Toronto College Park Ltd. v. The Queen, 94 DTC 6172, [1994] 1 CTC 194 (FCTD)

Simpson, J.:—

Background

The plaintiff, Toronto College Park Ltd. ("TCPL"), appeals reassessments by the Minister of National Revenue (the "Minister") pursuant to section 169 and subsection 172(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). The reassessments concern the proper timing of the deduction of tenant inducement payments and the deductibility of certain landscaping expenses. The evidence adduced related only to the 1983 taxation year. However, the parties have agreed that these reasons will apply to the 1984 and 1987 taxation years.

Tenant inducements

In 1983, TCPL owned a new commercial building located at 777 Bay Street in Toronto (the "building"). It was ready for occupancy but no tenants had been secured. In 1983, according to the statement of agreed facts (the "agreed facts"), TCPL suffered start up rental losses for the building in the amount of $4,853,000.

The agreed facts further indicated that, in 1983, TCPL made two payments (the "payments") which were described as tenant inducements. The first was a payment of $3,569,419 directly to McLean Hunter Ltd. ("MHL"). It was expressed to be for leasehold improvements but there was no obligation on the recipient to use it for that purpose. In any event, the agreed facts provided that it was for MHL's benefit. The second payment was indirect. It was made to contractors who were employed by the Ministry of Government Services ("MGS"). It was a payment of $1,723,289 and was made for the benefit of MGS. It was agreed that the payments were made in the ordinary course of TCPL's business and no issue was taken with the amounts or their bona fides. It was also agreed that the payments were made to earn income.

The issue is when the payments can be deducted under the Act. TCPL submitted that it was entitled to deduct the payments in full in the year in which they were made. The Crown argued that the payments ought to have been amortized and matched against future rental revenues. The MHL lease was for a period of 20 years with provision for a five-year renewal. The MGS lease was for a term of 11 years and five months. The Crown accordingly took the position that the payments should have been deducted over 25 years in the case of MHL and 11 years and five months in the case of MSG. TCPL, on the other hand, relied on the decision in Cummings v. The Queen, [1981] C.T.C. 285, 81 D.T.C. 5207 (F.C.A.) to support its deduction of the payments in the year in which they were made.

The case law

Cummings, supra, concerned, inter alia, the nature and deductibility of a payment of $200,000 by a prospective landlord to the owners of Place Ville Marie ("PVM") in Montreal. The payment was made to free a prospective tenant from its lease obligations at PVM. This payment was described as a lease pick-up payment.

The Court of Appeal decided that the lease pick-up payment was an income expenditure and then went on to consider its deductibility. In so doing, the Court of Appeal relied at pages 290-91 (D.T.C. 5210) of its decision on the following passage from Oxford Shopping Centres Ltd. v. The Queen, [1980] C.T.C. 7, 79 D.T.C. 5458 at page 18 (D.T.C. 5466-67) (F.C.T.D.); aff'd [1981] C.T.C. 128, 81 D.T.C. 5065 (F.C.A.):

I think it follows from this that for income tax purposes, while the “matching principle” will apply to expenses related to particular items of income, and in particular with respect to the computation of profit from the acquisition and sale of inventory, it does not apply to the running expense of the business as a whole even though the deduction of a particularly heavy item of running expense in the year in which it is paid will distort the income for that particular year. Thus while there is in the present case some evidence that accepted principles of accounting recognize the method adopted by the plaintiff in amortizing the amount in question for corporate purposes and there is also evidence that to deduct the whole amount in 1973 would distort the profit for that year, it appears to me that as the nature of the amount is that of a running expense that is not referable or related to any particular item of revenue, the footnote to Associated Industries of Can. Ltd. v. M.N.R., [1967] C.T.C. 138, 67 D.T.C. 5096 (Ex. Ct.), and the authorities referred to by Jackett, P., and in particular Vallambrosa Rubber Co. v. Farmer (1910), 5 T.C. 529, and Naval Colliery Co. v. C.I.R. (1928), 12 T.C. 1017, indicate that the amount is deductible only in the year in which it was paid. All that appears to me to have been held in M.N.R. v. Tower Investment Inc., [1972] C.T.C. 182, 72 D.T.C. 6161 (F.C.T.D.), and by the trial judge and LeDain, J. in Canadian Glassine Co.v. M.N.R., [1974] C.T.C. 63, 74 D.T.C. 6089 (F.C.T.D.); [1976] C.T.C. 141, 76 D.T.C. 6083 (F.C.A.), is that it was nevertheless open to the taxpayer to spread the deduction there in question over a number of years. It was not decided that the whole expenditure might not be deducted in the year in which it was made, as the earlier authorities hold. And there is no specific provision in the Act which prohibits deduction of the full amount in the year it was paid. I do not think, therefore, that the Minister is entitled to insist on an amortization of the expenditure or on the plaintiff spreading the deduction in respect of it over a period of years.

In Cummings, supra, Mr. Justice Heald concluded with respect to various payments including the payment to PVM at page 291 (D.T.C. 5211-12):

It seems clear to me that subject expenditure was a "running expense” and in the same category as for example, an extensive advertising campaign to obtain tenants or an offer to a prospective tenant of a rent-free period as an inducement to enter into a long-term lease or a finder's fee for obtaining tenants and leases. As Mr. Vineberg characterized it, the $790,000 was spent to “prevent a hole in income", said moneys being spent "to plug the hole”.

Accordingly, and for the foregoing reasons, I have concluded that the said sum of $790,000 was a current expenditure.

TCPL argued that the Cummings decision is binding authority even though the type of lease inducement before the Court of Appeal in Cummings was a lease pick-up payment and this case concerns inducements in the form of payments for leasehold improvements and indirect payments to third party contractors. It was TCPL's position that the form of the inducement is not important and that, if a payment is in the nature of an inducement, it is a "running expense that is not referable or related to any particular item of revenue" to use the language quoted above from the Oxford decision, supra.

The Crown submitted that, in Cummings, matching the expense against future lease revenues and deducting it over time was not possible because Mr. Cummings and his associates had sold the relevant property. The Crown concluded that the fact that matching was impossible was the underlying rationale for the decision to allow the deduction in one year. The Crown therefore suggested that the Cummings decision should serve as a precedent only in situations where matching cannot occur. However, Crown counsel acknowledged that Mr. Justice Heald made no reference to a concern about the impossibility of matching as a factor in reading his decision. Given the detailed nature of His Lordship's reasons I am not prepared to limit the applicability of Cummings by inferring that an unexpressed concern about the impossibility of matching supported his reasoning.

The Crown also argued that Cummings is not a binding authority because it is limited to a consideration of lease pick-up costs. Accordingly, comments referring to other types of tenant inducements and running expenses are obiter dicta. This is true but, in my view, Cummings does serve as authority for three general propositions. Firstly, certain tenant inducements may be classified as running expenses. Secondly, running expenses may, in some cases, be deducted in the year of the expense and, thirdly, the matching principle does not apply to running expenses.

In Associated Investors of Canada Ltd. v. M.N.R., [1967] C.T.C. 138, 67 D.T.C. 5096 (Ex. Ct.) at page 143 (D.T.C. 5098), Jackett, P. described running expenses using the language from the decision of Rowlatt, J. in Naval Colliery Co. v. C.LR. (1928), 12 T.C. 1017, as being those expenses of a business which cannot be allocated directly to corresponding items of receipts in a particular year. The quotation continued:

If running repairs are made, if lubricants are bought, of course no enquiry is instituted as to whether those repairs were partly owing to wear and tear that earned profits in the preceding year or whether they will not help make profits in the following year and so on. The way it is looked at, and must be looked at, is this, that sort of expenditure is [an] expenditure incurred on the running of the business as a whole in each year and the income is the income of the business as a whole for the year without trying to trace items of expenditure as earning particular items of profit.

In the view of Jackett, P. these kinds of expenses, which are incapable of being allocated against revenues, must be deducted in the year made or not at all.

The decision in M.N.R. v. Tower Investment Inc., [1972] C.T.C. 182, 72 D.T.C. 6161 (F.C.T.D.), related to intensive advertising campaign expenses which were classified as running expenses. Contrary to Associated Investors, supra, the taxpayer in Tower Investments took deductions in years other than those in which the payments were made and that treatment was allowed on the basis that, with such advertising, the benefit must reasonably be expected to extend over several years. The deferral of some of the advertising expense was permitted because the deferral accorded with the Generally Accepted Accounting Principles’ ("GAAP") requirement for the matching of income and expenses to more accurately reflect the taxpayer's true income position.

Finally, in Cummings, supra, the lease pick-up cost was identified as a running expense and the taxpayer was permitted to deduct it all in the year made on the basis that was a "current" expenditure. In this context I have taken current to mean that the primary benefit was obtained in the year in which the payment was made because the benefit was the signing of a lease with a new tenant.

Conclusion

I have concluded that the case law suggests the following approach.

1. I should determine first whether the expense is a running expense in the sense that it cannot be specifically allocated to a matching revenue item.

2. If the expense is a running expense, I must decide whether it is current or whether the benefit extends beyond the year of payment even though it cannot be matched as the revenues it generates are non specific.

3. If I conclude that the benefit of a running expense extends beyond the year of the expense, a taxpayer has two options. It may either deduct in the year of the expense, even if the income picture is somewhat distorted, or defer the deduction if deferral accords with GAAP and creates a truer income picture. In applying the above analysis to this case, I have found that the payments were running expenses, There was some evidence that, during the negotiations, the calculation of the total rent to be charged to MHL and MGS included amounts which represented the payments amortized over the rent. These amounts changed as the negotiations developed and there was no evidence that the final rent charged included specific amounts attributable to the payments. On these facts, I am satisfied that the payments were current running expenses because their primary objective, which was to attract tenants to the building, was achieved in the year of the expense. Any secondary benefits in the form of non specific revenues from the tenancies were too imprecise to affect this conclusion.

It is clear that there is no obligation imposed by the case law or by the Act to defer in the case of a current running expense. Accordingly, the deduction of the full amount of the payments in 1983 is allowed.

I should note that there was no evidence before me about whether deferral or immediate deduction produced a truer picture of the TCPL's income. Much was made of who bore the onus to adduce such evidence in the circumstances of this case. However, the search for a truer picture is not relevant in the case of a running expense which the taxpayer does not elect to defer. As the taxpayer did not so elect in this case, I have not found it necessary to resolve the question of who bore the onus of proof on this issue.

Landscaping

Two issues arise under this heading. Firstly, is a deduction for landscaping possible when TCPL did not own the land and, secondly, must the deduction be limited to expenses for earth and growing things?

In this case TCPL landscaped a public park which adjoined the building. It did not own the parkland in question. I am satisfied that, on a plain reading of paragraph 20(1 )(aa) (the "paragraph") of the Act, ownership of land is not a condition precedent to the deductibility of landscaping expenses. I do not even find the paragraph ambiguous on this issue. This view is bolstered by Interpretation Bulletin IT-296 entitled Landscaping of Grounds which, while not binding on the Crown, does provide an insight into the meaning of the paragraph. It requires the taxpayer to own a building but imposes no ownership requirement on the landscaped property.

A deduction for landscaping by TCPL is therefore allowed and the final issue is the amount of the deduction. The parties agreed that the following amounts were spent to create the public park.

Landscaping is not defined in the Act. However, Interpretation Bulletin IT-296 provides:

As the word “landscaping” is not defined in the Act, it must be given its generally accepted meaning. This means that the work is being done with aesthetic considerations, rather than utility alone, in mind, and one of its principal objects must be beautification of the area. Landscaping is not restricted, however, to the planting of trees or shrubs, the laying out and planting of flower beds or the laying of sod; it would extend even to the changing of the contour or the slope of land to improve the appearance of a building or of the grounds around it. However, the making of sidewalks or paths and the excavating or filling of land to provide, say, a level area for a parking lot or simply to improve its drainage would not be landscaping that land but would be capital expenditures that might qualify for inclusion under schedule B of the Regulations.

TCPL provided the following definitions found in Websters’ Dictionary (1987):

landscape: to engage in landscape gardening or landscape architecture.

landscape architecture: the planning, modifying and arranging of a large piece of land with an eye to scenic beauty, esp. with reference to the siting of roads, buildings etc.

landscape gardening: the planning and planting of gardens and grounds, esp. so as to produce picturesque and harmonious effects.

I am not prepared to read the definition of landscape architecture into the Act insofar as it extends to the siting of roads and buildings. However, I accept that landscape in an urban context means significantly more than the planning and planting of gardens and grounds. In an urban context, the "earth and growing things” limitation sought by the Crown is too narrow.

I have concluded that landscaping under the Act involves alterations to the earth's surface achieved by manipulating or reforming that surface to provide a more attractive and accessible environment. Landscaping expenses would therefore include expenditures for earth and growing things, pathways and sidewalks and reflecting pools and fountains. However, landscaping does not include the provision of moveable surface items such as statues. Accordingly, deductions for landscaping may be taken in respect of items 1, 2, 3 and 4 above.

The judgments in these matters will follow as the parties have agreed to submit draft judgments in accordance with my reasons for each of the three files before the Court.

Appeal allowed in part.