The Assistant Chairman:—The appellant, when it filed its income tax return for each of the years 1973 and 1974, in effect took the position that its principal business was that of “leasing, rental, development, sale or any combination thereof, of real property owned by it’’, and therefore the capital cost allowance it claimed was within Regulation 1100(12)(a) of the Income Tax Regulations to the Income Tax Act. The Minister of National Revenue however was of the view that the appellant was not within Regulation 1100(12) and consequently disallowed the capital cost allowance claimed by the appellant. Hence the appeal.
Regulation 1100(11) and (12) provides as follows:
(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 of which is
(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) Subsection (11) does not apply in respect of a taxation year of a taxpayer that was, throughout the year,
(a) a corporation whose principal business was the leasing, rental, development, 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).
The appellant contended that in each of the years its principal business was the rental and development of property. The respondent contended that the appellant’s principal business in those years was the construction of buildings on the land owned by others.
The appellant was incorporated on July 19, 1971. It had little activity in the remaining months of 1971. Its activity in 1972 was searching for property to develop for itself and construction for others. When the appellant was working for others, it was on a project management basis for a fee. This arrangement was not subject to the ups and downs of the market, and there was little investment needed and little overhead. The profit on this type of operation was smaller, but there was a profit and the risk was less. When operating for itself, much more cash was needed and the risk of loss was greatly increased.
In 1973 there were three projects where the appellant acted as project manager on a fee basis. Those projects were all for one client and were known as 4001 Steele, Norfinch Drive and Coronation Drive. The fee was based on the project and the appellant had no cash commitment. In the same year there were two projects for itself: the Fima Crescent project in Etobicoke, and the Gower Road project in East York. The president of the appellant described those projects as: “Our projects, our supervision of the buildings, our decisions all the way. We committed our funds and risked our dollars.” Mortgage investment plays a large part and on the Fima project the cost was approximately $300,000, about $75,000 of which was the appellant’s money. There was a binding contract to acquire the Fima property at the end of 1972, however the transaction was not closed until February, 1973.
The rental operations in 1973 and 1974 did not produce a profit to the appellant. In that respect, had no capital cost been claimed with respect to the Fima Crescent and Gower Road properties, still no profit would have been generated. The Minister disallowed all capital cost allowance claimed by the appellant with respect to those two properties. It is from this disallowance that the appellant appeals.
The acquisition of the Gower property was completed in October 1973. It was ultimately known by three municipal numbers: 10, 10A and 12 Gower. After acquiring the property on which there was a building, the first decision to be made was whether to demolish and build anew or to remodel. The decision to remodel was made and this started promptly as did the general work of cleaning up the property. As its first tenant on Gower, the appellant leased #10 to a printing company and then remodeled to its requirements. The president of the appellant believes some rent was paid by an old tenant in 1973, but the new tenant first paid rent in early 1974. Some rent was received from the Fima property in 1973 as two-thirds of the building was leased in that year. The balance could have been leased, but was not until 1974.
In 1974 the work for third parties continued on the Steele property, another project on the Norfinch land, and a project on Dundas Street. All was for the same client. For another client there was a project on Mavis Road.
For itself, the remodeling of #10A Gower for a tenant continued in 1974 and it did some construction on those premises. There was left #12 Gower, which was unoccupied. It was rented in 1976. As to the Fima project, the balance of the premises was leased to a paper salvage company in 1974.
According to the president of the appellant, if a company were a general contracting company a considerable capital commitment and investment would be required by the general contractor. However, if the company were a manager on a fee basis, the financial commitment would be considerably less. A general contractor needs financing equal to about 5% to 10% of the contract and a bonding company, before supplying the needed bond, would require clear assets of $50,000 to $100,000. In 1974, two contracts were completed (Mavis and Dundas) and they were at a fixed price. In these two cases the appellant took the risks and made larger than normal profits, all of which was reflected in its 1974 financial statements. All its construction revenue came from third parties.
As to the contracting business, the relationship with the owner could be cost plus fixed fee (not done in 1973 and 1974), fixed total price (people on the appellant’s payroll and charged to the job—Mavis and Dundas), and supervisory (employees on the payroll charged to the owner for whom the appellant was working). On a project management basis the appellant culled prices, analysed prices and made suggestions to the owner. As to employees, there were around 10 full time in each of the two years. As to Supervision, one person could and did supervise more than one property depending on the location of the property. The four buildings (Norfinch and Steele) had only one supervisor. The appellant was not concerned with gross revenue, but rather with money received.
Since considerable reference was made to the appellant’s 1973 and 1974 financial statements, it would appear best to reproduce the “Statement of Earnings and Retained Earnings” of the appellant for the years ending December 31, 1973 and 1974:
HADY CONSTRUCTION (1971) LIMITED
STATEMENT OF EARNINGS AND RETAINED EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 1974
REVENUE (note 1)
1974 1975 $ $ Construction revenue 388,560 128,091 Repairs and maintenance revenue 17,272 26,778 405,832 154,869 LOSS ON RENTAL OPERATIONS (Schedule) 46,653 12,537 GENERAL AND ADMINISTRATIVE EXPENSES Salaries and employee benefits 50,552 39,810 Management fees 5,250 6,600 Rent 2,458 4,951 Auto and truck expense 6,523 5,653 Depreciation 3,247 4,634 Audit and legal 2,450 3,790 Utilities 1,015 946 Insurance 1,125 313 Bank charges and interest 10,042 8,068 Mortgage interest 4,667 6,782 Miscellaneous 3,560 2,272 90,889 85,819 268,290 58,513 PROVISION FOR INCOME TAXES
Current 117,200 7,900 Deferred (1,100) 13,500 116,100 21,400 NET EARNINGS FOR THE YEAR 152,190 37,113 RETAINED EARNINGS—BEGINNING OF YEAR 42,527 5,414 RETAINED EARNINGS—END OF YEAR 194,717 42,527
The Schedule or Rental Operations for each of the years 1973 and 1974 are as follows:
HADY CONSTRUCTION (1971) LIMITED
SCHEDULE OF RENTAL OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1973
$ RENTAL INCOME 9,262 RENTAL EXPENSES Amortization of lease commissions 974 Depreciation 4,983 Mortgage interest 7,010 Realty taxes 1,870 Repairs and maintenance 6,962 21,799 LOSS ON RENTAL OPERATIONS 12,537 HADY CONSTRUCTION (1971) LIMITED SCHEDULE OF RENTAL OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1974 $ RENTAL INCOME 61,896 RENTAL EXPENSES Amortization of deferred charges 1,181 Depreciation 20,407 Mortgage interest 33,976 Realty taxes 1,627 Repairs and maintenance 38,571 Bad debt expense 12,787 108,549 LOSS ON RENTAL OPERATIONS 46,653
The balance sheet for each year showed the following assets for 1973 and 1974:
ASSETS
1974 1973 CURRENT ASSETS $ $ Accounts receivable (note 2) 292,704 180,022 Prepaid expenses and deposits 3,020 1,501 Unbilled costs and profits (note 1) 461,966 30,582 Non-interest bearing advance to employee 2,000 759,690 212,105 REVENUE PRODUCING PROPERTIES (note 2) —at cost 923,180 510,997 Accumulated depreciation 25,390 4,983 497,790 506,014
FIXED ASSETS—at cost 20,467 20,467 Accumulated depreciation 12,840 9,593 7,627 10,874 DEFERRED CHARGES (note 1)—at cost, less accumulated amortization 10,915 13,353 1,276,022 742,346
It is to be noted that the current assets really are only a receivable in some form or another and that there are fixed assets having an undepreciated capital cost of only a few thousand dollars. However, the revenueproducing properties have an undepreciated capital cost of about one-half million dollars in each year. The current liabilities (including accounts payable and accrued liabilities of $257,492 for 1973 and $316,922 for 1974) total $349,296 and $704,860 respectively. The mortgage payable (after current portion) is $336,223 and $363,245 respectively.
Also, if there were separate statements and earnings and retained earnings instead of just one and if repairs and maintenance revenue were included with construction revenue, the statements would be as follows:
| 1973 | 1974 | |
| Construction revenue | 154,869 | 405,832 |
| Expenses | 83,819 | 90,889 |
| — Profit | 71,050 | 314,943 |
| Rental revenue | 9,262 | 61,896 |
| Expenses | 21,799 | 108,549 |
| (LOSS) | 12,537 | 46,653 |
It follows from the two above statements that there obviously would be no retained earnings from rental operations.
Both counsel in making their submissions made reference to a decision of my colleague, Mr Taylor, in the case of Combined Appraisers and Consultants Company Ltd v MNR, [1979] CTC 2970; 79 DTC 770, and counsel for the appellant also referred shortly to Mr Taylor’s decision in the case of The Canada Trust Company v MNR, [1979] CTC 2199; 79 DTC 177. At pp 2975 and 773 respectively of the Combined Appraisers and Consultants case Mr Taylor referred to Regulation 1100(12) and stated as follows:
Regulation 1100(12) does not deal with “income”, “profit” or “loss”, it refers to “business”. In addition, that “business” must have been the principal business of the corporation “throughout the year”. I would hold without difficulty that the appellant was not in the rental business at the commencement of its 1975 fiscal year, and therefore could not have been in that business “throughout the year”.
Counsel for the respondent quickly took the position that in any event the appellant was not in the rental business, at least until February 1973—without considering whether or not it was its principal business—as the transaction by which it acquired its first property was not closed until February 1973. By “closed” I use the term as solicitors would use it, namely, the vendor (or his solicitor) delivered the deed to the purchaser (or his solicitor). Since the appellant had not acquired any property before February 1973, and there was no suggestion it had leased property for rental purposes, it was impossible for it to be in business “throughout” the 1973 year. While I am sure that Mr Taylor did not refer to any meaning of “throughout” as he believed that there would be no controversy as to its meaning, I note that the Oxford Illustrated Dictionary, second edition, at
page 886 defines “throughout” as follows: “from end to end of; in every part of; in every part or respect.”
Appellant’s counsel took the position that the appellant was in the rental business “throughout 1973” inasmuch as there was a binding contract between the appellant and his vendor which was signed sometime in the year 1972 and so the vendor, from that date (in 1972) until closing, held the property in trust for the appellant and so it follows that the appellant was in the rental business “throughout 1973”. As to the facts of that acquisition, no further evidence was given and consequently I cannot accept the appellant’s submission. How can one be in the rental business when one has nothing to rent? There was no evidence lead to show that the vendor moved out of the premises under the contract of sale in 1972 and the purchaser went into possession either personally or through a tenant in that Same year. There was evidence that no rental income was generated in 1972.
Since I find that the appellant was not in the rental business “throughout” 1973, it is obvious that it is not its principal business “throughout 1973” with the result that its appeal for that year must be dismissed.
One must turn to a consideration of the situation as it existed in 1974. It is to be noted that the key phrase in Regulation 1100(12) is “principal business”. By way of contrast, one can observe that the Regulation did not say:
(a) the business which produced the greatest revenue,
(b) the business which produced the greatest gross revenue,
(c) the business which produced the greatest net profit,
(d) the business which employed the greatest number of employees,
(e) e) the business which used the greatest value of assets,
or any positive definitive statement as to what is meant by the expression “principal business”. Nor does the regulation say that, if the operation of the business produces a net loss for the year, that operation cannot be considered the appellant’s principal business. Of the suggestions I made above clearly, if the test were any one of the first three, the construction business would be the principal business. As to the number of employees, while they numbered about 10 full time, no statement was made as to where they worked or whether or not a man worked on a project and in the same year worked on rented property. As to value of assets, clearly the rental property has the greatest value of assets. However if one were to consider the mortgage(s) payable and the accounts payable it could be there would be no net equity in those assets. It was stressed by counsel for the respondent that, had the appellant not been in the construction business in 1972, 1973 and 1974, it would not have been in the rental business without of course considerable additional investment of capital. Even without charging capital cost allowance there would have been, from rental operations, a substantial loss—about $7,500 in 1973 and $26,000 in 1974. From the same rental statements it is to be observed that repairs and mortgage interest alone exceed the rental income.
Considering the matter subjectively, according to the witness for the appellant, the business the appellant wanted to get into was the rental business. Its business was really a combination of building for others, and building for themselves for rental purposes. They were intertwined and so there was one business and that business was within the exception of Regulation 1100(12).
I cannot accept the appellant’s submission. In the circumstances of the case and considering that at the end of 1974 it had only been renting property since about March 1, 1973, and that the property rented could not have been owned without the profit from the construction business as well as the fact that the rental property did not generate sufficient income to pay the current expenses, I cannot consider that business the appellant’s principal business.
Judgment will go dismissing the appeal for 1973 and 1974.
Appeal dismissed.