The Queen (Plaintiff)
v.
Stanley A. Vineberg (Defendant)
and
The Queen (Plaintiff)
v.
Val Royal Corporation (Defendant)
and
The Queen (Plaintiff)
v.
Harlaw Investments Ltd. (Defendant)
Trial Division, Addy J.—Montreal, November
14; Ottawa, December 21, 1973.
Income tax—Rental insurance agreement—Option to pur
chase after fixed sum paid—Overpayment—Reacquisition of
property rights of defendant by payment back to plaintiff—
Whether deductible as business expense or capital outlay—
Income Tax Act, s. 12(1)(a).
Rental insurance agreements between the Central Mort
gage and Housing Corporation and the defendants, as
owners of apartment buildings, gave the Corporation an
option to purchase the properties, after a fixed amount had
been paid on account of rental insurance. When the Corpo
ration gave notice of exercising its option to purchase, the
amount paid by the Corporation was in excess of the limit
agreed upon. The parties agreed to compromise the excess
at the sum of $105,000, and that on repayment of this
amount by the defendants to the Corporation, the latter
would not exercise its right to obtain final title.
The repayment of this amount by the defendants to the
Corporation was assessed by the Minister as not deductible
from income. On appeal by the defendants to the Tax
Review Board, it was decided that the amount was
deductible.
Held, reversing the Tax Review Board, that the expendi
ture is not deductible. Regarding the first test of deductibili-
ty, it is conceded that the expense incurred by the defendant
taxpayers was for the purpose of producing income from the
properties, within section 12(1)(a) of the Income Tax Act,
R.S.C. 1952, c. 148. But as to the second test, as to whether
the payment was an expense relating to capital or income,
the payment was essentially a lump sum payment for the
reacquiring by the defendants of lost property rights and
therefore a capital expenditure.
British Columbia Electric Railway Co. Ltd. v. M.N.R.
58 DTC 1022; Mandrel Industries Inc. v. M.N.R. [1966]
Ex.C.R. 277; Atherton v. British Insulated and Helsby
Cables Ltd. (1925) 10 T.C. 155 (H.L.); Commissioners
of Inland Revenue v. Fleming & Co. (Machinery) Ltd.
(1951) 33 T.C. 57; Duke of Westminster v. C.I.R. (1934-
1935) 19 T.C. 490, considered.
INCOME tax appeal.
COUNSEL:
H. Richard and C. Bonneau for plaintiff.
P. Vineberg for defendants.
SOLICITORS:
Deputy Attorney General of Canada for
plaintiff.
Phillips and Vineberg, Montreal, for
defendants.
ADDY J.—This is an appeal by way of trial de
novo from a finding of the Tax Review Board
who found in favour of the taxpayers herein.
The three cases were ordered to be tried
together.
The facts in issue can best be summarized by
reproducing hereunder the agreed statement of
facts which was filed by consent of all parties at
the outset of the trial. In addition, at trial, a list
of documents was filed on consent. The state
ment of facts reads as follows:
1. The Defendants own various apartment buildings in St.
Laurent, collectively operated and administered by them
under pooling agreements and commonly known as Norgate
Housing Development.
2. Each Defendant entered into an agreement with Central
Mortgage and Housing Corporation (CMHC) for rental
insurance;
3. As a result of vacancies in the leasing of various of the
apartment units, rental insurance payments aggregating
$407,579.95 that were paid by CMHC to Defendants were
included in the taxable income of the Defendants in the
years paid and were taxed accordingly;
4. The tenants were concentrated in certain units and vacan
cies in other units, this method of operating called "stack-
ing" caused some buildings to be filled and others to be left
partially empty, resulting in greater rental insurance pay
ments by CMHC (in view of the minimum co-insurance for
each unit of apartments) than would have been the case if all
vacancies had been spread more or less uniformly amongst
all the building units; the Defendants contended that this
was a more efficient way to operate the buildings;
5. Under the terms and provisions of these contracts, the
Defendants received the following substantial payments of
rental insurance from Central Mortgage and Housing Corpo
ration in relationship to vacancies in the apartments:
Rental Total Excess
Buildings Limit payments paid
4-R1-33 $ 37,864.00 $ 53,486.70 $ 15,622.70
4- $1-34 37,864.00 97,033.17 59,169.17
4-R1-35 37,864.00 64,559.39 26,695.39
4- $1-36 37,864.00 114,118.99 76,254.99
151,456.00 329,198.25 177,742.25
(178,187.00)
38,054.00 78,381.70 40,327.70
$189,510.00 $407,579.95 $ 218,069.95
($ 219,524.00)
6. After various discussions between the parties relative to
the respective rental insurance agreements, the CMHC
served notice on the Defendants under the terms of the said
rental insurance agreements, had the notices registered in
the Registry Office and deposited with the notary the neces
sary cheques representing the price set in the rental insur
ance agreements for the purchase of the properties;
7. Negotiations ensued between the parties and eventually
there was a settlement under which it was agreed that the
owners would pay to Central Mortgage and Housing Corpo
ration an amount of $105,000.00;
8. The said amount of $105,000.00 was a compromised
figure resulting from proposals and counter-proposals made
by the parties during the normal process of negociation [sic];
9. The issue in the present case relates to the tax treatment
of the $105,000.00;
10. The parties agree that the issue shall be resolved on the
basis of the present agreed Statement of Facts and on the
basis of the documents which have been produced. It is
agreed that all the documents speak for themselves and
there are no facts to controvert them;
11. The Parties agree that if the Court shall be of the opinion
that the payments of instalments on account of the $105,-
000.00 under the settlement were non-deductible payments
in calculating the income of the Defendants, then the Appeal
shall be maintained with costs; and if the Court is of the
opinion that the payments of instalments on account of the
$105,000.00 under the settlement is deductible, then the
Appeal shall be dismissed with costs.
The twofold test for determining whether a
particular expenditure is deductible from
income seems to be well settled. One first has to
determine whether, in accordance with section
12(1)(a) of the Income Tax Act, R.S.C. 1952, c.
148, the expense or outlay was made or
incurred by the taxpayer for the purpose of
gaining or producing income from a property or
a business. Counsel for the plaintiff readily
conceded this. Having determined this first part,
one must then address oneself to the question as
to whether the payment is allowable as an
income expense or a capital outlay, since a
capital outlay, even if made to produce income,
is not deductible as an income expense. See
British Columbia Electric Railway Company
Limited v. M.N.R. 58 DTC 1022 at pages
1027-28:
Since the main purpose of every business undertaking is
presumably to make a profit, any expenditure made "for the
purpose of gaining or producing income" comes within the
terms of s. 12(1)(a) whether it be classified as an income
expense or as a capital outlay.
Once it is determined that a particular expenditure is one
made for the purpose of gaining or producing income, in
order to compute income tax liability it must next be ascer
tained whether such disbursement is an income expense or a
capital outlay. The principle underlying such a distinction is,
of course, that since for tax purposes income is determined
on an annual basis, an income expense is one incurred to
earn the income of the particular year in which it is made
and should be allowed as a deduction from gross income in
that year.
I fully agree with the statement of the law and
with the authorities quoted by my brother Cat-
tanach J. in Mandrel Industries, Inc. v. M.N.R.
[1966] Ex.C.R. 277 at page 285:
In order to determine whether a particular outgoing repre
sents an outlay of capital, several tests have been proposed,
one of which is that of Lord President Clyde in Robert
Addie & Sons' Collieries Ltd. v. I.R. 8 T.C. 671 at 676.
Is it an expenditure laid out as part of the process of
profit earning? Or, on the other hand, is it a capital
outlay? Is it expenditure necessary for the acquisition of
property or of rights of a permanent character, the posses
sion of which is a condition of carrying on its trade at all?
The most notable and frequently cited declaration as to what
constitutes a capital outlay is that of Viscount Cave in
British Insulated and Helsby Cables Limited v. Atherton
[1926] A.C. 205 at 213:
. But when an expenditure is made, not only once
and for all, but with a view to bringing into existence an
asset or an advantage for the enduring benefit of a trade, I
think there is very good reason (in the absence of special
circumstances leading to an opposite conclusion) for treat
ing such an expenditure as properly attributable not to
revenue but to capital.
In Vallambrosa Rubber Co. Ltd. v. Farmer 5 T.C. 529,
Lord Dunedin said in part at page 536:
I do not say this consideration is absolutely final or
determinative; but in a rough way I think it is not a bad
criterion of what is capital expenditure to say that capital
expenditure is a thing that is going to be spent once and
for all, and income expenditure is a thing that is going to
recur every year.
In applying the foregoing classical tests to the present
case, I cannot but think that the payment here in question
was an outlay on account of capital. What the appellant did
here was to make a payment once and for all, with a view to
bringing into being an advantage for the enduring benefit of
the trade. There is no question that the payment was made
once and for all.
See also Atherton v. British Insulated and
Helsby Cables, Ltd. [1926] A.C. 205 per Vis
count Cave L.C. at page 213 where he stated
that a useful criterion to determine whether an
outlay was a capital expenditure is to ask one
self whether it is going to be spent once and for
all or whether it is likely to recur every year
(this, of course, is not a final test). He added,
however, that, where an expenditure, in addi
tion, is made with a view to bringing into exist
ence an asset or an advantage of enduring ben
efit there would normally be "very good reason
(in the absence of special circumstances leading
to an opposite conclusion) for treating it as an
expenditure as properly attributable not to reve
nue but to capital." This test was specifically
approved by the Supreme Court of Canada in
British Columbia Electric Railway Co. Ltd. v.
M.N.R., (supra), not as an exhaustive test but as
a useful guide.
The defendants relied on an agreement, filed
at the trial and mentioned in paragraph 7 of the
agreed statement of facts above, wherein the
sum of $105,000.00 paid by the defendants to
C.M.H.C. was expressed to be paid "by way of
rental insurance fund." It was argued that this
simply meant that it was a rebate of payments
made in lieu of rental, which payments, when
originally received by the defendants, were
obviously taxable as income; the rebate would
therefore be deductible. It was further argued
on behalf of the defendants that, since the
agreement was a formal one and was obviously
entered into in good faith and was also the
expression of an arm's length transaction, the
agreement must speak for itself and the Court
should not look behind and indeed could not at
law look behind the actual words used in the
agreement in order to try to determine any other
reason, motive or purpose for the payment
being made. See Commissioners of Inland Reve
nue v. Fleming & Co. (Machinery), Ltd. (1951)
33 T.C. 57 at page 63 as per Lord President
(Cooper):
As was demonstrated in the Duke of Westminster, 19 T.C.
490, [1936] A.C. 1, it is not legitimate to look behind the
form and strict legal effect of a transaction to its so-called
"substance" in order to impose upon a taxpayer a liability
not otherwise enforceable against him ...
The original contract of rental insurance pro
vided that, after a fixed amount was paid, the
plaintiff would have an option to purchase the
lands and premises of the defendants for a price
determined by a fixed formula, and that, in
order to exercise that option, the plaintiff was to
register a notice. This was done and, according
to the original contract of insurance, the plain
tiff then became entitled to a conveyance of the
absolute title to it of the lands and premises in
question. Finally, after negotiations the agree
ment on which the defendants relied was
executed.
The original contract of rental insurance, the
notice exercising the option and the memoran
dum of agreement were undoubtedly executed
bona fide and were intended to be acted upon
by the parties and were not documents used as a
cloak to conceal a different transaction. There
fore, the memorandum of agreement must be
given its fair meaning and cannot be ignored or
treated as operating in a different way than as
expressed by the parties. I also fully agree with
counsel for the defendants to the effect that in
such a case the substance of the transaction is
to be found only by a proper construction of the
agreement and that it should be construed by
what appears on the face of the document and
not by evidence or documents en dehors the
instrument and not embodied in it or referred to
in it. See the Duke of Westminster v. C.I.R.
(1934-35) 19 T.C. 490 at pages 521, 524 and
528.
However, in construing the meaning of any
document and therefore in determining its pur
pose and effect, and, in this particular case, the
reason for payment of the sum of $105,000.00,
two basic principles must be borne in mind:
firstly, the whole of the agreement must be
considered and not only any particular word or
sentence isolated from the remainder of the
document and, secondly, one must also consider
the contents and legal effect of any documents
actually referred to in the agreement and pursu
ant to which the agreement is expressed to have
executed (in this case: the original rental insur
ance agreement, which granted the right to an
option and the registered notice, by which the
plaintiff purported to exercise the option to
assume ownership).
Dealing with the two last-mentioned docu
ments first, the rental insurance agreement
clearly gives an absolute option to purchase the
property after a fixed amount had been paid by
way of rental assurance payments, this option is
not expressed in any way to be by way of
security for monies advanced, because the
monies advanced under the contract are not a
loan but, on the contrary, the owner of the real
estate has an absolute right to these monies and
may retain them. The relevant portions of
clause 3 of the original rental insurance agree
ment read as follows:
3. (a) In consideration of the payment of the said annual
premium, and when claim is established in the manner
hereinafter provided, in respect of any operating year, the
Corporation shall pay to the Builder the amount by which
the gross rentals are less than the insured rentals. Such
insured rentals are the rentals set out in Schedule "A" to
this Contract increased or decreased for any operating year
by an amount equal to the amount by which the taxes and
rates (whether general, special, municipal, ecclesiastical or
school) levied upon or charged against the project for such
operating year is greater or less than the sum of Six thou
sand one hundred and fifty Dollars ($6,150.00) ... .
This clearly provides for an absolute obligation
on the part of the plaintiff to pay. Clause 7 of
the rental insurance agreement reads as follows:
7. At any time after the sum of Thirty-seven thousand Eight
hundred and Sixty-four Dollars ($37,864.00) has been paid
by the Corporation under this Contract, the Corporation
shall have the right and is hereby given an option to pur
chase the project on sixty days' notice in writing to the
owner of the project, at a price of Three hundred thousand
($300,000.00) less 2} per centum per annum thereof from
the first day of December 1949 to the date upon which the
purchase is completed and title to the project is transferred
to the Corporation, and less the sum required to discharge or
radiate all mortgages, privileges, hypothecs, liens and other
charges outstanding against the project, and the owner shall
convey the project to the Corporation free and clear of all
mortgages, privileges, hypothecs, liens and other charges,
except a first mortgage or hypothec made under Section 8B
of the Act, and shall execute all such documents and per
form all such acts as may be requisite to such conveyance.
When title to the project has been transferred to the
Corporation, the Corporation shall have no further obliga
tion under this Contract.
It is provided that if the said option to purchase is not
exercised by the Corporation within two years after the date
when it first becomes exercisable, the option shall be sus
pended until the builder makes a claim after such two-year
period, in which event the option to purchase may be
exercised at any time.
It is, therefore, also clear from this clause that
the option is an absolute one, if exercised
according to its terms: it is absolute in a sense
that it does not purport to be security for the
payment of an advance and it is absolute also in
a sense that it grants an absolute and irrevo
cable right to the property when exercised, the
only remaining obligation being that of the
defendants to execute the required documents
to perfect the plaintiff's title, from a conveyanc-
ing standpoint.
As to the notice of exercising the option it is
common ground that it was given and was prop
erly served and registered. From that moment
the plaintiff had the absolute right to title and
the only duty or obligation remaining on any of
the parties was the defendants' duty to execute
the required formalities to give effect to the
agreement.
After negotiations, which do not form part of
and are not mentioned in the agreement and,
therefore, should not, when interpreting the
agreement, be taken into consideration, the
agreement itself was signed. In addition to the
statement, that the $105,000.00 is to be paid
"by way of rental insurance refund," in five
yearly instalments, it also provides among other
things the following: an acknowledgment that
the plaintiff herein is entitled to become the
absolute owner of the properties and to a deed
of sale thereto, an undertaking on the part of the
Corporation not to exercise its right to obtain
the final title if the owners pay as provided for
in the agreement and in such event also an
undertaking on the part of the plaintiff to cancel
the notices exercising the option and to
renounce its acquired right; finally, the agree
ment provided for certain variations of certain
provisions of the original insurance rental
agreements.
These are the only considerations for the pay
ment of the $105,000.00 flowing from the plain
tiff to the defendants to be found anywhere in
this agreement or any of its incorporated docu
ments. Taking the agreement at its face value,
as urged to do by counsel for the defendants, I
cannot come to the conclusion that the payment
of the $105,000.00 was paid for anything but to
"bring into existence an advantage for the
enduring benefit of the defendants' business"; it
was money paid for the reacquisition of "per-
manent rights—the possession of which is a
condition of carrying on its trade or business,"
and was paid "with a view to bringing into
existence an asset or an advantage for an endur
ing benefit of a trade." It was not paid as an
income expense for the purpose of increasing
income for that or any particular year nor was it
laid out as a part of the income earning process.
Whether a payment is in the nature of an
income payment or a capital expenditure
depends on the nature of the payment and the
purpose for which it was made and not merely
the nomenclature which the parties, however
innocently, happen to attach to it, providing of
course in the case of a bona fide agreement such
true purpose can be gathered from the agree
ment itself. Had the agreement in this case
simply recited that there had been an overpay-
ment of rentals and that the plaintiff was en
titled to a refund, the result would have been
otherwise, but the document, when read by
itself and also when read with the other support
ing documents to which it refers and in pursu
ance to which it purports to have been execu
ted, clearly establishes that it could not in truth
be an insurance rental refund as the word
refund is normally used, that is, in the sense of a
replacement, a payment back, a reimbursement
of insurance money. It is to be noted that there
is not even any mathematical formula or calcu
lation or indication to establish how many
months of insurance premiums are purported to
be refunded or the manner in which the sum
was arrived at.
From the documents themselves I am, there
fore, driven to the conclusion that the payment
of the $105,000.00 was clearly and essentially
and solely a lump sum payment for the reacquir-
ing by the defendants of lost property rights and
it is therefore a capital expenditure. The plain
tiff is therefore entitled to succeed and will have
judgment with its costs. There shall be but one
set of costs throughout except for disburse
ments.
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.