Date: 20000313
Docket: 1999-3136-IT-I
BETWEEN:
ELIZABETH WITT,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
P.R. Dussault, J.T.C.C.
[1] These are appeals filed under the informal procedure of this Court with respect to the 1990, 1991, 1992, 1993, 1994 and 1995 taxation years.
[2] By assessment notices dated May 11, 1999, the Minister of National Revenue (the “Minister”) revised the appellant’s rental income or loss for each year in issue as follows:
|
YEAR |
INCOME (LOSS) AS CLAIMED |
INCOME (LOSS) AS REVISED |
|
1990 |
($17,907.51) |
($8,589.48) |
|
1991 |
($18,517.87) |
($7,501.46) |
|
1992 |
($21,132.03) |
($4,127.83) |
|
1993 |
($ 4,458.71) |
($ 433.83) |
|
1994 |
($ 4,190.04) |
$1,114.80 |
|
1995 |
($10,449.87) |
($5,629.14) |
[3] Details of the changes that were made are shown in Schedules “A”, “B”, “C” and “D” which are attached to the Reply to the Notice of Appeal (the “Reply”).
[4] In assessing the appellant the Minister relied on the assumptions of fact found in paragraph 15 of the Reply. This paragraph reads as follows:
in August, 1989, the Appellant purchased a property
located at 174 Pretoria Avenue, Ottawa Ontario;
(Property #1)
in September, 1995, the Appellant purchased a property located at 32 Thornton Avenue, Ottawa Ontario; (Property #2)
Property #1 was a rental property during the 1990, 1991, 1992, 1993, 1994 and 1995 taxation years and Property #2 was a rental property during the 1995 taxation year;
Property #1 consisted of two units and the Appellant resided in the lower unit during the 1990, 1991, 1992, 1994 and 1995 taxation years and for three months during the 1993 taxation year;
of the utilities expenses claimed by the Appellant with respect to Property #1, for the 1991 and 1992 taxation years, in the amounts of $1,973.55 and $2,307.28 respectively, she failed to substantiate the amounts of $308.43 and $362.87 for the 1991 and 1992 taxation years respectively;
of the maintenance and repairs expenses claimed by the Appellant with respect to Property #1, for the 1993 and 1994 taxation years, in the amounts of $1,579.78 and $133.66 respectively, she failed to substantiate the amounts of $791.72 and $74.75 for the 1993 and 1994 taxation years respectively;
of the interest expense claimed by the Appellant with respect to Property #1, for the 1993 taxation year, in the amount of $13,246.63, an amount of $2,529.52 represented a payment of principal;
the Appellant failed to substantiate the landscaping expense of $135.60 with respect to Property #1 for the 1994 taxation year;
of the maintenance and repairs expenses claimed by the Appellant with respect to Property #1, for the 1992 taxation year, in the amount of $10,314.92, an amount of $9,238.58 represented a payment on account of a capital outlay;
of the utilities expenses claimed by the Appellant with respect to Property #2, for the 1995 taxation year, in the amount of $756.48, she failed to substantiate an amounts [sic] of $189.06; and
of the current expenses claimed by the Appellant in relation to Property #1 for the 1990, 1991, 1992, 1993, 1994 and 1995 taxation years and otherwise deductible, the amounts allocable for personal usage of the said Property as noted in subparagraph 15(d) were as follows:
in regard to the 1990 taxation year, 50% of property taxes, maintenance and repairs, interest and insurance in the amounts of $1,183.22, $1,274.22, $9,041.49 and $292.06 respectively and totalling $11,790.99 as shown on the attached Schedule “A”;
in regard to the 1991 taxation year, 50% of property taxes, interest, insurance and landscaping in the amounts of $1,381.54, $7,299.22, $464.00 and $277.57 respectively and 50% of the maintenance and repairs applicable to the basement in the amount of $4,818.62 and totalling $14,240.95 as shown on the attached Schedule “A”;
in regard to the 1992 taxation year, 50% of property taxes, interest and insurance in the amounts of $1,443.40, $8,399.33, and $501.60 respectively and totalling $10,344.23 as shown on the attached Schedule “B”;
in regard to the 1993 taxation year, 12.5% (3/12 months x 50%) of property taxes and interest in the amounts of $428.94 and $1,339.64 respectively and totalling $1,768.58 as shown on the attached Schedule “B”;
in regard to the 1994 taxation year, 50% of property taxes, interest, insurance and utilities in the amounts of $1,723.03, $5,094.52, $468.72 and $982.04 respectively and totalling $8,268.31 as shown on the attached Schedule “C”; and
in regard to the 1995 taxation year, 50% of property taxes, interest, insurance and utilities in the amounts of $1,723.11, $4,631.66, $454.68 and $963.33 respectively and totalling $7,772.78 as shown on the attached Schedule “C”.
[5] In paragraph 16 of the Reply it is conceded that the rental loss for the 1992 taxation year should be $4,160.83 instead of $4,127.83.
[6] Four issues were raised in these appeals. They relate to the following:
unvouched expenses (paragraph 15(e), (f), (h) and (j) of the Reply)
allocation of personal and non-personal expenses (paragraph 15(k)I. to VI. of the Reply)
capital or current nature of certain expenses in 1992 (paragraph 15(i) of the Reply)
payment of capital claimed as interest (paragraph 15(g) of the Reply)
[7] As to 4. above, the appellant readily recognized that of the $13,246.63 interest expense claimed in 1993 an amount of $2,529.52 represented a payment of principal and was deducted by mistake.
[8] As to the issue raised in 1. above, after thoroughly reviewing the expenses claimed with the appellant and with Mr. Switzer, the appeals officer for Revenue Canada, who also testified, I have concluded that the appellant should be entitled to deduct all of the expenses relating to utilities that were disallowed (paragraph 15(e) and (j) of the Reply). Firstly, invoices supported all the expenses for utilities. Secondly, the personal portion of those expenses, as they relate to the unit occupied by the appellant in Property #1, did not form part of the expenses that were claimed.
[9] With respect to the remaining expenses relating to maintenance, repairs and landscaping (paragraph 15(f) and (h) of the Reply), most are recorded on the appellant’s Visa statements and some on more detailed invoices. I accept the appellant’s testimony that those expenses were for maintenance, repairs and landscaping in relation to Property #1. I do not think that more detailed invoices would have helped in the circumstances. The expenses should all be allowed except for the personal portion (50%) where applicable.
[10] Referring now to the issue raised in 2. above, the appellant, although admitting that the expenses in relation to Property #1 should be pro-rated on a 50-50 basis due to the fact that she resided in of one of the two units, which are of equal square footage, insisted that she should be allowed a deduction of 100% of the interest paid on the two mortgage loans taken out to buy and convert the property. The appellant’s reasoning, if my understanding is correct, is that when she bought the property, a century- old single family residence, the bank agreed to finance $100,000 of the total purchase price of $229,000 on the condition that the property be converted into a legal duplex and that one of the two resulting units be rented. The appellant did indeed proceed with the conversion, which required borrowing an additional $30,000. That subsequent loan was secured by a second mortgage. As the property was converted in order to earn rental income, the appellant claimed 100% of the interest paid on the two mortgage loans obtained from the bank.
[11] As during the years in issue, except for seven months in 1993, the appellant had always resided in what was initially a single-family residence and afterward in one of the units resulting from the conversion, the position of the respondent is that the interest expense should be pro-rated on a 50-50 basis like the other current expenses related to the property.
[12] In fact, there is simply no evidence that the borrowed money would have been used in a greater proportion for the creation of the rental unit than for the unit used by the appellant as her residence.
[13] Counsel for the respondent submits that paragraphs 18(1)(a), 18(1)(h) and 20(1)(c) of the Income Tax Act (the “Act”) are applicable in the circumstances and relies on the Supreme Court decision in Bronfman Trust v. Canada, [1987] 1 S.C.R. 32, the Federal Court of Appeal decision in Tonn v. Canada (C.A.), [1996] 2 F.C. 73 as well as on decisions of the Tax Court of Canada in Connor v. Canada, [1995] 2 C.T.C. 2991 and Pleet v. Canada, [1990] T.C. J. No. 1039.
[14] Subparagraph 20(1)(c)(i) of the Act states:
Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:
. . .
an amount paid in the year or payable in respect of the year (depending on the method regularly followed by the taxpayer in computing the taxpayer’s income), pursuant to a legal obligation to pay interest on
borrowed money used for the purpose of earning income from a business or property ...
or a reasonable amount in respect thereof, whichever is the lesser.
[15] In Bronfman Trust (supra) at page 46, Dickson C.J. wrote:
The interest deduction provision requires not only a characterization of the use of borrowed funds, but also a characterization of “purpose”. Eligibility for the deduction is contingent on the use of borrowed money for the purpose of earning income.
[16] In Tonn (supra), the Federal Court of Appeal referred to the above- quoted remarks by Dickson C.J. and added the following at page 89:
Subparagraph 20(1)(c)(i), it can be seen, sets out yet another business purpose test, albeit of a rather narrow application, but in other respects much like the tests contemplated by subsection 9(1) and paragraph 18(1)(a). In certain circumstances, and in view of the requirements set out in the Bronfman decision, any given interest expense may have to be allocated rateably between eligible and ineligible uses to the extent reasonably practical. Such allocation is contemplated by the statutory provision and is not unusual in the case law.12
12 See Connor (J.G.) v. Canada, [1995] 2 C.T.C. 2991 (T.C.C.); McHugh (B.J.) v. Canada, [1995] 1 C.T.C. 2652 (T.C.C.); and Pleet v. Canada, [1990] T.C.J. No. 1039 (T.C.C.) (QL).
[17] In the Connor case (supra) referred to by the Federal Court of Appeal, the situation was very similar to that in the present case. In my opinion, the reasoning found in paragraph 10 of the decision in that case is sound and should apply here. Paragraph 10 reads as follows:
It is quite common in matters of income tax for there to be an apportionment between personal and business use. It is frequently the subject of litigation involving automobiles, travel, the use of property, borrowing of money, capital cost allowances, and rarely is the mechanism of apportionment founded in statute or regulation. Generally, such attribution is done on the facts of each case, applying a standard of reasonableness or common sense to the process. Without the borrowing by the appellant in the within appeal, he would not have purchased a property, 40% of which produced rental revenue. At the same time, without the borrowing he would not have been able to complete the purchase of a property, of which 60% was used as his personal residence. The fact that a taxpayer should have borrowed more money and put less of his own cash towards the purchase price does not alter the requirement that some allocation be done to recognize the mixed use of certain properties which are wrapped up in one title, un-subdividable, except as a notional application, varying according to the perspective of the person undertaking the process. Otherwise, all of the borrowed funds in every instance could be deductible in the instance where a mixed-use property was purchased. If the requirements for some kind of rational allocation are to be disregarded, then the fact that 10% of a property was for business use would not, on that basis alone, prevent deduction of 100% of the interest because, without that borrowing, the revenue-producing component could not have been obtained. In the within appeal, the Minister allowed 40% of the interest relating to the $66,000.00 borrowed to purchase the property and in my view that is a reasonable method to use. When a person purchases a mixed-use property, there is going to be an ongoing requirement that operating expenses, municipal taxes, insurance, repairs, etc. are going to apply to the whole property but, in fairness, should be capable of reasonable attribution to each type of use.
[18] The question raised in 3. above concerns certain expenditures incurred in 1992 and characterized by the appellant as “maintenance and repairs” in relation to a water leakage problem in the basement of Property #1. Of the total amount of $10,314.92 claimed as current expenses, the Minister refused to allow the deduction of an amount of $9,238.58 as representing capital expenditures.
[19] The appellant testified that problems due to excessive moisture in the basement had already been identified in an engineering report dating back to 1983 and should have been addressed long ago. In 1989, when the appellant purchased Property #1 she obtained another engineering report (Exhibit A-1, Tab H). In that report, the problem is described in the following terms:
The original visible joists in the basement have suffered extensive dryrot damage. Additional joists have been staggered in over these joists, and these new joists appear to be sound and properly spaced. Their size of 2” by 8” is sufficient for their maximum span of eleven and one-half feet. The added steel I-beam and posts in the basement provide sufficient support for the joists. The fungus associated with dryrot will remain dormant if the moisture levels in the basement are maintained at a reasonable level. This maintenance includes installing a dehumidifier in the summer and ensuring good air circulation to prevent build up of humidity. All floors in the house are solid.
[20] In a letter addressed to Mr. Gary Switzer of Revenue Canada, dated September 24, 1998 (Exhibit A-1, Tab H), the appellant referred to the aforementioned report and added the following:
The severity of the water leakage problem only became apparent once I had assumed occupancy of the property. The dehumidifier was no more than a very temporary measure to control moisture levels around the joists, because of the volumes of water accumulating at various times throughout the basement. Indeed, the situation was progressively deteriorating and the danger of the replacement joists becoming contaminated by the fungus causing dryrot was certain unless the drainage problems were dealt with. In addition, weight was being added to the building by converting it into two separate apartments. Therefore, after having monitored the situation over a period of two years and consulting with various professionals, the problem was resolved by extensive foundation repairs including exterior sealing and interior vapour barrier, proper drainage and asphalt grading.
[21] The appellant said that extensive work was done outside the house in 1991. The work consisted in digging 6 foot-deep trenches, sealing the exterior wall, installing proper drainage and new asphalt paving. The total cost amounted to $9,689.46 (Exhibit A-1, Tab I, Statement of Real Estate Rentals for 1991).
[22] In 1992, in the Statement of Real Estate Rentals (Exhibit A-1, Tab I) the work done in the basement is described as “Basement interior wall repair, vapour barrier and insulation”.
[23] The description of the work to be done by the contractor is detailed in a document entitled “Proposal” dated November 20, 1992. It reads as follows:
The construction of insulated walls, closets and shelving in basement.
This contract includes:
The pointing of the mortar joints in stone walls.
Installation of R-12 insulation, vapor barrier and ½” drywall (1 coat of taping).
Installation of 17’ wide closet with 4’ x 8’ byfold doors. Also included 2’ shelves between windows as discussed.
An allowance of $100.00 is included for electrical work.
Removal-disposal of cooler & work table.
Not included: Paint
Structural problems (we do not foresee any)
Trim, baseboards, casings
Ceilings, heat ducts
GST
Cedar lining in closets
$7,200.00
[24] In the well-known decision in Atherton v. British Insulated and Helsby Cables Ltd., [1926] A.C. 205, Lord Cave enunciated one of the most important tests for determining whether an expenditure is to be treated as a current expense or a capital expenditure. At pages 213 and 214 he said the following:
But when an expenditure is made, not only once and for all, but with a view of bringing into existence an asset or an advantage for the enduring benefit of the 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.
[25] This test, albeit not the only one, had been widely used by our courts in trying to make that determination (see, inter alia, The Minister of National Revenue and Haddon Hall Realty Inc., [1962] S.C.R. 109 and other Supreme Court cases referred therein).
[26] Although the 1991 expenditures referred to above were ultimately considered to be in the nature of repairs and thus treated as current expenses by Revenue Canada, it is my opinion that the 1992 expenditures with respect to the basement of Property #1 cannot receive such treatment. The description of the work to be done by the contractor definitely indicates permanent improvements rather than repairs or maintenance. For the most part, if not in totality, the expenditures were made for work which upgraded the basement to put it in a state in which it had never been before. While pointing the mortar joints in the stone walls could perhaps be considered to be in the nature of a repair, the balance of the work is clearly an addition. However, on the one hand, the appellant has not provided me with any figures that could allow an allocation to be made between repair and addition. On the other hand, the pointing could also be viewed as an integral part of the improvements and thus as a capital expenditure. Although the appellant stated that the closets were built between 2” x 4” to help support the joists, that was nevertheless an improvement of the existing structure.
[27] The appeal for the 1990 taxation year is dismissed.
[28] The appeals for the 1991, 1992, 1993, 1994 and 1995 taxation years are allowed and the assessments are referred back to the Minister for reconsideration and reassessment on the basis that the appellant is entitled, in computing her rental income or losses for those years, to deduct the following additional amounts:
1991 - $308.43
1992 - $362.87
1993 - $791.72 (less the personal portion (50%) if applicable)
1994 - $210.35 ($74.75+$135.60) (less the personal portion (50%) if applicable)
1995 - $189.06.
[29] The assessment for the 1992 taxation year should also be corrected to reflect a net rental loss of $4,160.83 before the adjustment referred to above for that year, as conceded in paragraph 16. of the Reply.
Signed at Ottawa, Canada, this 13th day of March 2000.
"P.R. Dussault"
J.T.C.C.