Date: 19990914
Dockets: 98-1165-IT-I; 98-1166-IT-I
BETWEEN:
FELIX SCAMURRA, ALBERT SCAMURRA,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Teskey J.T.C.C.
[1] The Appellant in his Notice of Appeal wherein he appealed his reassessment of income tax for the years 1992, 1993 and 1994, elected the informal procedure.
[2] The Minister in his Reply to the Notice of Appeal (the "Reply") made assumptions of fact. These are found in paragraph 6 of the Reply and it was acknowledged by the agent for the Appellant that the facts set out in subparagraphs A, B, C, D and F are true. Also, the Appellant put in as Exhibit A-1 a copy of his T1 1998 tax return, which shows again a loss.
[3] The Appellant gave evidence on his own behalf and on behalf of his brother and both appeals were heard on common evidence. The Appellant stated: "On the advice of my father, and knowing that the building was managed by a professional management company, I bought this unit". There is no evidence before me that there were any surprises. There is no evidence before me that he or his brother even considered that there would be a profit in year one or any other year.
[4] It is suggested to the Court that I should take into consideration that real estate values took a tumble very shortly thereafter. Values of real estate did take a tumble in 1990 and 1991, but there is no evidence before me that the rental market tumbled. There is no evidence before me at the time he made his offer to purchase the rental unit, that the expectation of the rentals was a certain value, and by the time the unit was completed and the deal closed, that it was something less.
[5] There was no evidence in front of me that either the Appellant or his brother thought that the rents would go up and up, except he did say that next year (2000) he hoped, or it might have been this year, to make $1,200. The Appellant also said in cross-examination that he had never discussed the rentals with the agent.
[6] I assume that because it was a total arm's length transaction between him and the rental agent and all the tenants, that the rents they received were at market value. But there is no evidence before me that the rent received in 1990, the first year, and/or the rent received in 1992, was something less than he expected when he entered into the agreement.
[7] There is no evidence before me that the day he entered into the agreement, and by the time it closed, his interest expenses had skyrocketed and that when he bought the unit, it was calculated on a lesser percent.
[8] In fact, the Appellant knew next to nothing. When questioned by counsel for the Respondent and myself about his expenses, he could not explain the various expenses. He brought no receipts, tax bills or anything here to explain them and could not explain them.
[9] The unit was purchased in 1989 and that from 1990 up to and including 1998, no profit has been shown. No evidence is before me how capital cost allowance could be calculated. I do not have any evidence before me that would allow me to say of the $150,000 purchase price, $50,000 is land and $100,000 is bricks and mortar or vice versa, so I have no idea what the capital cost allowance would be if it was to be applied. I am satisfied that under the case-law, that there is no personal element, except that the losses were to be written-off against other income.
[10] Against these facts, I must look to the law. The seminal case on business expenses is the decision of Dickson J., as he then was, of the Supreme Court of Canada in Moldowan v. The Queen, 77 DTC 5213. He says at paragraph 11:
Although originally disputed, it is now accepted that in order to have a "source of income" the taxpayer must have a profit or a reasonable expectation of profit.
[11] Then in paragraph 12, he goes on and says:
The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive.
[12] In this appeal, the taxpayer never gave me a course of action of what they were going to do. They just bought it. We do know that he refinanced in 1997 and did pay off the second mortgage. There is no evidence that the Appellant, in 1989, had a conversation that might have gone as follows: "We knew we were over capitalized and we agreed to pay X number of dollars per year off the principal and the result was with the estimated increase in rental, by year six, we would make a profit". He never even thought about capital and profit, the unit was just purchased.
[13] Experience. I think that in rental losses experience is probably of little consequence to look at and the same with training. It's the intended course of action and the capability of the venture as capitalized to show a profit that must be shown.
[14] Herein, there was no intended course of action in front of me. The taxpayer did not even mention it and there was no course of action concerning the capitalization. It was obvious from day one that it could not produce a profit.
[15] The only way this unit could produce a profit would be to either escalate the rental income or to cut the expenses, and the only way they could cut the expenses, assuming that they are legitimate, was by paying down the over-capitalized cost of the borrowing, paying it down to a level so that it could produce a net profit.
[16] The only evidence that I have on paying down is that when asked by counsel for the Respondent: "In 1992, 1993 and 1994, did you intend to pay off the mortgage"; and the response to that: "Could not afford to pay down in those years". He might have said: "When we bought it, I figured in 1992 I could pay another five down, in 1993 and 1994", but he didn't say that.
[17] If the evidence had been: "In 1992, 1993 and 1994 I had hoped and my brother hoped that we would be able to pay down $5,000 each year, and that would have given us in 1995 a profit, but 1992 we had a crash in our business and we didn't have the extra money, but there was no explanation. In fact, there wasn't any evidence that said he even intended to do that when he bought it.
[18] Now, Moldowan has been visited by the Federal Court of Appeal on several occasions. The first significant case was Tonn v. The Queen, a decision by Linden J.A., and this is reported at [1996] 1 CTC 205, and also at 96 DTC 6001.
[19] Now, Linden broke reasonable expectations of profit into two categories. One category is where there is a strong personal element, and the other category is where there isn't a personal element.
[20] I am satisfied in this case that in what Linden was saying, there is no strong personal element. Strong personal element is where a person buys a house and rents the upper floor or the basement floor and also occupies the house or they buy a ski chalet at Collingwood and they use it part-time themselves and they rent it part-time or they have a hobby farm. That's your personal element cases.
[21] Linden says at paragraph 53:
The other group of cases consists of situations where the taxpayer's motive for the activity lacks any element of personal benefit, and where the activity cannot be classified as a hobby. The activity, in these cases, seems to be operated in a commercial fashion and not as a veiled form of personal recreation.
This case falls within that category.
[22] Now, he says in paragraph 64:
... I otherwise agree that the Moldowan test should be applied sparingly where a taxpayer's "business judgment" is involved, where no personal element is in evidence, and where the extent of the deductions claimed are not on their face questionable. However, where circumstances suggest that a personal or other than business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was in fact a business. Suspicious circumstances, therefore, will more often lead to closer scrutiny than those that are in no way suspect.
[23] Now, since Tonn, we have Mastri v. The Queen, [1997] 3 C.T.C. 234 and Mohammad v. The Queen, [1997] 3 CTC 321. Mastri was released on June 27th, 1997, a decision of MacGuigan, Robertson and McDonald. Robertson J.A., wrote this decision and at paragraph nine, he says:
First, it was decided in Moldowan that in order to have a source of income a taxpayer must have a reasonable expectation of profit. Second, "whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts". If as a matter of fact a taxpayer is found not to have a reasonable expectation of profit then there is no source of income and, therefore, no basis upon which the taxpayer is able to calculate a rental loss. ...
[24] Robertson, one month later, again writing for the Court of Appeal, wrote the Mohammad decision. Paragraph 11 thereof reads:
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 payment goes toward the payment of interest during the first five years of a twenty 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 acquisition. If because of the level of financing a property is unable to generate sufficient profits which can be applied against the outstanding indebtedness then the taxpayer must look to other sources of income in order to do so. If a taxpayer's other sources of income, e.g., employment income, are insufficient to permit him or her to pay down purchase-money obligations then the taxpayer may well have to bear the full cost of the rental loss. Certainly, vague expectations that an infusion of cash was expected from Aunt Beatrice or Uncle Bernie will not satisfy the taxpayer's burden of proof. In practice, the taxpayer will discharge that burden by showing that significant payments were in fact made against the principal indebtedness in the taxation years closely following the year of purchase.
[25] I may say I have had several of these cases where the taxpayer came in and said, I intended to pay down in year four, X number of dollars, in year five, X number of dollars and year six, and then, by the time they get to Court, years one, two, three, four, five and six have passed and they did do exactly what they said they had intended to do, and in those cases those appeals were allowed.
[26] There is no evidence before me that in 1989, this man intended to pay down on the principal any amounts of money at any time. The only evidence before me is that in 1997, he did make some payment by paying off the second mortgage which still was not sufficient.
[27] Concerning the financing, Robertson says at paragraph 26:
...It is both plausible and possible that a taxpayer could acquire property with full financing in circumstances where the rental income is going to exceed all of the rental expenses, including those attributable to interest payments. Astute real estate speculators are able to ferret out the bargains. In such circumstances, it is irrelevant whether the acquisition of the property involved full financing and, most certainly, such a business decision cannot be characterized as unreasonable.In my opinion, there is no legal justification for establishing a rule of law that permits the Tax Court to reduce arbitrarily the amount of interest that is deductible from rental income simply by the Minister showing that the taxpayer obtained 100 percent financing. That being said, taxpayers who are unable or unprepared to invest some of their own capital must prove to the Tax Court in accordance with the standards outlined earlier in these reasons that the rental initiative satisfies the profitability test imposed by the Supreme Court in Moldowan.
[28] In that case, the trial judge arbitrarily disallowed 25 percent of the interest that was being claimed and that's what Robertson is dealing with there.
[29] In this case, I must decide on the facts before me, there is no evidence of any intended pay-down. Now, the Appellants have put before me several cases and all of these have to be looked at in light of the facts that have been presented.
[30] In Costello v. The Queen, [1998] 2 C.T.C. 2832, a decision of my colleague Bowman, at paragraph 18, in the factual background, he said:
... Ms. Costello is an educated, intelligent woman who went about finding an investment property in a rational business-like way.
[31] I must say I cannot make that comment about the Appellant herein. In Costello (supra), Bowman J. said:
... Clearly the property was acquired to earn income and her projections were reasonable. ...
There are no projections here today in which the Court could say are reasonable or unreasonable. Again in Costello, a number of matters converged, however, to frustrate her expectations. There is no evidence today before me of what might have frustrated the Appellant's expectations because there is no evidence of what his expectations were. In Costello, her first set back was a break-up with her fiancée which resulted in her taking over a portion of the property. The second was the extensive and unforeseen repairs that needed to be done to the property. The third was the downturn in the economy and the change in the rental market. Again, there is no evidence of any changes in the rental market in the case at bar.
[32] Judge Bowman goes on and says:
I find as a fact that the rental operation had a reasonable expectation of profit. Indeed her loss in 1995 was nominal and by 1996, as a result of the repairs and renovations that she did, the decline in mortgage rates and the general improvement of the rental market, she began earning a net profit and expects to continue to do so.
[33] There has been no projection even put before me that I could say yes, this property is going to produce a profit. I have to decide years 1992, 1993 and 1994. I look on this as a purely non-personal investment which was entered into on the advice of somebody. We don't know what that somebody looked at. We don't know what rents were expected. We do not know what expenses were expected. The Appellant doesn't even know what the expenses are. I don't know how they were calculated. We do know that in 1994 or 1993 the condo fees were $94 a year, and his 1998 return puts him at $325 a month. I find that astounding, that the condo fees would be four times in four years. There is something wrong with those figures. Also, the taxes went down, and I do not know whether that is correct because tax bills were not produced, but if it is, it's the only property that I have heard on an appeal in this country where the taxes have gone down each year. Maybe they did. I don't know. But without the tax bills being produced, and saying this is the assessment, it's so much for land and so much for building, all I can sit here and say is the figures look very peculiar to me.
[34] Judge Rowe's decision in Howard & Davis v. The Queen, 97 DTC 1340, is of strong, personal content and just because something has a strong, personal content, I interpret what the Federal Court of Appeal has said is take a look at it very carefully, and there is no reason why a taxpayer who buys a duplex and moves in to one and rents the other half, that they cannot get a write-off of reasonable expenses. It depends. You have to look at the facts.
[35] If 50 percent of the expenses of the duplex is $10,000 and you can rent half of the duplex for $1,000 a month, there's nothing wrong with it even though there's a strong personal element. All that the Federal Court of Appeal was saying is, Judges of the Tax Court, you look at this. You look at the facts impartially and if it passes the test, fine, and many of them do but you have to look at the factual background that has been set before you.
[36] The same as when you rent the duplex to your mother-in-law, there's nothing wrong with that, provided the rent is the market value, and that has been established by the appropriate evidence before you, that the rental is $1,000 a month and that's the market value. All the non-arm's length does is put the onus on the taxpayer to make sure that it is the appropriate rent with appropriate expenses with a projected profit.
[37] For the years in question in front of me, I have no other alternative but to dismiss it for these reasons just given.
Signed at Ottawa, Canada, this 14th day of September, 1999.
"Gordon Teskey"
J.T.C.C.