A-236-04
2005 FCA 135
Pantorama Industries Inc. (Appellant)
v.
Her Majesty the Queen (Respondent)
Indexed as: Pantorama Industries Inc. v. Canada (F.C.A.)
Federal Court of Appeal, Létourneau, Noël and Nadon JJ.A.--Montréal, April 5; Ottawa, April 15, 2005.
Income Tax -- Income Calculation -- Deductions -- Appeal from T.C.C.'s dismissal of appeal against reassessments for 1995-1998 taxation years -- Appellant in business of selling clothing through chain of retail stores in leased premises in shopping malls -- Since 1979 Snowcap Investments Ltd. entrusted with finding new store locations, negotiating leases, renewals on behalf of appellant -- Fixed, variable fees payable every month under agreement with Snowcap -- Throughout years, appellant deducting fees as current expenses in computation of income -- Minister finding variable fees payments on account of capital, required to be amortized over term of leases with respect to which paid -- Appellant reassessed accordingly -- Deduction of variable fees not prohibited by Income Tax Act, s. 18(1)(b) as being "on account of capital" -- Variable fees not paid on capital account -- Variable fees not paid in order to secure actual asset to appellant but to enable it to continue to carry on -- Evidence showing appellant's network of leased locations well established by 1995, in stage of consolidation rather than expansion -- Once structure in place, moneys paid each year to insure continued profitability are on revenue account -- T.C.C. not focussing analysis on purpose of payments from perspective of appellant's business, as required to do -- Payments to Snowcap required to ensure ongoing operation of appellant's business -- Simply maintained appellant's network, not adding anything to business -- Appeal allowed.
statutes and regulations judicially
considered
Income Tax Act, R.S.C., 1985 (5th Supp.), c. 1, s. 18(1)(b).
cases judicially considered
applied:
Canada Starch Co. v. Minister of National Revenue, [1969] 1 Ex. C.R. 96; [1968] C.T.C. 466; (1968), 68 DTC 5320; 59 C.P.R. 241.
considered:
Rona Inc. v. Canada, [2003] 4 C.T.C. 2974; 2003 DTC 979; 2003 TCC 121.
referred to:
Canderel Ltd. v. Canada, [1998] 1 S.C.R. 147; (1998), 155 D.L.R. (4th) 257; [1998] 2 C.T.C. 35; 98 DTC 6100; 222 N.R. 81; Mitchell v. B.W. Noble, Ltd., [1927] 1 K.B. 719; Johns-Manville Canada Inc. v. The Queen, [1985] 2 S.C.R. 46; (1985), 21 D.L.R. (4th) 210; [1985] 2 C.T.C. 111; 85 DTC 5373; 60 N.R. 244; Hallstroms Pty. Ltd. v. Federal Commissioner of Taxation (1946), 72 C.L.R. 639 (H.C. Aust.); Algoma Central Railway v. Minister of National Revenue, [1967] 2 Ex. C.R. 88; [1967] C.T.C. 130; (1967), 67 DTC 5091; affd [1968] S.C.R. 447; (1968), 68 D.L.R. (2d) 447; [1968] C.T.C. 161; 68 DTC 5096; International Colin Energy Corp. v. Canada, [2003] 1 C.T.C. 2406; 2002 DTC 2185 (T.C.C.).
APPEAL from a decision of the Tax Court of Canada ([2004] 2 C.T.C. 3102; 2004 DTC 2536; 2004 TCC 256) dismissing an appeal against reassessments on the basis that variable fees paid by the appellant were payments on account of capital and as such could not be deducted pursuant to paragraph 18(1)(b) of the Income Tax Act. Appeal allowed.
appearances:
Denis A. Lapierre and Konstantinos Voggas for appellant.
Valérie Tardif and Marielle Thériault for respondent.
solicitors of record:
Sweibel Novek, Montréal, for appellant.
Deputy Attorney General of Canada for respondent.
The following are the reasons for judgment rendered in English by
Noël J.A.:
Introduction
[1]This is an appeal from a decision of the Tax Court of Canada [[2004] 2 C.T.C. 3102] dismissing the appellant's appeal against assessments under the Income Tax Act, R.S.C., 1985 (5th Supp.), c. 1, as amended (the Act) for the 1995-1998 taxation years.
Background
[2]The appellant has been in the business of selling pants and related casual clothing through a chain of retail stores in leased premises primarily located in shopping malls since 1971. Beginning in 1979, and throughout the period up to and including the four years in issue, the appellant has relied on the services of Snowcap Investments Ltd. (Snowcap), to find new locations for its stores and negotiate leases and renewals of leases on its behalf.
[3]The appellant had 233 stores in 1995, 222 stores in 1996, 212 stores in 1997 and 199 stores in 1998, all of which were operated in leased premises mainly in Quebec and Ontario. During this period, the appellant opened 46 new stores and closed about 80 stores. It also renewed between 25 and 30 of its leases each year.
[4]The majority of the new leases had a term of between five and seven years, and the renewals ran from one to seven years, depending on how the particular location was performing. The total rent paid by the appellant was approximately $20 million annually.
[5]Store location is an essential feature of the appellant's business, but because commercial developments and consumer preferences are in constant evolution, the appellant made a decision, back in 1979, to entrust Snowcap with the responsibility of dealing with this aspect of its business.
[6]Under the agreement with Snowcap, the appellant agreed not to engage any other real estate consultants, advisors or leasing agents to act in a similar capacity and Snowcap agreed not to provide its services to anyone in the same business as the appellant.
[7]Two types of fee were payable under the agreement. A fee of $2,500 payable every month (fixed fees) and another calculated according to the surface area for new leases or the duration of the extension for extended leases (variable fees). Variable fees totalling $203,639, $274,500, $202,476 and $111,000 were paid by the appellant in the course of its 1995-1998 taxation years, respectively.
[8]The appellant's vice-president (finance and operations) explained during his testimony that Snowcap acted as its "retail store advisor." It found rental space for the appellant and provided advice, market information and rental rates. When a decision was made to rent, Snowcap acted on the appellant's behalf to negotiate the terms of the leases and renewals with the landlords.
[9]Snowcap's chairman testified that his company had over the years developed a substantial client base (approximately 80 clients) which allowed it to lease up to 150,000 square feet of space in a given mall thereby giving it the power to command favourable rents.
[10]He added that there were about 20 landlords of large shopping malls in Canada, all of whom were known to Snowcap. In his view, Snowcap acts as a "real estate department" for its clients.
[11]Throughout the years, the appellant deducted both the fixed and the variable fees as current expenses in the computation of its income. As a result of the most recent audit, the Minister accepted this treatment with respect to the fixed fees, but took the view that the variable fees were payments on account of capital which had to be amortized over the term of the leases with respect to which they were paid. The Minister reassessed the appellant accordingly.
[12]In so doing, the Minister relied on paragraph 18(1)(b) of the Act which provides:
18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of
. . .
(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part; [Underlining added.]
[13]It is important to note that the issue raised by the appeal is not one of matching expenses with revenues with the view of obtaining a better or more accurate picture of the appellant's profit (compare Canderel Ltd. v. Canada, [1998] 1 S.C.R. 147). The only issue to be decided is whether the deduction of the variable fees is prohibited by paragraph 18(1)(b) as being "on account of capital." If not, the Minister does not take issue with the appellant's practice of deducting these amounts in the year in which they were paid.
Reasons of the Tax Court Judge
[14]The Tax Court Judge wrote at paragraphs 20-21 of his reasons:
The usual test for determining whether a payment is on capital account has been held to be whether it was made "with a view of bringing into existence an advantage for the enduring benefit of the appellant's business". (British Columbia Electric Railway Company Limited v. M.N.R., [1958] S.C.R. 133 at 138.)
The distinction between payments made by a taxpayer on capital and income account has also been said to correspond "to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organization and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it." (Hallstroms Pty. Ltd. v. Federal Commissioner of Taxation (1946) 72 C.L.R. 634, at 646-7.)
[15]He identified the "first question" which had to be answered as follows (at paragraph 24):
. . . what was the purpose of the expenditures, in the context of the Appellant's business? Was it to obtain new leases and renewals, or to receive real estate advice and general services including negotiation of leases?
[16]The Tax Court Judge went on to find that the fixed fees paid by the appellant "covered the general advice and planning assistance provided by Snowcap" (reasons, paragraph 26). The variable fees were paid "in relation to bringing new leases into existence or extending existing ones" (reasons, paragraph 28). As such, the variable fees "pertained to th[e] business structure" (reasons, paragraph 28).
[17]The leases provided the appellant with an "enduring benefit" (reasons, paragraph 29). The fact that the fees were recurrent from year to year did not alter the fact that "[t]he overriding purpose of the expenditures was to expand the Appellant's business by entering into new leases and by extending expiring ones" (reasons, paragraph 30).
Analysis and Decision
[18]In my respectful view, the Tax Court Judge made a number of errors in reaching the conclusion that the variable fees were paid on capital account. While it is possible that expenses which recur every year over the life of a long established business are on capital account, this would tend to be rather exceptional. When the matter is considered from the perspective of the appellant's business, as it must be, it seems clear that the variable fees were not paid "in order to secure an actual asset to the [appellant] but to enable [it] to continue to carry on, as it had done in the past" (see Mitchell v. B.W. Noble, Ltd., [1927] 1 K.B. 719, at page 737, as quoted in Johns-Manville Canada Inc. v. The Queen, [1985] 2 S.C.R. 46, at page 60).
[19]In reaching his conclusion, the Tax Court Judge relied on the decision of Archambault J. in Rona Inc. v. Canada, [2003] 4 C.T.C. 2974. In that case, Archambault J. had to decide whether professional fees incurred by Rona Inc. in the course of an expansion program intended to augment its sales outlets by outright purchases or by the adjunct of new partners were on capital account. He held that although these expenses had to be paid every year, "[e]ngaging in a planned phase of expansion of the business structure over a lengthy period of adding new sales outlets does not make a capital outlay an income expense" (Rona, at paragraph 38).
[20]The finding by the Tax Court Judge in the present case that the appellant was engaged in a similar expansion (paragraphs 27-30) is without any evidentiary foundation. Indeed, the evidence shows that the appellant's network of leased locations was well established by 1995, and that if anything, it was in a stage of consolidation, i.e., more stores were being closed than stores were being opened. It is sufficient in this regard to recall that the appellant had 233 stores in 1995 and that this number dwindled every year and stood at 199 at the close of its 1998 taxation year.
[21]As was pointed out in Canada Starch Co. v. Minister of National Revenue, [1969] 1 Ex. C.R. 96 (in a passage cited by Archambault J. in Rona, at paragraph 37), moneys spent towards the creation or the expansion of a commercial structure is on capital account as this type of expenditure gives rise to an asset of an enduring nature. However, once a structure is in place, moneys paid each year to insure that it can continue to be exploited profitably are on revenue account.
[22]In the present case, the nature of the payments is made clear when it is appreciated that they had to be made since 1979 and there is no suggestion that the appellant's business can continue without these payments being made every year (compare Johns-Manville, at pages 72-73). What this shows, unequivocally in my view, is that the payments are required to ensure the ongoing operation of the appellant's business.
[23]The Tax Court Judge focussed his analysis on the juristic classification of the legal rights secured by the payment of the variable fees (i.e., the individual leases) rather than the purpose of the payments from the perspective of the appellant's business (see Hallstroms Pty. Ltd. v. Federal Commissioner of Taxation (1946), 72 C.L.R. 639 (H.C. Aust.), as quoted in Johns-Manville, at page 57).
[24]What the appellant had in view in paying the variable fees every year was its continued profitability having regard to evolving consumer needs and preferences. The Tax Court Judge lost sight of the purpose of the expenditure from the perspective of the appellant's business when he held that the appellant was expanding its business every time it signed or extended a lease (compare Algoma Central Railway v. Minister of National Revenue, [1967] 2 Ex. C.R. 88; affd [1968] S.C.R. 447). The appellant had more than 200 such leases at the beginning of the period and payments which did nothing more than maintain this network in place did not add anything to the appellant's business which it did not already have.
[25] Finally, I believe that it can safely be said that the Minister would not have raised the assessments in issue if the services provided by Snowcap had been obtained in-house, and paid for in the form of salaries, travel expenses, etc. If that is so, the fact that the appellant made a decision to outsource this aspect of its business should have no bearing on the tax treatment of the expenditure (compare International Colin Energy Corp. v. Canada, [2003] 1 C.T.C. 2406 (T.C.C.), at paragraphs 45-46).
[26]For these reasons, I would allow the appeal, set aside the decision of the Tax Court and refer the reassessments back to the Minister of National Revenue for reconsideration and reassessment on the basis that the deduction of the variable fees is not prohibited by paragraph 18(1)(b) of the Act. The appellant should be awarded its costs in this Court and before the Tax Court of Canada.
Létourneau J.A.: I agree.
Nadon J.A.: I agree.