Canderel Ltd. v. Canada

Canderel Ltd. v. Canada
Collection
Supreme Court Judgments
Date
1998-02-12
Report
[1998] 1 SCR 147
Case number
24663
Judges
Gonthier, Charles Doherty; Cory, Peter deCarteret; Iacobucci, Frank; Major, John C.; Bastarache, Michel
On appeal from
Federal Court of Appeal
Subjects
Taxation
Notes
SCC Case Information: 24663
Decision Content
Canderel Ltd. v. Canada, [1998] 1 S.C.R. 147
Canderel Limited Appellant
v.
Her Majesty The Queen Respondent
Indexed as: Canderel Ltd. v. Canada
File No.: 24663.
1997: December 2; 1998: February 12.
Present: Gonthier, Cory, Iacobucci, Major and Bastarache JJ.
on appeal from the federal court of appeal
Income tax ‑‑ Calculation of income ‑‑ Rental income ‑‑ Deductions ‑‑ Tenant inducement payments (TIPs) ‑‑ Business requirements necessitating TIPs to be made in one year ‑‑ Whether TIPs deductible as running expense in that year or whether TIPs to be amortized over term of lease ‑‑ Income Tax Act, S.C. 1970-71-72, c. 63, ss. 9(1), 18(1), (9).
Canderel, a developer of commercial real estate, deducted from its income for the 1986 taxation year tenant inducement payments (TIPs) totalling just over $4 million. The TIPs had been made in response to a pressing need to attract tenants in an increasingly competitive rental market, a need which was intensified by certain conditions imposed upon the financing of the rental project. For financial accounting purposes, Canderel treated the TIPs as capitalized, but opted to deduct the entire amount from taxable income in 1986, the year in which they were paid. The deduction was disallowed by the Minister of National Revenue (the “Minister”) in a reassessment and Canderel appealed to the Tax Court of Canada. The Tax Court allowed the appeal, but this decision was overturned on further appeal by the Minister to the Federal Court of Appeal. At issue on this appeal was whether the TIPs were deductible from income entirely in the year in which they were incurred or whether the Minister of National Revenue was entitled to insist that they be amortized over the terms of the leases to which they related. To answer this question, it was first necessary to examine the fundamental principles of profit computation under the Income Tax Act.
Held: The appeal should be allowed.
The determination of profit is a question of law. The profit of a business for a taxation year is to be determined by setting against the revenues from the business for that year the expenses incurred in earning said income. In seeking to ascertain profit, the goal is to obtain an accurate picture of the taxpayer’s profit for the given year. In ascertaining profit, the taxpayer is free to adopt any method which is not inconsistent with: (a) the provisions of the Income Tax Act; (b) established case law principles or “rules of law”; and (c) well-accepted business principles. Well-accepted business principles, which include but are not limited to the formal codification found in generally accepted accounting principles (GAAP), are not rules of law but interpretive aids. They are non-legal tools, external to the legal determination of profit, whereas the provisions of the Act and other established rules of law form its very foundation. To the extent that well-accepted business principles may influence the calculation of income, they will do so only on a case-by-case basis, depending on the facts of the taxpayer’s financial situation, and only for the purpose of achieving an accurate picture of profit. It is not for the court to decide that one such principle is paramount, or applicable to the subordination of all others, by deeming it a rule of law. That is exclusively within the province of Parliament.
On reassessment, once the taxpayer has shown that he has provided an accurate picture of income for the year which is consistent with the Act, the case law, and well-accepted business principles, the onus shifts to the Minister to show either that the figure provided does not represent an accurate picture, or that another method of computation would provide a more accurate picture. If neither of these is established, then the Minister is not entitled to insist that one method be employed over another, equally supported method.
Canderel’s method of income calculation provided an accurate picture of its income for the year in question. It was not inconsistent with any provision of the Income Tax Act or other rule of law. The accounting evidence disclosed that GAAP, at the time of the payments, allowed for various alternative and acceptable methods of accounting for TIPs and endorsed the options contended for by both parties. No specific conclusion could be drawn as to which method was preferable in terms of yielding the more accurate picture of Canderel’s income.
The payments were found at trial to have yielded some benefits, including the generating of rental revenues, that would be realized over a period of years, and others, such as the satisfaction of interim financing requirements, that were immediately realized in the year the payments were made. No specific legal formula, however, exists for apportioning the expenses among the various benefits and such a device would have to be created by statute. The fact that the payments were amortized for financial accounting purposes does not mean that they must be similarly amortized for taxation purposes because the two portrayals of profit are substantially different in nature and purpose.
In this case, it could not be concluded that to amortize the TIPs over the respective terms of the leases to which they related would have provided a more accurate picture of income than their immediate deduction in the year paid. Where no one method emerges as clearly superior or more properly applicable than another, the taxpayer should retain the option of ordering its affairs in accordance with any method which is in accordance with well‑accepted business principles and which is acceptable in light of the reality of its business. Once the taxpayer has established that the method adopted gives an accurate picture of its income, the Minister bears the onus of proving that the method adopted by the taxpayer is inappropriate in the particular circumstances of each case. The Minister did not discharge this burden here.
The TIPs were not principally referable to any particular items of income. Since they qualified as running expenses, to which the matching principle does not apply, they could be deducted entirely in the year in which they were incurred and therefore did not need to be amortized over the terms of the leases which they induced.
Cases Cited
Considered: Symes v. Canada, [1993] 4 S.C.R. 695; West Kootenay Power and Light Co. v. Canada, [1992] 1 F.C. 732; Friesen v. Canada, [1995] 3 S.C.R. 103; referred to: Toronto College Park Ltd. v. Canada, [1998] 1 S.C.R. 183, and at trial (1993), 94 D.T.C. 6172; Ikea Ltd. v. Canada, [1998] 1 S.C.R. 196; Vallambrosa Rubber Co. v. Farmer (1910), 5 T.C. 529; Naval Colliery Co. v. Commissioners of Inland Revenue (1928), 12 T.C. 1017; Oxford Shopping Centres Ltd. v. The Queen, 79 D.T.C. 5458; Cummings v. The Queen, 81 D.T.C. 5207; Neonex International Ltd. v. The Queen, 78 D.T.C. 6339; Mattabi Mines Ltd. v. Ontario (Minister of Revenue), [1988] 2 S.C.R. 175; M.N.R. v. Tower Investment Inc., [1972] F.C. 454; Maritime Telegraph and Telephone Co. v. The Queen, 92 D.T.C. 6191; Friedberg v. Canada, [1993] 4 S.C.R. 285; Commissioners of Inland Revenue v. Gardner Mountain & D’Ambrumenil, Ltd. (1947), 29 T.C. 69; M.N.R. v. Irwin, [1964] S.C.R. 662; Associated Investors of Canada Ltd. v. M.N.R., [1967] 2 Ex. C.R. 96; Royal Bank of Canada v. Sparrow Electric Corp., [1997] 1 S.C.R. 411; M.N.R. v. Canadian Glassine Co., [1976] 2 F.C. 517; Johnston v. M.N.R., [1948] S.C.R. 486.
Statutes and Regulations Cited
Income Tax Act, S.C. 1970-71-72, c. 63, ss. 9(1), 18(1)(a), (9) [ad. 1980-81-82-83, c. 48, s. 9], (a) [ad. idem], (b) [ad. idem].
Authors Cited
Hogg, Peter W., and Joanne E. Magee. Principles of Canadian Income Tax Law, 2nd ed. Scarborough, Ont.: Carswell, 1997.
McDonnell, T. E. “Running Headlong into the GAAP (Again)” (1995), 43 Can. Tax J. 738.
Thomas, Richard B. “The Matching Principle: Legal Principle or a Concept?” (1996), 44 Can. Tax J. 1693.
APPEAL from a judgment of the Federal Court of Appeal [1995] 2 F.C. 232, 95 D.T.C. 5101, [1995] 2 C.T.C. 22, 179 N.R. 134, [1995] F.C.J. No. 221 (QL), allowing an appeal from a judgment of Brulé J., 94 D.T.C. 1133, [1994] 1 C.T.C. 2336, [1994] T.C.J. No. 7 (QL). Appeal allowed.
Guy Du Pont and Samuel Minzberg, for the appellant.
Roger Taylor and J. S. Gill, for the respondent.
The judgment of the Court was delivered by
1 Iacobucci J. -- In a narrow sense, this appeal raises one issue: how is a taxpayer to treat a payment made to a prospective tenant for the purpose of inducing that tenant to lease space in the taxpayer’s premises? More specifically, is the expenditure, commonly referred to as a tenant inducement payment (“TIP”), to be deducted from income entirely in the year in which it was made, or is it to be amortized over the term of the lease to which it relates?
2 More broadly, however, this Court is required to revisit the fundamental concept of profit computation for income tax purposes. The appeal raises serious questions about the ability of the taxpayer to calculate his or her income in accordance with well-accepted principles of business practice and with the provisions of the Income Tax Act, as interpreted by the courts. In the absence of statutory provisions or overriding legal principles to the contrary, is the Minister of National Revenue entitled to insist on a particular method of profit computation? Put another way, what is the analytical framework within which taxpayers can compute, and the Minister can dispute, profit?
3 This appeal was heard along with the appeals in Toronto College Park Ltd. v. Canada, [1998] 1 S.C.R. 183, and Ikea Ltd. v. Canada, [1998] 1 S.C.R. 196, reasons for which are being released simultaneously herewith.
I. Facts
4 The following summary of facts is taken substantially from the comprehensive factual summary of the trial judge, Brulé J., in the Tax Court of Canada.
5 In 1984, the appellant, Canderel Limited (“Canderel”), a company engaged in the development and management of commercial real estate, entered into an agreement with Mount-Batten Properties Limited to develop a commercial office development which eventually became Churchill Office Park (“COP”). The development was to be located in west-end Ottawa, where rental rates were generally around 30 percent lower than in downtown Ottawa. The project was part of a general business strategy in the area to provide private sector buildings and thereby centralize an area of business outside the downtown core. It was anticipated that lower rents and property taxes would attract tenants from downtown.
6 The duties assumed by Canderel in connection with the development of the project were wide-ranging, and included marketing, advertising, and negotiation of leases (subject to written approval and execution by the owners), among other things. Part of Canderel’s development fee was contingent upon 90 percent leasing. A separate agreement provided for Canderel to serve as property manager as well, and among its managerial duties was the ongoing negotiation and renewal of leases.
7 The projects in which Canderel participated were generally financed with mortgages to minimize equity requirements. Because the co-venturers did not supplement the cash flow of less successful projects, each project was required to succeed on its own merits and consequently, an early positive cash flow was imperative. The key to the success of a project, therefore, was leasing velocity. COP was no exception to this rule.
8 In a document entitled “Executive Summary of Carling Churchill Project”, dated January 18, 1984, prepared by Canderel and used to create and administer a construction budget by allocating projected expenses and costs, a “downside” view of capitalized losses by velocity of lease-up was projected. A total capitalized loss of $2,034,604 for the first two years was projected, and an allowance for this loss was accordingly made. The estimated time for the project to break even was in the ninth to tenth month of the second year.
9 For the development stage of the project, short-term “bridge financing” was arranged in the form of what essentially amounted to a demand loan. Jonathan Wener, the sole owner of Canderel, estimated that once the building was 75 percent to 85 percent leased, permanent financing would be obtainable, but testified at trial that if it had taken more than three years to obtain permanent financing, the co-venture would have risked seizure of the debt.
10 When construction of COP was commenced, there were no commitments to lease, owing to an aberration in the Ottawa market whereby prospective tenants generally required substantial completion before leasing. However, market surveys conducted by Royal LePage and verified by Canderel indicated that there was only a 1.67 percent vacancy in downtown Ottawa of the class of space offered by COP for the 1983 market, and a 3.42 percent vacancy in 1982. The short supply of space in the downtown area at the time construction commenced led Canderel to anticipate that the project would reach its break-even point by the time it opened. However, throughout construction and at completion, the amount of space available downtown was rising. Six to eight months into construction, Canderel realized that there were problems with the market: by 1984, the vacancy rate had risen to 11.2 percent and continued to rise, reaching 14 percent in 1986. When COP opened in June, 1985, only 2.3 percent of the building was leased. Several new office developments, both downtown and in the west end, created intense competition for tenants, and the absorption by the west end of downtown clients therefore came later than Canderel had initially expected.
11 In response to these developments, and to its intense need to attract tenants to its new complex, Canderel decided to reallocate budgeted losses to tenant inducement payments. A leasing blitz was commenced, and whereas about $2 million had initially been allocated to TIPs, just over $4 million was in fact paid out in the end. This tactic proved successful, because by the end of June, 1986, COP was 59 percent leased, and by June, 1987, it was 85 percent leased. Had Canderel failed to secure tenants at project completion or shortly thereafter, several adverse consequences could have occurred with respect to the interim financing provided by the Toronto Dominion Bank. The operating and financing costs of approximately $2.9 million might have had to be borne entirely by the joint venturers, permanent financing would not likely have been obtained, and the project could have become known as not having gained market acceptance, which would have reduced the likelihood of attracting stable tenants. Instead, on June 17, 1989, the project received a permanent financing commitment from Sunlife of Canada.
12 In the auditor’s report of January, 1986, an operating loss of $1,219,000 was shown, reflecting in part the treatment of the TIPs as capitalized. By 1986, $4 million had been capitalized and amortized, and income before amortization was minus $800,000. For income tax purposes, however, Canderel adopted a different approach, opting to deduct the TIPs from income entirely in 1986, the year in which they were paid. The deduction was disallowed by the Minister of National Revenue (the “Minister”) in a reassessment, and Canderel appealed to the Tax Court of Canada. The Tax Court allowed the appeal, but this decision was overturned on further appeal by the Minister to the Federal Court of Appeal.
II. Relevant Statutory Provisions
13 Income Tax Act, S.C. 1970-71-72, c. 63 (now R.S.C., 1985, c. 1 (5th Supp .))
9. (1) Subject to this Part, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.
18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of
(a) 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;
. . .
(9) Notwithstanding any other provision of this Act,
(a) in computing a taxpayer’s income for a taxation year from a business or property (other than income from a business computed in accordance with the method authorized by subsection 28(1)), no deduction shall be made in respect of an outlay or expense to the extent that it can reasonably be regarded as having been made or incurred
(i) as consideration for services to be rendered after the end of the year,
(ii) as, on account or in lieu of payment of, or in satisfaction of, interest, taxes ..., rent or royalty in respect of a period after the end of the year, or
(iii) as consideration for insurance in respect of a period after the end of the year ...;
(b) such portion of each outlay or expense made or incurred as would, but for paragraph (a), have been deductible in computing a taxpayer’s income for a taxation year shall be deductible in computing his income for the subsequent year to which it can reasonably be considered to relate. . . .
III. Judicial History
(1) Tax Court of Canada (Brulé J.), 94 D.T.C. 1133
14 Brulé J. began by noting that it has generally been held that an expense is deductible although it may not give rise to any directly resulting income: Vallambrosa Rubber Co. v. Farmer (1910), 5 T.C. 529 (Ct. of Sess.). However, he recognized that the instant case turned not on deductibility itself but on the timing of the deduction, and found that this required a determination of whether the TIPs were running expenses and whether or not there should have been “matching” of the expense and revenue. He relied on Naval Colliery Co. v. Commissioners of Inland Revenue (1928), 12 T.C. 1017 (H.L.), and Oxford Shopping Centres Ltd. v. The Queen, 79 D.T.C. 5458 (F.C.T.D.), for the proposition that running expenses are those which cannot be linked directly to any corresponding items of revenue, and therefore are not matched to revenue but are deductible in full in the year incurred. That is, the “matching principle” of accounting does not apply to such expenses.
15 Relying on the case of Cummings v. The Queen, 81 D.T.C. 5207, and the interpretation thereof in the trial judgment in Toronto College Park Ltd. v. Canada (a companion case to the instant appeal), Brulé J. found that in certain cases, TIPs may be classified as running expenses, which in some cases may be deducted in the year of the expense. Further, he found that the matching principle had been held not to apply to such expenses. To Brulé J., these cases were determinative, such that the TIPs here at issue qualified as running expenses.
16 Brulé J. rejected the Minister’s argument that the TIPs were incurred for the purpose of earning income over the whole terms of the leases and therefore, to arrive at true profits, each lease should have the TIPs amortized over its terms. He noted that in support of this argument the Minister had relied on Neonex International Ltd. v. The Queen, 78 D.T.C. 6339 (F.C.), but that Neonex did not deal with a running expense situation and was therefore inapplicable. He relied in this regard (at p. 1141) on the judgment of this Court in Symes v. Canada, [1993] 4 S.C.R. 695, at p. 733, where the words of Wilson J. in Mattabi Mines Ltd. v. Ontario (Minister of Revenue), [1988] 2 S.C.R. 175, at p. 189, were interpreted as “rejecting both the need for a causal connection between a particular expenditure and a particular receipt, and the suggestion that a receipt must arise in the same year as an expenditure is incurred”.
17 In response to the Minister’s argument that matching should have been employed in this case because it gave a better picture of Canderel’s true income, Brulé J. observed that although accounting theory may be helpful in considering the appropriate treatment of income for tax purposes, it is not determinative. He agreed with the submission by Canderel, relying on Oxford Shopping Centres, supra, that even if the law in many cases seemed to require matching, the expenses in this case should be matched against current benefits, as was in fact done here, since the use of the matching principle in cases such as M.N.R. v. Tower Investment Inc., [1972] F.C. 454 (T.D.), gave rise to no general principle of law.
18 Brulé J. found that the benefits generated by the TIPs for Canderel included (1) the prevention of a “hole in income” caused by maintaining a vacant building; (2) the satisfaction of its interim financing requirements and the ability to obtain permanent financing; (3) the ability to maintain its market position and reputation; and (4) the ability to earn revenues through rental, management, and development fees. Therefore, he concluded (at p. 1142) that “the expenses deducted by the Appellant were running expenses, that matching is not in this case the appropriate method for tax purposes, and that the Appellant should be allowed to adopt the expensing method”. Noting also that “there is no requirement under the law for consistency in accounting methods between financial statements and income tax calculation”, Brulé J. allowed the appeal and referred the matter back to the Minister for reconsideration and reassessment in accordance with the law as set out in his reasons.
(2) Federal Court of Appeal, [1995] 2 F.C. 232
(a) Reasons of Stone J.A., for the majority
19 Stone J.A. began by asserting at p. 236 that “the matching principle of accounting has, at least in this Court, been elevated to the status of a legal principle”. He found support for this position in the Court’s decision in West Kootenay Power and Light Co. v. Canada, [1992] 1 F.C. 732 (C.A.), where MacGuigan J.A. stated at p. 745:
The approved principle is that whichever method presents the “truer picture” of a taxpayer’s revenue, which more fairly and accurately portrays income, and which “matches” revenue and expenditure, if one method does, is the one that must be followed.
While acknowledging that West Kootenay was concerned with the time in which to report earned but unbilled income, Stone J.A. saw no reason to limit its application to that scenario and found that it should also apply when the issue is whether a taxpayer is required to match expenditures against revenue in computing profit for tax purposes.
20 Stone J.A. agreed with the trial judge that “running expenses” need not be matched with corresponding items of revenue for tax purposes, but found that the TIPs here at issue did not fit the classical description of “running expenses” in Naval Colliery, supra. He recognized, at pp. 237-38, that it could be argued that the TIPs were “in the nature of running expenses on the basis that they represented a cost of doing business in the 1986 taxation year and also that [Canderel] would likely have faced significant financial disadvantages if they had not been laid out and did achieve significant financial advantages by laying them out”. However, he found that the expenditures were not incurred in earning income solely in 1986, but in all of the years during which the leases were to run.
21 Moreover, Stone J.A. found that the present case was not analogous to Oxford Shopping Centres, supra, as in that case it was not possible to match the expenses with particular items of revenue. While acknowledging that in Cummings, supra, Heald J.A. was prepared in obiter to characterize lease pick-up expenses as running expenses, Stone J.A. was of the opinion that this too assumed that the expenses in question could not be allocated directly to corresponding revenue. In the present case, because the TIPs could be matched with revenue from the respective leases in accordance with the matching principle, and were in fact so matched for accounting purposes, Stone J.A. (Robertson J.A. concurring) would have allowed the appeal.
(b) Concurring reasons of Desjardins J.A.
22 Desjardins J.A. began with a brief discussion, based largely on that in Symes, supra, of the limited role to be played by generally accepted accounting principles (“GAAP”) in the determination of profit for tax purposes. She found at p. 244 that the trial judge erred in applying to the case at bar the interpretation in Symes of Wilson J.’s rejection in Mattabi Mines, supra, of “both the need for a causal connection between a particular expenditure and a particular receipt, and the suggestion that a receipt must arise in the same year as an expenditure is incurred”, as Symes was not concerned with the timing of a deduction, which was the only issue in the case at bar.
23 Desjardins J.A. turned next to the cases relied upon by the Minister in support of the proposition that where there are two methods acceptable both under GAAP and for tax purposes, the court will prefer the one that results in a “truer picture” of the taxpayer’s profit, including West Kootenay, supra, Maritime Telegraph and Telephone Co. v. The Queen, 92 D.T.C. 6191, and Friedberg v. Canada, [1993] 4 S.C.R. 285. She concluded at p. 256 that “[i]n essence, what the courts have been looking for is the true realized gains and losses of a taxpayer in the relevant taxation year”, and that to determine whether matching is the appropriate method in any given case would require an analysis of the specific facts in light of the cases in which the matching principle had been specifically developed. In this connection, she relied on Symes for the proposition that the determination of profit for tax purposes is a question of law, to be determined in accordance with “well accepted principles of business (or accounting) practice” (p. 257), unless they run counter to an express statutory provision or a principle of tax law.
24 Thus, Desjardins J.A. identified the key question as assessing which method most accurately shows the taxpayer’s actual profit. After reviewing Oxford Shopping Centres, supra, in which the taxpayer’s disbursement was considered to be a running expense and the matching principle therefore did not apply, even though amortization was available at the taxpayer’s option and would have provided a more accurate picture of income for the particular year, she found that where an expense could be related to a particular item of income, the matching principle would apply. She concluded, at p. 264, that TIPs are “clearly” related to particular items of income, as there is a “direct contractual relationship between the TIP and the stream of revenues gained over the period of the lease”. Therefore, in her view at p. 264, “[m]atching of TIPs is compulsory”.
25 Canderel had argued that the foundation on which rests the compulsory matching of expenses when related to a particular item of income, namely Commissioners of Inland Revenue v. Gardner Mountain & D’Ambrumenil, Ltd. (1947), 29 T.C. 69 (H.L.), was inapplicable because it dealt with costs of inventory, for which special rules have developed. Desjardins J.A. disagreed, noting that Viscount Simon’s words in that case were directed to both “services completely rendered or goods supplied”, and that Canderel was in a type of service industry, namely the rental of commercial premises. Therefore, she held that the TIPs were to be deducted as the services were rendered -- that is, over the period of the lease. She distinguished Vallambrosa Rubber, supra, and Naval Colliery, supra, as cases in which the expenses in question truly could not be matched to specific items of revenue. Further, she found that because timing was not raised in Cummings, supra, which dealt only with whether lease pick-up expenses were on account of income or capital, the obiter comments in that case concerning TIPs were neither binding nor persuasive.
26 Therefore, Desjardins J.A. was in agreement with the majority that the TIPs paid by Canderel in 1986 were to be amortized over the life of the respective leases, and that such would be (at p. 270) “the only method acceptable for income tax purposes”.
IV. Issues
27 As already stated, this appeal raises only one direct issue: whether tenant inducement payments are deductible from income entirely in the year in which they are incurred, or whether the Minister of National Revenue is entitled to insist that they be amortized over the terms of the leases to which they relate. To answer this question, however, it will first be necessary to examine the fundamental principles of profit computation under the Income Tax Act.
V. Analysis
(1) General Principles of Profit Computation
28 In the relatively recent case of Symes, supra, this Court considered the general principles which govern the computation of profit for income tax purposes. However, because some of the principles enunciated in Symes may have been misinterpreted, I propose to review these general principles in order to resolve the issue in this appeal and to clarify the critical issue of profit computation for the purposes of the Income Tax Act.
(a) The Interpretive Framework
29 It is appropriate to begin the consideration of profit with s. 9(1) of the Act, which defines a taxpayer’s income for a taxation year from a business or property source as “his profit therefrom for the year”. Significantly, “profit” is not defined in s. 9(1) or anywhere else in the Act. It seems to me that this approach was a deliberate legislative choice, particularly given that the Act contains exhaustive definitions of numerous other concepts and terms with which it deals. This choice reflects the reality that no single definition can adequately apply to the millions of different taxpayers bound by the Act. Under our self-assessment system, each taxpayer must be able to compute his or her income in such a way as to constitute an accurate picture of his or her income situation, subject, of course, to express provisions in the Act which require specific treatment of certain types of expenses or receipts.
30 What, then, is the true nature of “profit” for tax purposes? While the concept has been variously expressed, perhaps the clearest and most concise articulation of the term is to be found in the oft-quoted decision of this Court in M.N.R. v. Irwin, [1964] S.C.R. 662, at p. 664, where profit in a year was taken to consist of “the difference between the receipts from the trade or business during such year ... and the expenditure laid out to earn those receipts” (emphasis in original). This definition was echoed by Jackett P. in Associated Investors of Canada Ltd. v. M.N.R., [1967] 2 Ex. C.R. 96, where he stated at p. 102:
Ordinary commercial principles dictate, according to the decisions, that the annual profit from a business must be ascertained by setting against the revenues from the business for the year, the expenses incurred in earning such revenues.
31 Accepting this fundamental definition, in Symes, supra, at pp. 722-23, the majority made the following observations about the computation of profit:
. . . the “profit” concept in s. 9(1) is inherently a net concept which presupposes business expense deductions. It is now generally accepted that it is s. 9(1) which authorizes the deduction of business expenses; the provisions of s. 18(1) are limiting provisions only. . . .
Under s. 9(1), deductibility is ordinarily considered as it was by Thorson P. in Royal Trust, [Royal Trust Co. v. Minister of National Revenue, 57 D.T.C. 1055 (Ex. Ct.)] (at p. 1059):
... the first approach to the question whether a particular disbursement or expense was deductible for income tax purpose was to ascertain whether its deduction was consistent with ordinary principles of commercial trading or well accepted principles of business ... practice ... (Emphasis added.)
Thus, in a deductibility analysis, one’s first recourse is to s. 9(1), a section which embodies, as the trial judge suggested, a form of “business test” for taxable profit.
This is a test which has been variously phrased. As the trial judge rightly noted, the determination of profit under s. 9(1) is a question of law: Neonex International Ltd. v. The Queen.... Perhaps for this reason, and as Neonex itself impliedly suggests, courts have been reluctant to posit a s. 9(1) test based upon “generally accepted accounting principles” (G.A.A.P.).... Any reference to G.A.A.P. connotes a degree of control by professional accountants which is inconsistent with a legal test for “profit” under s. 9(1). Further, whereas an accountant questioning the propriety of a deduction may be motivated by a desire to present an appropriately conservative picture of current profitability, the Act is motivated by a different purpose: the raising of public revenues. For these reasons, it is more appropriate in considering the s. 9(1) business test to speak of “well accepted principles of business (or accounting) practice” or “well accepted principles of commercial trading”. [Emphasis in original.]
32 The great difficulty which seems to have plagued the courts in the assessment of profit for income tax purposes bespeaks the need for as much clarity as possible in formulating a legal test therefor. The starting proposition, of course, must be that the determination of profit under s. 9(1) is a question of law, not of fact. Its legal determinants are two in number: first, any express provision of the Income Tax Act which dictates some specific treatment to be given to particular types of expenditures or receipts, including the general limitation expressed in s. 18(1)(a), and second, established rules of law resulting from judicial interpretation over the years of these various provisions.
33 Beyond these parameters, any further tools of analysis which may provide assistance in reaching a determination of profit are just that: interpretive aids, and no more. Into this category fall the “well-accepted principles of business (or accounting) practice” which were mentioned in Symes, also referred to as “ordinary commercial principles” or “well-accepted principles of commercial trading”, among other terms. A formal codification of these principles is to be found in the “generally accepted accounting principles” (“GAAP”) developed by the accounting profession for use in the preparation of financial statements. These principles are accepted by the accounting profession as yielding accurate financial information about the subject of the statements, and become “generally accepted” either by actually being followed in a number of cases, by finding support in pronouncements of professional bodies, by finding support in the writings of academics and others, or by more than one of these methods: see Peter W. Hogg and Joanne E. Magee, Principles of Canadian Income Tax Law (2nd ed. 1997), at pp. 180-81. What must be remembered, however, is that these are non-legal tools and as such are external to the legal determination of profit, whereas the provisions of the Act and other established rules of law form its very foundation.
34 That is not to minimize the key role played by such well-accepted business principles (as I shall hereafter refer to them) in the profit-computation process. In Friesen v. Canada, [1995] 3 S.C.R. 103, Major J. made the following observation at para. 41:
The Act does not define “profit” nor does it provide any specific rules for the computation of profit. Tax jurisprudence has established that the determination of profit under s. 9(1) is a question of law to be determined according to the business test of “well-accepted principles of business (or accounting) practice” or “well-accepted principles of commercial trading” except where these are inconsistent with the specific provisions of the Income Tax Act. . . .
35 I think this statement aptly describes the proper relationship between tax law and business principles. In the absence of a statutory definition of profit, it would be unwise for the law to eschew the valuable guidance offered by well-established business principles. Indeed, these principles will, more often than not, constitute the very basis of the determination of profit. However, well-accepted business principles are not rules of law and thus a given principle may not be applicable to every case. More importantly, these principles must necessarily take a subordinate position relative to the legal rules which govern.
36 The reason for this is simple: generally speaking, well-accepted business principles will have their roots in the methodology of financial accounting, which, as was expressed in Symes, is motivated by factors fundamentally different from taxation. Moreover, financial accounting is usually concerned with providing a comparative picture of profit from year to year, and therefore strives for methodological consistency for the benefit of the audience for whom the financial statements are prepared: shareholders, investors, lenders, regulators, etc. Tax computation, on the other hand, is solely concerned with achieving an accurate picture of income for each individual taxation year for the benefit of the taxpayer and the tax collector. Depending on the taxpayer’s commercial activity during a particular year, the methodology used to calculate profit for tax purposes may be substantially different from that employed in the previous year, which in turn may be different from that which was employed the year before. Therefore, while financial accounting may, as a matter of fact, constitute an accurate determinant of profit for some purposes, its application to the legal question of profit is inherently limited. Caution must be exercised when applying accounting principles to legal questions.
37 I do not wish to be taken, however, as minimizing the role of GAAP in the determination of profit for income tax purposes. Some have inferred from my reasons in Symes an intention that GAAP are to be rejected entirely: see, for example, Hogg and Magee, supra, at pp. 185-87. This is not what I intended. In fact, the better view is that GAAP will generally form the very foundation of the “well-accepted business principles” applicable in computing profit. It is important, however, for the courts to avoid delegating the criteria for the legal test of profit to the accounting profession, and therefore a distinction must be maintained. That is, while GAAP may more often than not parallel the well-accepted business principles recognized by the law, there may be occasions on which they will differ, and on such occasions the latter must prevail: see, for example, Friedberg v. Canada, supra.
38 Moreover, there will, of course, be situations in which GAAP will offer various acceptable options in the preparation of financial statements, and the taxpayer will be free, for financial accounting purposes, to adopt whichever option best suits his financial objectives at the given time. In such cases, GAAP will surely not be determinative as to the method by which an accurate picture of profit may be obtained for taxation purposes, though it may still be useful as a guide to the various acceptable methods of computation, one of which may yield the appropriate result for taxation.
39 A good example of the relationship among the provisions of the Act, the principles developed in the case law, and GAAP or well-accepted business principles can be found in s. 18(9) of the Act, which requires the amortization of certain prepaid expenses over the periods of time to which they relate. It is possible, although I express no specific opinion on this matter, that some of these expenses could be treated otherwise for the purposes of GAAP or business practice; perhaps they might be deducted entirely in the year incurred, or even capitalized. However, this possibility is negated for tax purposes by their