Date: 20000628
Docket: 98-2077-IT-I
BETWEEN:
BRIAN BOWEN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
For the Appellant: The Appellant himself
Counsel for the Respondent: Ron Wilhelm
___________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench at Vancouver, British Columbia, on September 1, 1999)
Bowie J.T.C.C.
[1] The Appellant purchased a unit in a condominium project in Florida in 1985. He purchased it as an investment with a view to renting it at a profit, and in the expectation that after perhaps 15 years or so it would be paid for and would be available to him and his wife to use during retirement. In each of the years from 1985 to 1995 the unit produced not a profit, but a loss. The Appellant has filed his returns under the Income Tax Act (the Act) for all of these years on the basis that these losses are available to be offset against his other income from employment and a pension in the calculation of his income for the year pursuant to section 3 of the Act.
[2] For the years 1992, 1993, 1994 and 1995 the Minister of National Revenue has reassessed him on the basis that during each of these years there was no reasonable expectation of profit from this condominium unit, and that it is therefore not a source of income, and its losses are not to be taken into account for the purposes of section 3. It is from these reassessments that he appeals.
[3] The condominium unit in question is located on the Gulf Coast of Florida. It was built by an entrepreneur from Hull, Quebec, and has in total 45 units. The Appellant purchased his unit for US$65,800, which was raised by way of a mortgage for US$47,900 and a bank loan for C$25,000, which at the then prevailing rate of exchange yielded US$17,900. In other words, all of the money to purchase the unit was borrowed.
[4] Along with the other unit owners, the Appellant entered into a rental pool, which was governed by a rental pool agreement, and was operated by a Florida corporation incorporated for the purpose. That corporation, in effect, took charge of the units for the purpose of advertising their availability, renting them, maintaining them, doing the budgeting and financial record keeping and the maintenance in connection with the units. The rental pool agreement is one which ensures that it is greatly to the advantage of the unit holders to remain as part of the rental pool and, for practical purposes, makes it virtually impossible for an owner who is dissatisfied to leave the rental pool. For example, an owner leaving the rental pool would be required to forego all rents from his unit for the ensuing year, while continuing to pay the expenses for the unit.
[5] This condominium unit was not used by the Appellant or by his family members, with the exception of one two-week period, and two days in the year 1995, when he made a visit to Florida, the purpose of which I shall deal with more fully in a moment. Amongst the terms of the rental pool agreement, it was provided that owners using their units, or any of the units in the complex, could only do so by paying to the corporation the wholesale rate for rental of that particular unit. The project was aimed largely at the Quebec market and, as I understood the evidence, it was heavily advertised in that market and, indeed, many of the owners were from the province of Quebec or Eastern Ontario.
[6] At the time the units were sold a prospectus was given to would-be buyers which showed projected increases in the market value of the units of 7 percent per year for the first 15 years, and projected losses from 1985 to 1990. The projected losses were in the amount of C$16,568 during the first year, 1985, increasing to $24,008 in 1986 and then reducing steadily from there to $17,800 in 1987, $3,343 in 1988, $1,134 in 1989 and $84 in 1990, a total loss of approximately $63,000 over the first six years of ownership. The projection also suggests that at a 50 percent marginal rate of tax half of these amounts could be written off against a taxpayer's other income.
[7] No doubt, the assumption of these declining projections of losses is predicated on the assumption that rentals will reduce the mortgage principal and, thus, the mortgage interest payable on the units. On the basis of these projections, Revenue Canada appears to have accepted that, at least during the first three years of ownership, there would be losses which would be deductible under section 3, and to have authorized that withholding taxes be reduced accordingly in the years 1985, 1986 and 1987.
[8] In fact, the losses proved to be much greater than those shown on the projection found in the prospectus. The gross income, according to a table reproduced at paragraph 6(h) of the Reply to the Notice of Appeal, and accepted by the Appellant as being accurate, is shown in 1986 as being $16,976. The following year it had reduced to $13,616 and in 1989 it was $10,354. By 1991 it was reduced to $2,875 and it declined from there steadily to $1,635 in 1994, with an upturn to $3,571 in 1995. Expenses in the meantime were seldom less than twice the gross income, and during the years from 1991 to 1995 they seem to have been generally about five or six times the gross income, producing losses in the years 1991 to 1995 of $8,854, $3,921, $9,154, $7,734 and $6,198. The apparent reduction in the loss for the year 1992 is probably attributable to the fact that the Appellant failed to include in his computation for that year what are referred to as monthly subsidy payments. By that time, and in fact probably earlier, the condominium directors, in preparing their budget for each year, were projecting losses such that it was necessary to make assessments at the beginning of the year upon the unit owners so that there would be operating funds to carry the condominium throughout the year. For example, in 1993 the assessment is described as an eight-month subsidy and the amount of it in Canadian dollars is $4,800. In 1994 it was $3,600 over a six-month period and in 1995 it was $3,600 over a six-month period.
[9] These losses were sustained by the Appellant, notwithstanding that in 1988 he had sold certain other assets in order to pay off the bank loan and thereby reduce the amount of his yearly interest payments. By 1989 the owners of the units had begun an action against the builder as a result of all these losses, alleging that there had been certain misrepresentations in connection with the original prospectus and the selling price of the units. I was not given particulars of the exact nature of the cause of action, but it clearly had its origins in the unhappy financial results that the owners were then experiencing. This action was abandoned in 1994.
[10] In 1995 the Appellant visited the complex and stayed there for two days. During this visit he spoke with the manager of the property, and with people engaged in the real estate business in the area. At about the same time he also had discussions with one or two people in Canada engaged in selling real estate. Ultimately, his conclusion was that this investment was, for practical purposes, a lost cause, and after two years of unsuccessful attempts to find a buyer for the property he sold his equity in the unit for ten dollars.
[11] The issue before me is whether, viewed objectively, as the authorities require, it can be said that in 1992, 1993, 1994 or 1995 it was reasonable to expect that this condominium unit might produce a profit. In other words, was it, during any of that period of time, a source of income, such that the losses emanating from it might be applied in the section 3 computation?
[12] I should say at this point that I do not view this as being one of the class of cases described by Linden J.A. in Tonn et al. v. The Queen[1] as a personal use property. While the Appellant apparently had at least a vague intention that he might use this property in retirement, this certainly was a long way in the future and did not, I think, form any very definite part of his planning at the time of purchase. The case, in my view, falls to be determined simply on the prospects of the property being able to produce an income in all of the circumstances.
[13] The Appellant in his evidence blamed the lack of success of this property on a lengthy list of factors, including the unfavourable rate of exchange between Canadian and American dollars; adverse weather and, in particular, Hurricane Mitch which devastated a good deal of the Florida coast; international politics, both in Canada and in Europe; certain random shootings which took place of European visitors to Florida; the Quebec referendum and federal/provincial politics in general; the recession; the high interest rates which prevailed at some times; the high cost of medical insurance for people vacationing in Florida; and the fact that, while his particular property was a desirable one which rented easily, because of the pooling arrangement it had to subsidize the results of less desirable properties. Of all of these factors, only Hurricane Mitch could be described as one which by the year 1992 was unknown or unanticipated. All of the others were part of the environment of the late 1980s and the early 1990s.
[14] It is, of course, trite to say that the Court should not be quick to second-guess the business judgments made by taxpayers. That said, however, it was clear before 1992 that this condominium unit was far short of living up to the projections which had been put forward by the vendor in the initial prospectus, to which I referred earlier, and was not producing a net income, even after the time when the bank loan was paid off.
[15] The principle which governs in cases such as this is to be found in the reasons for judgment written by Robertson J.A. of the Federal Court of Appeal in Mohammad v. The Queen,[2] where he said at page 5505:
Frequently, taxpayers acquire a residential property for rental purposes by financing the entire purchase price. Typically, the taxpayer is engaged in unrelated full-time employment. Too frequently, the amount of yearly interest payable on the loan greatly exceeds the rental income that might reasonably have been earned. This is true irrespective of any anticipated downturn in the rental market or the occurrence of other events impacting negatively on the profitability of the rental venture, e.g., maintenance and non-capital repairs. In many cases, the interest component, is so large that a rental loss arises even before other permissible rental expenses are factored into the profit and loss statement. ...
Further on he says, at page 5506:
The above analysis is to the effect that there can be no reasonable expectation of profit so long as no significant payments are made against the principal amount of the indebtedness. This inevitably leads to the question of whether a rental loss can be claimed even though no such payment(s) were made in the taxation years under review. I say yes, but not without qualification. The taxpayer must establish to the satisfaction of the Tax Court that he or she had a realistic plan to reduce the principal amount of the borrowed monies. As every homeowner soon learns, virtually all of the monthly mortgage payments go toward the payment of interest during the first five years of a tweny to twenty-five year amortized mortgage loan. It is simply unrealistic to expect the Canadian tax system to subsidize the acquisition of rental properties for indefinite periods. Taxpayers intent on financing the purchase of a rental property to the extent that there can be no profit, notwithstanding full realization of anticipated rental revenue, should not expect favourable tax treatment in the absence of convincing objective evidence of their intention and financial ability to pay down a meaningful portion of the purchase-money indebtedness within a few years of the property’s acquisition. ...
[16] In the present case, the loan for the down payment was paid off within a few years, but this quite clearly did not make the property a profitable one. Indeed, the loss reported for 1988 was $15,537 and for 1989 it was $10,178. The conclusion would seem to be, therefore, that of the 1988 loss, only one-third was eliminated by paying off the bank loan. I was not furnished in the evidence with any particulars of the rate of rental of the property, and so cannot conclude that the unfortunate financial results of this project are attributable, either in whole or in part, to a failure of the company running the rental pool to be able to meet the initial projections with respect to occupancy rates.
[17] In the present case, the Appellant certainly recognized by 1995 that he could not reasonably anticipate profits from this unit. In my view, all of the facts satisfy me that he should have reached that conclusion at least by 1992, and probably a good deal earlier than that. The Appellant, in the course of argument, relied on the judgment of Thorson P. of the Exchequer Court in National Trust Co. Ltd. (R.R. McLaughlin) v. M.N.R.,[3] where, according to some abstract of that case that he had read, he said that the Court there had found a reasonable expectation of profit, notwithstanding something like 30 years of losses.
[18] I do not find in President Thorson’s judgment any statement to the effect that there had been 30 years of continuous losses by Mr. McLaughlin. In any event, Mr. McLaughlin was a farmer and the appeal brought by his Executor was against income tax assessments for the two years, 1944 and 1945. There was substantial evidence in that case that Mr. McLaughlin had been a very hard-working and knowledgeable farmer who had built up a substantial and high-quality herd of Holstein cattle. The finding of the Court was based very specifically upon expert evidence that was led to the effect that Mr. McLaughlin had a better-than-average herd, that it had become one of the best herds in Canada, and that at any time during the last few years of his operations, which of course, included the years under appeal, Mr. McLaughlin could, if he had seen fit, have sold his herd and shown a profit. The case, therefore, turns on that very specific evidence, and has no application to the situation at bar.
[19] As I have said, a person viewing objectively the circumstances as they existed prior to 1992 would have reached the conclusion that this condominium unit was not capable of producing a profit, and it follows that the appeals are dismissed.
Signed at Ottawa, Canada, this 28th day of June, 2000.
"E.A. Bowie"
J.T.C.C.