Judgments

[1995] 2 F.C. 232

A-62-94

Her Majesty the Queen (Appellant)

v.

Canderel Limited (Respondent)

Indexed as: Canada v. Canderel Ltd. (C.A.)

Court of Appeal, Stone, Desjardins and Robertson JJ.A.—Ottawa, November 22, 23, 24, 25, 1994 and February 13, 1995.

Income tax — Income calculation — Deductions — Appeal from T.C.C. decision allowing commercial real estate developer to deduct full amount of tenant inducement payments in year made — GAAP permitting both amortization of payments over life expectancy of leases and deduction of full amount in year made — Method presenting truer picture of taxpayer’s revenue, more fairly and accurately portraying income, matching revenue and expenses to be followed — Whether TIPs in nature of “running expenses” — Not incurred to earn income only in 1986, but during terms of leases — Could be matched with revenue.

This was an appeal from a Tax Court of Canada decision that the total amount of payments made to induce tenants to enter into leases was deductible in the 1986 taxation year, the year in which they were made. Taxpayer was a commercial real estate developer and manager. As property manager of a commercial building in Ottawa, it had to find tenants before or shortly after project completion, or suffer adverse consequences. Market conditions were difficult and, upon opening, the building was only 2.3% leased. Lease inducement payments were made to tenants on the signing of 3 to 10 year leases. Taxpayer deducted its share of tenant inducement payments (TIPs) made in the 1986 taxation year as an expense incurred to earn business income. The Minister disallowed the deduction, but allowed taxpayer a deduction of the amount realized when each of the TIPs was amortized over the initial term of the lease in respect of which the it had been made. The Tax Court Judge applied case law as rejecting both the need for a causal connection between a particular expenditure and a particular receipt, and the suggestion that a receipt must arise in the same year as an expenditure was incurred. He held that the TIPs were running expenses, and that “matching” or amortizing the payments over the life expectancy of the respective leases was not the appropriate method of profit calculation for tax purposes. In 1986, generally accepted accounting principles (GAAP) permitted both the expensing and the amortization methods for financial reporting purposes. The Tax Court also found that there was no legal requirement for consistency in accounting methods between financial statements and income calculations, and that it was not required in law to follow the GAAP rules.

The appellant submitted that where two methods are acceptable under GAAP which are also acceptable for tax purposes, the Court will prefer the one that results in a “truer picture” of the taxpayer’s profit.

Held, the appeal should be allowed.

Per Stone J.A. (Robertson J.A. concurring): The matching principle is that whichever method presents the “truer picture” of a taxpayer’s revenue, which more fairly and accurately portrays income, and which “matches” revenue and expenditure, if one method does, is the one that must be followed. In law, as in accountancy, current expenses need not be matched with corresponding items of revenue for tax purposes if they are “running expenses” to be deducted in the year in which they are incurred. The TIPs did not fit the classical description of “running expenses,” although it was arguable that they were in the nature of running expenses in that they represented a cost of doing business in the 1986 taxation year, and also that the respondent would likely have faced significant financial disadvantages if they had not been laid out and did achieve significant financial advantages by incurring them. An expenditure becomes deductible in the year in which it was incurred even if the whole of the expenditure did not bear fruit in that year. In the present case, the expenditures were not incurred in earning income solely in 1986, but in all of the years during which the respective leases were to run. The expenses could be matched with revenue from the particular leases in accordance with the matching principle. That they could be so matched is evident from the fact that they were matched for financial reporting purposes.

Per Desjardins J.A.: Prima facie, a taxpayer’s income for a year from a business is his profit therefrom for the year. Profit is the surplus by which receipts exceed expenditures necessary to earn them. It is to be determined in the sense in which the word is understood by businessmen or, in accordance with “well accepted principles of business (or accounting) practice” or “well accepted principles of commercial trading” unless they run counter to an express statutory provision.

The question that must be addressed is which method most accurately shows the profit from the year’s operation? The “matching principle” applies to expenses related to particular items of income, but does not apply to the running expense of the business as a whole. At issue therefore is whether the TIPs were expenses related to a particular item of income, or whether they were running expenses. If they were related to a particular item of income, the “matching principle” applies. If they were running expenses, the taxpayer will have the option of deducting the amount in full or amortizing it. TIPs are clearly expenses related to particular items of income. They were not running expenses, the essence of which is that they are akin to an overhead item which cannot be traced to specific items of revenue. There is a direct contractual relationship between the TIP and the stream of revenues gained over the period of the lease. Matching of the TIPs was compulsory. In calculating the taxable profit of a business, services completely rendered or goods supplied, which are not to be paid for until a subsequent year, cannot be dealt with by treating taxpayer’s outlay as pure loss in the year in which it was incurred and bringing in the remuneration as pure profit in the year that it is paid. The respondent is in a service industry, namely commercial rentals. TIPs are to be deducted as the services are rendered, that is, over the period of the lease. The TIPs disbursed by taxpayer in 1986 were to be amortized over the life of the respective leases. The amortization method is the only method acceptable for income tax purposes.

STATUTES AND REGULATIONS JUDICIALLY CONSIDERED

Income Tax Act, S.C. 1970-71-72, c. 63, ss. 9(1), 12(1)(b) (as am. by S.C. 1980-81-82-83, c. 140, s. 4), 18(1)(a).

Income War Tax Act, R.S.C. 1927, c. 97.

CASES JUDICIALLY CONSIDERED

APPLIED:

West Kootenay Power and Light Co. v. Canada, [1992] 1 F.C. 732 [1992] 1 C.T.C. 15; (1991), 92 DTC 6023; 136 N.R. 146 (C.A.).

DISTINGUISHED:

Oxford Shopping Centres Ltd. v. R., [1980] 2 F.C. 89 [1980] 1 CTC 7; (1979), 79 DTC 5458 (T.D.); affd R. v. Oxford Shopping Centres Ltd., [1982] 1 F.C. 97 [1981] CTC 128; (1980), 81 DTC 5065 (C.A.); Cummings (J L) v The Queen, [1981] CTC 285; (1981), 81 DTC 5207; 37 N.R. 574 (F.C.A.).

CONSIDERED:

Naval Colliery Company, Limited v. Commissioners of Inland Revenue (1928), 12 T.C. 1017 (K.B.); Duple Motor Bodies, Ltd. v. Ostime (1961), 39 T.C. 537 (H.L.); Symes v. Canada, [1993] 4 S.C.R. 695; (1993), 94 DTC 6001; Maritime Telegraph and Telephone Co. v. Canada, [1992] 1 F.C. 753 (1992), 92 DTC 6191; 140 N.R. 284 (C.A.); affg. [1991] 1 C.T.C. 28; (1991), 91 DTC 5038 (F.C.T.D.); Friedberg (A.D.) v. Canada, [1992] 1 C.T.C. 1; (1991), 92 DTC 6031; 135 N.R. 61 (F.C.A.); Friedberg v. Canada, [1993] 4 S.C.R. 285; [1993] 2 C.T.C. 306; (1993), 93 DTC 5507; 160 N.R. 312; Russell v. Town and County Bank (1888), 13 App. Cas. 418 (H.L.); Minister of National Revenue v. Canadian Glassine Co. Ltd., [1976] 2 F.C. 517 [1976] CTC 141; (1976), 76 DTC 6083; 12 N.R. 382 (C.A.); Rossmor Auto Supply Ltd. v. M.N.R., [1962] C.T.C. 123; (1962), 62 DTC 1089 (Ex. Ct.); Commissioners of Inland Revenue v. Gardner, Mountain & D’Ambrumenil, Ltd. (1947), 29 T.C. 69 (H.L.); The Queen v. Remington (1994), 94 DTC 6549 (F.C.A.); Mattabi Mines Ltd. v. Ontario (Minister of Revenue), [1988] 2 S.C.R. 175; (1988), 53 D.L.R. (4th) 656; [1988] 2 C.T.C. 294; 87 N.R. 300; 29 O.A.C. 268; Vallambrosa Rubber Company, Limited v. Farmer (1910), 5 T.C. 529 (Ct. Sess.); Silverman, Harry v. Minister of National Revenue, [1961] Ex. C.R. 19; [1960] C.T.C. 262; (1960), 60 DTC 1212; Minister of National Revenue v. Tower Investment Inc., [1972] F.C. 454; [1972] CTC 182; (1972), 72 DTC 6161 (T.D.); Associated Investors of Canada Ltd. v. Minister of National Revenue, [1967] 2 Ex. C.R. 96; [1967] C.T.C. 138; (1967), 67 DTC 5096.

REFERRED TO:

Whimster and Company v. Commissioners of Inland Revenue (1925), 12 T.C. 813 (Ct. Sess.); Macdonald & Sons Ltd. v. M.N.R., [1970] Ex. C.R. 230; [1970] C.T.C. 17; (1970), 70 DTC 6032; Roenisch, C. W. v. The Minister of National Revenue, [1931] Ex. C.R. 1; Ken Steeves Sales Ltd. v. Minister of National Revenue, [1955] Ex. C.R. 108; [1955] C.T.C. 47; (1955), 55 DTC 1044; Urbandale Realty Corporation Limited v. M.N.R. (1992), 93 DTC 154 (T.C.C.); Neonex International Ltd. v. The Queen (1978), 78 DTC 6339; 22 N.R. 284 (F.C.A.); Consolidated Textiles Ltd. v. Minister of National Revenue, [1947] Ex. C.R. 77; [1947] 2 D.L.R. 172; [1947] C.T.C. 63; (1947), 3 DTC 958.

AUTHORS CITED

Arnold, B. J. “The Concept of Profit” in Timing and Income Taxation: The Principles of Income Measurement for Tax Purposes, Can. Tax Paper No. 71, Toronto: Canadian Tax Foundation, 1983.

Hansen, B. G. et al. Essays on Canadian Taxation: Basic Accounting Concepts, Toronto: Richard De Boo Ltd., 1978.

Jackett, W. R. “Computation of Business Profits for Tax Purposes” in Corporate Management Tax Conference, 1981. Current Developments in Measuring Business Income for Tax Purposes, Toronto: Canadian Tax Foundation, 1982.

McDonnell, T. E. “Current Cases—More on GAAP and Profit” (1994), 42 Can. Tax J. 452.

APPEAL from the T.C.C. decision (Canderel Ltd. v. The Queen (1994), 94 DTC 1133) allowing a commercial real estate developer to deduct the full amount of lease inducement payments in the year in which they were made. Appeal allowed.

COUNSEL:

Roger E. Taylor and Alnasir Meghji for appellant.

Guy Du Pont and Stephen Klar for respondent.

SOLICITORS:

Deputy Attorney General of Canada for appellant.

Phillips & Vineberg, Montréal, for respondent.

The following are the reasons for judgment rendered in English by

Stone J.A.: I too have come to the conclusion that this appeal should be allowed but do so to an extent by a somewhat different route.

In my view, the matching principle of accounting has, at least in this Court, been elevated to the status of a legal principle. The principle was best expressed by MacGuigan J.A. in West Kootenay Power and Light Co. v. Canada, [1992] 1 F.C. 732(C.A.), at page 745:

The approved principle is that whichever method presents the “truer picture” of a taxpayer’s revenue, which more fairly and accurately portrays income, and which “matches” revenue and expenditure, if one method does, is the one that must be followed.

That case, of course, was concerned with earned but unbilled income, and it was decided that the accrual method of accounting “presented a truer picture of the appellant’s revenue because it more accurately and fairly matched revenue and expenditure” (at page 747). However, I do not see that its application should be limited to a determination of in which of two years revenue should be reported and therefore that it should have no application where, as here, the issue becomes whether a taxpayer is required to match expenditures against revenues in computing “profit” for tax purposes under subsection 9(1) of the Income Tax Act, S.C. 1970-71-72, c. 63, as amended.[1]

It is true, as the Trial Judge concluded [(1994), 94 DTC 1133 (T.C.C.)], that in law as in accountancy, current expenses need not be matched with corresponding items of revenue for tax purposes if they are “running expenses,” to be deducted in the year in which they are incurred. It is apparent, however, that the tenant inducement payments here in issue do not fit the classical description of “running expenses” in the off-quoted passage from the judgment of Rowlatt J. in Naval Colliery Company, Limited v. Commissioners of Inland Revenue (1928), 12 T.C. 1017 (K.B.), at page 1027:

Now, one starts, of course, with the principle that has often been laid down in many other cases—it was cited from Whimster’s case, a Scotch case—that the profits for Income Tax purposes are the receipts of the business less the expenditure incurred in earning those receipts. It is quite true and accurate to say, as Mr. Maugham says, that receipts and expenditure require a little explanation. Receipts include debts due and they also include, at any rate in the case of a trader, goods in stock. Expenditure includes debts payable; and expenditure 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. [Emphasis added; footnote omitted.]

It can, however, be argued that the tenant inducement payments laid out by the respondent were in the nature of running expenses on the basis that they represented a cost of doing business in the 1986 taxation year and also that the respondent would likely have faced significant financial disadvantages if they had not been laid out and did achieve significant financial advantages by laying them out. It is a well-established principle that an expenditure becomes deductible in the year in which it was incurred even if the whole of the expenditure did not bear fruit in that year (Vallambrosa Rubber Company, Limited v. Farmer (1910), 5 T.C. 529 (Ct. Sess.). Lord Reid explained this principle in Duple Motor Bodies, Ltd. v. Ostime (1961), 39 T.C. 537 (H.L.), at page 571:

It matters not that certain expenditure may have proved abortive, or may have been spent solely with a view to production and profit in some future year and have no relation at all to production during the year of account. This was settled as long ago as 1910 in Vallambrosa Rubber Co., Ltd. v. Farmer, 5 T.C. 529, a decision often followed and never questioned.

In the present case, it is apparent that these expenditures were not incurred in earning income solely in the taxation year 1986 but in all of the years during which the respective leases were to run.

Nor am I able to equate these expenditures with the kind of outlay that was before the Court in Oxford Shopping Centres Ltd. v. R., [1980] 2 F.C. 89(T.D.). It is evident in that case that it was not possible to match the outlay with particular items of revenue. The case of Cummings (J L) v The Queen, [1981] CTC 285 (F.C.A.), did not deal directly with the issue. It was concerned with whether lease pick-up expenses were to be treated as income expenses or as capital expenses. It is true that Heald J.A. in obiter, was prepared to characterize those expenses both as current and as “running expenses,” but I am not satisfied that his analysis was intended to extend beyond the circumstances under which expenses of that kind had theretofore been so categorized. He relied on what he described as the “double rationale” of the Oxford Shopping, supra, and went on to say, at page 291:

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”.

It seems to me, however, that these views assume, as it was put in Naval Colliery, supra, that the expenses “cannot be allocated directly to corresponding items of receipts” which, as my colleague points out, accords with a view expressed by Thurlow J. (as he then was) in Silverman, Harry v. Minister of National Revenue, [1961] Ex. C.R. 19.

In the present case, I share my colleague’s view that the expenses in question could be matched with revenue from the particular leases in accordance with the matching principle discussed above. That they could be so matched is evident from the fact that they were matched for financial reporting purposes.

I would dispose of this appeal in the manner proposed by my colleague.

Robertson J.A.: I agree.

* * *

The following are the reasons for judgment rendered in English by

Desjardins J.A.: The issue in this appeal of a judgment of the Tax Court of Canada[2] is one of timing. It relates to whether the respondent is entitled to deduct in full, in its taxation year 1986, the sum of $1,208,369[3] which it disbursed in 1986 as tenant inducement payments (TIPs) (hereinafter referred to as the “expensing method”) or whether, as contended by the appellant, the sum should be amortized over the life of the respective leases (amortization method).

It should be made clear that this is not a case as to whether the disputed expenditures are of a capital or income nature. The parties agree that the TIPs were expenses incurred by the respondent for the purpose of gaining or producing income from the business and that the requirements of paragraph 18(1)(a) of the Income Tax Act (the Act) are satisfied.[4] What is at stake is in which taxation year or years are the inducement payments, made by the respondent in 1986, deductible in computing its profit. The question arises in the context of expert evidence that, in the relevant year, generally accepted accounting principles (GAAP) permitted the use of both the expensing method and the amortization method for financial reporting purposes. Moreover, it is admitted by the appellant that the expensing method applied by the respondent was in usage in the real estate industry at the relevant time under the guidelines published by the Canadian Institute of Public Real Estate Companies (CIPREC).

The facts

The facts are not in dispute and can be found in the reported decision of the Tax Court of Canada. I propose, therefore, to relate only those which are essential for an understanding of this appeal.

Canderel, wholly owned by Jonathan Wener until 1985, at which time ownership was transferred to Canderel Holdings Inc., also wholly owned by Jonathan Wener, is a corporation mainly involved in the business of managing and developing commercial real estate. To a lesser extent, it engages in industrial development and management.

On February 3, 1984, it entered into an agreement with Mount-Batten Properties Ltd. for the development of a property located at 1600 Carling Avenue, Ottawa, which eventually became known as Churchill Office Park project (COP). A management agreement was signed contemporaneously with the development agreement according to which the respondent would also act as the property manager of COP. Its duties were, among other things, to negotiate leases and their renewals. The project was to be financed with a mortgage to minimize equity and cover the cost with mortgage debt. An early positive cash flow was imperative and the key to the success of the project was leasing velocity. Short-term “bridge financing” was arranged in essentially demand loan form. Once the building was 75% to 85% leased, permanent financing would be obtainable.

The market conditions turned out to be difficult. When COP opened in June 1985, the building costs were approximately $25 million but only 2.3% of the building was leased. There was intense competition for tenants in the locality.

The Toronto Dominion Bank had provided interim financing by a $1.5 million operation loan and mortgage of $22 million. According to the evidence at trial, Canderel had to find tenants at project completion, or shortly thereafter, or several adverse consequences would occur namely:[5] (a) the operating and financing costs which approximated $2.9 million (amortized) would have to be entirely borne by the joint venturers, significantly reducing COP’s prospective cash yield; (b) permanent financing would not be obtained leaving the joint venturers with a demand full recourse loan funding a long-term asset with floating interest rates; (c) the project could become known as not having gained market acceptance, thus reducing the likelihood of attracting stable credit-worthy tenants that, in essence, would ensure the financial viability of the project.

The respondent’s management decided to allocate budgeted losses to lease inducement payments and to reorganize the budget in order to meet those difficulties. To obtain permanent financing for a period of ten years, management needed to show the lender it had long-term leases of approximately the term of the loan generating revenues of $17 per square foot. A leasing campaign was orchestrated to induce tenants to enter into leases which would generate such revenues. Lease inducement payments were given to tenants on the signing of leases which, ultimately, ran between three to ten years. An example of such an inducement clause reads thus:[6]

6.   Tenant Inducement

Landlord, acknowledging the desire to obtain Tenant as a lessee in the building has agreed to pay Tenant an inducement of one million eighty-one thousand eight hundred and seventy-two dollars ($1,081,872) to execute this lease, receipt of which is hereby acknowledged. If for any reason Tenant does not bona fide take possession of its premises on the Commencement Date and fulfil all obligations which become due under the Lease during the first two (2) months of the term, Tenant shall forthwith return to the Landlord the amount of said inducement.

The quantum of these payments was not a function of the rental rate being paid or of the length of the lease but was a function of a myriad of factors including market conditions, tenant requirements and ad hoc negotiations.

By the end of June 1986, COP was 59% rented and, by June 1987, it was 85% rented.

On June 17, 1986, the respondent’s agent acquired a Sun Life permanent financing commitment for ten years in the amount of $25.5 million.

The auditor’s report of January 1986 showed an operating loss of $1.219 million and the notes to the balance sheet showed that the TIPs were treated in the respondent’s books as being capitalized. By 1986, $4 million had been capitalized and amortized. For 1986, income was minus $800,000 (before amortization). The return showed that the TIPs were deducted from income in the year of payment. The reconciliation showed that the respondent changed the treatment from capitalization to write off in the current year.

In computing its income for income tax purposes for its 1986 taxation year, Canderel deducted the full amount of $1,208,369 representing its share of the tenant inducement payments made or incurred in that taxation year as an expense incurred to gain or produce income from its business for that taxation year.

The Minister, in his reassessment, disallowed the deduction of $1,208,369 and, instead, allowed the respondent a deduction of $69,274 being the resultant amount of amortizing each of the tenant inducement payments over the initial term of the lease in respect of which the tenant inducement payment was made. The decision was based on the fact that the respondent, in computing its “profit,” was not permitted to deduct the entire amount of an inducement payment in the year of payment, but rather was required to amortize the inducement over the term of the respective leases. Commissions paid by the respondent in the amount of $735,000 incurred in relation with these leases were deducted by Canderel for income tax purposes in the taxation year they were incurred. The deduction of those expenditures was not challenged by the Minister.

The Tax Court of Canada allowed the respondent’s appeal.

The judgment below

The Tax Court Judge found four main benefits that were generated by the TIPs. These were:[7]

(1) to “prevent a hole in income” otherwise caused by maintaining a vacant building;

(2) to satisfy the underlying requirements of its interim financing and to obtain permanent financing;

(3) to meet its competition, maintain its market position and reputation;

(4) to earn revenues through rentals, management, and development fees.

He started with the proposition that courts had consistently held that an expense is deductible entirely in the year on which it was paid although there is no directly resulting income in that year. The genesis of that principle, he said, was to be found in Vallambrosa Rubber Company, Limited v. Farmer.[8] He then examined whether the TIPs were running expenses and whether these should be matched with the generating revenues. He referred to the recent decisions of the Supreme Court of Canada in Symes v. Canada[9] where Iacobucci J. quoted Wilson J. in Mattabi Mines Ltd. v. Ontario (Minister of Revenue),[10] where she said:

The only thing that matters is that the expenditures were a legitimate expense made in the ordinary course of business with the intention that the company could generate a taxable income some time in the future.

Following which, Iacobucci J. added:[11]

In making this statement, and in proceeding to discuss an interpretation bulletin reference to the “income-earning process” (at pp. 189-90), Wilson J…. was rejecting both the need for a causal connection between a particular expenditure and a particular receipt, and the suggestion that a receipt must arise in the same year as an expenditure is incurred. Her reference to the “ordinary course of business” is merely a reflection of these other conclusions.

The Trial Judge inferred from Wilson J.’s reference that the “intention” of the taxpayer was a relevant factor. After an extensive review of the case law, he concluded that the expenses deducted by the respondent were running expenses, that matching was not in that case the appropriate method of profit calculation for tax purposes and that the respondent should be allowed to adopt the expensing method. In addition, he found that there was no requirement under the law for consistency in accounting methods between financial statements and income tax calculation, and that there was no requirement in law for him to follow the GAAP rules.

The contention of the parties

The appellant submits that this case is exclusively one where section 9 receives application. The fundamental error of the Trial Judge was to confuse the principles elaborated by the courts in dealing with paragraph 18(1)(a) of the Act with those concerned with section 9.[12] The Tax Court Judge, she says, incorrectly applied the decision of the Supreme Court of Canada in Symes where the issue was whether the child care expenses in dispute had been incurred for the “purpose of gaining or producing income” within the meaning of paragraph 18(1)(a). It was in the context of speaking to this “purpose” test that Iacobucci J. rejected both the need for a causal connection between a particular expenditure and a particular receipt and the suggestion that a receipt must arise in the same year as an expenditure is incurred. In the instant case, she says, it is admitted that the tenant inducements were incurred for the purpose of earning income from business. Therefore, none of the cases on paragraph 18(1)(a), on which the respondent relies in support of its contention that the expenses are deductible in the year of payment, can be of any assistance.

Moreover, claims the appellant, the question as to what method of computing profit is required to be used in computing profit for income tax purposes when there is more than one method acceptable for financial reporting purposes has been addressed most recently by this Court in three cases: West Kootenay Power and Light Co. v. Canada;[13] Maritime Telegraph and Telephone Co. v. Canada;[14] and Friedberg (A.D.) v. Canada.[15] The basic rule to be derived from these cases is the following: if there are two methods acceptable under GAAP, but one method is not appropriate at all for tax purposes, then it is not a question of choosing between acceptable methods because only one method is appropriate for tax purposes. This is the implication of the Friedberg case. Where, however, as here, there are two accounting methods acceptable under GAAP for financing reporting purposes, namely the expensing method and the amortization method, and both methods are otherwise appropriate for tax purposes, the Court will prefer the method that results in a “truer picture” of the respondent’s profit. This is the implication in the West Kootenay case.[16] It follows that, in the case at bar, the amortization method more fairly and accurately reflects profit since the matching of revenues with expenditures can reasonably be made. It is, therefore, the only method which determines Canderel’s “profit” as that word is to be understood in legal terms. The taxpayer, according, to the above cases, has no choice but to follow this method of accounting. Hence, concludes the appellant, the Trial Judge made a fundamental error of law when he stated:

While the matching principle may have its usefulness, especially for accounting purposes, such is not necessarily the case for income tax purposes.[17]

The respondent, for its part, claims that the Trial Judge found as a fact that the impugned expenditures generated four key benefits. Based on those finding of facts, which were amply supported by the evidence, the learned Judge found that these expenditures were running expenses with the result that there is no obligation to match. Absent any overriding error in these findings, these expenditures are deductible in the taxation year they are incurred as it was decided by this Court in Cummings (J L) v The Queen.[18]

The respondent adds that there is no rule of law or statutory provision in the Act which expressly or implicitly requires Canderel to “match” or “endeavour to match” these current expenditures against revenues to be earned by it in subsequent taxation years, and the Minister cannot compel Canderel to adopt any. As a general rule, current expenditures made for the purpose of gaining or producing income are deductible in the taxation year they were incurred, whether or not they generate revenue in the taxation year incurred, in the subsequent taxation years or no revenue at all. The respondent relies heavily on cases such as Naval Colliery Company, Limited v. Commissioners of Inland Revenue[19] and Vallambrosa Rubber Company, Limited v. Farmer[20] to support its proposition. But, even if Canderel were required in law to “match” or “endeavour to match,” which is denied, the expensing method gives the true picture of the respondent’s income for the year because: (i) for a business person in Canderel’s position, the true profits for its 1986 taxation year were the revenues it generated less these current expenses incurred in that taxation year for the purpose of gaining or producing its income from its business; (ii) these amounts, consistent with the learned Trial Judge’s findings of fact, should be matched against the many immediate financial benefits they gave rise to; (iii) Canderel, by paying these TIPs, was filling a hole in its income which, absent these TIPs, would have been created by otherwise deductible costs in the taxation year in issue, and (iv) the effect of the appellant’s “matching” and “endeavouring to match” theory would be the taxation of unrealized gains and the deduction of incurred losses.

Analysis

The interrelationship of subsection 9(1) and paragraphs 18(1)(a) and 18(1)(h) of the Income Tax Act was clearly stated by Iacobucci J. in Symes v. Canada:[21]

At one time, it was not clearly understood whether the authority for deducting business expenses was located within what is now s. 9(1) or within what is now s. 18(1)(a). In a series of decisions culminating in Royal Trust Co. v. Minister of National Revenue, 57 DTC 1055 (Ex. Ct.), however, Thorson P. recognized that the deduction of business expenses is a necessary part of the s. 9(1) “profit” calculation. In Daley v. Minister of National Revenue, [1950] Ex. C.R. 516, Thorson P. commented upon s. 3 (the forerunner to s. 9) and s. 6(a) (the forerunner to s. 18(1)(a)) of the Income War Tax Act, R.S.C. 1927, c. 97, in the following terms (at p. 521):

The correct view, in my opinion, is that the deductibility of the disbursements and expenses that may properly be deducted “in computing the amount of the profits or gains to be assessed” is inherent in the concept of “annual net profit or gain” in the definition of taxable income contained in section 3. The deductibility from the receipts of a taxation year of the appropriate disbursements or expenses stems, therefore, from section 3 of the Act, if it stems from any section, and not at all, even inferentially, from paragraph (a) of section 6.

In other words, the “profit” concept in s. 9(1) is inherently a net concept which presupposes business expense deductions. It is now generally accepted that it is s. 9(1) which authorizes the deduction of business expenses; the provisions of s. 18(1) are limiting provisions only. See The Queen v. MerBan Capital Corp., 89 DTC 5404 (F.C.A.).

To so describe ss. 9(1) and 18(1)(a) does not, however, clarify the proper approach in this case. While ss. 18(1)(a) and (h) may first appear logically to limit—within the structure of the Act—deductions which have already satisfied s. 9(1), this structure can make less logical sense than one might suppose. This is because it is generally not clear what kinds of expenses would be deductible under s. 9(1), yet prohibited by ss. 18(1)(a) or (h).

Under s. 9(1), deductibility is ordinarily considered as it was by Thorson P. in Royal Trust, supra (at p. 1059):

… the first approach to the question whether a particular disbursement or expense was deductible for income tax purpose was to ascertain whether its deduction was consistent with ordinary principles of commercial trading or well accepted principles of business … practice … [Emphasis added]

Thus, in a deductibility analysis, one’s first recourse is to s. 9(1), a section which embodies, as the trial judge suggested, a form of “business test” for taxable profit.

This is a test which has been variously phrased. As the trial judge rightly noted, the determination of profit under s. 9(1) is a question of law: Neonex International Ltd. v. The Queen, [1978] C.T.C. 485 (F.C.A.). Perhaps for this reason, and as Neonex itself impliedly suggests, courts have been reluctant to posit a s. 9(1) test based upon “generally accepted accounting principles” (G.A.A.P.): see also “Business Income and Taxable Income” (1953 Conference Report: Canadian Tax Foundation) cited in B. J. Arnold and T. W. Edgar, eds., Materials on Canadian Income Tax (9th ed. 1990), at p. 336. Any reference to G.A.A.P. connotes a degree of control by professional accountants which is inconsistent with a legal test for “profit” under s. 9(1). Further, whereas an accountant questioning the propriety of a deduction may be motivated by a desire to present an appropriately conservative picture of current profitability, the Act is motivated by a different purpose: the raising of public revenues. For these reasons, it is more appropriate in considering the s. 9(1) business test to speak of “well accepted principles of business (or accounting) practice” or “well accepted principles of commercial trading”.

Adopting this approach to deductibility, it becomes immediately apparent that the well accepted principles of business practice encompassed by s. 9(1) would generally operate to prohibit the deduction of expenses which lack an income earning purpose, or which are personal expenses, just as much as ss. 18(1)(a) and (h) operate expressly to prohibit such deductions. For this reason, there is an artificiality apparent in the suggestion that one can first examine s. 9(1) in order to determine whether a deduction is authorized, and can then turn to s. 18(1) where another analysis can be undertaken: N. Brooks, “The Principles Underlying the Deduction of Business Expenses” in B. G. Hansen, V. Krishna, and J. A. Rendall, eds., Essays on Canadian Taxation (1978), 249, at pp. 253-54; V. Krishna, The Fundamentals of Canadian Income Tax (4th ed. 1992), at p. 365, footnote 44, and p. 367.

Although ss. 18(1)(a) and (h) may, therefore, simply be analytically repetitive or confirmatory of prohibitions already embodied in s. 9(1), they may serve to reinforce the point already made, namely, that the s. 9(1) test is a legal test rather than an accountancy test. At the same time, they conveniently summarize what might otherwise be abstract principles of commercial practice. As noted by D. Ish, J. A. Rendall, and C. A. Brown (“Deductions” in Materials on Canadian Income Tax, supra, at pp. 387-88):

… the frequency with which paragraph 18(1)(a) appears in the cases confirms that it is useful, if not necessary, for the Minister to have specific statements which can be relied upon … Arguably, paragraph 18(1)(h) is just a refinement of paragraph 18(1)(a); indeed, one might suppose that the taxpayer’s personal or living expenses would not be deducted according to standard practices of accounting for business profits, the test erected by subsection 9(1). The process we are describing is one in which the focus is progressively narrowed. Although a personal or living expense prohibited by paragraph 18(1)(h) arguably would also be prohibited by paragraph 18(1)(a) … the Minister may nevertheless find it very useful to concentrate attention on the specific characterization of a disputed expense as being of a personal consumption nature.

There is no doubt that, in some cases, s. 9(1) will operate in isolation to scrutinize deductions according to well accepted principles of business practice. In this respect, I refer to cases, also noted by the trial judge, in which the real issue was whether a particular method of accounting could be used to escape tax liability: e.g. Associated Investors of Canada Ltd. v. Minister of National Revenue, [1967] 2 Ex. C.R. 96; Canadian General Electric Co. v. Minister of National Revenue, [1962] S.C.R. 3. In other cases, including the present case, however, the real issue may be whether a deduction is prohibited by well accepted principles of business practice for the reason that it is not incurred for the purpose of earning income, or for the reason that it is a personal or living expense. In such cases, any treatment of the issue will necessarily blur s. 9(1) with ss. 18(1)(a) and (h).

In the case at bar, there is no dispute with regard to the expenses being of an income nature. Our examination is directed, therefore, to subsection 9(1) of the Act. On this basis, we are not concerned with the purpose of the expenditure but with the net of the year. The Trial Judge erred in relying on the statement made by Iacobucci J. in Symes (where he says that Wilson J. rejected “both the need for a causal connection between a particular expenditure and a particular receipt, and the suggestion that a receipt must arise in the same year as an expenditure is incurred”)[22] so as to make it a rule applicable to the case at bar. When read in context, it is clear that Iacobucci J. was not addressing his mind to the timing of a deduction. It is a misapplication of the law to ignore that his pronouncement was made secundum subjectam materiam. What we are concerned with here is the proper legal treatment of those TIPs so as to determine the net profit of the taxpayer for the year in question.

The appellant relies on three decisions of this Court to support her proposition that where there are two methods acceptable under GAAP, which are also acceptable for tax purposes, the Court will prefer the one that results in a “truer picture” of the taxpayer’s profit.

I shall first briefly summarize each of these cases. I will then state what, in my view, they stand for.

West Kootenay Power and Light Co. v. Canada[23] dealt with the question as to whether estimates of earned but unbilled revenue at December 31, the end of the taxpayer’s taxation year, must be included in its income from business in that year. The appellant was an investor-owned corporation engaged in the business of generating and distributing hydro-electric power in British Columbia. Its residential customers were on a two-month-billing cycle and meter readings were made on a bi-monthly basis. At the relevant fiscal year-ends 1983 and 1984, the appellant had delivered some electricity for which, as of these year-ends, the customers had not yet been billed. The British Columbia Utilities Commission, who approved tariff, did not permit the appellant to issue bills for electricity supplied to December 31 until the completion of the billing cycle ending after that date. Until 1979, the accounting practice followed by the taxpayer did not take account of earned but unbilled revenue but, in that year, on the advice of accountants, the appellant changed its practice and recorded income based on estimates of the revenue anticipated to be received, both for financial statements of its operation and for tax purposes. The accrual basis was continued through 1982. In 1983, while maintaining the accrual basis for calculating income for its annual statements, the appellant changed from an accrual to a “billed” basis for its income tax return, eliminating from its income the estimate of revenue unbilled at year end and reported revenues only as billed. Both methods of accounting were permitted under GAAP. The unbilled revenue was added by the Minister to the taxpayer’s taxation year. MacGuigan J.A., for the Court, estimated that there was no absolute requirement of conformity between financial statements and tax returns. He then added:[24]

The approved principle is that whichever method presents the “truer picture” of a taxpayer’s revenue, which more fairly and accurately portrays income, and which “matches” revenue and expenditure, if one method does, is the one that must be followed.

He then addressed his mind to the question as to whether the unbilled revenues in question came under the provision of paragraph 12(1)(b) of the Act[25] as amended by S.C. 1980-81-82-83, c. 140, s. 4(1) as an amount receivable. He concluded that they were both sufficiently ascertainable to be receivable even though not yet billed or due and had to be included in income for the year then ending and were not excluded by the “unless” clause of paragraph 12(1)(b). The principle to be applied for that part of the Act was, therefore, the “truer picture” or “matching principle” which had the effect of denying the taxpayer the right to use the billed account method.

Maritime Telegraph and Telephone Co. v. Canada[26] dealt with the same paragraph 12(1)(b) of the Income Tax Act as amended in 1983 which was considered in West Kootenay Power and Light Co. The question in Maritime Telegraph and Telephone Co., was whether year end amounts, which the taxpayer included in its 1985 income, should, as the respondent argued, be included in its 1984 taxation year (and similarly for the year end of 1985 in relation to 1986). The appellant, a telephone company, placed its customers into nine separate billing groups. Each group was billed at different times of the month for services rendered up to the date of billing. The customer had thirty days within which to pay the bill before an interest charge became payable. There was little doubt that the amount earned but not billed during “the stab end” of the taxation year could be ascertained with a considerable degree of accuracy. Until 1984, the first of the two taxation years in issue, the appellant did its accounting for income tax purposes on the basis of the “earned” method, estimating the amount of revenue earned by year-end (its fiscal year coinciding with the calendar year), even though some customers had not yet been billed for those amounts. Its financial statements were prepared in the same way, both for reporting to its shareholders and for review by the Nova Scotia Board of Commissioners of Public Utilities. However, as of the 1984 taxation year, the appellant changed its method of accounting for income tax purposes, adopting a “billed” method for reporting income, but retaining the “earned” method for its financial statements. This change in its tax reporting, as Reed J. found at trial [[1991] 1 C.T.C. 28 (F.C.T.D.)], was made on the advice of its accountants, who relied on what they considered to be the meaning of the 1983 amendment to paragraph 12(1)(b). Either of the methods was permissible under GAAP. The Trial Judge found that the unbilled but earned revenues were to be brought into income pursuant to subsection 9(1) of the Act, and that the earned method gave a truer picture of the taxpayer’s income for the year than the billed method. She was upheld on her finding by the Court of Appeal.

In Friedberg v. Canada,[27] the taxpayer, in 1978, purchased contracts for the delivery of gold in 1979. Also, in 1978, he sold the same number of contracts for gold, for settlement in 1979. Before the end of 1978, he closed out the losing leg of the straddle, realizing an actual loss. He carried the winning leg over into 1979. In computing his income for 1978 (and for that matter in 1979, 1980 and 1981), he deducted the losses but did not include the accrued gains. The taxpayer employed a method called the “lower of cost or market” method, acceptable under GAAP, by which a gain in trading is recognized as income when it is closed out and sold, whereas an unrealized loss is immediately accounted for and debited from income. The Crown challenged this because under the “marked to market method” which, it contended, better reflected the economic reality, the realized loss was to be netted against the accrued gain at the end of 1978, in the computation of income. The Supreme Court of Canada was of the view that the “marked to market” accounting method could not describe income, for income tax purposes.[28] The Court recognized that the “lower of cost or market” method advocated by the taxpayer suggested that unincurred losses could be deducted in the calculation of income, but noted that no unincurred losses were deducted by the taxpayer on the facts of the case. Accordingly, it had acted properly. The Court declined to comment on the implications of the “lower of cost or market” method in that case.

The first two cases deal with revenue. The third deals with a loss. In the first two cases, the Court looked at the year the income had in fact been earned and felt that the method of accounting, which best reflected the taxpayer’s true revenue position for the year, was the one that should be accepted for income tax purposes. In Friedberg, the Supreme Court of Canada was evidently satisfied that the method adopted by the taxpayer in deducting his actual loss was, on the facts, the proper one for tax purposes. In essence, what the courts have been looking for is the true realized gains and losses of a taxpayer in the relevant taxation year. In West Kootenay Power and Light Co., this true position could be found by following the accrual method, a form of matching.[29] But whether matching is the acceptable method for tax purposes, in this case, I would rather decide it on the basis of those decisions where the “matching principle” has been specifically developed.

As stated by W. R. Jackett,[30] “[t]he commencement point for the computation of business profits for income tax purposes in Canada is the rule to be found in subsection 9(1) of the Income Tax Act that, prima facie, a taxpayer’s income for a year from a business is his ‘profit therefrom for the year’.”

Profit from a business is a question of law for the Court. It has been defined by Lord Herschell in Russell v. Town and County Bank[31] in the following manner:

The profit of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts.

It is to be determined in the sense in which that word is understood by businessmen[32] or, as has been frequently said, in accordance with “well accepted principles of business (or accounting) practice” or “well accepted principles of commercial trading”[33] unless they run counter to an express statutory provision or a principle of income tax law.

In Silverman, Harry v. Minister of National Revenue,[34] Thurlow J. stated:

… since what is declared to be the income from a business is the profit therefrom for the year, the method adopted must be one which accurately reflects the result of the years’ operations, and where two different methods, either of which may be acceptable for business purposes, differ in their results, for income tax purposes the appropriate method is that which most accurately shows the profit from the years’ operations.

Thus in Publishers Guild v. Minister of National Revenue ([1957] C.T.C. 1; 57 DTC 1017), Thorson P. said at p. 29:

What is basically to be determined under the Income War Tax Act is the amount of “net profit or gain … received” by the taxpayer during the year. It was established by the House of Lords in Sun Insurance Office v. Clark, [1912] A.C. 443, that “the question of what is or is not profit or gain must primarily be one of fact, and of fact to be ascertained by the tests applied in ordinary business”. Thus, what is to be determined here is, not whether the Department has accepted the accrual basis system of accounting and rejected the instalment system, but rather which system more nearly accurately reflects the taxpayer’s income position.

See also Minister of National Revenue v. Anaconda American Brass Ltd. ([1955] C.T.C. 311; 55 D.T.C. 1220), and Ken Steeves Sales Ltd. v. Minister of National Revenue ([1955] Ex. C.R. 108).

The question that must be addressed, therefore, is which method most accurately shows the profit from the year’s operation?

Both parties have cited numerous cases. For the most part, they are the same except that the parties apply them differently. The leading case is Oxford Shopping Centres Ltd. v. R.[35] Timing was considered in that case and there was an admission similar to the one in the case at bar with regard to paragraph 18(1)(a). Moreover, Oxford Shopping Centres Ltd. was affirmed by this Court.

Two main issues were raised in Oxford Shopping Centres Ltd. One was whether an amount paid by Oxford Shopping Centres Ltd. (the taxpayer) to the city of Calgary under the terms of a written contract was an outlay of capital or an expense deductible in computing income for tax purposes. The second was whether, if the amount was deductible as an expense, the taxpayer was required to amortize it over a period of fifteen years deducting only an appropriate portion of it in the taxation year in question. That the amount was expended for the purpose of gaining or producing income from business or property was admitted.

In order to facilitate the access of the shopping centre to customers, the taxpayer and the city concluded a number of agreements for the construction of a “tight-diamond” interchange to accommodate traffic. These agreements formed one transaction for which the taxpayer paid a total of $490,050. Thurlow A.C.J. [as he then was] established first that the expenditures should be classified as a revenue expense and not an outlay of capital. He then turned his mind to the apportionment of the expenditure. A note in the balance sheet of the taxpayer stated that the $490,050, treated as an asset, would be amortized over a period of fifteen years. But, for income tax purposes, the taxpayer deducted the amount in full as an expense in the year 1973.

Thurlow A.C.J.[36] noted that in Minister of National Revenue v. Tower Investment Inc.,[37] [Collier J. had concluded that, in respect of monies disbursed in 1963, 1964 and 1965 for advertising the taxpayer’s apartments over a period of years, the taxpayer was not required to deduct the actual amounts in the year in which the expenditure had been made but, in accordance with accounting principles, he could defer an appropriate part of the deduction to a later year under the “matching principle” since there was no prohibition in the statute against it.[38] Thurlow A.C.J. then cited the dissenting opinion of Le Dain J. who, in Minister of National Revenue v. Canadian Glassine Co. Ltd.,[39] approved Jackett P.’s statement in Associated Investors of Canada Ltd. v. Minister of National Revenue.[40] There is no sound basis for taking it into account in computing the profit for a subsequent year. What Jackett P. said was that the principle expressed in Rossmor Auto Supply Ltd. v. M.N.R.,[41] that a deduction of an outlay was limited to that incurred in the year of assessment, was not “applicable in all circumstances,” and that “there are many types of expenditure that are deductible in computing profit for the year ‘in respect of’ which they were paid or payable.” [My emphasis.]

Thurlow A.C.J. in Oxford Shopping Centres Ltd. was careful to cite in full Jackett P.’s comments which were contained in a footnote.[42] Then, he said:[43]

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 (compare Neonex International Ltd. v. The Queen [1978] CTC 485 at page 497), 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 the Associated Investors case and the authorities referred to by Jackett P., and in particular the Vallambrosa Rubber case and the Naval Colliery case, 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 the Tower Investment case and by the Trial Judge and Le Dain J. in the Canadian Glassine case 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. [My emphasis.]

Thurlow A.C.J. was convinced that the amount disbursed by the taxpayer in Oxford Shopping Centres Ltd. was in the nature of a “running expense of the business as a whole” and was not “an expense related to a particular item of income.” Matching, therefore, did not apply, though the deduction of the disputed amount in the year it was paid would distort the income for that particular year. He recognized that under Tower Investment Inc., and Canadian Glassine Co. Ltd. when an expense was characterized as a running expense, the taxpayer had the option of amortizing the amount.

Thurlow A.C.J., in Oxford Shopping Centres Ltd., added another reason which confirmed his conclusion that the amount should be deductible in full in the year of payment. The fifteen-year period chosen by the taxpayer had not much relation to the expected life of the street improvements. They may last longer. But, he said, it was not the expected life of the street improvements that should be considered. What, if anything, should be considered for such a purpose was the expected duration of the benefits to the expected popularity of the shopping centres, and this compounded with the competition of other developments in a rapidly growing city was, in his view, imponderable.

The particular passage of Thurlow A.C.J. which I find key to the case at bar is the following [at page 107]:

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... 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. [My emphasis.]

What is at stake here is whether TIPs are expenses related to a particular item of income, or whether they are running expenses. If they are related to a particular item of income, the “matching principle” will apply. If they are running expenses, the taxpayer will have the option of deducting the amount in full or amortizing it.

TIPs are clearly expenses related to particular items of income. They are not running expenses such as those disbursed for advertising the taxpayer’s apartments over a period of years (Tower Investment Inc.) where the return is unknown or where, as in Oxford Shopping Centres Ltd., the matching would have been inappropriate and, in any case, impossible. The essence of a running expense is that it is akin to an overhead item which cannot be traced to specific items of revenue. This, however, is a far cry from a TIP of the present kind where, as evident from the lease agreements themselves, there is a direct contractual relationship between the TIP and the stream of revenues gained over the period of the lease. The real and immediate effect of the TIPs is to pull a string of revenues. It is the revenues which, once they flow in, on account of the TIPs, have the remaining financial benefits described by the Trial Judge.

Matching of TIPs is compulsory.

The authority on which Thurlow A.C.J. rested his proposition, that matching is compulsory when related to a particular item of income, is Commissioners of Inland Revenue v. Gardner, Mountain & D’Ambrumenil, Ltd.[44] which Jackett P. cited in his now famous footnote. In that case, the company acted for certain underwriters at Lloyd’s, who formed themselves into syndicates, the members of the syndicates being known as “Names.” The functions of the company were to obtain Names and, on behalf of the group of Names for which it acted, to accept risks, issue policies, collect premiums, settle claims and adjust returns of premiums when due. As underwriter’s agent, it entered into agreements with certain underwriters at Lloyd’s under which it was entitled to receive commissions on the net profits of each year’s underwriting. The agreements provided that accounts should be kept for the period ending 31 March in each year. The company did not discharge all its duties in reference to a given transaction of insurance by merely underwriting the risk and receiving the premiums. It had to follow the transaction through the end, which might involve modifications of premiums and reinsurance of risk as well as possible questions of average and payment of losses—matters which may have occupied the attention of the agents for as much as two years after the year in which the risk was undertaken. The net profits resulting from a year’s underwriting could not be ascertained till two years later. It was only then that the figure of profit for the year was known and only then that the commission on that profit was calculated and paid. The question became whether the commission earned was to be brought into account in the underwriting year, or whether it was to be brought into account when it was received, which was normally at the end of the second year after the conclusion of the underwriting year. In the House of Lords, Viscount Simon was of the view “that the commission, though ascertained by reference to profits arising from underwriting in the year 1938-39 and its subsequent outcome and paid two years later, e.g., in March, 1941,”[45] was “remuneration for work done, and completely done, in the year ending 31st March, 1939.” He then said:[46]

In calculating the taxable profit of a business … services completely rendered or goods supplied, 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 transaction, 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. [My emphasis.]

The respondent says[47] that this part of the statement by Viscount Simon, with respect to costs, dealt with costs of inventory for which special rules have developed.[48]

I do not share this view. Gardner, Mountain & D’Ambrumenil, Ltd. dealt with a service industry, that of an underwriter’s agent, and Viscount Simon’s words were directed both to “services completely rendered or goods supplied” (my emphasis). The respondent, in the case at bar, is in a type of service industry, namely that of commercial rentals. The principles enunciated in Gardner, Mountain & D’Ambrumenil, Ltd. apply to it. The net result is that the TIPs are to be deducted as the services are rendered, that is, over the period of the lease.

Vallambrosa Rubber Company, Limited v. Farmer,[49] relied on by the respondent, is precisely a case where matching was resisted, and rightly so. The question arose with regard to the profits of the first year of operation of a new venture. The company was in the business of cultivation and sale of rubber, and owned an estate for that matter. It claimed, as expense, a sum which represented expenditures such as superintendence, allowances, weeding etc. There was an admission that only one-seventh of the rubber tree was in full bearing the first year. The Crown’s claim was, therefore, that only one-seventh of those expenses were to be deducted and not the other six-sevenths. This proposition, said to be “startling,” was flatly rejected. The Court dismissed the Crown’s proposition that:[50]

… nothing ever could be deducted as an expense unless that expense was purely and solely referable to a profit which was reaped within the year. [My emphasis.]

It then said:[51]

I think the proposition only needs to be stated to be upset by its own absurdity. Because what does it come to? It would mean this, that if your business is connected with a fruit which is not always ready precisely within the year of assessment you would never be allowed to deduct the necessary expenses without which you could not raise that fruit. This very case, which deals with a class of thing that takes six years to mature before you pluck or tap it, is a very good illustration, but of course without any ingenuity one could multiply cases by the score. Supposing a man conducted a milk business, it really comes to the limits of absurdity to suppose that he would not be allowed to charge for the keep of one of his cows because at a particular time of the year, towards the end of the year of assessment, that cow was not in milk, and therefore the profit which he was going to get from the cow would be outside the year of assessment …. the real point is, What are the profits and gains of the business? …. when you come to think of the expense in this particular case that is incurred for instance in the weeding which is necessary in order that a particular tree should bear rubber, how can it possibly be said that that is not a necessary expense for the rearing of the tree from which alone the profit eventually comes? And the Crown will not really be prejudiced by this, because when the tree comes to bear the whole produce will go to the credit side of the profit and loss account. When the year comes when the tree produces the only deduction will be the amount which has been spent on the tree in that year; they will not be allowed to deduct what has been deducted before.

Indeed, there comes a point where expenses cannot be related reasonably to a particular item of income.

Vallambrosa Rubber Company, Limited is, however, not our case.

In Naval Colliery Company, Limited v. Commissioners of Inland Revenue,[52] also relied on by the respondent, a colliery company had to make reconditioning of its equipment after a national stoppage in the coal mining industry had created damages. The final accounting period for excess profits duty ended June 30, 1921, but no expenditure was made until after the period. The company, however, entered a debit in respect of those costs during the accounting year. Such amounts were disallowed as not being a proper deduction in the period. In rendering his decision, Rowlatt J. of the King’s Bench Division elaborated a number of key principles:[53]

Now, one starts, of course, with the principle that has often been laid down in many other cases—it was cited from Whimster’s case, a Scotch case—that the profits for Income Tax purposes are the receipts of the business less the expenditure incurred in earning those receipts. It is quite true and accurate to say, as Mr. Maugham says, that receipts and expenditure require a little explanation. Receipts include debts due and they also include, at any rate in the case of a trader, goods in stock. Expenditure includes debts payable; and expenditure 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. [My emphasis.]

Naval Colliery Company, Limited, again, is not our case.

The respondent’s contention[54] is that the present issue was decided in its favour by our Court in Cummings (J L) v The Queen.[55] I find, however, that timing was not raised in Cummings. The matter was, therefore, never decided.

Cummings had erected a 15-storey office building in the city of Montréal. At the time construction began, the market appeared buoyant. Shortly thereafter, the market deteriorated and Cummings encountered difficulties in leasing their building. They managed to persuade Domtar Ltd. to lease the entire building for a ten-year lease with further renewals of four ten-year periods. As part of their agreement, Cummings undertook to “pick-up” Domtar’s existing leases in the Place Ville-Marie and CIBC buildings in Montréal. Three payments were made with regard to these leases which represented a total of $790,000. They were: $200,000 to Place Ville-Marie’s owners, $500,000 to Canadian Imperial Bank of Commerce and Sun Life Insurance, and $90,000 commissions paid to the real estate broker, Montreal Trust.

The lease pick-up obligation owing to Place Ville-Marie in an amount of $200,000 was paid on July 31, 1968. Then, prior to the time the amounts of $500,000 and $90,000 were owing, the Cummings building was sold to a company called Holstead Holding Ltd. Holstead assumed the obligation to pay these last expenditures. The amount of $500,000 was paid by October 31, 1969. The fee of $90,000 was paid earlier, in July of 1969.

What was at stake was whether the $790,000 was a capital expenditure or a current expenditure of the business. Heald J.A., relying on Oxford Shopping Centres Ltd. and what he called the “double rationale” of the case, held that the amount of $790,000 was on account of income, the advantage given to the taxpayer in Cummings being even less of a permanent nature than in Oxford Shopping Centres Ltd. He then said it was clear to him that the expenditure was a “running expense” 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. He accepted that the $790,000 had been spent to “prevent a hole in income” and concluded that the amount of $790,000 was a current[56] expenditure. With regard to the portions of $500,000 and $90,000, however, those liabilities, as of October 31, 1968, the end of the appellant’s 1968 taxation year, were contingent and therefore no amount in respect thereof was deductible in the appellant’s 1968 taxation year.

But, since the only issue raised was whether the amount spent was of a capital nature rather than revenue, the rest was obiter.

Conclusion

I conclude that the tenant inducement payments disbursed by the respondent in the taxation year 1986 are to be amortized over the life of the respective leases. The amortization method is the only method acceptable for income tax purposes.

In arriving at my conclusion, I am not unmindful of the decision of this Court in The Queen v. Remington[57] where it was decided that an amount of $1,000,000 received by the taxpayer as inducement to enter a lease was taxable to him as income in the year of receipt with a reserve of $100,000 pursuant to subparagraph 20(1)(l)(i) of the Income Tax Act for doubtful debt.

I would, therefore, allow this appeal with costs, I would set aside the judgment of the Tax Court of Canada, and I would restore the Minister’s reassessment for the 1986 taxation year dated 15 June 1990.

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