Joyal, J.:—The Court is again facing the issue of deciding whether certain payments to a taxpayer are on account of capital or are of an income nature.
In the case The Queen v. Canadian Pacific Ltd., [1977] C.T.C. 606; 77 D.T.C. 5383 and in The Queen v. Consumers’ Gas Ltd. (No. 1), [1984] C.T.C. 83; 84 D.T.C. 6058 and The Queen v. Consumers' Gas (No. 2), [1987] 1 C.T.C. 79; 87 D.T.C. 5008, the Federal Court of Appeal enunciated the general principle that moneys received on account of a capital purpose constitute a capital receipt.
In the Canadian Pacific case, supra, certain sums of money were paid to the taxpayer on account of extensions to railway facilities. The Court ruled that such moneys did not reduce the capital costs to the taxpayer of these facilities for capital cost allowance purposes.
In the Consumers' Gas case, supra, the Court of Appeal dealt with the capital costs incurred by the taxpayer in relocating certain of its pipeline facilities to accommodate the needs of third parties. The taxpayer was reimbursed these costs. The Court affirmed the principle originally established in the Canadian Pacific case, supra, and ruled that such reimbursements constituted a capital payment and again ruled that they need not be applied to reduce the undepreciated capital costs of the taxpayer.
A similar issue came up before the Trial Division of this Court in Pacific Northern Gas Ltd. v. The Queen, [1990] 1 C.T.C. 380; 90 D.T.C. 6252. In that case, the tariff imposed by the Public Utilities Commission of British Columbia required the taxpayer to pay the costs of the small pipeline connecting its mainline to the customer. These costs were limited however to 70 feet of pipeline, any excess being charged to the customer. With regard to these reimbursements from the customer for any excess footage, the taxpayer followed the same accounting and reporting principles as were expressed in the earlier Canadian Pacific and Consumers' Gas cases, supra. These were again challenged by the Crown but at trial, the Court found for the taxpayer. That decision is now the subject of cross-appeal by the Crown to the Federal Court of Appeal.
The Court now faces the same issue again. It is a case, as counsel stated, of déjà vu. It is also a case, in terms of prior judgments, of déjà lu. As the facts disclose, however, it provokes a new enquiry into the whole field.
The Facts
The facts are not in dispute and all material ones were graciously agreed to by the parties. The plaintiff is a well-known general merchandiser operating some 24 department stores in the provinces of British Columbia and Alberta.
In 1982, Daon Shopping Centres Limited Partnership (‘Daon”) was constructing two shopping centres in Alberta, one the Bower Place Shopping Centre in Red Deer and the other, the Sunridge Shopping Centre in Calgary.
Daon desired the plaintiff, presumably as an anchor tenant, to enter into long-term leases with respect to these two locations. Negotiations took place and in due course, these were successfully concluded and long-term leases were executed.
The deal between Daon and the plaintiff included what might otherwise be euphemistically called an inducement. It called for Daon to pay its tenant a "fixturing allowance” of $3,000,000 on account of the Red Deer location and of $750,000 on account of the Calgary location. The importance of such payments to the plaintiff was that the tenant's improvements under the terms of the lease were considerable. The plaintiff, on taking possession of the premises, faced a bare space consisting of perimeter concrete walls, concrete ceilings and concrete floors.
In fact, on account of these fixtures, the plaintiff actually expended $6,658,228.13 for Calgary and a further $4,991,174.81 for Red Deer in fixtures before it could open for business.
For the year 1982, and in accordance with generally accepted accounting principles, the plaintiff itemized that total amount on account of capital and reduced its total undepreciated capital costs by an amount of $3,750,000. Subsequently, this position was reversed and the total undepreciated capital costs in the plaintiff's books were increased by the same amount. This treatment was accepted by the defendant Crown.
It was on February 17, 1988, that the defendant reassessed the plaintiff. This was followed by a further reassessment on October 27, 1989. In both reassessments, the defendant took the position that the sum of $3,750,000 constituted income in the hands of the taxpayer.
The Issue
The issue may be briefly stated: is the amount of $3,750,000 properly included in the plaintiff's income for the 1982 taxation year?
The Plaintiff's Position
The plaintiff's case may also be briefly stated. According to its counsel, the plaintiff acquired vacant space. It required fixturing expenditures. The landlord decided to reimburse the plaintiff for a portion of these expenditures. The plaintiff did not take into income the amount of this reimbursement. Leases and fixtures are capital assets. The reimbursement was of a capital nature to be fed into capital assets. The treatment given by the plaintiff is not only in accordance with generally accepted accounting principles but fully in accordance with the doctrine set down by the Federal Court of Appeal in the Canadian Pacific and the Consumers’ Gas cases, supra. The factual situation in all these cases is sufficiently similar that there is no reason to depart from that doctrine in deciding the case at bar.
The Crown's Position
According to Crown's counsel, the transaction is a simple section 9 case, meaning that the moneys received by the plaintiff were from a business or property and should be included in income so as to determine the plaintiff's profit for the year. These moneys were inducements to enter into leases and as such, it does not really matter where the money goes. Although it can be said that there is a connecting link between a capital payment and a capital expense attributable to it, such is not necessarily the case when dealing with inducements. After all, says Crown counsel, the plaintiff is negotiating leases as part of its business. It runs some 24 stores of which half of them are on leased premises. The Court should not view the transaction with respect to Red Deer and Calgary in isolation and simply abstract from all the negotiations and from all alternative forms of inducements a cash payment under a form which is categorized as "fixturing" costs. These would be costs which the plaintiff would have had to meet in any event.
Furthermore, Counsel for the Crown argued that an analysis of the documentary evidence submitted by the parties would indicate that it was open to the plaintiff in the process of lease negotiations to get into the leasing business by way of property management contract with the landlord or to run the leasing operation for the whole shopping centre on behalf of the lessor. I should conclude, urged counsel, that the factual situation before the Court is so substantially at variance with the circumstances in Canadian Pacific or Consumers’ Gas cases, supra, that I should not be required to apply the principles stated in those cases.
The Evidence
Verbal evidence adduced by the plaintiff was admittedly of limited assistance. The plaintiff's auditor, Mr. Edward George Williams, emphasized that the treatment given to the $3,750,000 payment was wholly in accordance with generally accepted accounting principles (GAAP). For financial statement purposes, the payment was not on income account but should only be used to reduce the total undepreciated capital expenditures by a like amount. This has the effect of course of reducing the capital cost allowances from year to year and it can then be said that it is''expensed" through a higher profit margin on the profit and loss statement.
The foregoing was confirmed by Mr. James D. Kerr, a chartered accountant, whose expert report was admitted in evidence. In his report, Mr. Kerr stated that the accounting treatment of the $3,750,000 was in accordance with GAAP and to include these amounts in income in the year received would not be proper under GAAP. He looked upon a fixturing allowance as analogous to government assistance for the acquisition of fixed assets. The amount of such assistance could be deducted from the cost of related fixed assets or otherwise the amount could be deferred and amortized to income on the same basis as the related assets are depreciated.
In adopting the first method, noted Mr. Kerr, the benefit of the receipt is spread over the length of time the fixtures are depreciated and properly matches the receipt with the economic benefit. A straightforward application, he concluded, of the matching principle.
The only other witness the plaintiff could rely on was its vice-president, real estate and store planning. The senior officers in charge of the negotiations with Daon in 1978-1982 had all left the company when it had later gone through a major reorganization and these officers were no longer available. The current senior officer, John Russell Gauer, was not privy to these negotiations and often time could not really explain the rationale behind many of its features. His evidence, nevertheless, was straightforward and in any event the documents submitted to him tend to speak for themselves.
It is a fact, said Mr. Gauer, that negotiations leading to a long-term lease are complex and they involve any number of issues. Mr. Gauer admitted that the plaintiff had developed a certain expertise in this area. Of the total of 24 stores operated by the plaintiff, a dozen of them are under leasehold. Furthermore, the plaintiff at one time owned a whole shopping centre, the Landsdowne Shopping Centre, in Richmond, B.C., and in some cases, store development programmes were on the basis of a joint venture with developers.
Mr. Gauer also argued that a rental rebate is no less an inducement than a fixtures’ allowance. In the case of Calgary and Red Deer, it meant that the capital costs to the plaintiff were simply reduced by $3,750,000. The whole operation, he said, is to arrive at a fair net rental. In the process, therefore, the annual rent to be paid is a factor in the inducements and the inducements to be offered are a factor in the annual rent.
Dealing first with the Calgary lease, Mr. Gauer identified a proposal originally made by Daon on September 11,1978 [Ex. 3(3)]. !t called for the leasing of some 210,000 feet at an average annual rent of $4.90 a foot. The term of the lease would be 30 years with renewal options. The plaintiff would be offered a property management contract and leasing contract on competitive industry terms. The plaintiff would also be entitled to revenue participation equivalent to ten per cent of the cash flow after debt service of the first mortgage. In lieu of that participation, the plaintiff would be entitled to a $1 per foot rebate over the term of the lease.
Discussion subsequently took place between the parties and this resulted on October 2, 1978 with an offer to lease submitted by Daon [Ex. 3(4)]. The annual rent was fixed at $4.95 a foot and the term of the lease would be 35 years with renewal option. After providing for some alternative to the $4.95 rental figure, the offer provided, as extra incentive, a rebate of $1.15 a foot. Furthermore, the tenant was being offered a contract to both lease and manage the operation of the shopping centre. The fees for this would be $1.50 per foot of commercial rental space and 3.75 per cent of gross revenues respectively.
This offer was followed on October 26, 1978 by a detailed proposal, effectively a letter of intent, from the plaintiff to Daon [Ex. 3(5)], the terms and conditions more pertinent to the issue before me being as follows:
(1) Woodward would take on the foregoing leasing and management services on terms submitted by Daon in its proposal.
(2) The lease would be for an initial 30-year term with option to renew for seven further periods of ten years each.
(3) The annual rental for the initial term would be fixed at $3.80 a foot or an amount by which .5 per cent above the 35-year amortization contract would totally amortize certain capital costs set out in the agreement, the whole minus a rebate of $1.15 a foot.
The proposal by the plaintiff was made open for acceptance until November 3,1978. Nothing, however, seems to have resulted from this proposal until June 19,1979 when a further letter of intent from the plaintiff to Daon was submitted [Ex. 3(8)]. This proposal provided for a leasing contract at a fee of $1.50 a foot plus bonuses. It also fixed at 35 years the original term of the lease together with some ten-year renewal options. The rent would be fixed at $3.80 a foot during the original term and at $1.90 a foot for each renewal period.
This proposal was accepted but it would appear that on the same day, June 19, 1979, the plaintiff wrote to Daon [Ex. 3(6)] and confirmed that if Daon did not agree to pay the plaintiff a fixturing allowance of $750,000, Daon would grant an option to the plaintiff to buy ten acres of property adjoining the shopping centre site. The letter went on to say that if Daon agreed to the $750,000 fixturing allowance, the plaintiff would waive its right to the leasing contract as provided in the letter of intent of the same date.
On September 27,1979, Daon wrote to the plaintiff [Ex. 3(9)], agreed to pay the fixturing allowance of $750,000 and confirmed that the option to purchase land as well as the right to a leasing contract were rescinded. The deal was closed.
Let us now take a look at Red Deer. Perhaps by reason of the concurrent negotiation between Daon and the plaintiff relating to Calgary, the parties seemed to have come to terms more expeditiously.
According to Ex. 3(11) and Ex. 3(12), the City of Red Deer expressed great interest in having the plaintiff participate in a new shopping centre in Red Deer. The plaintiff's response on January 10, 1979 [Ex. 3(13)] was far from encouraging. It was only later that apparently the plaintiff and Daon got together and on June 28, 1979, in a letter to Daon [Ex. 3(14)], the plaintiff agreed in principle to participate as a major tenant, thus supporting Daon's application to the City of Red Deer for developer's rights. This arrangement was confirmed by the plaintiff to the City of Red Deer as an exclusive undertaking favouring Daon.
There is no evidence as to what transpired between the plaintiff and Daon after that. It was on December 4, 1979, however, that a letter of intent was executed by the plaintiff and duly accepted by Daon.
Most of the terms and conditions of this agreement [Ex. 3(16)] are identical to those found in the Calgary agreement. There is reference to a floor area of some 140,000 square feet, a requirement to pay a fixturing allowance of $3,000,000, an initial term of 35 years with seven ten-year renewal options, an annual rent of $3.80 per foot during the original term of the lease and $1.90 a foot thereafter. The more detailed provisions respecting cost escalations on maintenance and taxes, option to build an extra flow to the store area, provisions for parking and other items of a similar nature parallel those in the Calgary agreement.
The Law
The judgments of the Federal Court of Appeal in both the Canadian Pacific and Consumers' Gas cases, supra, have extensively reviewed the nature and disposition of third-party contributions to capital expenditures.
In the Canadian Pacific case, one of the main contentions was the method which should be applied to determine the undepreciated capital cost of capital improvements. The Crown argued that the capital cost to the taxpayer or the expenditure incurred by it was the amount of the taxpayer's outlay minus the contribution of the third party. This argument was rejected by the Court. It quoted in support the decision of the House of Lords in Birmingham Corporation v. Barnes, [1935] A.C. 292 when it was held that "the actual cost to" a taxpayer of depreciable property is equal to the amount paid by the taxpayer. It was said by Lord Atkin at page 298:
What a man pays for construction or for the purchase of a work seems to me to be the cost to him: and that whether some one has given him the money to construct or purchase for himself; or, before the event, has promised to give him the money after he has paid for the work; or, after the event, has promised or given the money which recoups him what he has spent.
The Court also rejected an attempt made by the Crown to distinguish the Birmingham case on the grounds that in that case the capital expenditure had not been incurred at the request of a third party and the amount contributed by the third party was not earmarked for any special purpose.
In Consumers' Gas No. 2, supra, the taxpayer, in the normal course of its affairs, received payments from third parties in respect of pipeline relocations carried out at the latter's request. The question was whether or not such payments should be brought into income.
The following is from Hugessen, J.A., at page 81 (D.T.C. 5010):
It is common ground on the present appeal that the expenditures made by Consumers' Gas for pipeline relocations in the circumstances described are for capital account. In the judgment now under appeal, Muldoon, J. in the Trial Division held that the partially offsetting receipts from third parties were also for capital account and need not be taken into income for the purposes of the Income Tax Act. In my view, he was right.
There is no dispute, and indeed the expert evidence called on both sides was unanimous on the point, that generally accepted accounting principles require these receipts to be treated in the way that Consumers' Gas in fact treated them for financial statement purposes. In other words, proper accounting practice required that the receipts be offset against the capital expenditure in respect of which they were paid by third parties so that only the net cost of the relocation be carried to the asset side of the balance sheet. It was also not disputed that Consumers' Gas' practice of taking straight line depreciation over a period of 70 years calculated on the net cost of pipeline relocations was consistent with generally accepted accounting principles. Finally, the expert accounting evidence was that the receipts should be treated as capital receipts and not as income.
At page 82 (D.T.C. 5011), Hugessen, J.A. added this comment:
It is common ground here that the cost of pipeline relocations is a capital outlay and that the receipts from third parties in respect thereof need not be taken into account in determining undepreciated capital cost for the purposes of calculating capital cost allowance. The mere fact that this results in such receipts not being reflected in income does not make them income. Absent some provision of the statute specifically bringing them into income, they continue to be treated, as required by generally accepted accounting principles, as capital receipts. The submission therefore fails.
This last and apparently final disposition of those issues was made by the Federal Court of Appeal on December 2, 1986. Six months earlier, however, on June 12, 1986, my colleague Teitelbaum, J. decided the case of French Shoes Ltd. v. The Queen, [1986] 2 C.T.C. 132; 86 D.T.C. 6359. It is an important case because the facts before the learned judge are quite similar to facts before me.
In that case, the taxpayer, who ran a chain of shoe stores, had been urged on several occasions during 1977 to lease a store in a proposed shopping centre in Cowansville, Quebec. A variety of inducements were made but these did not appear to satisfy the taxpayer. Finally, the developer of the shopping centre agreed to give the taxpayer $50,000“ to be applied against its inventory".
The taxpayer took the position that this payment constituted a windfall and did not constitute income in the taxation year 1977. Its counsel cited the case of Walker (Inspector of Taxes) v. Carnaby, Narrower, [1970] 1 All E.R. 502; Murray (Inspector of Taxes) v. Goodhews, [1978] 2 All E.R. 40; all cases which had ruled that certain ex gratia payments received by a taxpayer, or the benefit conferred to the taxpayer through the payment by a third party of an outstanding debt owing to a creditor did not constitute income in the hands of the taxpayer.
Teitelbaum, J. however, would have none of it. On the facts before him he said, at page 138 (D.T.C. 6363):
Was the payment unrelated to the taxpayer's business activities? At first glance one would have to answer in the affirmative, it was not related to the taxpayer's business activity of selling shoes. This would be true if I would only be restricted to looking at the business activity of plaintiff as only selling shoes to the public.
It is important, as part of plaintiff's business activity, to sign leases for stores under the best possible conditions, that is, the cheapest rent, the least amount of expenditures for start-up costs, etc. In the present case, there was an additional benefit, a single payment of $50,000 in addition to the other benefits already described.
I also believe that the plaintiff, after signing the lease, had a right to legally claim the $50,000 promised and moreover had, according to the lease, an obligation to apply the sum to its inventory.
I am not so convinced as to believe that such a payment could not have happened again. It is my belief that there was a good possibility of its happening again for plaintiff because of plaintiff's outstanding reputation. Plaintiff was a very desirable tenant and, as such, could arrange for such an inducement if an owner of a shopping centre really wanted plaintiff as a tenant.
And His Lordship to conclude at 138 (D.T.C. 6363-64):
I am satisfied that the $50,000 received by plaintiff is part of its revenue. When a taxpayer receives an inducement to sign a lease, then those moneys received must form part of the taxpayer's revenue for the year in which the inducement was received. An inducement is not a "windfall", it is an incentive, a reason for doing something. Taxpayers and lessors use inducements as a form of doing business. For the lessor, it rents out space and for the taxpayer it is a benefit received. In the end, the receipt of the benefit helps to make a profit. It is part of the taxpayer's revenue that is derived because of, and is part of, its business activity.
In the present case, the money, $50,000, received by plaintiff is part of its business revenue.
Although each case must be judged on the facts of that particular case, I am of the opinion that incentive payments, inducements, generally form part of the revenue of the taxpayer. The payment is received as a result of the business activity carried on by the taxpayer and would not have otherwise been received.
Teitelbaum also had to dispose of the taxpayer's argument that in 1985, there had been added to subsection 12(1) of the Income Tax Act a new paragraph, 12(1)(x), to include as taxable income any payment in the nature of an inducement. This indicated, according to the taxpayer, that before this amendment, inducement payments such as received were not revenue.
His Lordship did not agree. He applied the rule laid down in subsection 37(2) of the Interpretation Act, R.S.C. 1970, c. I-23 and concluded that the amendment did not imply a change in the law but simply clarified it.
In Neonex International Ltd. v. The Queen, [1978] C.T.C. 485; 78 D.T.C. 6339, the Federal Court of Appeal ruled that a foreign exchange gain relating to the repayment of a loan made for a capital purpose and not one made as part of the taxpayer's financing operations constituted a non-taxable capital gain.
In the case of The Queen v. Metropolitan Properties Co., [1985] 1 C.T.C. 169; 85 D.T.C. 5128 (F.C.T.D.), Walsh, J. reaffirmed the rule that respect must be paid to generally accepted accounting principles in the determination of a capital as against a current expense unless there is a provision in the Income Tax Act requiring a departure from such principles. In that case, it was the Crown and not the taxpayer which urged the Court to be guided by those principles, a situation which makes it clear that the reasoning works both ways.
In the case of Golden Horseshoe Turkey Farms v. M.N.R., [1968] C.T.C. 294; 68 D.T.C. 5198 (Ex. Ct.), Gibson, J. relied on the general rule in determining that a forgiven amount of a debt that did not arise out of the taxpayer's normal trading operations was on account of capital and did not constitute income.
In Maison de Choix Inc. v. M.N.R., [1983] C.T.C. 2241; 83 D.T.C. 204, Tax Review Board Member Guy Tremblay (now Tremblay, T.C.J.), faced a situation remarkably similar to the case at bar and to the French Shoes case, supra. The taxpayer was a retail merchant renting space in a number of shopping centres. As an inducement to enter into leases, the developers respectively paid the taxpayer $15,000 for one lease, $35,000 for another and $20,400 for a third. The Crown alleged that these payments were made in order to reduce the taxpayer's rental expenses. As an alternative, and this is an interesting point, the Crown alleged that if such payments were not in the nature of rental reductions, they were aimed at reducing the taxpayer's construction costs and should therefore be applied in reduction of its depreciable leasehold improvements.
The Board, after reviewing all the evidence, found that the payments in question were not disguised forms of rent reduction. The Board found the taxpayer already paying bottom rent. Neither were the allocations meant to reduce construction costs. The Board specifically referred to subsection 6(3) of the Income Tax Act which deals with inducements paid to employees as "consideration for accepting the offer or entering into a contract of employment" and provides that such inducements constitute income in the hands of the employee. The Board found that in a landlord-tenant relationship, the taxation of an inducement payment was not provided for in the Act. The Board then applied fundamental business principles and after quoting a number of cases in support, ruled that the payments were of a capital nature.
In Valley Camp Ltd. v. M.N.R., [1974] C.T.C. 418; 74 D.T.C. 6337 (F.C.T.D.), the taxpayer was in receipt of an annual payment from Canadian National Railways equivalent to 101/4 per cent of the final actual capital cost of transhipment facilities at Thunder Bay built by the taxpayer on C.N.R. lands. The contract between the parties was for 25 years and the annual payment was to amortize these costs over that term. The Crown contended that these payments were not part of a subsidy under paragraph 20(6)(h), nor was it a capital repayment but it arose out of an ordinary business contract negotiated by both parties for business reasons and therefore revenue derived therefrom was income to the taxpayer. Urie, J. agreed with the Crown. He found on the facts before him that the handling charge payable to the taxpayer as well as the annual payment were not the result of separate and independent transactions but part of the same commercial transaction. Both were part of the taxpayer's revenue and therefore the amount of 101/4 per cent payments were to be taken into account in the taxpayer's income.
I should finally refer to the very recent case of Westfair Foods Ltd. v. Canada, [1991] 1 C.T.C. 146; 91 D.T.C. 5073. This is a judgment of Madam Justice Reed who was asked to decide whether certain sums ($880,000 and $1,000,000) paid to the taxpayer in the years 1983 and 1984 respectively on account of the early termination of leases should be treated for tax purposes as capital receipts or as business income.
Counsel for the plaintiff in that case argued that since the proceeds received were on the disposition of capital assets, namely the leases, the proceeds constituted capital receipts.
Counsel for the Crown raised substantially the same argument as in the case before me, namely that the taxpayer was itself a landlord and received rental income in the ordinary course of its business. Further, counsel noted, the disposition of the two leases did not affect the earning situation of the plaintiff. As a consequence, the money received on cancellation was more of an income receipt than a capital receipt.
Counsel for the Crown relied naturally on the judgment of this Court in the French Shoes case, supra, which decided that a cash payment of $50,000 to a lessee for inventory purposes and as an inducement to enter into a lease was income to the taxpayer. After reviewing the facts of that case, Reed, J. stated as follows at page 150 (D.T.C. 5075-76):
I am not convinced that that decision helps the defendant. The amount paid in that case could legitimately be characterized as compensation for income. It was described as imposing on the taxpayer “an obligation to apply the sum to its inventory". Also, as I read that case, no argument seems to have been made as to whether the amount might be classified as a capital gain. In any event, it is not sufficient to say, as counsel would have me conclude on the basis of that case, that merely because the signing of leases is related to the plaintiff's business, a termination payment, in the circumstances of the present case, should therefore be characterized as an income receipt. Such a rule would wipe out all distinction between capital assets and income. All capital receipts and capital expenditures are related to the taxpayer’s business in some way or other.
The plaintiff does not dispute the fact, that, the negotiation of leases for premiums and the sublease to franchisees is part of its business. The plaintiff agrees that the leases are related to the food distribution and sales business. However, it points out that it is not in the business of buying and selling leases. It does not trade in leases. The headleases in its hands are capital assets. It needs physical premises from which to conduct its food distribution and sales business and these are obtained either by outright ownership of the premises or by way of long-term leases.
Reed, J. then went on to find that the amounts paid as compensation for the termination of the leases were paid as replacement for capital assets and were therefore capital receipts.
The Findings
The case law I have cited has certain dialectical overtones. In the Consumers' Gas case, supra, the Federal Court of Appeal acknowledged that in the absence of a statutory provision to the contrary, the generally accepted accounting approach to a determination of a capital as against an income receipt or to a capital expense as against a more current one should be adopted. This is to mean that should a taxpayer incur a capital expense for some purpose or other and should he be subsequently reimbursed that expense from any party on whose behalf the expense was incurred, such reimbursement is of a capital and not of an income nature. This, in my mind, is not only common sense but is consonant with the general tenor of the Income Tax Act which, by its very title, imposes a tax on "income".
In the Consumers' Gas case, or in the Pacific Northern Gas case, supra, the analysis of the facts might very well be reduced to simple terms which any reasonable person could understand: what did the taxpayer gain in these transactions? The answer would be obvious. The only gain might be found in an increase in the undepreciated capital costs of the taxpayer with a corresponding increase in the capital cost allowances from year to year. This advantage, however, does not arise by reason of the application of generally accepted accounting principles which provides that such capital costs should be reduced by the amount of reimbursement, but it arises from an interpretation of the statute which was adopted by the House of Lords over 50 years ago in the Birmingham Corp. case, supra, to which Pratte, J.A. referred in the Canadian Pacific case, supra, and which provides that the capital cost to a taxpayer is the cost to him, irrespective of any reimbursement. The anomaly this creates might be obvious but such was the state of the law in the taxation years in question.
The question may now be put as to whether the principles laid in the cases I have cited are applicable to the case before me. There is no doubt that the facts are different yet it is an open question as to whether or not they are materially different.
One might start with the fact that in the Consumers' Gas case, supra, no material benefit was enjoyed by the taxpayer. It expended moneys for capital purposes and was reimbursed accordingly. Although many transactions of that nature took place in the course of the years in question, it could not evidently be established that a public utilities company is in the business of relocating its pipelines to accommodate third parties. In any event, if it could be found that it was part of its business, the expense incurred would be evidently a business expense and the moneys received would be an equivalent amount of income. The income and the expenditure would in that sense cancel each other out and there would be no taxable benefit to the taxpayer on that account.
It is a fact that the Consumers' Gas case, supra, for its own accounting purposes, applied GAAP principles governing capital expenses and capital receipts. Thus, symmetry under GAAP was balanced by the reduction in undepreciated capital balance equivalent to the amount received from third parties. The fact that under tax rules, this reduction need not be made is another matter altogether.
In the case before me, the Crown alleges that the $3,750,000 received by the plaintiff from the developer is income and as such taxable in the year of receipt. It is a material consideration, however, that such a sum was earmarked for capital purposes, i.e., the installation of the necessary fixtures in an otherwise barren space. The benefit received by the taxpayer was of course to reduce the total capital expenditure by an equivalent amount.
Yet this so-called benefit would not necessarily change the nature of the transaction. As the lengthy exhibits disclose, parties do not enter into 100-year leases without a lot of number-crunching and fine-tuning by both sides. The various proposals exchanged between the plaintiff and the developer refer to ancillary business contracts either for management services or for leasing services. That the plaintiff had developed a certain expertise in these fields was obviously known and recognized. No doubt any profits accruing from these contracts would have been taxable in the hands of the plaintiff. I note, however, that throughout the negotiations, as the parties played one proposal against the other, the figures relating to the base rent remained fairly stable and in fact were somewhat reduced when the final deal was completed.
Does it follow, as the Crown contends, that the plaintiff was running a leasing business and moneys received from the developer represent current income? On the facts before me, I should not think so. As in the Westfair Foods case, supra, the leasing of property to conduct a general merchandising business may be said to be part of the plaintiff's business, but the plaintiff is not in the business of buying or selling leases and to quote Hugessen, J.A. in Consumers' Gas (No. 2), supra, the mere fact that certain receipts are not reflected in income does not make them income.
The other aspect of the case which I find favourable to the plaintiff reflects the general economy of the Income Tax Act in dealing with either capital or income receipts as well as with capital or current expenditures. Absent some special statutory provisions, of which of course there are many, there is a general respect for the matching principle between capital receipt and capital expense as well as between operating income and operating expense. Furthermore, it could be said that the benefit received by the plaintiff is no more than the benefit it would otherwise have enjoyed if the developer, as part of the lease conditions, had undertaken to provide leasehold improvements at the lessee's specification to a maximum of $3,750,000. As far as the plaintiff is concerned, what tax connotations would that have provoked? None that I can see.
Finally, it would appear to me that the fixturing payment becoming categorized as operating income might logically create out of the matching fixturing expense an operating expense, again one neutralizing the other. There are, however, statutory provisions against this kind of logic, just as, in my view, it would require a statutory provision to categorize a payment for a capital purpose as income.
Courts have repeatedly said in tax matters that one must look at the pith and substance of a transaction and not at the particular form that the ingenuity of tax planners might devise. Such an approach has often resulted in findings which are quite unfavourable to taxpayers. Well, it works both ways.
Courts have also repeatedly stated that the classification of receipts or expenditures into capital or income depend on all the surrounding facts and circumstances of each case, judicial precedents being no more than guidelines to a court to make sure that all material and relevant facts are considered or analyzed. In the case at bar, absent any statutory enactment to the contrary, the treatment given to the fixture allowances is in accordance with GAAP. Furthermore, an analysis of the contract documents submitted to me does not convince me that the terms incorporating such allowances are other than what they clearly appear to be, namely capital payments earmarked for capital purposes.
The Crown urges me to adopt the reasoning of Teitelbaum, J. in the French Shoes case, supra. No doubt, the learned judge's analysis of the facts before him invite a similar analysis of the facts before me. With respect, however, I should prefer to follow the line of reasoning of our colleague Reed, J. in the Westfair Foods case, supra, who did point out that the inducement paid to the taxpayer in the French Shoes case was“ "to apply the sum to its inventory" and not to capital improvements.
Reed, J. also stated that merely because the signing of leases is related to a taxpayer's business, it does not follow that termination payments should therefore be characterized as income receipts. “All capital receipts and capital expenditures”, she said, “are related to a taxpayer's business in some way or other”.
It is common ground that paragraph 12(1)(x) was introduced to the Income Tax Act in 1986. This new provision constitutes a departure from generally accepted accounting principles and, for policy reasons, specifically categorizes inducement payments as income receipts. In the French Shoes case, supra, the learned judge relied on the Interpretation Act to find that this new provision did not amend the law but merely clarified it.
With all respect, I am not at all sure that I should agree with my colleague on that point. Inducements were obviously a matter of concern to the Crown and, if one looks at the legislative history of paragraph 12(1)(x) of the Income Tax Act, the change it brought about certainly had elements of substance in it.
One might develop that train of thought by quoting from Interpretation Bulletin IT-359 dated December 27, 1976. Paragraph 8 originally read as follows:
The tax treatment of an amount received by a tenant from a landlord for entering into a lease depends on the facts of the case. If a payment is a contribution towards the cost of leasehold improvements to be made by the tenant, it generally reduces the amount that would otherwise be the tenant's capital cost of the leasehold interest for capital cost allowance purposes. Otherwise, depending on the circumstances, the amount received may be considered to be either a reduction of rental expense or a Capital receipt to the tenant.
This bulletin was modified on December 20, 1983, such that paragraph 9 of IT-359R2 now reads as follows:
A payment received by a tenant from a landlord as an inducement to enter into a lease will be considered in the hands of the tenant as
(a) a non-taxable capital receipt where the payment is a reimbursement of part or all of the tenant's capital cost of leasehold improvements within the meaning of Regulation 1102(4);
(b) a reduction of those expenses where the payment is a reimbursement of other expenses incurred by the tenant;
(c) income where the negotiation of leases is a regular part of the tenant's business operations (eg. a chain store);
(d) a reduction of what would otherwise be the rental expense of the tenant where the payment is a rebate of rent for a period of the lease;
(e) a non-taxable capital receipt in other cases.
Subsequent to the French Shoes decision, supra, Revenue Canada indicated that it would maintain its previous practice for lease inducement payments received prior to May 23, 1985, as set forth in paragraph 9 of IT-359R2:
It is the department's opinion that this decision [i.e., French Shoes] provides support for the position described in paragraph 9(c) of Interpretation Bulletin IT-359R2 (dated December 20, 1983). It is not viewed as broadening the position to include in income every inducement payment received by a tenant. The position on lease inducements received before May 23, 1985 continues to be as stated in paragraph 9 of IT-359R2.
Paragraph 12(1)(x) of the Act was added by 1986, c. 6, subsection 6(2), made applicable by subsection 6(6) as later amended by 1986, c. 55, section 79. The text of this new provision is 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:
(x) any amount . . . received by the taxpayer in the year, in the course of earning income from a business or property, from
(i) a person who pays the amount (in this paragraph referred to as "the payor") in the course of earning income from a business or property or in order to achieve a benefit or advantage for himself or for persons with whom he does not deal at arm's length, or
(ii) a government, municipality or other public authority
where the amount can reasonably be considered to have been received
(iii) as an inducement, whether as a grant, subsidy, forgivable loan, deduction
from tax, allowance or any other form of inducement, or
(iv) as a reimbursement, contribution, allowance or as assistance, whether as a grant, subsidy, forgivable loan, deduction from tax, allowance or any other form of assistance, in respect of the cost of property or in respect of an expense
to the extent that the amount
(v) was not otherwise included in computing the taxpayer's income for the year or a preceding taxation year,
(vi) except as provided by subsection 127(11.1), does not reduce, for the purposes of this Act, the cost or capital cost of the property or the amount of the expense, as the case may be,
(vii) does not reduce, pursuant to subsection 13(7.4) or 53(2)(s), the cost or capital cost of the property, as the case may be, or
(viii) may not reasonably be considered to be a payment made in respect of the acquisition by the payor or the public authority of an interest in the taxpayer, his business or his property;
There was also included the following transitional provision:
. . . with respect to amounts received after May 22, 1985 other than amounts received after that date pursuant to the terms of an agreement in writing entered into before 4:30 p.m. Eastern Daylight Time on May 23, 1985 or to the terms of a prospectus, preliminary prospectus or registration statement filed before May 24, 1985 with a public authority in Canada pursuant to and in accordance with the securities legislation in Canada or of any province and, where required by law, accepted for filing by such authority.
The existence of this transitional provision would seem to rebut, in my view, any presumption that the legislator merely intended to clarify the existing state of law when paragraph 12(1)(x) was enacted. However, paragraph 12(1)(x) also provides in subparagraph (v) that inducement payments shall be included in income to the extent that they are not otherwise included in computing the taxpayer's income for the year.
Some persons may take this particular subsection to mean that inducement payments may, even in the absence of paragraph 12(1)(x), be included in income, presumably by section 3 or subsection 9(1) of the Act. This was the case in French Shoes for example. However, insofar as inducement payments of a capital nature are now included in income by paragraph 12(1)(x), I think that paragraph 12(1)(x) has changed the state of the law.
Subsection 37(2) of the Interpretation Act [now subsection 45(2)] simply states that there is no presumption that a legislative amendment indicates a change in the law. This cannot mean that an amendment can never be interpreted as reflecting a change in the law, especially when there is external evidence to that effect.
It is also important to note in this regard that a taxpayer may now elect to have the capital cost of his depreciable property reduced by the amount of the inducement payment, provided, of course, that the money relates to the acquisition of that property—subsection 13(7.4) and subsection 53(2.1). This is definitely a change in the law, as it was held by the Federal Court of Appeal in Consumers' Gas, supra, that the capital cost of depreciable property need not be reduced by the amount of the payment for capital cost allowance purposes.
I should find that with respect to some transactions between landlord and tenant involving inducements, paragraph 12(1)(x) adopted new rules which might appear to confirm the position taken by the plaintiff before me when it originally reduced its undepreciated capital cost by the amount of the inducement it received. It also means that the anomaly between GAAP rules and tax rules no longer exists.
The Conclusions
I have perhaps gone too far afield in analyzing the state of the law with respect to inducements paid out by a landlord to a tenant, and to the categorization of such payments as a windfall, as a capital gain, as a capital receipt or as income. Were it not for the decision of this Court in the French Shoes case, supra, I would perhaps have had an easier time of it.
I must nevertheless conclude that that decision should not be followed in the case before me. In French Shoes, the Court found that the cash payment to the taxpayer was for purposes of inventory, clearly a non-capital expense. This view of it was also adopted by Madam Justice Reed in the Westfair Foods case, supra.
Furthermore, as I have found that the provisions of paragraph 12(1)(x) represent a statutory departure from generally accepted accounting principles, it is, in my respectful view, new law and therefore the findings in the French Shoes case in that respect are not necessarily binding on me.
There is of course some weight which might be given to IT-359R2 which suggests that any payment received by a tenant from a landlord or an inducement is "income when the negotiations of leases is a regular part of the tenant's business operations (e.g., a chain store)". On the other hand, that same Interpretation Bulletin considers any such payment as a " non-taxable capital receipt when the payment is a reimbursement of part or all of the tenant's capital cost of leasehold improvements". There is further the comment of Reed, J. in Westfair Foods, supra, that "all capital receipts and expenditures are related to a taxpayer's business in some way or the other".
I should also conclude that the generally accepted accounting principles should apply unless there is found some statutory rule to the contrary. In the matter before me, I fail to find sufficient grounds to depart from those principles.
The plaintiff's action is maintained and the defendant's reassessment for the year 1982 is vacated. The plaintiff is entitled to its costs.
Appeal allowed.