Date: 19991027
Docket: 97-3509-IT-G
BETWEEN:
MARKLIB INVESTMENTS II-A LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Brulé, J.T.C.C.
[1] Marklib Investments II-A Limited, the appellant, appealed its assessment dated September 12, 1997 in respect to its 1991, 1992 and 1993 taxation years. The appellant owned a number of rental buildings from which it earned rental income and these were managed by the appellant.
Facts
[2] The appellant acquired the buildings municipally known as 10-12 St. Dennis Drive, and 35 Cedarcroft Boulevard. The buildings at 10-12 St. Dennis Drive consisted of 325 suites and the building at 35 Cedarcroft Boulevard consisted of 207 suites. Several notices and work orders had been issued by the appropriate municipal officials requiring that certain repairs be made to the buildings.
[3] The appellant made numerous repairs with respect to the buildings. In computing its income for its 1991 taxation year, the taxpayer deducted the expenditure of $3,457,385. As a result the appellant suffered a loss of $2,593,054. The Minister of National Revenue’s (the "Minister") 1991 reassessment disallowed the appellant’s expenses. The revised net income of the appellant was $864,331, rather than the loss. The appellant had non-capital losses in respect of its 1989 and 1990 taxation years in the amount of $380 and $36,584, respectively. Since the appellant filed its income tax return for its 1991 taxation year, on the basis that it suffered a loss, it did not apply the non-capital losses in respect of the 1989 and 1990 taxation years in computing its taxable income for its 1991 year.
[4] On September 12, 1997, the Minister issued a Notice of Reassessment permitting the appellant to deduct capital cost allowance in the amount of $69,148 and its non-capital losses equalling $36,964, however the Minister confirmed the disallowance of the $3,457,385.
Issue
[5] Whether the expenditures incurred by the appellant to renovate the three properties in 1991 were operating expenses or expenses of a capital nature.
Relevant Legislation
"18(1) –In computing the income of a taxpayer from business or property no deduction shall be made in respect of
(a) General limitation –an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;
(b) Capital outlay or loss –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;"
Evidence
[6] Sheldon Libfeld, the general manager of the appellant, gave evidence at trial.
[7] The Libfeld family held minor interests in a number of corporations prior to 1988. In 1988, through a butterfly transaction, the corporations were reorganized and the Libfeld family (or Marklib) received 100% interest in a few properties. Marklib Investments II-"A" Limited was incorporated pursuant to the laws of the Province of Ontario for purposes of this reorganization. Among those properties split up in 1988, the Libfeld family received 100% interest in 10-12 St. Dennis Drive, and 35 Cedarcroft Boulevard. All outstanding work orders were to be complied with upon reorganization.
[8] The first notice or work order was received by the appellant on March 16, 1989. However, the majority were received between November 1989 and June 1990.
[9] Mr. Libfeld testified that a ‘Notice of Violation’ would be issued by the municipality first and if the ‘Notice of Violation’ had not been complied with upon investigation, a ‘Work Order’ would be issued. The consequences of not complying with a ‘Work Order’ include possible fines, freezing of rents, rent abatements, municipality doing the work and owner receiving the bill etc. Inspections were done approximately every two years.
[10] Mr. Libfeld went through the list of repairs explaining whether notices or work orders had been issued, what exactly was repaired and why. He also provided evidence as to what Marklib’s procedure was when a notice or a work order was received. He stated that Marklib did not always wait until a work order was issued before doing repairs. The list of repairs done by the appellant and disallowed by the Minister is as follows:
REPAIRS |
10-12 St. Dennis Dr. |
35 Cedarcroft Blvd. |
|
Garage Restoration |
$695,000 |
$275,000 |
|
Consulting Engineers -reg. Garage repair |
$48,500 |
$21,250 |
|
Garage Exhaust Fans |
$10,000 |
|
|
Fresh Air Kits |
$17,400 |
$12,600 |
|
Roof Replacement |
$176,700 |
|
|
Tile Work in common areas |
$58,050 |
$30,500 |
|
Lighting Fixtures |
$57,780 |
$38,285 |
|
Stairwell Guard-rails and Railings |
$23,900 |
$30,000 |
|
Kitchen Countertops and Cupboards |
$49,392 |
$76,927 |
|
Kitchen Sinks and Plumbing |
$38,886 |
$15,600 |
|
Exterior Walls-materials |
$206,628 |
|
|
Exterior Walls-labour |
$135,787 |
|
|
New Windows |
$610,000 |
$425,000 |
|
Balcony Railings |
$185,000 |
|
|
Balcony Dividers |
$60,200 |
|
|
New Garbage Chute |
$14,800 |
|
|
New Carpeting |
$75,400 |
$68,800 |
TOTAL |
$1,699,108 |
$1,758,277 |
[11] After the repairs were made, the rent review board did grant a rent increase (15% over three years) however, the value of the building remained unchanged. At all times the buildings were in use (i.e. units were rented).
[12] In addition, Mr. Barry Lebow, an expert witness, testified for the appellant as to the fair market value (FMV) of the buildings in 1990. He provided that it was not unusual for individuals to ask for replacement value estimates and not just FMVs. The FMV in 1988 was $7,235,000 for St. Dennis buildings and $6,600,000 for Cedarcroft. Mr. Lebow determined the replacement value of the buildings at that time to be approximately $20 million for St-Dennis and $16 million for Cedarcroft.
[13] It was agreed that the issue to be resolved was whether or not the expenditures incurred by the appellant to renovate the three properties in 1991 were current expenses or capital expenses.
[14] There was no argument involving the Minister having carried forward losses from 1989 and 1990 twice. The issue of $678,549 having already been allowed as a deduction and the total of what was claimed to be deducted was $4,134,934 never seemed to be addressed by either party. However, a list was provided which appears to list the repairs already permitted by the Minister. It remains unclear as to why the Minister would have allowed the expenses listed and disallowed those now in issue. However, the letter was not explained in great detail by neither the appellant nor the respondent.
[15] Two years after the reorganization the appellant expended significant amounts of money on repairs to the buildings in response to work orders from the municipality. The appellant argued that all the expenditures were deductible in computing its income for its 1991 taxation year, as they were in the nature of repairs, or replacement of worn or damaged portions of the buildings.
[16] The respondent submitted that regardless of the notices and work orders, the expenses incurred went beyond current expenses. This was an entire renovation project and the expenses were capital in nature. The respondent argued that the appellant acquired these properties in 1988 when the Libfeld family gave up minor interests in other properties for 100% interest in these particular properties. The respondent went on to submit that at the time of acquisition the properties were in a poor and deteriorated state. The appellant did not suffer non-capital losses in the 1991 taxation year and therefore there were no non-capital losses to be carried forward to the 1992 and 1993 taxation years.
Analysis
[17] For a taxpayer to deduct an expense, the expense must be made or incurred for the purpose of gaining or producing income from business or property. This first test is not an issue for the appellant. The appellant owned and operated a business of renting out apartments; any expenses incurred for the purpose of gaining income from the rental buildings fulfils the requirements of the test. However, it is the second test in paragraph 18(1)(b) which the taxpayer may have more difficulty meeting. The taxpayer must show that the expense is not an expense related to capital but a current expense.
[18] There is no one rigid test when determining whether an outlay is capital in nature or current. It becomes very much a question of fact and circumstances specific to the individual taxpayer. The determination of whether the characterization of expenditures as current expenses or capital outlays depends, not upon the nature of property acquired but upon the nature of the expenditure. The classic description of what constitutes a capital expenditure is in British Insulated and Helsby Cables Limited and Atherton, [1926] AC 205 (H.L.) at 213:
"...when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital."
[19] However, this description has been watered down and subsequent decisions have attempted to avoid extreme interpretations. Some judges have stood by the ‘once and for all test’ however others have used the test as one factor to consider among many. Judge Abbott of the Supreme Court of Canada referred expressly to the “once and for all test” in the 1961 case of M.N.R. v. Haddon Hall Realty Inc. (1961), 62 DTC 1001 [hereinafter Haddon Hall]. However in 1985, in Johns-Manville Canada Inc. v. The Queen (1985), 85 DTC 5373 [hereinafter Johns-Manville],the Supreme Court of Canada tried to clarify when an expenditure will be deductible and what tests to use. Mr. Justice Estey speaking for the Court relied on Lord Pearce in B.P. Australia Ltd. v. Commissioner of Taxation of the Commonwealth of Australia, [1966] A.C. 224 at 264-265:
"The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in border line cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree.
In Johns-Manville, the corporation wanted to deduct the cost of digging holes in the ground and the cost of land. Upon analysis of the facts specific to that case, the expenditures were incurred year in and year out, they were more or less a constant element and a part of the daily and annual cost of production, the expenditures produced a transitional benefit and one which had no enduring value, nor did the expenditures increase in the productive capacity of the mine."
[20] In Canada Steamship Lines Limited v. M.N.R., 66 DTC 5205 (Ex.Ct.) [hereinafter Canada Steamship Lines], the decks, bulkheads and one of the ship’s boilers were replaced. The Court held that the decks and bulkhead replacement constituted a repair which was deductible as a current expense. They were extensive repairs with substantial cost, however, the Court found that it was a typical kind of ship repair and that the replacement was because of wear and tear. However, the boiler replacement was an upgrade which constituted an outlay in capital, therefore, it was considered a capital expenditure and was not deductible. At page 5207, President Jackett had this to say regarding expenses:
"Things used in a business to earn the income – land, buildings, plant, machinery, motor vehicles, ships – are capital assets. Money laid out to acquire such assets constitutes an outlay of capital. By the same token, money laid out to upgrade such an asset – to make it something different in kind from what it was – is an outlay of capital. On the other hand, an expenditure for the purpose of repairing the physical effects of use of such an asset in the business – whether resulting from wear and tear or accident – is not an outlay of capital. It is a current expense."
[21] Returning to the issue of the ‘once and for all test’, Mr. Justice Jerome in Gold Bar Developments Ltd. v. M.N.R. (1987), 87 DTC 5152 (F.C.) [hereinafter Gold Bar], also dealt with the application of the test. The taxpayer had done repairs to the exterior of a rental building because bricks were falling loose. Instead of using the same brick veneer as used when the building was constructed 10 years earlier to repair the defect, the taxpayer used metal cladding. In allowing the taxpayer’s appeal and thereby reversing the Tax Court’s decision, Mr. Justice Jerome of the Federal Court-Trial Division spoke of the importance of the taxpayer’s intention at the time of the expenditure, in addition to whether the taxpayer had a choice in regards to doing the repair. At 5153 he stated:
"I do not think the solution to this problem can be found in the effect of the expenditure. It is expected that repairs to a capital asset should improve it. Where the source of income is a residential apartment building, that is always the case, especially where the repairs are substantial. Nor do I find the “once-in-a-lifetime” approach of much assistance. The more substantial the repair, the less likely it is to recur (certainly the fervent hope of the building owner) but it remains a repair expenditure nonetheless.
I think it is more helpful to emphasize the purpose of the outlay by the taxpayer. What was in the mind of the taxpayer in formulating the decision to spend this money at this time? Was it to improve the capital asset, to make it different, to make it better? That kind of decision involves a very important elective component – a choice or option which is not present in the genuine repair crisis.
It is not in dispute that the plaintiff discovered in 1979 that the bricks were coming loose and falling on the ground around the building used by tenants and passersby. Obviously, it was a risk that would be unacceptable to the public, but also one likely to meet a reaction from city officials, in the extreme even closure of the premises. In the circumstances, I cannot conclude that the plaintiff had any real choice. To ignore that condition would certainly have brought about a reduction in occupation, or in rental income."
[22] Mr. Justice Jerome found that it was the intention of the taxpayer to repair a condition which had become dangerous rather than to improve the asset. Because the plaintiffs in the case went beyond answering the defects, and made the building not only fully resistant to the problem of falling bricks, but also substantially improved the building’s appearance does not necessarily make the expenditure capital in nature. Once the decision to repair is forced upon the taxpayer, he does not have to ignore advancements in building techniques and technology in carrying out the work. However, Mr. Justice Jerome examined the building’s value at the material time compared to the sum expended on repairs and it was found that the sum in issue represented less than 3% of the value of the asset. Therefore there was no issue of the expenditure being so substantial as to constitute a replacement of the asset. Not to mention that Mr. Justice Jerome found that the structure of the building remained unchanged.
[23] Mr. Justice Jerome also acknowledged that the break-down of the brick veneer was due to faulty work by the original subcontractor when the plaintiff had arranged to have the building constructed some ten years earlier. He went on to state, at page 5153, that the faulty workmanship...
"...is not directly relevant to the taxation issue, but certainly verifies the fact that the plaintiff had this decision forced upon him and did not initiate it. This was not a voluntary expenditure with a view to bringing into existence a new capital asset for the purpose of producing income, or for the purpose of creating an improved building so as to produce greater income. The plaintiff was faced with an unexpected deterioration in the walls of the building which put the viability of the property at risk. The decision to spend the money was a decision to repair to meet that crisis and despite the fact that I am sure the plaintiff’s expectation was, and still is, that it will not recur in the lifetime of the building, it remains fundamentally a repair expenditure."
[24] In Canaport Limited v. The Queen (1993), 93 DTC 1226 (T.C.C.), Judge Beaubier found that even though the expenditure would most likely be a one-time occurrence the expense was a current one. A fibreglass liner was inserted into an underwater oil pipeline which had become badly corroded. It was found that the liner was dependent on the structural strength of the original steel pipeline and the concrete encasing, therefore it was not a separate structure. In summary the headnote stated at page 1226 that:
"The purpose of the expenditure of $4,047,470 in issue, therefore, was to enable current pumping operations through the Sealine to continue. In addition, the expenditure was probably a one-time occurrence and the benefit derived was transitional in the sense that it would only exist as long as the Sealine itself and maybe for a lesser period."
[25] Regardless of the fact that in Haddon Hall the Supreme Court of Canada relied on the “once and for all test”, the acquisition of refrigerators, stoves, venetian blinds installed in an apartment building were nevertheless found to be capital outlays rather than repairs to the building. The finding is not unlike the boiler being found to be a capital expenditure in Canada Steamship Lines. Mr. Justice Abbott in Haddon Hall stated at page 1002:
"...Among the tests which may be used in order to determine whether an expenditure is an income expense or a capital outlay, it has been held that an expenditure made once and for all with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade is of a capital nature.
Expenditures to replace capital assets which have become worn-out or obsolete are something quite different from those ordinary annual expenditures for repairs which fall naturally into the category of income disbursements."
[26] Unlike Haddon Hall, in Le Sous-Ministre du Revenu du Québec c. Denise Goyer, 1987 CarswellQue 122 [hereinafter Goyer], the Quebec Court of Appeal found that the replacement of decrepit balconies, plumbing, windows and doors did not constitute capital property but was rather components to capital property which only required repair, not replacement. Emphasis was placed on whether a new capital asset had been created. Justice Vallerand stated at paragraph 19:
"...as long as one is not creating new capital property, or causing the normal value of the property to be inflated, or replacing a property that has disappeared, then the work done will amount to repairs and maintenance in efforts to restore the property to its normal value."
[27] When an individual has done more than repair the defect but has created something different in kind then it is considered to be a capital expenditure. When the floor of a rental building subsided and broke because the underlying sanitary landfill compacted rendering the floor unusable and damaging subsidiary structures in Shabro Investments Limited v. The Queen (1979), 79 DTC 5104 (F.C.A.) [hereinafter Shabro], emphasis was placed on how the damage was repaired. The Federal Court of Appeal allowed the taxpayer’s appeal in part for the repairs made to the damaged subsidiary structures however the repairs to the floor were disallowed. The floor was fixed by installing a new concrete floor reinforced by steel beams and supported by steel piles. President Jackett went on to state at page 5107:
"I am of the view that, if the replacement of the floor could otherwise be regarded as being the remedying of damage to the fabric of the building, it would have been properly deducted as a current expense on repairs notwithstanding
(a) that the damage arose from a hidden defect in the original structure and not from wear and tear, aging of materials or some accidental or malicious happening in the course of use, or
(b) that the damage was remedied in accordance with technology or knowledge as of the time thereof that incidentally effected an improvement in the structure over what it was when originally built.
The real problem, in my view, with regard to that part of the $95,198.10 that can be reasonably be attributed to the replacement of the floor, is whether the replacement of the floor was merely the remedying of damage to the fabric of the building as it had theretofore existed or whether it was an integral component of a work designed to improve the building by replacing a substantial part thereof by something essentially different in kind."
[28] The Court found that an improvement had been made that was essentially different in kind from the original structure. That was not to say that the exact same materials had to be used, however the sinking of steel piles and reinforcing concrete slabs with steel was an improvement which went beyond the original structure of the building. President Jackett, well before Mr. Justice Jerome’s decision in Gold Bar, stated at page 5107:
"“repairs” do not become disqualified as “repairs” in that sense merely because they are carried out in the light of technology unknown when the original structure was built or because they take into account conditions (such as dampness) not taken into account when the original structure was built. [Footnote: In a limited sense, such repairs may be improvements; but, from a business man’s point of view (which is what is being applied here), within reasonable limits, that is disregarded.]"
[29] In regards to improvements that are considered different in kind, Earl v. The Queen (1992), 93 DTC 65 (T.C.C.) [hereinafter Earl], and Shabro are cases often cited. Both the appellant and the respondent rely on them in the case at bar. In Earl, the taxpayer’s $33,039 expenditure for a new roof on a commercial rental property was found to be capital in nature and could not be deducted. It was not a matter of replacing the old roof with a new roof of similar quality, the taxpayer had replaced her leaking flat roof with a pitched roof. Judge Rowe of this Court found that the new roof created an improvement to the building of an enduring nature. There was no significant change in appearance nor was there an increase in value due to the new roof, however, the new roof did comprise a substantially different integral part of the capital asset comprising the building. Judge Rowe found that all jurisprudence with the exception of Goyer, favoured the finding, he stated at page 69:
"In principle, there is no real difference between the installation of a new roof and the expenditures in Goyer, when the purpose was to maintain the asset in its normal revenue-producing condition. However, with the exception of the decision in Goyer, the line of authority is consistent that work of the nature undertaken by the appellant will, barring unusual circumstances, be regarded as capital in nature."
[30] Very little information is given in Goyer in regards to the extent of the repairs. In Earl, there was a change in the building structure however in Goyer perhaps there was no change in the building from its original structure after completion of the repairs.
[31] In Blanche Morel v. M.N.R. (1951), 51 DTC 431 [hereinafter Morel], the Tax Appeal Board found that when the kitchen, laundry room, tap room and beverage rooms were moved to different locations in a hotel the expense was of a capital nature. The taxpayer tried to argue that the expenses were incurred to comply with the regulations of the Liquor Control Board of Ontario. The Tax Appeal Board found that regardless of the reasons for incurring the expense, the nature of the expense does not change. It stated at page 433:
"...even if it was to comply with the regulations of the Liquor Control Board of Ontario that such work was carried out, this fact would not in any way change the nature of the expenditure, fo[:] if an expenditure is in se a capital expenditure, I fail to see why the nature of such expenditure would be changed because a taxpayer has been compelled to incur it."
[32] However, in that particular case, Chairman Fabio Monet found that not only was the evidence on point not very conclusive but that it was very likely that the work was done more out of competition and fear of other licenses being issued in the area than anything else. In Sydney Harold Healey v. M.N.R. (1983), 84 DTC 1017 (T.C.C.) [hereinafter Sydney Harold], it was found that most of the work done was for new additions or renovations which effected changes so fundamental in character that they could not possibly have been regarded as current expenses. Twenty-three years after Morel, Chief Judge Christie reiterated in Sydney Harold at page 1026 the nature of the expense being separate and distinct from the reason for why the expense was incurred:
"Assuming that work is done under the compulsion of a legal requirement in a safety or sanitary code, this would not change the expenditure from what would otherwise be a capital outlay to current expense."
[33] However, it is important to keep in mind Mr. Justice Jerome of the Federal Court in Gold Bar who acknowledges that the taxpayer’s intentions and purpose must also be examined.
[34] This Court is unable to find the relevance of a number of cases the respondent relied on in his argument. The respondent relied on cases involving newly-acquired buildings in poor condition, the need of repairs to get the building operational, and payment of a decreased purchase price because of the building’s poor condition. All of the above cases are distinguishable from the case at bar as all involved the taxpayer acquiring or purchasing a deteriorated property. The taxpayers knew the state and condition of the property upon acquisition. I have to wonder whether the respondent is extracting the reasoning out of the cases and erecting it into general principles without taking into consideration the specific facts of the cases. If there is one thing that is established through the case law, I think it is that, to determine the question of current or capital, the facts specific to the particular situation must be examined and given some weight.
[35] It is the purpose, rather than the result, of an expenditure that determines whether it is characterized as a capital outlay or a current expense; and the focus of the test is on whether or not the expenditure brings into existence an asset of enduring value, rather than on the determination of the frequency or recurrence of the expenditure. The cases seem to promote the idea that as long as the repairs were done to preserve or conserve the asset and not to create a new asset then the repairs will be considered current expenses.
[36] An expenditure that merely maintains an asset or restores it to its original condition is a deductible current expense. As already seen from the cases above, this is easier said than done. There is a lot of grey area in between the capital outlay and current expense distinction. Furthermore, the magnitude of the expense must be examined in the context of the value of the building. However, simply because the amount of money expended is significant does not in itself render the expenditure capital in nature.
[37] There is no one test for determining whether the expenditure is of a capital nature or a current nature. A number of factors and circumstances are to be examined and weighed. The appellant made reference to Interpretation Bulletin IT-128R –Capital Cost Allowance-Depreciable Property which lists a number of common factors to be examined. In the Court's opinion the respondent cited many cases that were distinguishable from the present case, not to mention that the respondent places emphasis on the buildings being newly acquired and the ‘once and for all test’. Given the case law and the Interpretation Bulletin the ‘once and for all test’ is not the only factor to be examined. Judge Bowman and this Court have both referred to this section of the IT-128R, as have other judges, when dealing with the issue of capital versus current expenditures. The relevant section of the Interpretation Bulletin reads as follows:
"Capital Expenditures on Depreciable Property versus current Expenditures on Repairs and Maintenance
4. The following guidelines may be used in determining whether an expenditure is capital in nature because depreciable property was acquired or improved, or whether it is currently deductible because it is in respect of the maintenance or repair of a property:
(a) Enduring Benefit –Decisions of the courts indicate that when an expenditure on a tangible depreciable property is made “with a view to bringing into existence an asset or advantage for the enduring benefit of a trade”, then that expenditure normally is looked upon as being of a capital nature. Where, however, it is likely that there will be recurring expenditures for replacement or renewal of a specific item because its useful life will not exceed a relatively short time, this fact is one indication that the expenditures are of a current nature.
(b) Maintenance or Betterment –Where an expenditure made in respect of a property serves only to restore it to its original condition, that fact is one indication that the expenditure is of a current nature. This is often the case where a floor or a roof is replaced. Where, however, the result of the expenditure is to materially improve the property beyond its original condition, such as when a new floor or a new roof clearly is of better quality and greater durability than the replaced one, then the expenditure is regarded as capital in nature. Whether or not the market value of the property is increased as a result of the expenditure is not a major factor in reaching a decision. In the event that the expenditure includes both current and capital elements and these can be identified, an appropriate allocation of the expenditure is necessary. Where only a minor part of the expenditure is of a capital nature, the Department is prepared to treat the whole as being of a current nature.
(c) Integral Part or Separate Asset –Another point that may have to be considered is whether the expenditure is to repair a part of a property or whether it is to acquire a property that is itself a separate asset. In the former case the expenditure is likely to be a current expense and in the latter case it is likely to be a capital outlay. For example, the cost of replacing the rudder or propeller of a ship is regarded as a current expense because it is an integral part of the ship and there is no betterment; but the cost of replacing a lathe in a factory is regarded as a capital expenditure, because the lathe is not an integral part of the factory but is a separate marketable asset. Between such clear-cut cases there are others where a replaced item may be an essential part of a whole property yet not an integral part of it. Where this is so, other factors such as relative values must be taken into account.
(d) Relative Value –The amount of the expenditure in relation to the value of the whole property or in relation to previous average maintenance and repair costs often may have to be weighed. This is particularly so when the replacement itself could be regarded as a separate, marketable asset. While a spark plug in an engine may be such an asset, one would never regard the cost of replacing it as anything but an expense; but where the engine itself is replaced, the expenditure not only is for a separate marketable asset but also is apt to be very substantial in relation to the total value of the property of which the engine forms a part, and if so, the expenditure likely would be regarded as capital in nature. On the other hand, the relationship of the amount of the expenditure to the value of the whole property is not, in itself, necessarily decisive in other circumstances, particularly where a major repair job is done which is an accumulation of lesser jobs that would have been classified as current expense if each had been done at the time the need for it first arose; the fact that they were not done earlier does not change the nature of the work when it is done, regardless of its total cost.
..."
[38] Regarding the issue of acquisition, if it is true that the Libfeld family had minor interests in these particular properties and then upon reorganization received 100% ownership in the same properties it is unlikely to be an acquisition. However, it is worth noting that it was Ted Libfeld Holdings Limited and Marklib Holdings Limited that had the minor interests and then it was Marklib Investments Limited that had 100% interest. To a certain extent, the issue seems irrelevant because most of the repairs were done one to two years later based on specific notices and work orders. There is no evidence to indicate that the appellant purchased or received the properties for a lower price because of the deteriorated state of the building nor is there any evidence that the repairs were done to render the building inhabitable. The buildings were in use as rental properties at all times. Furthermore, Mr. Libfeld gave evidence that these types of buildings are in constant need of repair. In the Court's opinion, it is understandable that because of the size and number of units, the buildings would take a certain amount of abuse.
[39] The onus is on the appellant to show on a balance of probabilities that the Minister’s assessment was incorrect. There is a lot of grey area in this case, and depending on how a person interprets the facts as produced at trial the answer may vary. In the Court's opinion, Mr. Libfeld was a credible witness and most of what he said seemed to go uncontradicted, not to mention that the work orders and notices provided in the appellant’s exhibit book were very clear and specific in nature. Therefore, in the Court's opinion the appellant was able to demonstrate that most of the repairs were not capital in nature.
[40] The Court is uncertain in regards to the impact or importance of the issued work orders and the by-law changes on the analysis in this case. On one hand, the fact that work orders were issued or that by-laws had changed only explains why all of a sudden repairs were being made, it does not automatically make the expenditure current in nature. Morel and Sydney Harold both state in passing that the nature of an expenditure is not changed because a taxpayer has been compelled to incur it. However, both those cases involve substantial renovations and somewhat obvious capital expenditures. On the other hand, Mr. Justice Jerome in Gold Bar focuses on whether or not the expenditure was voluntarily made with a view to bringing into existence a new capital asset for the purpose of producing income. In other words, Mr. Justice Jerome focuses on the intention of the taxpayer. Notices and work orders could not only have serious financial repercussions for the appellant if left unanswered but could result in dangerous situations for the appellant’s tenants.
[41] It is also worth noting that the work orders and notices were very specific. Mr. Libfeld described the serious repercussions of not complying with work orders and by-laws and because of those serious consequences I think it could be argued that the appellant was placed in an involuntary position in regard to certain repairs and that the appellant had a genuine repair crisis that needed to be resolved.
[42] In addition, I have to wonder whether a change in a by-law could be considered a hidden defect, as discussed in Shabro, and as long as the repair does not change the original structure of the building then it is considered a current expense.
[43] Furthermore, Mr. Libfeld and appellant’s counsel made reference a number of times to the repairs performing the same function. In the Court's opinion, it is not a matter of performing the same function. A pitched roof performs the same function as a flat roof as does a concrete floor and a steel reinforced floor. It is a matter of whether an improvement of an enduring nature has been made. It is the question of whether an improvement or upgrade has been made to the building that impacts substantially on the original structure not whether the same function is being performed.
Repairs as a Whole
[44] The respondent relied on Audrey B. Wager v. M.N.R. 85 DTC 222 (TCC) [hereinafter Wager] and Jean Méthé v. M.N.R. (1986), 86 DTC 1360 (TCC) [hereinafter Méthé] to argue that the end result was a reconstruction of the appellant’s buildings or the total effect was at the very least a renovation project and therefore the expenditures were capital. The Tax Court in Wager found that where substantial repairs were made to one of two buildings purchased by the taxpayer, in very poor condition, the expenses were capital in nature because the repairs were made to bring the building into operational use. Judge Taylor went on to state at page 224:
"Therefore, as I see it, the nature of an individual expenditure itself may not be, in circumstances such as this case, the sole criterion upon which the distinction is made. Clearly a replaced “door” can be a repair, but it also can be a capital expenditure in circumstances where the general overview of that accomplished by all the repairs is a total reconstruction or rehabilitation of the structure."
[45] Similarly in Méthé it was stated that “the replacement of certain items which ordinarily would be regarded as repairs, might well be characterized as capital expenditures when done within the context of an entire renovation project”. From M. Libfeld’s testimony a lot of the repairs would not have been made had the work orders not been issued. The question becomes one of whether the appellant was involved in a renovation project. In the Court's opinion that is unlikely; most of the repairs did not prolong the buildings’ life but simply kept the building in good operating condition. The only part of the repairs where the Court has serious doubts are the repairs done to the garage. After looking at the details of the repairs listed in the work orders and notices, the tenders, the consulting fees, in addition to the installation of new garage exhaust fans, arguably there may have been a total rehabilitation of the garage structure.
[46] The other issue that does concern the Court is the fact that the expenses for the previous year and the two years that followed 1991 hovered around the $130,000 to $180,000 range for 10-12 St. Dennis and the $50,000 to $110,000 range for 35 Cedarcroft. These ranges are no where near the amount expended in 1991. However, the Court realizes that these buildings are not little houses with one parking space and five rooms, they are big apartment buildings with corresponding repair and maintenance costs. In addition, this Court does not believe that the buildings are in the best location. From Mr. Libfeld’s testimony, the Court received the impression that these buildings take an extraordinary amount of abuse by the appellant’s tenants and neighbours simply because of the buildings’ location. To a certain extent the Court feels a certain amount of weight should be given to the fact that these buildings were always operational and that maintenance costs had to be incurred in order to safeguard and maintain the level of rental income.
[47] The Court does not think the appellant should be penalized simply because it made a lot of large repairs in one year. As provided by Mr. Justice Jerome in Gold Bar, the appellant’s intent and purpose must be kept in mind. Given the work orders and by-law changes there appears to be no intent of improving the asset or making substantial changes to the structure of the buildings. The purpose of most of the repairs was to comply with municipal requirements. If Mr. Libfeld is correct in stating that municipal inspections occur approximately every two years, the notices and work orders issued in 1989/90 would have been the first inspection under the appellant’s new 100% ownership. Under the butterfly transaction, Mr. Libfeld testified that the appellant was to receive the properties without any outstanding work orders. Therefore assuming that the seriousness of the problems came about within the two years and the by-laws changed within that time, the repairs were out of the appellant’s control yet they had to be made or the appellant’s income could be adversely affected.
[48] The Court does not think that it can be said that the buildings in question were restored beyond their original condition as was the case in Shabro and Sydney. In Chambers v. Canada, [1997] T.C.J. No.1244 [hereinafter Chambers] the Court said:
"It would seem that if the repairs resulted in virtually the same old building as before the repairs were undertaken then such should be properly expensed, but if on finishing the repairs a virtually new building or at least quite a different building results then the repairs should be on capital account."
[49] This Court allowed the appeal finding that the expenditures were not capital in nature. The expenditures were small in relation to the value of the building. In the present case, the Court has difficulty believing that a virtually new building resulted through the listed repairs.
Conclusion
[50] The Court feels that the expenses incurred by the Appellant are justified to be treated as current expenditures and not on capital account. The matter will be returned to the Minister for reconsideration and reassessment.
Signed at Ottawa, Canada, this 27th day of October 1999.
"J.A. Brulé"
J.T.C.C.