Minister of National Revenue (Appellant)
v.
Tower Investment Inc. (Respondent)
Trial Division, Collier J.—Montreal, March 17;
Ottawa, April 10, 1972.
Income tax—Business profits, computation of—Alloca-
tion of advertising expenses on principle of matching reve
nues and costs—Application of accounting principles.
Respondent company built 24 apartment buildings con
taining 660 apartments in 1963 and 1964 and spent $92,351
in advertising for tenants in 1963, $58,595 in 1964 and
$2,354 in 1965. In computing its income for those years,
however, respondent allocated the advertising expenditures:
$7,351 to 1963, $63,595 to 1964 and $82,354 to 1965. In
assessing respondent the Minister allowed the actual adver
tising expenditures to be- deducted in each of the three
years. The Tax Appeal Board reversed the Minister's deci
sion and the Minister appealed.
Held, that the appeal is dismissed. The respondent's allo
cation of the advertising expense to the three years was, on
the evidence, most appropriate having regard to the
accounting principle of matching costs with revenues.
Associated Investors of Can. Ltd. v. M.N.R. [1967]
Ex.C.R. 96, applied; Steer v. M.N.R. [1965] Ex.C.R.
458, referred to.
INCOME tax appeal.
Paul A. Boivin, Q.C. for appellant.
Philip F. Vineberg, Q.C. for respondent.
COLLIER J.—This is an appeal from a deci
sion of the Tax Appeal Board [1969] Tax
A.B.C. 769. The Minister had re-assessed the
present respondent for its taxation years 1963,
1964 and 1965 and it successfully appealed to
the Tax Appeal Board.
The evidence before this Court consisted of
the evidence and proceedings before the Board
with the addition of evidence from one witness
called on behalf of the respondent.
The issue is whether the respondent must
deduct in each of the years in question the
actual amount laid out in that year for advertis
ing expenses (as contended by the Minister) or
whether it is entitled to defer some portion of
these amounts into subsequent years in accord
ance with ordinary commercial principles or
well-accepted principles of business and
accounting practice subject, always, to any spe
cial directions in the Income Tax Act (as con
tended by the respondent).
The facts are really not in dispute and I adopt
the following excerpts from the reasons for
judgment of the assistant chairman of the
Board. (The "appellant" referred to in these
excerpts is the taxpayer):
Appellant describes itself as a realty company and has a
fiscal period ending on 31st August. Its first taxation year
of activity appears to have been 1963. In that year, on farm
land in a sparsely-occupied area about ten miles from the
core of Montreal acquired in September, 1962, appellant
proceeded with the erection of 24 apartment buildings that
were to contain 660 apartments. There was also to be a
"shopette" for the convenience of tenants. The whole pro
ject was duly completed in about fourteen months and
became available for renting. Some of the apartments were
furnished by the appellant, but the majority were not.
In order to obtain tenants, an intensive advertising cam
paign was conducted; it was such as had never been waged
before. About every known means of attracting prospective
tenants was devised and exercised incessantly, including the
singing of a jingle. Radio was the medium mostly used; no
real estate agents were employed. The radio announcements
were so frequent and repeated over such a lengthy period
that people even began to complain of the unceasing flow of
advertising that was forced upon them daily by appellant's
publicity agents. Nevertheless, good results were obtained
and by October, 1964, a ninety-per-cent occupancy had
been achieved. The cost of all this advertising was heavy, as
may be supposed, and amounted to $153,301.78 in all.
However, the rental income thereby generated grew to
$674,328.16 in 1964. Appellant later deducted the first-
mentioned sum from its taxable income in the following
proportions: $7,351.01 in 1963; $63,595.87 in 1964, and
$82,354.90 in 1965, in which year the entire undertaking
was sold, rather unexpectedly it would appear, for over
$4,425,000.00. The respondent did not approve of this
procedure and considered that the appellant had improperly
deferred deducting the said advertising expense at one fell
swoop and, instead, had deducted such proportions thereof
as it saw fit in'the three years under appeal. The appellant's
right to deduct the advertising expense is not questioned; it
is the method of doing so that is challenged. There is also no
dispute as to the correctness of the figures involved.
I add at this point the following: the actual
amounts expended for advertising were $92,-
351.01 in 1963, $58,595.87 in 1964; and $2,354
in 1965.
With respect to the sale of the undertaking in
1965, the assistant chairman said this and,
again, I adopt his language:
Abe Weitzman, the first and other witness who testified,
stated that he and Kenneth Wolof sky, a builder, were the
appellant's promoters and that, originally, the firm intention
had been to retain the buildings erected; not to sell them.
Later, however, differences arose between the two men
and, rather than continue in what he claimed was an unten
able situation, Weitzman ultimately gave in. He said: "I
went along with my partner and we sold." This occurred in
October, 1964, or within the appellant's 1965 taxation year,
which ended on 31st August, 1965. There is nothing in the
evidence adduced to suggest that Messrs. Weitzman and
Wolofsky knew before October, 1964, that the sale of the
project would be made; in fact, Weitzman specifically
denied that there was ever any intention to sell. It was only
when an unsolicited offer was received, in 1964, that
proved too tempting to Wolofsky that the question of
whether to sell, or not to sell, ever arose and it was
Wolofsky alone who then insisted on selling.
The decision to sell having been arrived at—albeit reluc
tantly, where Weitzman was concerned—it became a case
of "now or never" as regards deducting the balance remain
ing of the advertising expense and quite understandably this
balance was therefore deducted from appellant's income for
the 1965 taxation year. It appears to me that his was the
logical course to adopt in the circumstances disclosed.
The respondent called as a witness before the
Tax Appeal Board a chartered accountant who
had prepared its financial statements. This was
Harry Stein who had 33 years' experience. In
his opinion the procedure adopted in this case
was the most appropriate and in accordance
with well-accepted accounting principles; that
is, when an intensive advertising campaign is
such that the benefit must reasonably be
expected to extend over future years the prac
tice is to charge a certain proportion of the
expense to those years instead of deducting the
whole expenditure from the income of the pre
vious year. Mr. Stein referred to accounting
textbooks and other publications to support his
position.
On the appeal to this Court, an independent
chartered accountant, Howard Gilmour, was
called on behalf of the respondent. He testified
that the method used by the respondent for the
years in question was in accordance with recog
nized accounting practice and involved the
proper matching of revenue and expense. He
said the essence of accrual accounting was
based on the matching principle and this
demanded a certain amount of judgment on the
part of the individual accountant or his client as
to how one should proportion these advertising
expenses over the subsequent years.
As was the case with Mr. Stein, Mr. Gilmour
supported his evidence with excerpts from vari
ous textbooks on accounting and other
publications.
Generally speaking, the evidence here and
before the Tax Appeal Board was that on the
facts of this particular case the method adopted
by the taxpayer of deferring some of the adver
tising expense into future years was not only in
accordance with generally accepted accounting
principles but also more accurately reflected the
truth about the taxpayer's income position.
The appellant, both in the Tax Appeal Board
and in this Court, did not adduce any evidence
to challenge or contradict Mr. Stein or Mr.
Gilmour. The appellant argues the decision of
the Tax Appeal Board is wrong:
(1) The principle of matching revenue and
expense has not been accepted by the Courts
and is not permissible under the Income Tax
Act, except under certain special provisions
of the Act.
(2) As a matter of law under the Income Tax
Act expenditures such as the ones here must
be deducted in the year in which they are laid
out and cannot be deferred.
Counsel for the appellant chose to argue this
case as a matter of general principle. I propose,
so far as possible, to confine my decision to the
facts of this particular case.
In my view, the first contention advanced by
the appellant is too broad. As was said by
Thorson P. in Publishers Guild of Canada Ltd.
v. M.N.R. [1956-60] Ex.C.R. 32 at p. 50:
... the prime consideration, where there is a dispute about a
system of accounting is, in the first place, whether it is
appropriate to the business to which it is applied and tells
the truth about the taxpayer's income position and, if that
condition is satisfied, whether there is any prohibition in the
governing income tax law against its use.
I do not find there is any prohibition in the
statute against the matching system. In fact, it
was held appropriate under the particular cir
cumstances of the case by Kerr J., in Sherritt
Gordon Mines Ltd. v. M.N.R. [1968] 2 Ex.C.R.
459 at p. 481. I quote from p. 481 of the
judgment:
I am satisfied that at least where the amount is significant
in relation to the business of a company, it is in accordance
with generally accepted business and commercial principles
to charge, as a cost of construction, payments of interest in
respect of the construction period on borrowed money
expended by the company for such construction and to
write such payments off over a period of years. The prac
tice of doing so is not as common outside the public utility
field as within that field but it has extended to companies
outside that field.
The facts in the case referred to were quite
different from the facts in the present case.
In my view, the system used here more accu
rately sets forth the respondent's true income
position: for instance, by its method it showed
some profit for the year 1963; by the appel
lant's method it would have shown a loss.
It seems to me the main argument advanced
by the appellant was the second one I have
referred to earlier. A number of authorities
were cited but in my opinion many of them are
distinguishable in that they did not involve,
either directly or by analogy, the point in issue
here. I shall refer to only those cases which
appear to be directly on point.
In Consolidated Textiles Ltd. v. M.N.R.
[1947] Ex.C.R. 77, the taxpayer sought to
deduct certain operating expenses incurred in
1938 from its 1939 income. That case arose
under the Income War Tax Act. Thorson P.
held at pp. 82-83:
In my opinion, section 6(a) excludes the deduction of
disbursements or expenses that were not laid out or expend
ed in or during the taxation year in respect of which the
assessment is made. This is, I think, wholly in accord with
the general scheme of the Act, dealing as it does with each
taxation year from the point of view of the incoming
receipts and outgoing expenditures of such year and by the
deduction of the latter from the former with a view to
reaching the net profit or gain or gratuity directly or indi
rectly received in or during such year as the taxable income
of such year.
In my opinion, that case is distinguishable;
without going into detail, the relevant sections
considered by Thorson P. are substantially dif
ferent from the relevant sections of the present
Act.
In L. Berman & Co. v. M.N.R. [1961] C.T.C.
237, Thorson P. considered whether certain
payments made by the taxpayer were proper
deductions within the present section 12(1)(a)
of the Income Tax Act, R.S.C. 1952, c. 148. He
found the payments in question there were
properly deductible. The taxpayer had sought to
deduct all the payments from the 1956 receipts,
including some made in 1955. Thorson P.
referred to the Consolidated Textiles case and
held the deductions could only be claimed in the
year they were laid out. He said at p. 249:
But the appellant is not entitled to deduct from what
would otherwise have been its taxable income for 1956 all
the payments made by it. The payments made in September
and December, 1955, are not deductible. I had occasion to
consider a similar question in Consolidated Textiles Limited
v. M.N.R. [1947] Ex.C.R. 77; [1947] C.T.C. 63. In that case
the appellant, a manufacturer of lingerie fabrics, in making
its income tax return for the year 1939, sought to deduct
from its 1939 receipts certain operating expenses incurred
in 1938. The deduction was disallowed by the Minister and
the appellant appealed. I agreed with the Minister and held
that Section 6(a) of the Income War Tax Act excluded the
deduction of disbursements or expenses that were not laid
out or expended in or during the taxation year in respect of
which the assessment was made. Consequently, I hold that
the appellant was not entitled to deduct from its 1956
receipts any of the payments made by it in 1955. My
reasons for doing so are the same as those set out in the
case to which I refer and I include them, mutatis mutandis,
in these reasons.
Similarly, Thorson P. in Rossmor Auto
Supply Ltd. v. M.N.R. [1962] C.T.C. 123 at p.
126 again referred to his previous judgment in
the Consolidated Textiles Limited case.
The aspect of the Rossmor case which dealt
with the year in which a deduction must be
claimed was commented on by Jackett P. (now
the Chief Justice of this Court) in Associated
Investors of Canada Ltd. v. M.N.R. [1967] 2
Ex.C.R. 96 in a footnote at pp. 100-101. I set
out the footnote in full here and, respectfully,
adopt it.
A submission was also made that section 12(1)(a) of the
Income Tax Act, which reads as follows:
12. (1) In computing income, no deduction shall be made
in respect of
(a) an outlay or expense except to the extent that it was
made or incurred by the taxpayer for the purpose of
gaining or producing income from property or a business
of the taxpayer,
must be interpreted as prohibiting the deduction in the
computation of profit from a business for a year of any
outlay or expense not made or incurred in that year. In
support of this submission, reliance was placed on Rossmor
Auto Supply Ltd. v. M.N.R. [1962] C.T.C. 123, per Thorson
P. at page 126, where he said, "As I view Section 12(1)(a),
the outlay or expense that may be deducted in computing
the taxpayer's income for the year ... is limited to an outlay
or expense that was made or incurred by the taxpayer in the
year for which the taxpayer is assessed" (the italics are
mine). If this view were a necessary part of the reasoning
upon which the decision in that case was based, I should
feel constrained to follow it although, in my view, it is not
based on a principle that is applicable in all circumstances.
In that case, however, the loan was clearly not made in the
course of the appellant's business and the President so held.
In my view, while certain types of expense must be deduct
ed in the year when made or incurred, or not at all, (e.g.,
repairs as in Naval Colliery Co. Ltd. v. C.I.R. (1928) 12
T.C. 1017, or weeding as in Vallambrosa Rubber Co., Ltd.
v. Farmer, (1910) 5 T.C. 529), there are many types of
expenditure that are deductible in computing profit for the
year "in respect of" which they were paid or payable.
(Compare sections 11(1)(c) and 14 of the Act.) This is, for
example, the effect of the ordinary method of computing
gross trading profit (proceeds of sales in the year less the
amount by which opening inventories plus cost of purchases
in the year exceeds closing inventories) the effect of which
(leaving aside the possibility of market being less than cost)
is that the cost of the goods sold in the year is deducted
from the proceeds of the sale of those goods even though
the goods were acquired and paid for in an earlier year. This
is, of course, the only sound basis for computing the profits
from the sales made in the year. Compare I.R.C. v. Gardner
Mountain & D'Ambrumenil, Ltd., (1947) 29 T.C. per Vis
count Simon at page 93: "In calculating the taxable profit of
a business ... services completely rendered or goods sup
plied, which are not to be paid for till a subsequent year,
cannot, generally speaking, be dealt with by treating the
taxpayer's outlay as pure loss in the year in which it was
incurred and bringing in the remuneration as pure profit in
the subsequent year in which it is paid, or is due to be paid.
In making an assessment ... the net result of the transac
tion, setting expenses on the one side and a figure for
remuneration on the other side, ought to appear ... in the
same year's profit and loss account, and that year will be
the year when the service was rendered or the goods
delivered." (Applied in this Court in Ken Steeves Sales Ltd.
v. Minister of National Revenue, [1955] Ex.C.R. 108, per
Cameron J. at page 119). The situation is different in the
case of "running expenses". See Naval Colliery Co. Ltd. v.
C.I.R., supra, per Rowlatt J. at page 1027. "... and expend
iture incurred in repairs, the running expenses of a business
and so on, cannot be allocated directly to corresponding
items of receipts, and it cannot be restricted in its allowance
in some way corresponding, or in an endeavour to make it
correspond, to the actual receipts during the particular year.
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 to make profits
in the following year and so on. The way it is looked at, and
must be looked at, is this, that that sort of expenditure is
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".
See also Riedle Brewery Ltd. v. Minister of National Reve
nue, [1939] S.C.R. 253. With regard to the flexibility of
method permitted under the Income Tax Act for computing
profit, see Cameron J. in the Ken Steeves case, supra, at
pages 113-4.
In my view, the distinctions made by Jackett
P. are applicable in a case such as this. The
advertising expenses laid out here were not
current expenditures in the normal sense. They
were laid out to bring in income not only for the
year they were made but for future years.
I have therefore concluded that the treatment
of the advertising expenses by the respondent
in this case was proper and not prohibited by
the Income Tax Act.
I refer to the judgment of Noël J. (now the
Associate Chief Justice of this Court) in Steer v.
M.N.R. [1965] Ex.C.R. 458) He said at pp.
466-7:
If the problem were merely one of determining the profit
from the whole life span of a business undertaking or other
source of income, it would be relatively simple. When the
undertaking or other source comes to an end, you add up all
the receipts therefrom and deduct all the expenses thereof
and the balance is the profit or loss. Under the Income Tax
Act, it is not so simple because you must determine the
taxpayer's profit from a source for each taxation year. This
raises problems of allocation as between various years
where the life of the undertaking or other source extends
over more than one year. These problems have been solved
for the most part in the case of businesses and other
sources that fall into common categories. The solutions
adopted, however, vary greatly even within the same
categories. It may well be acceptable to adopt a "cash
basis"—i.e., taking into account for each year any cash
receipts and cash expenditures in the year—for one busi
ness and equally acceptable to adopt, for a very similar
business, some quite sophisticated so-called "accrual
basis".
The appeal is dismissed with costs.
This decision was reversed on appeal ([1967] S.C.R. 34).
In my opinion, the excerpt quoted is an obiter dictum, but I
consider it appropriate to this case.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.