Truscan Realty Limited v. Her Majesty the Queen, [1996] 3 CTC 2301, 96 DTC 1513

Bowman J.T.C.C.: — This appeal is from an assessment for the appellant’s 1987 taxation year. The issue is whether a loss sustained by the appellant of $206,221, together with related legal fees of $2,111, on a loan it made to a prospective tenant that was to be used to construct tenant improvements and purchase equipment constitutes a loss (or, in the case of the legal fees, an outlay) on revenue or capital account.

The basic facts were agreed to and are set out in an agreed statement of facts which was filed at the opening of trial. It reads as follows:

AGREED STATEMENT OF FACTS

RE: TRUSCAN REALTY LIMITED v. HER MAJESTY THE QUEEN

1. The Appellant was incorporated by Letters Patent under the Canada Corporations Act on May 29, 1972 and continued under the Canada Business Corporations Act on October 3, 1980, has its registered and Head Office at 380 Wellington Street, London, Ontario, N6A 4S4 and has offices in several locations in Canada.

2. The Appellant is a wholly-owned subsidiary of Canada Trustco Mortgage Company (“Canada Trustco”) and a member of the Canada Trust group of companies.

3. The principal business of the Appellant is the acquisition, development, ownerships, leasing and management of real estate, both for investment purposes and for occupancy by members of the Canada Trust group of companies.

4. The properties held by the Appellant are located in all provinces of Canada and include suburban retail shopping plazas, office buildings, shopping centres, mixed-use office and retail buildings and commercial development land.

5. At all material times, the Appellant was the owner of a strip mall type retail shopping plaza situate on lands known for municipal purposes as 8899 120th Street, Delta, British Columbia (hereinafter called the “Kennedy Heights Shopping Centre”).

6. The Appellant entered into an offer to lease dated the 24th day of March, 1986 (hereinafter called the “Offer”) wherein it agreed to lease to Nautilus Fitness Ltd., a British Columbia corporation (hereinafter called the ‘Tenant”), premises consisting of 5,733 square feet forming part of the Kennedy Heights Shopping Centre (hereinafter called the “Leased Premises”) for a term of ten years commencing on the 15th day of March, 1986 at an initial rental of $10.00 per square foot during the first five years during the term of the lease and $14.00 per square foot in the second five years of the terms of the lease. The said Offer provided for the Tenant to have two successive optional renewal terms of five years each.

7. It was a term of the Offer that the Appellant provide financing in the total amount of $221,163.00 to the Tenant to finance the cost of Tenant improvements to the Leased Premises and to be used by the Tenant to form part of the purchase price of equipment to be owned by the Tenant and installed in the Leased Premises.

8. The Offer provided for the Tenant to give security in the form of a Debenture creating fixed and floating charges against the property and assets of the Tenant, a joint and several limited guarantee from the principals of the Tenant, Michael Barnick and Karen Barnick (collectively, the “Guarantors”) and a collateral mortgage given by the Guarantors against their personal residence.

9. At all times, the Appellant was dealing at arms length with the Tenant and with the Guarantors.

10. The Offer provided that the repayment of the financing advanced by the Appellant would be made over a five year term based on a ten year amortization on equal payments of principal together with interest calculated at the prime lending rate of The Canada Trust Company (an affiliate of the Appellant) from time to time plus 1 per cent per annum, and also provided for the Tenant to pay a share of its annual net profits in reduction of the principal of the financing advanced by the Appellant.

11. The Tenant went into possession of the Leased Premises and gave to the Appellant a Debenture dated the 24th day of March, 1986 which was duly file with the Registrar of Companies of the Province of British Columbia on April 7, 1986.

12. The Debenture given by the Tenant was amended by Supplemental Debenture dated the 20th day of November, 1986 which was filed with the Registrar of Companies of the Province of British Columbia on the 1st day of December, 1986, and which provided certain serial numbers on certain chattels charged by the Debenture in favour of the Appellant.

13. Pursuant to the terms of the Offer, the Appellant received the joint and several limited personal guarantee of the Guarantors dated the 24th day of March, 1986 and also received the collateral mortgage on the personal residence of the Guarantors, which mortgage was registered in the appropriate Land Registry Office.

14. During 1986, the Appellant advanced to the Tenant the said sum of $221,163 which was used by the Tenant for the purpose of constructing the Tenant’s improvements to the Leased Premises and for the purpose of purchasing equipment which was installed in the Leased Premises, all as provided for in the Offer.

15. In the fall of 1987, the Tenant went into default under the lease of the Leased Premises and also went into default under the Debenture.

16. Despite the Appellant’s best efforts at collection from the Tenant and from the Guarantors, the Appellant ultimately incurred a loss of $206,221 on the financing provided to the Tenant in accordance with the Offer and also incurred legal expenses of $2,111 with respect to the loan.

17. During the period 1981 to 1987 inclusive, the Appellant has provided financing to other tenants, namely, Dr. Jean Stavro and Thorne, Ernst, Whinney, in conjunction with its leasing operations.

18. When the Appellant prepared its 1987 income tax return, it deducted the said sums of $206,221 and $2,111 from its income.

19. By means of a Notice of Reassessment dated the 17th day of July, 1992, the Minister of National Revenue disallowed each of the two amounts.

20. The Appellant duly and timely filed a Notice of Objection dated September 2, 1992 pursuant to the provisions of the Income Tax Act (Canada) and the said Notice of Reassessment was confirmed by the Minister of National Revenue by Notification dated the 20th day of July, 1993.

The appellant’s position is that the loan was an integral part of its business of renting, managing, developing and selling property. The respondent’s position on assessing and at trial is that the loan was an investment and that the loss, when the loan became uncollectible, was on capital account. In using the term “investment” the respondent meant an investment of a capital nature.

One witness, Mr. John Edward Harris, CA testified. He was, at the time of trial, the Senior Vice-President, Real Estate of the appellant, and had been employed by the appellant since 1984. He did not participate personally in the negotiation of the loan with Nautilus Fitness Ltd., but he was able to testify as to the nature of the appellant’s business and the type of inducements given to prospective tenants. He testified that since an aspect of the appellant’s business was the ultimate disposition of the leased properties,they were treated for income tax purposes and in the books of the company as inventory.

The respondent contended that the loan, being only one of three made by the appellant between 1981 and 1987, was a placement of capital similar to an isolated loan made by an individual.

The funds to make the loan were provided by the appellant’s parent, which is admittedly a money-lender. They were provided to the appellant at prime, or less than prime and loaned by the appellant to Nautilus at prime plus one percent. Accordingly, the appellant made a profit on the loan. I do not regard this in itself as determinative. I think that a more important purpose in making the loan was to induce Nautilus to enter into the lease. Mr. Harris described the various forms of inducement given to tenants such as non-refundable cash payments, periods of free rent, the building of tenant improvements by the appellant for the tenant, loans of the type involved above or a combination of non-refundable cash payments and loans. He stated that loans were regarded as the least desirable, and for that reason were less common than other types of inducements.

I have no hesitation in concluding that the making of the loan was a form of inducement to the tenant to lease space from the appellant and was an integral part of its commercial lending business. Nautilus was not a major or anchor tenant in the shopping mall. There were other much larger tenants such as Sears, Canada Safeway and the Canadian Imperial Bank of Commerce, the WhiteSpot restaurant and the B.C. Liquor Commission store. [1] The space had been vacant for 18 months and the appellant was anxious to lease it. The loan was tied to the making of tenant improvements and the purchase of equipment and was part of a larger inducement under which an additional $50,000 was paid as a non-refundable inducement by the appellant to the tenant. The repayment of the principal was to be made over a five year term based on a 10-year amortization and, in addition, further principal repayments were to be made equal to 25 per cent of the tenant’s net profits. The inducement of $271,163, of which the tenant was to repay $221,163 was described in the appellant’s request for lease approval as “Leasing Expense/Tenant Allowance”.

It is obvious that this was an essential and integral part of the appellant’s leasing business. It bore none of the indicia of a casual, isolated investment of capital, independent of the appellant’s leasing operations. I might observe in passing that it would be rather strange for a leasing subsidiary of money lending company to borrow from its parent to make a casual loan to one of its tenants unless its doing it were related to its leasing business.

The respondent draws a distinction between a non-repayable inducement which, it would appear, is accepted as an expense on revenue account and a loan. There is, in my view, no magic in an inducement that takes the form of a loan. The expectation of repayment does not transform, in the circumstances of this case, a transaction that is plainly on revenue account into one of a capital nature. This is, I think, clear from Associated Investors of Canada Ltd. v. Minister of National Revenue, [1967] C.T.C. 138, 67 D.T.C. 5096 where a loss on a loan to an employee was held to be deductible. At page 144 (D.T.C. 5099) Jackett P. as he then was, stated:

...A profit arising from an operation or transaction that is an integral part for the current profit-making activities must be included in the profits from the business. See Minister of National Revenue v. Independence Founders Ltd. (1953) S.C.R. 389 [53 D.T.C. 1177], and the foreign exchange cases such as Tip Top Tailors Ltd. v.. Minister of National Revenue, (1957) S.C.R. 703 [57 D.T.C. 1232]. If such a profit must be included in computing profits from a business, then a loss arising from any such source — that is, from an operation or transaction that is a part of the current profit-making activities of the business — must also be taken into account in computing the overall profit from the business.)

The determination here is essentially one of fact and no purpose would be served by a lengthy citation of authorities. The conclusion that I have reached here is, in my view, consistent with that reached by Walsh J. in R. v. Lavigueur, [1973] C.T.C. 773, 73 D.T.C. 5538, the Supreme Court of Canada in Minister of National Revenue v. Freud (sub nom. Freud v. Minister of National Revenue), [1969] S.C.R. 75, [1968] C.T.C. 438, 68 D.T.C. 5279, and by Kempo J. in Panda Realty Ltd. v. Minister of National Revenue, [1986] 1 C.T.C. 2417, 86 D.T.C. 1266. The conclusion must be based upon “a commonsense appreciation of all the guiding features...” (Minister of National Revenue v. Algoma Central Railway (sub nom. Algoma Central Railway v. Minister of National Revenue), [1968] S.C.R. 447, [1968] C.T.C. 161, 68 D.T.C. 5096), and upon “the practical and commercial aspects” [of the transaction] (R. v. F.H. Jones Tobacco Sales Co. (sub nom. R. v. Jones, F.H., Tobacco Sales Co. Ltd.)), [1973] C.T.C. 784, 73 D.T.C. 5577, and upon “what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process”. (Hallstroms Propriety Ltd. v. Federal Commissioner of Taxation (1946), 72 C.L.R. 634).

The appeal is therefore allowed with costs and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the loss of $206,221 and the legal expenses of $2,111 are deductible in computing the appellant’s income for 1987.

Appeal was allowed.