Date: 20010920
Docket: T-1290-88
Neutral citation: 2001 FCT 1023
BETWEEN:
PETER TRYNCHY
Applicant,
- and -
HER MAJESTY THE QUEEN
Defendant.
REASONS FOR JUDGMENT AND JUDGMENT
[1] By the budget of November 1981, the federal government changed the tax law to limit the ability of investors to write off "soft costs" of construction projects against current account income. The present case concerns the Tax Act (R.S.C. 1952, c.148, as amended) provisions imposing this change, and how, against the arguments of the Plaintiff, they were interpreted to support a reassessment of the Plaintiff's tax liability by the Minister of National Revenue (the Minister) for the years 1982, 1983, and 1984.
[2] The trial of this matter proceeded by admission of key facts, the most basic of which are as follows: the Plaintiff was a limited partner in a limited partnership (the Raintree Limited Partnership) established under the laws of Alberta for the purpose of developing an office, retail, and hotel complex in Edmonton known as "Raintree Place"; the Plaintiff owned 120 of the total of 2,470 units issued by the partnership; in each of the years 1982, 1983, and 1984, the partnership suffered large losses per unit and the Plaintiff deducted, from current account income, his incurred losses; based on an interpretation of the 1981 amendments, in the reassessments appealed from, the Minister significantly reduced the amounts of the losses for each of the years mentioned; and by Notification dated March 30, 1988, on certain contested assumptions, the Minister confirmed each of the reassessments.
[3] The relevant provisions of the Tax Act interpreted by the Minister are as follows, with particular emphasis added to elements of s.18(3.1)(a):
(3.1) Costs relating to construction of building or ownership of land --
Notwithstanding any other provision of this Act, in computing a taxpayer's income for a taxation year,
(a) no deduction shall be made in respect of any outlay or expense made or incurred by the taxpayer, other than an amount deductible by virtue of paragraph 20(1)(a) or (aa) or section 37 or 37.1, that
(i) may reasonably be regarded as a cost incurred during the period of the construction, renovation or alteration of a building and that relates thereto or to costs incurred during that period relating to the ownership, during that period, of land
(A) that is subjacent to the building, or
(B) that
(I) is immediately contiguous to the land subjacent to the building,
(II) is used, or is intended to be used, for a parking area, driveway, yard, garden or any other similar use, and
(III) is necessary for the use or intended use of the building, and
(ii) was made or incurred before the completion of the construction, renovation or alteration of the building; and
(b) the amount of such outlay or expense shall be included in computing the cost or the capital cost to the taxpayer of the land or building, as the case may be.
(3.3) Completion -- For the purposes of subsection (3.1), the construction, renovation or alteration of a building is completed at the earlier of the day on which the construction, renovation or alteration is actually completed and the day on which all or substantially all of the building is used for the purpose for which it was constructed, renovated or altered.
(3.5) Idem -- Subsection (3.1) does not apply in respect of an outlay or expense in respect of a building or the land described in subparagraph (3.1)(a)(i) or (ii),
(a) where the construction, renovation or alteration of the building was in progress on November 12, 1981,
(b) where the installation of the footings or other base support of the building commenced after November 12, 1981 and before 1982,
(c) if, in the case of a new building being constructed in Canada or an existing building being renovated or altered in Canada, arrangements, evidenced in writing, for the construction, renovation or alteration were substantially advanced before November 13, 1981 and the installation of footings or other base support for the new building or the renovation or alteration of the existing building, as the case may be, commenced before June 1, 1982, or
if, in the case of a new building being constructed in Canada, the taxpayer was obligated to construct the building under the terms of an agreement in writing entered into before November 13, 1981 and arrangements, evidenced in writing, respecting the construction of the building were substantially advanced before June 1, 1982 and the installation of footings or other base support for the building commenced before 1983,
and the construction, renovation or alteration, as the case may be, of the building proceeds after 1982 without undue delay (having regard to acts of God, labour disputes, fire, accidents or unusual delay by common carriers or suppliers of materials or equipment).
(3.7) Commencement of footings -- For the purposes of this section, the installation of footings or other base support for a building shall be deemed to commence on the first placement of concrete, pilings or other material that is to provide permanent support for the building.
[4] In order to understand the basis for the reassessment, it is necessary to understand the economic and legal context in which Raintree Place was developed. This context is complex, and without some clear and careful explanation is not easily understood by anyone not a tax lawyer or accountant. Such an explanation was clearly provided by Mr. J.D. Gilbert, counsel for the Defendant, in his opening address during the trial. For the benefit all readers of these reasons, the following is an edited abridgement:
The November 12, 1981 federal budget caused all the problems here.
The Raintree Limited Partnership was conceived of and structured as what
was commonly referred to or thought of as a tax shelter which would be marketed to private investors who had significant income from other sources and, therefore, could use the tax deductions.
Real estate projects were particularly good for that sort of thing; you buy in before the thing is even built because there are going to be a lot of expenses or "soft costs" incurred before the property is finished and can start generating income. That is, you will have a whole bunch of expenses deductible up front under specific provisions of the Tax Act, and then income much, much later down the road. So, the tax benefit really was a big incentive for the investors to put their money in this type of investment as opposed to something a little bit more conventional.
The Department of Finance and Parliament decided that they were going to put limits on these types of tax shelters, and, thus, announced tax law amendments in the November 1981 budget. One of the provisions was s.18(3.1) which attacked the deductibility of soft costs such as mortgage interest during the period of construction, and legal and accounting fees for things like land transfers and doing the prospectus; that is, expenses that go into creating a building other than the bricks and mortar construction expenses were deductable.
Thus, s.18(3.1) was aimed at the soft costs that generated the tax writeoffs that were attractive to the tax shelter investors, like the Plaintiff in this case.
So, Parliament said in the budget of November 1981, "we are not going to let you people write off those soft costs anymore during the construction phase; they are all going to have to be attributed to either the cost of the land, or the cost of the building". Therefore, to the extent that the expenses would relate specifically to the land, they would be added to the land cost for capital gain purposes, and to the extent that the expenses could be said to relate to the building, they would be put in what is called a "capital cost allowance" class, because unlike land, a building can be depreciated for income tax purposes. Thus, under the change, the costs of constructing a building can be written off over a period of years, but not as fast as writing them off immediately as currently deductible expenses.
When the budget was handed down, people all over the country, like our Raintree people, said: "well, that is very nice, we just finished putting together a prospectus; we were getting ready to issue it and to market it for the December year-end, because this is when people who have money and income start looking for these types of investments; and, now, you have said that we are not going to be able to write this off anymore".
As Parliament typically does with income tax amendments in the budget, they become effective on budget day, and then later on down the road, the legislation gets put into place with retroactive effect. And, of course, budget amendments are always very secret, so you get these usually quite without warning.
The literature from the time period suggests that everybody was very, very surprised that Parliament was going to take that kind of a stance with projects like Raintree Place, but it did. And so in fairness to taxpayers, you get grandfather provisions, which is what we are looking at in subsection s.18(3.5). So, they say: "all right; we recognize that a lot of you out there have spent a lot money and done a lot of work getting these projects up and ready to go; and, within limits, we are willing to let the old rules apply to you. And so, s.18(3.5) sets the limits.
And I think the evidence will show that the budget caused a big derailment of the planned marketing of Raintree Place because of the uncertainty. They got some advice from their tax lawyer who said: "put in a piling because the transitional provision s.18(3.5) says that if we take this step, we can still have the old rules apply and market this as a tax shelter; if we don't take this step, then all of the costs that we are going to incur throughout the whole phase of construction are going to have to be capitalized, because s.18(3.1) will apply, and nobody is going to want to buy the Partnership units; they will go invest their money in something that qualifies as a tax shelter".
So, they made very, very sure that they put that piling in the ground and poured the concrete to engage s.18(3.5). There is no doubt about it. And the evidence will show that over the subsequent years efforts were made by the Raintree Limited Partnership to try to get Revenue Canada to say in writing: "yes, your project is grandfathered; we agree that even though you haven't built a building at all, your project is eligible for grandfathering; these new soft cost rules won't apply, and you can go out and sell it to people and tell them that".
Thus, what Parliament said in the amendments is: "if you get your piling in the ground before 1982, we are going to give you a year of grace, so to speak, to get your ducks in a row, and then that building has to go up; so, once we get to January 1, 1983, this building has to go up without delay, or there will be no grand fathering". I think they imposed restrictions like this because they were serious about wanting the new rules to apply; they were saying: "for projects that are seriously going forward, here is how you can avoid these new rules; we don't want to have a bunch of vacant plots of land all over the country sitting with one pile in them forever, arguably grandfathered from this new provision; so, fine, if you comply with s.18(3.5) and the building goes up starting on January 1, 1983, without delay, having reference to the factors listed in s.18(3.5), s.18(3.1) will not apply".
The Raintree Limited Partnership put itself in the grandfathering provision so that it could market Raintree Place as a tax shelter. If it had not tried to engage s.18(3.5) and claim the grandfathering, then there is no doubt that s.18(3.1) would have applied had the construction gone forward.
(Transcript, September 10, 2001, pp.17-22.)
[5] With respect to s.18(3.1) and s.18(3.5), and their applicability to the Raintree Place project, it is agreed as follows: to try to comply with the first of the two requirements of the exemption provided by s.18(3.5), a single concrete piling was inserted into the ground after November 12, 1981 and before December 18, 1981, being the only piling that was ever poured; 50 to 100 pilings would be required as the base support for the Raintree project structure; at the time the single piling was inserted, no fencing was put around the building site, and such was not done until 1983; no permanent financing for the project was in place on December 18, 1981, and not only had no construction contract been awarded, the conditions precedent for even negotiating for permanent financing had not been met in that no firm quote of construction costs had been ascertained, and no proof that the partnership had 25% equity in the project had yet been supplied by way of a bank letter of credit; nothing occurred on the building site in 1982; only the erection of the fencing, and the removal of a vacant building and levelling of the ground on the site, both for safety reasons, occurred in 1983; and nothing occurred on the site between 1983 and 1986 when the land was foreclosed.
[6] It is also agreed that in November 1981, the prospects of successfully completing the Raintree Place project were good, and that essentially a downturn in the Alberta economy sometime later contributed to the project's failure.
[7] In essence, the key assumptions in dispute as made by the Minister on confirming the reassessments are that the construction of the building commenced with the insertion of the single piling, and that the construction of Raintree Place had not ceased at the time of the reassessments. In attacking these assumptions, Mr. P. Knaak Q.C., counsel for the Plaintiff, forcefully argues that the admitted facts prove there never was an intention to commence construction of a building, and, therefore, no "period of construction of a building", as contemplated by those words used in s.18(3.1), ever occurred; the insertion of the single piling was only an attempt to meet one requirement of the exemption provision s.18(3.5), and it failed because no construction ever commenced after January 1983, let alone construction that proceeded without undue delay. Mr. Gilbert, counsel for the Defendant, very fairly admits that work done on the site in 1983 does not constitute "construction".
[8] Thus, the question to be answered is: On the facts of the present case, does the pouring of the single piling constitute the commencement of "the period of the construction...of a building" contemplated by those words in s.18(3.1(a)(i)? I find that, on the intended meaning of that provision, the answer is: "no".
[9] As agreed, by the terms of s.18(3.5)(b) and s.18(3.7), the placement of at least a single footing was required to signify a certain level of commitment in completing, and the ability to complete, a given development project. That is, in order to place a footing, at least land for a project would have to be assembled, and the necessary permits obtained to go upon it and sink a footing. As s.18(3.5) sets out, if this level of commitment and ability is shown by December 31, 1981, then a developer has until January 1, 1983 to proceed with construction without undue delay after that date. Thus, to gain the exemption, two conditions must be met: the installation of a footing within a prescribed period of time; and proceeding with construction without undue delay after a certain date. In my opinion, even if a developer is unable to take advantage of the exemption provided by s.18(3.5) by accomplishing the former, but failing to accomplish the latter, whether "the period of the construction of a building" has commenced is a finding of fact to be made after considering the full context of the case at hand.
[10] There is no dispute that the Raintree Limited Partnership, understandably, wanted to take advantage of the exemption provided by s.18(3.5). On the agreed facts, there was absolutely no ability or intention in place to proceed with construction of Raintree Place at the time the single piling was inserted. Thus, I find that the footing was placed for the sole purpose of obtaining the exemption; this activity was undertaken purely in an attempt to conform with a legal requirement, and was not intended to, nor did it constitute, an act which can or should be construed in any other way. In my opinion, the sinking of the piling did not commence construction because such was an impossibility at the time, and, indeed, no "period of construction of a building" ever took place.
[11] Therefore, I find that the Minister proceeded to confirm the reassessment on an erroneous assumption.
JUDGMENT
[12] Accordingly, I give judgement to the Plaintiff in this action, and, order that the reassessments of April 15, 1986, and August 14, 1987, as confirmed on March 30, 1988, are vacated.
[13] I award costs of this action to the Plaintiff.
Judge
Ottawa, Ontario