The Canada Trust Company v. Minister of National Revenue, [1985] 1 CTC 2367

Tremblay, TCJ:—This appeal was heard on September 24, 1984 in the City of London, Ontario.

1. The Point at Issue

The point is whether the appellant trust company, successor to Lincoln Trust and Savings Company (Lincoln Trust) since amalgamation from December 31, 1976, is correct in contending that in the determination of the non-capital loss of Lincoln Trust for 1976, the respondent made an error in the classification of the office building located at 60 James Street, St Catharines, Ontario.

The respondent indeed disallowed the capital cost allowance of $79,336.58 claimed by Lincoln Trust. He based his decision on the fact that the said building was used “principally for the purpose of gaining or producing gross revenue that is rent” within the wording of subsection 1100(14) of the Income Tax Regulations. This is denied by the appellant trust company. The latter contends in- deed that it was used principally as a head-office building and that the rental income was a distinctly secondary part of the purpose of the said building and, therefore, the capital cost allowance must be computed pursuant to subsection 1100(1) of the Income Tax Regulations.

2. The Burden of Proof

2.01 The burden of proof is on the appellant to show that the respondent’s assessment is incorrect. This burden of proof results particularly from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

2.02 In the same judgment, the Court decided that the assumed facts on which the respondent based his assessment or reassessment are also deemed to be correct. In the present case, the assumed facts are described in the reply to notice of appeal as follows:

3. The respondent in computing the income of The Lincoln Trust and Savings Company for the 1976 taxation year, acted upon the following findings or assumptions of fact:

(a) the facts contained in Paragraphs 2, 4 and 5 of the Notice of Appeal (quoted below);

(b) the building was constructed for The Lincoln Trust and Savings company and was officially opened for occupancy on September 9, 1974;

(c) from September 9, 1974, The Lincoln Trust and Savings Company head office was located in the building;

(d) the total square footage of the building available for occupancy is approximately 55,000 square feet of which approximately 37,000 square feet was leased to outside tenants throughout the 1976 taxation year of The Lincoln Trust and Savings Company;

(e) the offices of The Lincoln Trust and Savings Company, at all material times occupied approximately 18,000 square feet of the building throughout the 1976 taxation year;

(f) many of the leases between The Lincoln Trust and Savings Company and outside tenants were of a five-year duration with renewal privileges.

3. The Facts

3.01 In substance most of the facts are not in dispute. The facts indeed are quite the same as those evidenced in the case The Canada Trust Co v MNR [1979] CTC 2199; 79 DTC 177 before the then Tax Review Board except concerning some facts: years involved 1973 and 1974 and proportionate square footage. The then sole witness, Mr Leo Sauvé, Senior Vice-President Pacific Region of Canada Trust Company, was also the sole witness in the case at bar. In substance he gave the same testimony and referred to the same exhibits as he has given and referred to in the former case for the years 1973 and 1974.

All the facts alleged by the appellant in the Statement of Allegations of Fact of the notice of appeal are admitted by the respondent. They read as follows:

STATEMENT OF ALLEGATIONS OF FACT

1. The Notice of Determination of a Loss referred to above was issued to The Lincoln Trust and Savings Company which, during the year 1976 carried on the business of a trust company in the Province of Ontario.

2. The said The Lincoln Trust and Savings company (hereinafter called the “Lincoln Trust”) was amalgamated with The Canada Trust company and continued under the name “The Canada Trust Company” with the approval of the Governor-General- inCouncil with effect from the 31st day of December, 1976.

3. The appellant, the successor to Lincoln Trust, duly and timely filed a Notice of Objection dated the 22nd day of April, 1981 to the said Notice of Determination of a Loss dated the 24th day of February, 1981 and the Minister confirmed the Determination of Notification dated the 29th day of April, 1981.

4. The sole point in issue in the present appeal in the determination of loss is the classification of the office building owned by the appellant at 60 James Street, St Catharines, Ontario. The said premises are hereinafter called the “said building’’.

5. The said building was officially opened for occupancy on September 9, 1974 and during 1976 contained the head office and St Catharines branch of Lincoln Trust.

6. Lincoln Trust, in computing its income for its October 31, 1976 taxation year, sought to deduct the sum of $79,336.58 as capital cost allowance on the said building pursuant to paragraph 20(1 )(a) of the Income Tax Act (Canada).

7. The respondent, in computing the income of Lincoln Trust for its taxation year ended October 31, 1976, did not allow Lincoln Trust to deduct the sum of $79,336.58 and this disallowance led to the Determination of Loss which forms the subject matter of the present appeal.

3.02 Mr Sauvé in his testimony testified that:

(a) The Lincoln Trust House (five storey building) was constructed by Lincoln Trust for the purpose of its head office and main branch during the 1973 and 1974 taxation years. At the time of incorporation, the head office of Lincoln Trust was established at Niagara Falls, Ontario and this was changed to St Catharines by a by-law approved by the shareholders of Lincoln Trust in March of 1974. (Exhibit A-l: Photograph No 1)

(b) The said building was constructed for future expansion with a view to all of the said building being used by Lincoln Trust for the purpose of its head office. As evidence of this there was constructed an extra vault in the basement of the said building (Exhibit A-1: Photograph No 2) The said building was decorated in a manner appropriate to the head office of a financial institution (Exhibit A-1: Photograph No 3) and leases that were written with respect to those areas of the said building not occupied by Lincoln Trust were either written on a five-year term basis or provided for the termination at the end of five years.

(c) Mr Sauvé said that 10 or 20 years is not a long time in this industry. Lincoln Trust had to build for expansion. At the time of the approval of the construction drawings for the said building and until almost the end of its 1976 taxation year, Lincoln Trust expected that its rapid growth would soon require it to occupy all of the said building for the purposes of its own head office and St Catharines branch premises. (Exhibit R-2)

(d) The gross rental income from third parties that rented space in the said building was less than $125,000 during the 1975 taxation year of Lincoln Trust. The gross rental revenue during the year the said building was first fully occupied, the 12 months ended October 31, 1976, did not exceed $217,406. This gross rental amount is clearly insignificant when compared with the gross income of approximately $18,427,893 from the trust operations of Lincoln Trust during its 1976 taxation year. (Exhibit A-2: ten year financial results 1966-1975 of the appellant) (Exhibit A-5: gross income of Lincoln Trust in 1976)

(e) A document was filed (Exhibit A-3) showing the leased space and the square footage of each tenant of the building in 1976. The whole square footage is 62,283 including 7,600 square feet of parking space.

(f) Another document was filed (Exhibit A-4) showing the occupants of the building by category.

Mr Sauvé explained that the arm’s length professional and financial tenants were compatible with Lincoln Trust. Crawford, Smith and Swallow firm was Lincoln auditors. The insurance companies had deposits with Lincoln Trust. Their customers needed to buy various things from Lincoln Trust. They bought guaranteed investment certificates and income averaging annuity contracts.

(g) As a form of investment, the said building clearly showed a rate of return (10 per cent) which was most unfavourable when compared with other forms of investment of Lincoln Trust (mortgage portfolio: 14 per cent). The existence of the said building cannot be justified as an investment in rental property but only as an investment in property which was used to earn income from trust company operations.

3.03 With a view to demonstrating to the shareholders and customers, that Lincoln Trust intended to be there for a long time, a fund was created to be used in the year 2000 for the needs of the community of the Niagara-St Catharines Peninsula.

We started a fund which resulted in our depositing $1,000 a year into a trust starting with 1975. We would deposit $1,000 every year until the year 2000, so it was a 25-year plan. That money would earn interest at our savings account rate, so by the year 2000 it would have the $25,000 deposited plus the accumulated interest. We would then — we had announced to the public that in the year 2000 we would form an advisory board in the Peninsula to deal with the disposition of those funds, so this was a way of indicating to the public that we intended to be there for a long time, that we were interested in the community and in fact were contributing this sum to be dealt with by citizens of the community. The citizens would be selected initially by us and then they in turn would select others, so that our board of directors would play a very small part in the distribution of those funds.

We had started to show the growth of that fund by having a graph in each of our offices so that the public could see how much money was accumulating ultimately for their benefit, so that was one of the community projects. TS p 30

3.04 Mr Sauvé said that the prestige of Lincoln Trust increased because of the prestige of the Lincoln Trust House.

The site that was available in St Catharines was an expensive site. It would have not made sense to build a small building on an expensive site. Now it is a prestigious site. It is the prestigious building they needed in the heart of the Niagara Peninsula.

For the 12 months ending October 31, 1974, the income from all sources of Lincoln Trust was $10,697,581. The next year in 1975, the income rose to $15,357,757. The head office being in a prestigious building was an important favourable factor of the increase.

3.05 Lincoln Trust used the ground floor and the top floor, the two most expensive floors to rent.

4. Law — Cases at Law — Analysis

4.01 Law

The relevant sections of the Income Tax Act and regulations read as follows:

18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

20. (1) Notwithstanding paragraphs 18(l)(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(a) such part of the capital cost to the taxpayer of property, or such amount in respect of the capital cost to the taxpayer of property, if any, as is allowed by regulation;

1100. (11) Notwithstanding subsection (1), in no case shall the aggregate of deductions, each of which is a deduction in respect of property of a prescribed class owned by a taxpayer that includes rental property owned by him, otherwise allowed to the taxpayer by virtue of subsection (1) in computing his income for a taxation year, exceed the amount, if any, by which,

(a) the aggregate of amounts each which ts

(i) his income for the year from renting or leasing a rental property owned by

him, computed without regard to paragraph 20(1 )(a) of the Act, or

(ii) the income of a partnership for the year from renting or leasing a rental property of the partnership, to the extent of the taxpayer’s share of such income

exceeds

(b) the aggregate of amounts each of which is

(i) his loss for the year from renting or leasing a rental property owned by him, computed without regard to paragraph 20(1 )(a) of the Act, or

(ii) the loss of a partnership for the year from renting or leasing a rental property

of the partnership, to the extent of the taxpayer’s share of such loss.

(12) Subject to subsection (13), subsection (11) does not apply in respect of a taxation year of a taxpayer that was, throughout the year,

(a) a life insurance corporation, or a corporation whose principal business was the leasing, rental, development or sale, or any combination thereof, of real property owned by it; or

(b) a partnership each member of which was a corporation described in paragraph (a).

(14) For the purposes of this section and section 1101, “rental property’’ of a taxpayer of a partnership means

(a) a building owned by the taxpayer or partnership, whether jointly with another person or otherwise,

if, in the taxation year in respect of which the expression is being applied, the property was used by the taxpayer or the partnership principally for the purpose of gaining or producing gross revenue that is rent, but, for greater certainty, does not include a property leased by the taxpayer or the partnership to a lessee, in the ordinary course of the taxpayer’s or partnership’s business of selling goods or rendering services, under an agreement by which the lessee undertakes to use the property to carry on the business of selling or promoting the sale of, the taxpayer’s or partnership’s goods or services.

4.02 Cases at Law

Cases at law and doctrine referred to the Court by the parties:

1. John M Turner v MNR, [1975] CTC 2198; 75 DTC 190 (TRB);

2. The Canada Trust Company v MNR, [1979]CTC 2199; 79 DTC 177 (TRB);

3. Combined Appraisers and Consultants Company Limited v MNR, [1975] CTC 2970; 79 DTC 770 (TRB);

4. Hady Construction (1971) Ltd v MNR, [1980] CTC 2135; 80 DTC 1101 (TRB);

5. Dr Wylie F Verge v MNR, [1981] CTC 2375; 81 DTC 330 (TRB);

6. Combined Appraisers and Consultants Ltd v MNR, [1983] CTC 2606; 83 DTC 543 (TCC);

7. Morris Strug v MNR, [1980] CTC 2463; 80 DTC 1426 (TRB) (quoting Partington v Attorney-General (1869), LR 4 HL 100 at 122);

8. Lyle A Meredith v The Queen, [1975] CTC 570; 75 DTC 5412;

9. Trans-Prairie Pipelines Ltd v MNR, [1970] CTC 537; 70 DTC 6351;

10. The Queen v Marsh & McLennan Limited, [1983]CTC 231; 83 DTC 5180;

11. Interpretation Bulletin No IT-367R2 dated September 7, 1981

Interpretation Bulletin No IT-195R3 dated April 27, 1981

Interpretation Bulletin No IT-371 dated April 25, 1977;

12. The Shorter Oxford Dictionary, 1973 Edition, Volume 2 at page 1672;

13. Canadian Tax Journal, Vol. 27, May-June, 1979, p 341.

4.03 Analysis

4.03.1 The legal issue

From the provisions of the Income Tax Regulations, quoted above (par 4.01), it appears that section 1100, subsection (11) limits capital cost allowance for rental properties notwithstanding subsection (1). The latter provides the maximum rate of capital cost allowance of the different classes of properties from Class I to Class XXIII.

Subsection (12) of section 1100 indicates that the limitation does not apply to ‘‘a life insurance corporation or a corporation whose principal business was the leasing, rental, development or sale or any combination thereof of real property owned by it.”

Subsection (14) of section 1100 defines what a rental property is:

. . . “rental property” of a taxpayer or a partnership means

(a) a building . . . owned by the taxpayer or partnership . . .

if, in the taxation year in respect of which the expression is being applied, the property was used by the taxpayer . . . principally for the purpose of gaining or producing gross revenue that is rent, but . . .

Therefore the limitation exists for the appellant only if in 1976, the building was used principally for the purpose of producing revenue that is rent.

In sum, the legislator envisages three situations concerning rental property:

(1) The property is owned by a taxpayer whose principal business is not the renting of property and the property involved is not a rental property in the sense of 1100(14). In such a case there is no limitation. Subsection 1100(1) applies.

(2) The property is owned by a taxpayer whose principal business is the renting of property (or a life insurance company). In that case there is no limitation. Regulation 1100(12)(a).

(3) The property is owned by a taxpayer whose principal business is not the renting of property but the property involved is a rental property in the sense of 1100(14). This is the only time when there is a limitation. It is provision 1100(11) of the Regulation.

The respondent contends that the third situation applies and thence that the limitation exists for the capital cost allowance.

The appellant’s contention is that the first situation applies and thence there is no limitation.

4.03.2 Appellant's Contention

Based on the testimony of Mr Leo Sauvé and on Exhibits A-l to A-5 and R-2 (par 3.02, 3.03, 3.04, 3.05) the appellant contends that the building was not a form of investment but rather was built principally to serve the expanding needs of Lincoln Trust. Therefore there is no limitation to the capital cost allowance.

According to the appellant, the evidence adduced in the instant case concerning the year 1976 is in substance the same as the one given before the Tax Review Board concerning the years 1973 and 1974. And Mr Taylor, member of the then Tax Review Board allowed the appeal.

The summary of the decision described by DTC reads as follows:

The taxpayer’s appeal was allowed. The Board noted that the important point was whether or not the building was used for the purpose of producing rent regardless of whether it did produce rent and with only limited importance put on the financial and physical dimensions involved. While the Board found that provision of a new head office was not dominant in the decision-making which led to construction of the building (there being additional concerns regarding accommodation of a branch office and return on the money expended), it concluded that the principal purpose of the building was to serve the company’s business rather than its investment needs. The building was used principally for company business and not to gain rental income. Accordingly, the taxpayer’s appeal was allowed.

4.03.3 Concerning Mr Taylor’s decision, the fundamental reasons for allowing the appeal were that concerning 1973 taxation year, the building was not yet completed and concerning 1974 taxation year, the main user was Lincoln Trust. Therefore it was correct to conclude that in the years involved, the building was not used by the taxpayer principally for the purpose of producing revenue that was rent.

4.03.4 In a case of this nature, the intention of Lincoln Trust in making the investment (the question of building as head office site, par 3.02(b)(c)) is not so important. It is not a trading case where the point is whether the profit made on the sale of the building is a capital gain or a business income. The motivation at the time of the construction is then fundamental.

In the case at bar, the crux of the matter is the capital cost allowance to be applied on the building which is a physical item. The appellant’s argument for the insignificance of the $217,406 of rent income in 1976 compared with the $18,427,893 of gross investment income of the principal business of Lincoln Trust (par 3.02(d)) does not impress me. As stressed by counsel for the respond ent, there is a substantial difference between the principal business of Lincoln Trust and the phrasing of the Regulation.

the property was used by the taxpayer principally for the purpose of producing gross revenue that is rent.

The subject of the sentence is “the property” ie the building, once again a physical item. The main concern of the legislator relates to capital cost allowance of rental property.

4.03.5 There is no dispute that the principal business of Lincoln Trust was trust operations and not the renting of property. In many decisions to which it was referred to by the appellant, (John Turner, Combined Appraisers & Consultants Company Ltd, Hady Construction (1971) Ltd, par 4.02) the point at issue was the principal business, which is not the point in this case. Indeed the second situation envisaged by the legislator and described (above 4.03.1) is not at issue.

The point at issue is the construction of 1100(14) concerning the actual use of the building involved in the taxation year 1976, and not the intention or motivation of Lincoln Trust in building it even if the thrust of Mr Sauvé’s testimony was that the said building was built as a “flagship building”, a “prestige building” to attract business, as counsel for the appellant submitted.

In the subsection 14, the adverb “principally” modifies the word “used”. Pursuant to Exhibit A-3, 35.1 per cent of the Lincoln Trust House was used by Lincoln Trust and 64.9 per cent by other tenants. I do not accept however that the occupancy of the building by the “arm’s length professional and financial industry tenants” (insurance company, solicitors, etc) as shown in Exhibit A-4 (par 3.02(f)) be taken into account in the computation of the percentage of the occupancy by Lincoln Trust in 1976. The fact that these tenants be compatible with Lincoln Trust and that they were its customers prove that they were probably the best tenants but not more. Based on percentage of occupancy, I would dismiss the appeal.

I share the opinion of Mr Taylor that the square footage of occupancy is not the only criterion. However, it is a good one. In this respect, I quote hereinafter the comments made in the Canadian Tax Journal (May/June 1979, pg 343) commenting on the Canada Trust Co v MNR decision given by Mr Taylor.

Read literally, this suggests that one looks to the use or function of the building in the year in which the issue is raised. One is directed to look at “principal use or function” rather than “principal business”. Proceeding from this one might infer that “principal use” means primary use. In this regard, a very significant although perhaps not totally determinative factor would be the relative percentage of space used for business purposes compared to that used for rental purposes. An exact square footage calculation is probably not appropriate, having in mind that certain space in an office building may be more valuable in a commercial sense than another space. For example, for a bank or trust company the ground or street floor would be more valuable for the branch operations than the upper floors. So perhaps a more acceptable test would be to look at the relative economic values of the space occupied for business purposes and that used for rental purposes.

The Court agrees with this economic test to compute the principal use. The Court does not ignore that Lincoln Trust used the ground floor and the top floor of the Lincoln Trust House, the two most expensive floors to rent. (par 3.05) However no figures representing the respective value of these two floors were given in evidence. The appellant had the burden of proof. Despite the fact that the Court has the feeling that with such test, the principal use would perhaps be in favour of the appellant, however, because of the lack of evidence, the appeal must be dismissed.

4.03.6 The Court does not retain the argument of Counsel for the appellant concerning the fact that sections 160(1), 161 and 162 (Exhibit A-6) of the Ontario Loan and Trust Corporations Act RSO 1970, (c 254) forced Lincoln Trust to apply for an Order-in-Council to get permission to build the said building because it was a large one. The Company needed it for its own purposes. The legal dispositions limited the amount they could use for investment purposes. The aforesaid Act in indicating that if a trust company ts going to build a pure rental property, it cannot exceed so much of a dollar value but it can use part of its own premises to lease out. The Court does not see how such an Act would prevent this particular property from being considered a rental property, pursuant to the Income Tax Act.

5. Conclusion

The appeal is dismissed in accordance with the above reasons for judgment.

Appeal dismissed.