Pantorama Industries Inc. v. The Queen

Pantorama Industries Inc. v. The Queen Court (s) Database Tax Court of Canada Judgments Date 2004-04-02 Neutral citation 2004 TCC 256 File numbers 2000-5000(IT)G Judges and Taxing Officers Brent Paris Subjects Income Tax Act Decision Content Docket: 2000-5000(IT)G BETWEEN: PANTORAMA INDUSTRIES INC., Appellant, and HER MAJESTY THE QUEEN, Respondent. ____________________________________________________________________ Appeal heard on October 27, 2003 at Montreal, Quebec, Before: The Honourable Justice Brent Paris Appearances: Counsel for the Appellant: Denis A. Lapierre Konstantinos Voggas Counsel for the Respondent: Valérie Tardif Marielle Thériault ____________________________________________________________________ JUDGMENT The appeal from the reassessments made under the Income Tax Act for the 1995, 1996, 1997 and 1998 taxation years is dismissed with costs. Signed at Ottawa, Canada, on this 2nd day of April 2004. "Brent Paris" Paris, J. Citation: 2004TCC256 Date: 20040402 Docket: 2000-5000(IT)G BETWEEN: PANTORAMA INDUSTRIES INC., Appellant, and HER MAJESTY THE QUEEN, Respondent. REASONS FOR JUDGMENT Paris, J. [1] The Appellant is a public company that operates several chains of clothing stores in Canada under such names as Pantorama, Levi's, 1850 and D'Gala. Its headquarters are in Montreal and its stores are located primarily in leased premises in shopping malls. Since 1979, the Appellant has engaged another company, Snowcap Investments Ltd., to find new locations for its stores and to negotiate leases and renewals of leases on its behalf. It paid Snowcap a monthly fee of $2,500 and set amounts for each new lease or renewal that it arranged. [2] The Appellant treated the payments to Snowcap as a current expense of its business. The Minister, however, took the view that those fees paid in respect of new leases and renewals were payments on account of capital and reassessed the Appellant for its 1995 to 1998 taxation years to disallow the deduction of the fees in the calculation of its business income. Those amounts[1] were added to the capital cost of the Appellant's leases and capital cost allowance was allowed. The Appellant is appealing those reassessments. Facts [3] The facts of this case are largely undisputed. [4] Mr. Ralph Fragomene, the Appellant's vice-president in charge of finance and operations, explained the circumstances surrounding the payments made to Snowcap. The original agreement between the Appellant and Snowcap ran for three years, and was renewed every few years. It provided that Snowcap was to act as Appellant's consultant and advisor for the establishment of all of its retail locations with certain limited exceptions. 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 work for anyone in the same business as the Appellant. Although it was not set out in the original agreement, it is clear from the evidence that the Appellant also used Snowcap to negotiate the terms of its new leases and its lease renewals. [5] In addition to the set monthly amount, the Appellant paid Snowcap a fee for each new lease and each lease renewal that it arranged, and for arranging to convert one of the Appellant's stores to another one on the same premises. (For example, if the Appellant wanted to convert a Levi's store to an 1850 store on the same premises, Snowcap would negotiate this arrangement with the landlord.) Payment was generally based on the size of the premises involved and, for renewals, on the length of the renewal. The fees became payable only upon a binding agreement being entered into between the Appellant and the landlord. [6] Mr. Fragomene said that, in the years under appeal, the Appellant carried on business in several provinces, although most of its stores were located in Ontario and Quebec. 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. From 1995 to 1998 the Appellant opened 46 new stores and closed about 80 stores. It also renewed between 25 and 30 of its leases each year. The majority of the new leases that were entered into had a term of between five and seven years, and the renewals ran from one year to seven years, depending on how the particular location was performing. The total rent paid on its stores was approximately $20 million annually. [7] Mr. Fragomene referred to Snowcap as a "retail store advisor" to the Appellant. He said that Snowcap was responsible for finding suitable rental space for the Appellant's new stores. Snowcap also provided advice to assist the Appellant in deciding whether it wanted to open a store in a particular new location. With respect to renewals, the Appellant's in-house lease administrator tracked upcoming lease expiry dates and gave a list of them to Snowcap. In the case of both new leases and renewals, Snowcap provided the Appellant with market information and rental rates and contacted the landlord to establish what terms the landlord was seeking. Snowcap would act on the Appellant's behalf to negotiate the terms of the leases and renewals with the landlords. Upon reaching a deal, it would prepare a letter of understanding to be signed by the Appellant and the landlord, and a formal lease would subsequently be drawn up by the Appellant's lawyers. [8] Mr. Fragomene explained that the Appellant hired Snowcap to save time. Given the volume of new leases and lease renewals in the Appellant's business it would have taken a lot of his time on a daily basis if he had dealt with landlords directly. He also said that Snowcap was able to obtain the best rental rates on behalf of the Appellant because it acted for so many clients. [9] When asked about the two different types of fees (monthly and lease specific) that the Appellant paid to Snowcap, Mr. Fragomene said that there was no distinction that could be drawn in terms of the services that it received. He said all of Snowcap's efforts went to finding new leases for the Appellant and that there was "no rhyme or reason" to there being two types of charges. However, in cross-examination he agreed that Snowcap charged the Appellant according to the fee schedule they had agreed to for the specific leasing services provided by Snowcap. [10] Mr. Seymour Obrant, chairman of Snowcap, also gave evidence on behalf of the Appellant. He described Snowcap as a retail leasing consultant whose business consisted of negotiating shopping mall store leases and renewals for clients, and resolving any conflicts they had with the landlords. In essence, he said, it acted as a real estate department for its clients. [11] In the years under appeal Snowcap had about 80 clients of which the Appellant was one of the largest. Snowcap's sizable client base gave it the potential to lease up to 150,000 square feet of space in a mall and allowed it to obtain more favourable rents on their behalf. Mr. Obrant said that there were about 20 landlords of large shopping malls in Canada, and that Snowcap saved clients the time of having to deal with all of them. [12] Snowcap representatives talked on the phone daily with the Appellant's management and met with them once a month to review ongoing leasing matters. Twice, yearly meetings were held to review the Appellant's plans for new locations and for renewals of existing locations and to develop a strategic plan for the Appellant's growth. Because of Snowcap's involvement in the retail property market, it was aware of new property developments coming available 4 to 5 years in the future and could pass this information on to the Appellant for its consideration. [13] Mr. Obrant said that the monthly fee charged to the Appellant was originally intended to cover part of Snowcap's overhead. Snowcap charges a monthly fee to its larger clients to ensure cash flow, to pay for travel and to help with staffing and service. He did not indicate whether the monthly fee entitled the Appellant to services over and above those provided on a fee specific basis. [14] Ms. Anne McCarel, the Appellant's external auditor from BDO Dunwoody, gave evidence of how the payments to Snowcap were accounted for by the Appellant. She stated that she treated the Snowcap fees as a current expense because in her view they were incurred as part of the Appellant's ongoing revenue earning operations. The store leases were considered to be operating leases as opposed to capital leases for accounting purposes. She explained that, under generally accepted accounting principles, capital leases are ones that transfer substantially all risks and benefits of ownership to the lessee and are treated as the acquisition of an asset on the books of the lessee. Issue [15] The issue in this appeal is whether the fees paid by the Appellant to Snowcap are deductible as current expenses or whether they were incurred on account of capital. [16] Counsel for the Appellant submitted that the payments to Snowcap were not on capital account because the leases to which the payments related were not capital assets to the Appellant. He said that the leases, having terms of seven years or less, did not provide an enduring benefit to the Appellant; they were not a long-term asset. The leases were entered into to permit the Appellant to carry on business on a daily basis. Furthermore, the leases were recurring. The Appellant was constantly negotiating new leases and renewals of existing leases, entering into between 40 and 60 per year. Also, he suggested that the tax treatment of the leases and the payments related to them should follow generally accepted accounting principles under which the leases were not treated as capital assets. Finally, he said that, even if the leases were capital property of the Appellant, the payments were not necessarily on capital account, and that the same factors, such as duration of the benefit received, recurrence and reason for the payments should be considered. [17] Counsel for the Appellant referred to the Supreme Court of Canada decision in Johns-Manville Canada Inc. v. Her Majesty the Queen[2] where certain expenses relating to the purchase of land in the course of the taxpayer's mining operation were found to have been on income account. He likened the payments in issue here to those in the Johns-Manville case on the basis that the payments here did not result in the acquisition of a capital asset, that the expenditures were incurred every year as an integral part of the Appellant's operations, that they formed part of the daily and annual cost of production, that the benefit was not long lasting because similar expenditures would be required every year, and the operations of the Appellant could not continue in the future without these annual expenditures. Analysis [18] The Minister has disallowed the deduction of the amounts in issue pursuant to paragraph 18(1)(b) of the Income Tax Act[3], which reads: 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; [19] It has been noted on many occasions that the phrase "outlay or expenditure on account of capital" is not defined in the Act. In this respect, the Supreme Court of Canada has said: There being no statutory criterion, the application or non-application of these expressions to any particular expenditures must depend upon the facts of the particular case. [20] 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".[4] [21] 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."[5] [22] Put another way: an expenditure for the acquisition or creation of a business entity, structure or organization, for the earning of profit, or for an addition to such an entity, structure or organization, is an expenditure on account of capital, and ...an expenditure in the process of operation of a profit-making entity, structure or organization is an expenditure on revenue account.[6] [23] The question of whether payment of professional fees incurred by a taxpayer was on income or capital account arose in Rona Inc. v. The Queen[7]. In that case, Archambault, J. said at p. 989: ... The nature of the fees depends on the purpose of the services that were rendered. If the professional fees involve current transactions, they are income expenditures. If the fees involve the expansion of the business structure, they are capital outlays. For example, if fees are paid for negotiations with respect to a marketing campaign, they are income expenses. However, if fees are paid in order to acquire a competitor, they are capital outlays. What needed to be determined first is the nature of the transactions conducted by Rona in order to characterize the nature of the professional services required for these. Here, the professional services were retained for transactions in which franchised stores, or "corporate" stores to be constructed or already owned by competitors were to be acquired. The purpose of these services was to confer on Rona an advantage [Translation] "for the lasting benefit of [its] business." [24] In applying these principles to this case the first question to ask is: 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? [25] Although there was some suggestion that the Snowcap fees were for on-going consultations and advice provided to the Appellant, more in the nature of day-to-day management type services and not related to specific leases, I am not satisfied that this was the case. The evidence was clear that the payments in issue were all made for Snowcap arranging new leases or lease renewals or for similar services for the Appellant, and were made according to the fee schedule to which the parties had agreed. Snowcap was only entitled to receive the payments once lease agreements or renewals were signed. [26] While the evidence indicated that Snowcap assisted the Appellant in the development of its leasing strategy and with planning, which would be part of day- to-day management functions, these services were ancillary and subordinate to its main activity of negotiating leases. The bulk of Snowcap's efforts were focused on producing new leases and renewals and I find that the payments were made for that purpose. It is also reasonable to infer that the monthly payments made by the Appellant covered the general advice and planning assistance provided by Snowcap. [27] The Appellant's counsel argued that the decision in Rona could be distinguished on the basis that the Appellant here was not embarking on an expansion program. I am not convinced that this distinction is valid. I agree with counsel for the Respondent that the new leases and renewals did amount to an expansion of the Appellant's business structure. They resulted in new premises from which it could sell clothing, or an extension of its right to sell clothing from a particular location that would otherwise have had to be closed if the lease had expired. The evidence also showed that, in the years under appeal, the Appellant had a strategy for opening new locations in order to grow its business. [28] It is clear that the leases were part of the structure of the Appellant's business which permitted it to carry on its daily commercial activity and to earn its income. They were part of the Appellant's means of production. The payments made by the Appellant in relation to bringing new leases into existence or extending existing ones pertained to that business structure. [29] The leases here also provided an enduring benefit to the Appellant. The terms of the new leases here were from five to seven years. Also, it may be inferred from the number of lease renewals that the Appellant executed each year that it had a certain expectation that its leases would be renewed, presuming adequate sales were achieved in that location. [30] It is true that the payments to Snowcap were recurrent through the years under appeal, but this does not necessarily mean that they were expenses on current account. The overriding purpose of the expenditures was to expand the Appellant's business by entering into new leases and by extending expiring ones, and the fact that this was accomplished many times in a given period does not make the benefit acquired in respect of each new lease any less enduring. Each renewal was for a different location, and the frequency of the renewals was a function of the total number of leases that the Appellant had. Each payment to Snowcap was a one-time payment in relation to the particular lease or renewal and the duration of the benefit the Appellant received was equal to the length of the lease or renewal. [31] I do not see the leases in this case as similar in nature to the land that was purchased in the Johns-Manville case. There, the Court found that the land was not part of structure of the taxpayer's mining operation and the land was consumed in the course of production. The expenditures on the land were held to relate more to the daily production of the mine than to the structure and not to provide any benefit beyond the year in which they were made. In the case before me the leases were not consumed in any way analogous to the land in Johns-Manville and the Appellant enjoyed the benefit of the new leases and renewals over the entire life of the leases. [32] The fact that the Appellant treated the payments to Snowcap as current expenses in its financial statements is not relevant to the determination of their character for the purposes of the Income Tax Act. The question of whether the payments are on capital or income account is one of mixed fact and law, and the principles that must be applied to the determination are priniciples of law and not those of accounting. Even if I had decided that I should consider accounting principles in arriving at my decision, there is no expert evidence in this case as to what those principles are. Although Ms. McCarel told the Court how the payments were treated in the Appellants books, she was not presented or qualified as an expert. [33] The Appellant's counsel urged me to accept Ms. McCarel's testimony as evidence of the applicable generally accepted accounting priniciples, and referred me to the case of R. v. Graat[8], in which a non-expert witness was permitted to give opinion evidence. This case is not applicable because it does not deal with expert evidence. Expert evidence is treated differently than opinion evidence given by a non-expert and is only admissible where the subject matter calls for expertise, where the expert is qualified and where procedural requirements relating to introduction of expert evidence have been met. The latter two conditions have not been met in this case. [34] After considering all of the circumstances of this case and in particular the purpose of the payments and the benefit received by the Appellant as a result of them, I am satisfied that the fees paid by the Appellant to Snowcap were on capital account. [35] The appeal is therefore dismissed, with costs. The parties agreed at the hearing that the applicable class of proceedings for the purpose of determining costs is Class B because the amount in issue is less than $150,000. Signed at Ottawa, Canada, on this 2nd day of April 2004 "Brent Paris" Paris, J. CITATION: 2004TCC256 COURT FILE NO.: 2000-5000(IT)G STYLE OF CAUSE: Pantorama Industries Inc. v. Her Majesty The Queen PLACE OF HEARING Montreal, Quebec DATE OF HEARING October 27, 2003 REASONS FOR JUDGMENT BY: The Honourable Justice B. Paris DATE OF JUDGMENT April 2, 2004 APPEARANCES: Counsel for the Appellant: Denis A. Lapierre Konstantinos Voggas Counsel for the Respondent: Valérie Tardif Marielle Thériault COUNSEL OF RECORD: For the Appellant: Name: Denis A. Lapierre Firm: Sweibel Novek Montreal, Quebec For the Respondent: Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada [1] $203,639 in 1995, $274,500 in 1996, $202,476 in 1997, and $111,000 in 1998 [2] 85 D.T.C. 5373 [3] R.S.C. 1985 (5th Supp.), c. 1 (the "Act"). [4] British Columbia Electric Railway Company Limited v. M.N.R. (1958) S.C.R. 133 at 138 [5] Hallstroms Pty. Ltd. v. Federal Commissioner of Taxation (1946) 72 C.L.R. 634, at 646-7 [6] Sun Newspapers Ltd. et al. v. Fed. Com. of Taxation (1938) 61 C.L.R. 337 at 359 [7] 2003 D.T.C. 979. [8] [1982] 2 S.C.R. 819