwood purchase money note and the Stonehill partnership purchase money note.

21. In computing its net income for the 1983 taxation year, the appellant deducted the uncollected portion of the Burnhill partnership purchase money note.

22. For each of the 1981, 1982, 1983 and 1985 taxation years, the appellant included in computing its income the amount deducted in computing its income for the immediately preceding year in respect of each of the purchase money notes.

REASSESSMENT

23. By notices of reassessment dated July 8, 1988, the Minister of National Revenue disallowed the appellant's deduction and included in income the full amount of each of the purchase money notes in the year each of the said notes was received, on the basis that section 3 and subsection 9(1) of the Act precluded the appellant claiming a deduction in respect of the uncollected portion of each of the said Notes.

CONFIRMATION

24. By notice of confirmation dated September 1, 1989, the Minister of National Revenue disallowed the appellant's notice of objections for the 1980, 1981, 1982, 1983 and 1985 taxation years and confirmed the reassessments as issued.

Although not pleaded, the appellant, as indicated, presented evidence at trial (without objection) regarding wrap-around mortgages. These mortgages were given by two of the limited partnerships [Stonehill and Burnhill] to the appellant. The appellant argued that these wrap-around mortgages should be given the same income treatment for tax purposes as the appellant gave to the purchase money notes.

Issue

Whether the full amount of the purchase money notes and wrap-around mortgages should be included in the computation of the appellant's income for the taxation years pursuant to section 9 and paragraph 12(1)(b) of the Act.

Legislation and jurisprudence

Subsection 9(1) of the Act reads as follows:

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.

In Dixie Lee (Maritimes) Ltd. v. The Queen, [1988] 1 C.T.C. 193, 88 D.T.C. 6108 (F.C.T.D.), McNair, J. stated at page 199 (D.T.C. 6112):

By subsection 9(1) of the Act, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.

Mr. Justice Cartwright alluded to the predecessor provision [section 4] in Dominion Taxicab Association v. M.N.R., [1954] C.T.C. 34, 54 D.T.C. 1020 (S.C.C.), stating at page 37 (D.T.C. 1021):

The expression profit” is not defined in the Act. It has not a technical meaning and whether or not the sum in question constitutes profit must be determined on ordinary commercial principles unless the provisions of the Income Tax Act require a departure from such principles . . . . It is well settled that in considering whether a particular transaction brings a party within the terms of the Income Tax Act its substance rather than its form is to be regarded.

Edwin C. Harris, Canadian Income Taxation, 4th edition, makes the following statement in reference to subsection 9(1) at page 430:

This rule has been interpreted to mean that the taxpayer must adopt the method for computing his annual income that most nearly accurately reflects his profit — which is essentially a question of following generally accepted accounting principles” except where the Act, or a limited number of court decisions that follow no clear principle, requires otherwise. Speaking in accounting terms, the rule requires that there be a reasonable “ matching” of revenues and related expenses in any fiscal period.

Generally speaking, an amount received by a taxpayer in a taxation year is taxable as income in his hands if his right to it is absolute and subject to no restriction as to its disposition, use or enjoyment, regardless of whether or not it is earned in that particular year: Robertson Ltd. v. M.N.R., [1944] C.T.C. 75, 2 D.T.C. 655.

Paragraph 12(1)(b) of the Act reads as follows:

12(1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:

(b) any amount receivable by the taxpayer in respect of property sold or services rendered in the course of a business in the year, notwithstanding that the amount or any part thereof is not due until a subsequent year, unless the method adopted by the taxpayer for . . . .

[Emphasis added.]

Pursuant to paragraph 12(1)(b) of the Act, unless the Minister accepts the cash method of accounting, income from rendering services must be reported on the accrual method of accounting. Thus, all amounts receivable for services rendered will normally be included in income in the year in which the services were performed. The due date is not determinative; however, it is essential that the service contracted for be completed so that the amount is legally characterized as receivable" before it is included as income under paragraph 12(1)(b) of the Act.

The appellant submits that the full amount of the purchase money notes and wrap-around mortgages were not receivable in any of the taxation years because the appellant had not completed the performance of the services contracted for. Therefore, in accordance with paragraph 12(1)(b), the appellant is not required to include the full amount of the purchase money notes in income in any of the taxation years.

From Ken Steeves Sales Ltd. v. M.N.R., [1955] C.T.C. 47, 55 D.T.C. 1044 (Ex. Ct.), it is clear that receivables are included in income under section 9 of the Act. [1]

The expression “due” must be distinguished from the expression "receivable". MacGuigan, J.A. of the Federal Court of Appeal in West Kootenay Power and Light Co. v. The Queen, [1992] 1 C.T.C. 15, 92 D.T.C. 6023 at page 25 (D.T.C. 6030) stated the following:

The language of paragraph 12(1)(b) itself makes a distinction between "receivable" and "due" so that an amount may be receivable even though not due until a subsequent year. As this Court said in The Queen v. Derbecker, [1984] C.T.C. 606, 84 D.T.C. 6549 per Hugessen, J.A. "the words 'due to him’ look only to the taxpayer’s entitlement to enforce payment and not to whether or not he has actually done so" (at page 607 (D.T.C. 6549)).

As to the meaning of the word receivable” reference is made to West Hill Redevelopment Co. v. The Queen, [1991] 2 C.T.C. 83, 91 D.T.C. 5430 (F.C.T.D.), where a taxpayer corporation which took back mortgages from purchasers of its condominium units at interest rates below the prevailing market rates was required to include in income the face value rather than the fair market value of such amounts secured by the mortgages as "receivables" pursuant to paragraph 12(1)(b).

In particular, Cullen, J. stated the following at page 88 (D.T.C. 5433):

Clearly, the mortgages are receivable” within the meaning of the subsection, as" receivable" has been interpreted to mean that a taxpayer has an unconditional legal, though not necessarily immediate, right to receive an amount in question: The Queen v. Imperial General Properties Ltd., [1985] 1 C.T.C. 40, 85 D.T.C. 5045 (F.C.A.) and M.N.R. v. Colford, [1960] C.T.C. 178, 60 D.T.C. 1131 (Ex. Ct.)

Thus, although an amount may not in fact be collected until some time in the future, that amount will be characterized as receivable" if there is at present an unconditional legal right to collect it. While the receivable may be included for financial statement purposes if there is not an unconditional right to collect, the receivable need not be included for taxation purposes. For the reasons given below, I have concluded that in the years under appeal, the appellant did not have an unconditional legal right to collect the amounts scheduled by the purchase money notes.

The following clauses and schedules from the development agreements, the " purchase money notes" and the “wrap-around mortgages" are relevant. [2]

Purchase money notes

The purchase money notes given by the limited partnerships to the appellant incorporate the respective development agreements as evidenced by the face of the purchase money notes which reads as follows:

This purchase money note is given pursuant and subject to the development agreement and the undersigned shall be entitled to set off against any instalment of principal or interest owing under this purchase money note such amount as Huang & Danczkay Ltd. may then owe to the undersigned.

The payment schedules set forth were yearly instalment payments over the term of the development agreements.

Pursuant to clause 2.00(e) of the development agreements the appellant undertakes to provide cash flow guarantees:

2.00 H&D [the appellant] covenants, warrants and represents with the Ltd. partnership . . . [that]

(e) H&D will as agent for the Ltd. partnership provide the initial services including without limitation the cash flow guarantee.

The development agreements further provide for cash flow guarantees (to cover operating expenses and including mortgage payments) as follows:

ARTICLE IX — CASH FLOW GUARANTEE

9.00. . . the parties agree that H&D shall indemnify the Ltd. partnership against all losses incurred in operating the projects and as additional consideration for so agreeing to indemnify the limited partnership H&D shall be entitled to receive from the limited partnership any operating profits from the projects during such period . . . .

The cash flow guarantees operated to the end of the development agreements. In one year, the evidence indicated the cash flow guarantee exceeded $750,000.

Wrap-around mortgages

Pursuant to clause 23 of the charge (mortgage) documentation, the wraparound mortgages were also subject to the development agreements:

23. This charge is given pursuant to the provisions of a purchase and development agreement. . . and the rights, obligations and liabilities of the mortgagor and the mortgagee hereunder shall be subject to the provisions of the purchase and development agreement. Thus, the mortgages were subject to the appellant fulfilling its obligations under the development agreements.

The payment schedules were also by way of yearly instalment payments over the term of the development agreements.

Pursuant to the mortgage documentation:

4. The mortgagee covenants and agrees to maintain the existing charges in good standing and to make all payments of principal and interest falling due thereunder ....

And pursuant to the development agreements:

2.00(1) H&D will pay off and discharge as and when the same fall due the NHA mortgages, the bank mortgage and the acquisition mortgage as provided for in the wrap-around mortgages and will indemnify and save harmless the limited partnership from all liability under the NHA mortgages, the Bank mortgage and the acquisition mortgage.

Thus, the development agreements and wrap-around mortgages provided for the appellant to pay off existing underlying mortgages.

In summary, as is evident from the development agreements, the appellant was obligated pursuant to the development agreements, inter alia, to provide the following services to the various limited partnerships:

— firstly, to construct and develop the projects into functioning MURBS and manage and initially lease the development properties, and;

— secondly, in relation to initial services honour the cash flow guarantees for the period of the development agreements and pay out as they fell due and then ultimately discharge the underlying institutional mortgages.

The appellant's obligation to perform the services extended over the period of development agreements and, in order for the purchase money notes to be receivable for a particular period as set forth in the payment schedule, the cash flow guarantee had to be satisfied. This was not a contingency, this was part of the agreement that required a specific performance after an accounting.

Furthermore, in order for the wrap-around mortgages to be receivable by the appellant, as set forth in the payment schedule, over the period of the development agreement, the latter must fulfil its ongoing obligations in respect of the underlying mortgages. This obligation was an integral part of the development agreement and related directly to its right to receive payments under the development mortgages.

Because of these continuing conditions precedent, I am of the opinion that the appellant did not have an immediate, absolute and unconditional right to sue for the uncollected portion of the purchase money notes and the wraparound mortgages in any of the particular taxation years. Accordingly, the uncollected portion of the purchase money notes and the wrap-around mortgages are not receivable” as contemplated by the Act and therefore, should not be included in income in any of the taxation years until these conditions precedent found within the development agreements relating to the purchase money notes and the wrap-around mortgages for each period in question have been complied with.

Decision

The appeals are allowed for the taxation years for the foregoing reasons and are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the full amount of the purchase money notes for all three projects and the wrap-around mortgages for the [Stonehill and Burnhill] projects are not receivable as contemplated by the Act until the conditions precedent, as set out in the development agreements, have been fulfilled. The appellant is not entitled to any other appeal relief. The appellant is entitled to its costs.

Appeal allowed.