Date: 20000214
Docket: A-594-98
CORAM: STRAYER J.A.
SHARLOW J.A.
MALONE J.A.
BETWEEN:
J. BRUCE ENSTONE
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
Heard at Ottawa, Ontario, on Wednesday, January 19, 2000
Judgment delivered at Ottawa, Ontario, February 14, 2000
REASONS FOR JUDGMENT BY: SHARLOW J.A.
CONCURRED IN BY: STRAYER J.A.
MALONE J.A.
Date: 20000214
Docket: A-594-98
CORAM: STRAYER J.A.
SHARLOW J.A.
MALONE J.A.
BETWEEN:
J. BRUCE ENSTONE
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
SHARLOW J.A.
[1] The appellant Mr. Enstone, in filing his income tax returns for 1991, 1992, 1993 and 1994, claimed deductions for expenditures he made in respect of three properties, 418-420 Hinton Avenue and 132 Faraday Street in Ottawa. He claims that those properties comprise a rental business. Initially all of the deductions were disallowed on the basis that there was no reasonable expectation of profit. Mr. Enstone appealed to the Tax Court.
[2] At the commencement of the trial in the Tax Court, the Crown conceded that some of Mr. Enstone"s expenditures relating to the two Hinton Avenue properties were deductible. However, the Crown maintained that the remaining expenditures relating to the Hinton Avenue properties were not deductible because they were capital expenditures, and that none of the expenditures relating to the 132 Faraday Street property were deductible because Mr. Enstone was not using it as a rental property.
[3] The Tax Court allowed Mr. Enstone"s appeal only to the extent of allowing the expenditures on the two Hinton Avenue properties that counsel for the Crown had conceded were deductible. Mr. Enstone has appealed the Tax Court decision.
Facts
[4] I summarize the undisputed facts as follows.
[5] In 1991, Mr. Enstone"s father died leaving four residential properties in Ottawa, two half doubles at 418-420 Hinton Avenue and two half doubles at 132-134 Faraday Street.
[6] Mr. Enstone"s father had owned these properties for many years. He lived at 134 Faraday Street. The other three properties had been used by him as rental properties. The last tenants left these rental properties in the late 1980's and Mr. Enstone"s father, due to failing health, did not maintain them well enough to attract new tenants. These rental properties were vacant when Mr. Enstone"s father died.
[7] The will granted Mr. Enstone a life interest in all four properties, subject to the obligation to pay the costs of maintenance, all taxes, insurance premiums and any other costs related to the properties. The will also granted Mr. Enstone a limited power of sale. In the case of a disposition by expropriation or damage beyond repair, any proceeds of sale belong to Mr. Enstone. In the case of a sale, Mr. Enstone is obliged to use the proceeds to acquire replacement property in Ontario to be held on the same terms as the original properties. Upon the death of Mr. Enstone, the properties are to be divided among other members of the family.
[8] The will does not require that the four properties be used in any particular way. Mr. Enstone is entitled to any rent he receives for them during his lifetime, but he is free to leave them vacant or use them himself. His only personal use to date is with respect to 134 Faraday Street, where he lives.
[9] Mr. Enstone accepted the bequest and has paid all of the costs that he is required to pay by the terms of the will. He has made significant expenditures on the two Hinton Avenue properties, with the result that those properties have had tenants since 1995.
[10] The same cannot be said of the 132 Faraday Street property. The expenditures relating to that property appear to consist primarily of insurance, taxes, utilities, and an allocated portion of general costs incurred by Mr. Enstone"s real estate business, such as the cost of a computer. There may also have been some painting and some repair of eaves to this property. Mr. Enstone has never sought tenants for the 132 Faraday Street property, and it was vacant as of the date of trial.
Are any of Mr. Enstone"s expenditures on capital account?
[11] It is argued for Mr. Enstone that all of his expenditures on the rental properties must be treated as expenses on revenue account, and thus deductible, because he has only a lifetime income interest and he possesses no capital ownership interest in the properties.
[12] In the Tax Court, the legal nature of Mr. Enstone"s ownership interest in the properties was held not to dictate any particular conclusion as to whether the expenditures were on capital or income account. The Tax Court Judge held that all of the expenditures that Mr. Enstone makes for the purpose of earning income from the properties should be characterized according to the well established jurisprudence relating to rental properties generally: M.N.R. v. Haddon Hall Realty Inc., [1962] S.C.R. 109. For the reasons below, I have concluded that the Tax Court Judge was correct on this point.
[13] Counsel for Mr. Enstone asserted that because Mr. Enstone does not own the properties outright, he will not be able obtain any tax relief for his expenditures unless they are deductible on a current basis. This inability to deduct expenditures would put Mr. Enstone in a worse position than taxpayers who own rental properties. For that reason, he argues that the general prohibition against the deduction of capital expenditures should not apply to Mr. Enstone.
[14] To evaluate this argument, its premises must be explained. Section 9 of the Income Tax Act is the general charging section for profits from a business or property. The computation of profit requires the deduction of expenses, and for that reason section 9 is sometimes said to be the provision that authorizes the deduction of expenses incurred to earn income from a business or property. However, section 9 is overridden by other provisions, including section 18 and section 20.
[15] Paragraph 18(1)(b) prohibits the deduction of capital expenditures except as expressly permitted elsewhere in Part I of the Act. Deductions for capital expenditures are allowed by several such provisions. For present purposes, it is necessary to consider only one of them, paragraph 20(1)(a). It provides for capital cost allowance, resulting in the deduction over time of the capital cost of depreciable property used for an income earning purpose.
[16] It was argued for Mr. Enstone that, as the holder of only a life interest in the rental properties, he is not entitled to claim capital cost allowance under paragraph 20(1)(a) for the cost of capital improvements made to the properties. It is true that if paragraph 20(1)(a) does not apply, then no tax relief is available for expenditures made for capital improvements to the rental properties unless the application of paragraph 18(1)(b) is barred by characterizing the expenditures as current expenses.
[17] The question, then, is whether to accept the submission of counsel for Mr. Enstone that the scope of paragraph 18(1)(b) should be narrowed in Mr. Enstone"s case to ensure that he obtains some relief.
[18] The Tax Court Judge concluded that it should not, though she appeared to accept the submission of counsel for Mr. Enstone that he would not be entitled to claim capital cost allowance. She indicated that he did not cite any jurisprudence in support of his position.
[19] In this Court, counsel for Mr. Enstone relied on the decision of the Supreme Court of Canada in Johns-Manville Canada v. The Queen, [1985] 2 S.C.R. 46. In that case, the Court found that annual expenditures made by a mining company to purchase additional surface area to permit the enlargement of its open pit mine were on income account, not capital. If that had not been the conclusion reached by the Court, there would have been no tax relief for the expenditures even though they were made for bona fide business reasons. The absence of alternative tax relief was found to be a basis for characterizing the expenditures as on income account as opposed to on capital account. Estey J. said this at page 67:
| ... if the interpretation of a taxing statute is unclear, and one reasonable interpretation leads to a deduction to the credit of the taxpayer and the other leaves the taxpayer with no relief from clearly bona fide expenditures in the course of his business activities, the general rules of interpretation of taxing statutes would direct the tribunal to the former interpretation. That is the situation here. |
[20] I do not read this case as establishing a general principle that a business expenditure must always be characterized as on income account if it does not fall within the scope of the statutory relief provided for capital expenditures. At most, the absence of alternative relief is a factor that may be taken into account in doubtful cases. The Court"s analysis of the facts in Johns-Manville was capable of supporting the conclusion that the expenditures were on income account under the existing principles applicable to the characterization of expenditures. Estey J., speaking for the Court, said this at page 58:
| The removal of the ore here was obviously the continuous and recurrent struggle in which the taxpayer was principally engaged, and the expenditure here was, as revealed by its role in the process of the recovery of the ore, part of the essential profit-seeking operation of the taxpayer. |
[21] This echoes the familiar quotation from B.P. Australia Ltd. v. Commissioner of Taxation of the Commonwealth of Australia, [1966] A.C. 224 (P.C.), at page 271:
| Finally, were these sums expended on the structure within which the profits were to be earned or where they part of the money-earning process? |
[22] In any event, counsel for the Crown argued that even if the Johns-Manville case stands for the broad principle propounded by counsel for Mr. Enstone, that principle is not applicable in this case. He said that the expenditures made by Mr. Enstone to make capital improvements to the rental properties are within the scheme of paragraph 20(1)(a). According to counsel for the Crown, Mr. Enstone can claim capital cost allowance in respect of those expenditures because his life estate is a sufficient ownership interest in the rental properties.
[23] In response to that point, counsel for Mr. Enstone argued that the estate is the owner of the rental properties during the lifetime of Mr. Enstone and therefore only the estate is in a position to claim capital cost allowance. That is obviously not the case. The will did not establish a trust to hold the properties and then grant Mr. Enstone a life interest in the trust. The terms of the will granted Mr. Enstone a life estate in the properties themselves.
[24] No jurisprudence was cited to suggest that capital cost allowance cannot be claimed by the owner of a life interest in an income earning property. There is no provision of the Income Tax Act or the Regulations that would preclude such a claim. I conclude that there is no basis for denying Mr. Enstone the right to claim capital cost allowance on the costs he incurs to make capital improvements to the rental properties in which he has a life interest. Therefore, the principle for which the Johns-Manville case was cited has no application to this case.
[25] For these reasons, I agree with the Tax Court Judge that the expenditures made by Mr. Enstone to improve and repair the rental properties in which he has a life interest must be classified as on capital or income account according to the well established principles. The expenditures he made for capital improvements to the rental properties were capital expenditures, the deduction of which is prohibited by paragraph 18(1)(a), except to the extent that paragraph 20(1)(a) applies.
Was the 132 Faraday Street property a rental property?
[26] With respect to the 132 Faraday Street property, the principal argument made on behalf of Mr. Enstone is that the two Hinton Avenue properties and the 132 Faraday Street property comprise a single rental business, and therefore the tax treatment of his expenditures on the 132 Faraday Street property should be the same as the tax treatment of his expenditures on the two Hinton Avenue properties.
[27] The Tax Court Judge rejected this argument, saying (at paragraph 22):
| In the years in question, the 132 Faraday property was not an ongoing rental activity due to a stoppage of activity of a length that was much outside normal commercial practice. Sometimes a rental activity has to be stopped for the purpose of major repairs. This may not change the nature of the activity if it is done in accordance with commercial practice. In this particular case, the length of the stoppage was not within the normal commercial bounds. The evidence has shown that the property did not have tenants for nine years and contrary to what was done on the Hinton properties, no substantial repairs were made on the Faraday property and there was no advertising for rental nor listing with a leasing agent. As there was no ongoing rental business regarding that property, the expenses incurred in those years for the basic upkeep of the property, are not current expenses made for the purpose of earning income from a business or from a property. |
[28] It is argued for Mr. Enstone that there is no factual or legal basis for treating the Hinton Avenue properties differently from the 132 Faraday Street property, and that in any event there was no evidence before the Tax Court Judge as to "normal commercial practice".
[29] This argument must fail due to the lack of evidence that is capable of establishing that the 132 Faraday Street property was in fact a rental property in Mr. Enstone's hands. Mr. Enstone"s testimony on this point is found in the transcript (page 16:18 - 17:6) as follows:
| Q. So the question I would ask then in light of that fact, and in light of the fact that the will clearly provides that your interest is a life interest in the real property. Why would you have accepted the interest in light of the fact that the properties were vacant at the time? |
| A. Well, the trade-off is between the hassle value of having to do the work, and the income value, the income won. |
| Q. Were you confident throughout - |
| A. The money won. |
| Q. Where you confident throughout that the properties could produce income? |
| A. Oh yes. |
[30] Specifically with respect to the 132 Faraday Street property, his evidence was the following (transcript page 36:17 - 37:5):
| Q. As of today"s date, what is the tenancy situation with respect to Faraday? |
| A. It is empty. |
| Q. It is empty. What is your personal opinion as to its rentability and profitability? |
| A. Well, it needs some work. The maintenance was really let go on it. I have concentrated on Hinton because it is another building. It was better to get tenants in that, to have them - occupancy is the best way to look after a building. |
| I occupy one half of Faraday so, I can keep an eye on that building myself. I do not know exactly what the maintenance will be in terms of profitability, to me it is already profitable. |
And in cross-examination, he said the following (transcript page 82:9-23):
| Q. So when you listed the Hinton properties, you did not list the Faraday property at the same time. |
| A. No, it was all - a sort of one thing at a time basis was the strategy. |
| Q. So you chose to leave that property completely vacant. |
| A. I chose to do the other one first. The business decision was to do the other first, to get an occupant in, in it. In terms of simply cutting the lawn myself on the other half of the house, but you can"t do it in a building if you don"t occupy it, that is some distance away, if you have a picture of how the properties relate. |
[31] It is significant that Mr. Enstone does not say what plans he has for the 132 Faraday Street property. He does not say that he has any intention of finding tenants for that property. He expresses the view that it is "already profitable". Why would he make this comment with respect to a property that is not rented? Perhaps he meant that the value of the 132 Faraday Street property is sufficient economic justification for the maintenance costs he has incurred. It is far from clear from this comment that he had any intention of using the 132 Faraday Street property as a rental property. Nor is there any other evidence that is capable of establishing as a matter of fact that the 132 Faraday Street property is part of any rental business.
[32] Counsel for Mr. Enstone argues that the evidence establishes that Mr. Enstone always regarded the three rental properties as a single business, and that he had simply made a business decision to delay the expenditures that would have been required to make the 132 Faraday Street property attractive to renters. However, the Tax Court Judge clearly did not interpret Mr. Enstone"s evidence that way.
[33] I am unable to discern any error in the Tax Court Judge"s finding of fact that during the taxation years under appeal, Mr. Enstone had no intention of using the 132 Faraday Street property for the purpose of earning income. It follows that none of the expenditures he made on that property are deductible.
Conclusion
[34] For these reasons, I would dismiss the appeal with costs.
Karen R.Sharlow
J.A.
"I agree:
B.L. Strayer"
"I agree:
B. Malone"