Francis J. Ryan v. Minister of National Revenue, [1986] 1 CTC 2142, 86 DTC 1108

Brulé, T.C.J.:—

Issue

This is an appeal along with 16 others involving two pieces of property that were classified as MULTIPLE UNIT RESIDENTIAL BUILDINGS, known as Rockland Village, for the 1980 taxation year, and Grenfell Court, for the 1979 taxation year. By agreement all appeals were heard on common evidence with differences being ascribed where necessary, but not in principle.

Facts

In 1980 this appellant acquired, from Rockland Developments, being a partnership of Frank Foley Limited and Eastland Holdings Limited, a five per cent interest in the 108-unit residential apartment complex in St. John’s, Newfoundland, known as “Rockland Village,” which qualified as a multipleunit residential building.

In his tax return for 1980 the appellant claimed his proportion of the "soft costs" that had been incurred on behalf of the investors in the Project in 1980, as reported to him by the syndicate, as well as his proportion of capital cost allowance based upon the capital costs properly applicable to the depreciable assets of the Project.

By notice of reassessment dated July 9, 1982, the respondent reassessed the appellant for 1980 by disallowing the deduction of his share of certain of the "soft costs" claimed with respect to the Project, but by permitting additional capital cost allowance on the basis that some of the disallowed "soft costs" represented additional capital costs of the building. The claims for "soft costs" so added to the cost of the building included building permits, landscaping, "overhead" and "commissions" totalling $435,009.95; legal fees disallowed totalling $6,855.40 were added to the cost of land; and mortgage buy-down and financial services totalling $103,023 were to be amortized over future years but not including 1980.

The appellant duly filed a notice of objection to the disallowance as a deduction in 1980 of certain of the "soft costs" claimed by him.

By notice of reassessment dated June 23, 1983, the respondent confirmed the previous disallowance of the "soft costs" and further disallowed the appellant’s share of $224,115.63 of "soft costs” on the ground that the appellant only became an owner on December 4, 1980, when the acquisition of his interest in the Project was closed and he could only deduct his share of "soft costs" incurred after that date. The appellant signed a firm undertaking to invest on October 30, 1980, and made a down payment at that time. Most of the additional costs were added to the cost of the building, but certain interest and landscaping costs were added to the cost of the land. Additional capital cost allowance was granted accordingly.

The results of this latter reassessment indicated the Minister's position as follows:

Issues

Two matters must be determined in respect of the deductibility of the amounts claimed.

1. When did the appellant become entitled to have costs deducted on his behalf? There are three pertinent times involved. Firstly, when the partnership was formed was a trust created for future participants thus giving them the rights to have deductions from the outset after they were ascertained? Secondly, could these be deducted at the time each individual signed a letter of intent to commit himself to becoming a participant and therefore an owner? Thirdly, was ownership in the Project only achieved by each participant when the actual deed of ownership was completed on December 4, 19802

2. Which items properly qualified as “soft costs/' and therefore deductible, and which should be considered as capital items? With respect to these costs: (a) were they reasonable? and (b) when do these "soft costs" become deductible?

Analysis

As to the first question of when the appellant became an owner in the Project his counsel argued that a trust was created at the time the promoter, a Mr. Robinson, entered into an agreement with the builder and owner of the property. After that time all proper "soft costs" should be the subject of a tax deduction by the unit holders in the proper time period.

For a trust to be created there is no need for any technical words or expressions. It must be established that the person involved had an intention to create a trust, that the subject matter of the trust be in existence and identifiable and that the objects of the trusts or beneficiaries may be ascertainable. To be ascertainable these objects must be capable of being determined by name or by class, and if by class the totality of the membership of the class must be known. For land to be the subject of a trust the Statute of Frauds of 1677, reproduced in common law in Canada, requires all such trusts to be evidenced in writing. In the case of Grenfell Court, Mr. Robinson did acquire the land in trust as set out in Exhibit A-5 tendered to the Court, but that document shows in the second recital that the land was acquired on behalf of a corporation to be formed and not for individuals in an ascertainable class. Presumably this was the modus operand! in both cases and there is no way that it can be conceived that Robinson on acquiring the property, did so in trust on behalf of individuals who later would become unit holders.

When did the unit holders then become owners? A prerequisite to the taxpayer's claim for deducting certain costs is that he must have ownership in the property. There is no doubt that the appellant had his interest as of December 4, 1980, when the project was formalized, but did he acquire an interest as of October 30, 1980, when he signed a letter committing himself to purchase an interest and providing a deposit? Was this letter merely a right to acquire the property in the future, or did the committal impose obligations at that time including the risks in the property although no actual title passed?

The basic rule is that property passes and is therefore acquired by the purchaser at the time when the parties intend it to pass as evidenced by any contract, the conduct of the parties or other circumstances. Here the property is land and the transaction must be examined in view of the Statute of Frauds mentioned above and also in relation to the law of vendor and purchaser. The purpose of the Statute of Frauds in requiring an agreement to be in writing is that it might be enforceable, for if either party does not commit in writing the agreement is not enforceable against that party. Such was the case here as to a written agreement in that presumably the offer was Oral, but there was an acceptance by the signing of the letter of committal and the deposit payment. The transaction was completed and the date to be determined for this appellant is either October 30, 1980, or December 4, 1980.

R. E. Megarry and H. W. R. Wade in their text The Law of Real Property — Fourth Edition set out at page 542:

A Contract to sell or make any other disposition of land is made in the same Way as any other contract. As soon as there is an agreement for valuable consideration between the parties on definite terms, there is a contract; and this is so whether the agreement was made orally or in writing.

But although a valid contract relating to land may be made orally, it will be unenforceable by the most important method of enforcing contracts, namely, by action, unless either the statutory requirements as to written evidence of the contract, or the requirements of equity as to part performance, have been satisfied. These requirements put contracts for dispositions of land into a special category by themselves. Another distinguishing rule, peculiar to such contracts, is the rule that a purchaser, even before conveyance, acquires an immediate equitable interest in the property.

As to when property is “acquired” within the meaning of the Income Tax Act there is no definition found in the Act, but it undoubtedly has broader implications than having “legal title.” It would seem to extend to a taxpayer's interest under an executory contract wherein the taxpayer has an interest that gives him the right to obtain “legal title.”

Di Castri in his text Law of Vendor and Purchaser — Second Edition says at page 115:

A contract is the result of the manifested mutual assent of two parties to certain terms, generally speaking, springing from an offer and the acceptance thereof; . . . The question is always one of intention depending upon the language used and the circumstances of the particular case.

In the present appeal there was obviously an oral offer made to the appellant communicated in such a manner, or perhaps by advertising material, neither of which was mentioned in evidence, and then there was a written committal (acceptance) to buy contained in the letter of committal. This would seem to be sufficient to allow the Court to arrive at the conclusion that the appellant then had an interest as of October 30, 1980, but on examining the actual documentation entered into by the appellant as evidenced with another appellant in Exhibit A-9, one arrives at a different conclusion.

In this joint venture agreement dated December 3, 1980, there is a recital on page 2 as follows:

WHEREAS Rockland is the registered owner of certain lands and premises situate at St. John's, in the Province of Newfoundland . . .

This refers to the property subject to the MURB project. Rockland Developments (Rockland), as set out, was a partnership of the promoter's company, Eastland Holdings Limited, and the construction company, Frank Foley Limited.

Further in the agreement Exhibit A-9 at page 12, Rockland warrants: ‘‘(a) That it is the sole beneficial owner of the project.”

This agreement was entered into with each investor and as a result each thereby acknowledged that as of December 3, 1980, he had no actual interest in the property as an owner, and it would seem to place his letter of committal only as such and that he did not acquire an interest until the joint venture agreement was signed. There is no mention of holding the property upon trust.

The appellant did not have any prior interest in the Rockland Village Development. In the circumstances then, I find that the appellant had an interest in the property as of December 4, 1980. The same situation would apply for all appellants in both Rockland Village and Grenfell Court. The date of the joint venture agreement in each case is the date upon which each obtained an interest in the property for tax purposes.

The other major issue in this appeal involves which items qualify as “soft costs”, what are reasonable amounts which can be deducted for these, and when are they deductible.

As set out above the Minister disallowed the majority of the amounts claimed by all the unit holders in the projects and there resulted these appeals.

According to the evidence the amounts claimed were reasonable and I make no further comment on this.

In order to determine the availability of a “soft cost” deduction it is necessary to examine the contractual arrangement between the developer and the investor. In this case there is no question that the developer, Mr. Robinson, through Eastland Holdings Limited entered into a partnership agreement with the construction company to be known as “Rockland Developments”. In that agreement submitted to the Court as Exhibit A-2, it is clearly set out that the purpose was to develop a MURB Project.

“Soft costs” are those which include certain outlays or expenses made or incurred during a period of construction and are permitted under proper circumstances to be deducted on a current basis. The outlays or expenses which are not deductible are added to the capital cost of the land or building to which they relate, as the case may be. The Income Tax Act contemplates an investor having property to obtain benefits by claiming “soft costs” in a proper case.

G. D. F. Skerrett's paper in The Canadian Tax Foundation Corporate Management Tax Conference of 1977 dealing with “Tax Sheltering and Syndication of Multiple-Unit Residential Buildings” sets out at page 143 under the heading “First Time Costs or "Soft Costs' ”:

In getting a MURB Project off the ground, there are numerous outlays and expenses to be made in addition to the basic cost of acquisition of the land and the cost of acquisition or construction of the building and other tangible property. These amounts can be quite substantial and their deductibility to the investor in the first year of his investment will add to the tax sheltering inducement.

Further Mr. Skerrett points out at page 147:

Where an investor makes his investment after a portion of the first-time costs has already been expended, he may not be entitled to deduct his share of such portion from income but may be required to add it to his capital cost.

He then provides by way of a footnote to this statement the following:

At least where the investor acquires an undivided interest in the project. A partnership or limited partnership may permit an investor to share in all such costs over the fiscal period of the partnership ending after the investor becomes a partner.

In the present appeals there were no partnership arrangements, rather, each of the participants acquired an undivided interest in his respective project.

As a result of the determination in the case of this appellant (and the others accordingly) that he became an investor on December 4, 1980, it follows that he is only entitled to deduct "soft costs” after that date, depending on when such "soft costs” were provided and paid for.

Counsel for the appellants argued that the "soft costs” which were being incurred during the building of the projects were, for the account of the investors, to be formalized by the joint agreement when the investors were to be responsible for payment. If paid before that time they were paid on behalf of the investors by the construction company.

Counsel referred the Court to an article in the Canadian Tax Papers No. 71 by B. J. Arnold on the subject of “Timing of Deductions for Tax Purposes”. At page 224 he says:

It is well established for income tax purposes that a cost or expense is incurred only when the taxpayer has a clearly legal, though not necessarily immediate, obligation to pay an amount.

It was submitted that the costs were incurred when the investors were presented with invoices and paid as agreed to in the joint venture agreement.

In the alternative it was suggested that the promoter incurred these expenses on behalf of a group to be identified later and to be paid by them after they formally became investors.

It does not seem logical to say the costs were being incurred on behalf of ultimate investors. These people were not known at the time many of the costs were ordered. One could ask: “What could happen if it turned out that no investors were found?” The Rockland Development partnership would have to pay the cost.

By agreement in the Rockland Village Project, wherein an investor became liable, dated December 3, 1980, and submitted to the Court as Exhibit A-9, the associate (investor) agreed to purchase a share of the beneficial ownership of the Project including "development expenses of $790,000”. This would seem to indicate that the "soft costs” were already paid for and that the associate was merely reimbursing the developing partnership for expenses already paid.

The associate must be developing the property to qualify for "soft costs”, not merely agreeing to pay for these after he obtains an interest in the Project. Before the joint venture agreement is signed he has no obligation vis-a-vis the "soft costs”.

Grenfell Court

The Project known as Grenfell Court had as a formal date of its joint venture agreement the 11th day of December, 1979. All "soft costs” were marked paid as of December 7 of that year and consequently none were liable for payment by the associates or investors in the Project at the time they purchased an equitable interest. They merely undertook to buy, and part of the purchase price was the reimbursement for the "soft costs” already paid. As a result, these costs formed a part of the capital cost of each investor.

In addition to these costs, there had been charged to the investors a lease-back insurance fee of $160,000. The Minister set out that such provided a benefit to each investor for a period of five years and claimed that the total deduction of this in 1979 would unduly distort the net profit from Grenfell Court in that and subsequent years.

In so far as the Income Tax Act was concerned as at December 11, 1979, the date of the joint agreement, there seemed to be a basic distinction between expenses related to specific items of revenue and expenses that were not so closely related. Two treatments were possible:

1. if the amount could not be closely related to future items of revenue, the deduction was to be made in the year it was incurred regardless of the accounting treatment;

2. the deduction could be accrued if it was an expense that would provide future benefits.

[it is interesting to know that after December 11, 1979, the date of this joint venture agreement, subsection 18(9) of the Income Tax Act was added to provide for a mandatory deferral in a situation such as this.]

The principle of matching expenses with revenues has been dealt with by various writers and also by the courts. A review of this situation was provided by Thurlow, A.C.J. in the Federal Court case of Oxford Shopping Centres Ltd. v. The Queen, [1980] C.T.C. 7; 79 D.T.C. 5458 (later upheld in the Federal Court of Appeal).

The learned judge, after reviewing earlier cases, said at 18 (D.T.C. 5466):

I think it follows from this that for income tax purposes, while the “matching principle” will apply to expenses related to particular items of income . . . it does not apply to the running expense of the business as a whole . . .

In the present case it is easily ascertainable that the lease back insurance fee is related to the five-year period it covers, it is also noted that this is not the expense of a business in relation to its income but rather income from property. I believe that the Minister was correct in his treatment of this $160,000 amount.

Rockland Village

Mr. Robinson, the promoter, mentioned in evidence dealing with Rockland Village that all the services related to in the schedule attached to Exhibit A-9 totalling some $790,000 and representing so-called “soft costs” were provided prior to December 3, 1980, with the possible exception of some of the overhead expenses, accounting fees, legal fees and commissions.

With reference to these latter items the overhead expenses, the accounting and legal fees were set out in the joint venture agreement and specific amounts included for legal fees and overhead expense. The accounting fees were mentioned in the agreement in Schedule “Z” attached thereto and formed part of the agreed price for development expenses of $790,000. They were not mentioned in Schedule "A” which totalled $790,000 so presumably they are included in some other category. In any event there is no special cost to the investors as they were obligated to pay only the total of $790,000.

As a result, it is concluded that these amounts are not part of deductible costs, but form a part of the cost of acquisition acquired by the investors on December 4, 1980.

The commissions in the amount of $175,000 were set out in the closing and claimed as a “soft cost”. For the same reason as the other items are rejected this amount paid by the investors must be considered as part of the cost of acquisition and is thus required to be capitalized.

As to the landscaping charges the Minister alleged that $80,539 of the total was for excavation and should not be a part of landscaping. In view of the landscaping not being allowed as a "soft cost”, it is not necessary to deal with this, the total being part of acquisition costs.

The financial services fee of $70,000 was originally undertaken to set up a line of credit by Eastland Properties, a division of the promoter's company, to ensure adequate funds for the Project for a period up to seven years during which it undertook to manage the property. It was not an expense incurred by the investors nor does it relate to any specific revenue, but rather the possibility of the lack of revenue. The “matching principle” does not apply and can be considered as an expense when incurred. Inasmuch as that time was before the date of the joint venture agreement and all investors undertook to pay the amount, it is considered as a cost of acquisition.

The final two items in contention are those of the mortgage insurance and mortgage interest. These items properly relate to certain fixed time periods and accordingly are not eligible as expenses in the year claimed. The Minister has treated these correctly in allowing the amounts shown in the reply to the notice of appeal.

Conclusion

The disposition of these appeals is as follows:

In the case of Grenfell Court investors, it is determined:

1. that each acquired an interest in the property as of the 11th day of December, 1979, and the claim for expenses in that year in the total amount of $437,000 is disallowed and this amount is to form part of the capital cost of the investors in the project; and

2. the lease-back insurance fee of $160,000 must be claimed over a period of five years, and only the sum of $32,000 is allowed to the investors in 1979.

In the case of Rockland Village, it is determined that each investor acquired an interest in the property as of the 4th day of December, 1980, and the claim for expenses in that year in the total amount of $790,000 with the exception of $14,187.52 for mortgage interest and $6,808.50 for mortgage insurance is disallowed and the amount remaining of $769,003.98 is to form part of the capital cost of the investors in the Project.

The end result is that these appeals are dismissed.

Appeals dismissed.