The Armour Group v. R. - TCC: Lease cancellation fee of $2.24 million not deductible

The Armour Group v. R. - TCC:  Lease cancellation fee of $2.24 million not deductible

http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/230635/index.do

The Armour Group Limited v. The Queen (May 24, 2017 – 2017 TCC 65, Paris J.).

Précis:  In a complex land transaction with the Province of Nova Scotia the taxpayer claimed to have paid $2.24 million by way of set off to cancel a ground lease with the Province under which its wholly-owned subsidiary, Founders Square Limited (“FSL”), was the tenant.  FSL acted as a bare trustee for the taxpayer and the taxpayer claimed to deduct the payment made by FSL as a business expense.  CRA denied the deduction as being on account of capital, or alternatively, a non-deductible pre-payment of rent.  The Tax Court held that the payment was on account of capital and dismissed the appeal with costs to CRA.

Decision:  The Tax Court held that the $2.24 was a payment to the Province to acquire a capital property:

[46]        Regardless of the provision in the Surrender Agreement that “the delivery of this Surrender and the Conveyance shall in no way constitute a merger of the fee simple title and the leasehold title in the Lands”, the surrender of the Ground Lease to the Province caused it to merge with the fee simple title by operation of law.

[47]        This view of what took place in law is also supported by the Warranty Deed given to ADL by the Province. According to the Deed, the Province conveyed the fee simple title to the Property to ADL, free and clear of any encumbrances.

[48]        Given that the Province and FSL had agreed in the Minutes of Settlement that the fair market value and purchase price of the Property was $2.4 million, it would appear that all of the $2.4 million credit owing to FSL by the Province provided for in the Minutes of Settlement was set off against the purchase price of the Property, rather than just $160,000.

[49]        I would attach little weight to the fact that, for municipal tax purposes, ADL reported a value of $160,000 for the property it received from the Province. While the Appellant maintained that this value was accepted by the municipality, there is no evidence that the details of the transactions between FSL, ADL and the Province were ever examined or analyzed by the municipality.

[50]        In my view, upon the proper construction of the agreements that are before me, FSL used the $2.4 million credit under the Minutes of Settlement to pay for the transfer of the Property to ADL. Since, under the Transfer Agreement, FSL transferred to ADL the option to acquire the fee simple interest to the Property, it appears to me that FSL paid the $2.4 million purchase price on ADL’s behalf.

[51]        In exchange, ADL gave FSL the right to enter into a new long-term ground lease of the Property with ADL at a minimal rent.

[52]        A leasehold interest, such as that given in the New Ground Lease, is a capital asset. In T. Eaton Company Limited v. The Queen, 99 DTC 5178, the Federal Court of Appeal stated that:

…A leasehold interest in land also represents a capital asset, the value of which depends on both the terms of the lease and market conditions. For example, a tenant whose rent obligation is one-half the market rate has a valuable asset which can be sold by way of assignment, subject to any restriction protecting the interests of the landlord…(at para 36)

[53]        It seems clear to me that the leasehold interest that FSL obtained from ADL at a nominal rent under the New Ground Lease was a capital asset and therefore that the payment made by FSL by offset on behalf of ADL was on capital account.

Accordingly the Tax Court held that the payment was on account of capital and dismissed the appeal with costs to CRA.