Date: 200008027
Docket: 98-9369-IT-G
BETWEEN:
NEIL DONALD BROWN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Sarchuk J.T.C.C.
[1] These are appeals by Neil Donald Brown from assessments of tax with respect to this 1992 and 1993 taxation years. For the purposes of these appeals, the truth of the following facts has been admitted by the Appellant:[1]
1. In or about April 1981, the Appellant purchased property located at 380 East 49th Avenue in Vancouver, British Columbia (the "Property").
2. At the time of purchase, there was a dwelling (the "Old Dwelling") on the Property.
3. In or about September 1993, the Appellant demolished the Old Dwelling.
4. In or about December 1993, the Appellant subdivided the Property and sold a portion of the lot for $120,000.
5. As a result of the subdivision referred to directly above, the address of the Appellant's remaining lot changed from 380 to 388 East 49th Avenue, Vancouver, B.C.
6. The Appellant then began construction of a new dwelling (the "New Dwelling") on 388 East 49th Avenue.
7. The New Dwelling was ready for occupancy on or about June 1, 1994.
8. Except for the period of time from when the Old Dwelling was demolished until the New Dwelling was built and ready for occupancy, the Appellant personally occupied between 25% and 30% of the Property as his principal residence and rented out the remainder to tenants.
9. No rental income was earned from June 1993 to June 1994, due to the demolition of the Old Dwelling and the construction of the New Dwelling.
10. In his original returns of income for the 1981 to 1994 taxation years, the Appellant reported gross rental income, expenses and net rental losses with respect to the Property as set out below and as further detailed in Schedule "A" attached hereto:
|
Taxation year |
Gross Rental Income |
Expenses |
Net Rental Income (Loss) |
|
1981 |
$ 2,343 |
10,210 |
($ 7,867) |
|
1982 |
5,950 |
20,735 |
( 14,785) |
|
1983 |
8,400 |
25,972 |
( 17,572) |
|
1984 |
9,600 |
16,915 |
( 7,315) |
|
1985 |
7,200 |
14,052 |
( 6,852) |
|
1986 |
6,000 |
12,455 |
( 6,455) |
|
1987 |
6,000 |
11,621 |
( 5,621) |
|
1988 |
6,000 |
17,802 |
( 11,802) |
|
1989 |
6,000 |
17,966 |
( 11,966) |
|
1990 |
7,200 |
20,030 |
( 12,830) |
|
1991 |
7,200 |
16,557 |
( 9,357) |
|
1992 |
5,986 |
13,800 |
( 7,814) |
|
1993 |
8,674 |
20,195 |
( 11,520) |
|
1994 |
17,379 |
19,583 |
( 2,204) |
11. In 1995, the Appellant did not report any rental income or loss, but claimed gross business income of $7,200 and a net business loss of $11,778.82.
12. The Appellant subsequently claimed adjustments to revenue and expenses for the Property, as detailed in Schedule "B" attached hereto. [2]
Appellant's testimony
[2] In 1981, the Appellant and his partner were living in a house they owned in Burnaby, BC. At some point of time in that year, they acquired the Property in issue for $163,000. He testified that it was zoned for two suites, one on the main level and one in the basement, both self-contained and that it was acquired for rental purposes. The Appellant described the East 49th Avenue area as consisting principally of older homes, many of which were in the process of being demolished. The Property itself was located close to a collegeand attending students were seen as a primary source of tenants. He also said that although the Burnaby house was to remain their place of residence, financial difficulties made it necessary for them to consider using one of the suites in the Property. As a result, at some point of time in 1981, he and his partner moved into the main-floor unit and continued to rent the remaining unit(s).[3]
[3] According to the Appellant, in 1992 and 1993, only two suites at the Property were suitable for rental purposes since the upper level was, in his words, not habitable. He said the rent being charged at that time was $400 per unit.[4] A decision was taken to demolish the house on the Property and this was completed in or about September 1993. Concurrently, discussions with his neighbour led to the subdivision of the Property and the sale of one-half thereof for $120,000. Construction began almost immediately thereafter and the new dwelling was ready for occupancy on or about June 1, 1994. The Appellant noted that once completed, the two suites in the new dwelling were leased for $750 and $900 per month.
[4] The Appellant's position is that at all relevant times the property had been acquired for the purposes of carrying on a rental business and that it was only as a result of financial problems, caused principally by the high cost of borrowing money, which precluded him from showing a profit. This, he says, was compounded by the fact that they had initially intended to sell the Burnaby property but were unable to do so. In result, it was necessary to borrow a larger amount than anticipated in order to acquire the Property and to use the Burnaby property as security for those loans.[5]
Conclusion
[5] In order to succeed the Appellant must demonstrate that the expenditures in issue were made for the purpose of gaining or producing income from a property. Subsection 9(1) of the Act defines the concept of business income by reference to profit while paragraph 18(1)(a) of the Act contains specifically prescribed statutory limitations on expense deductions. In particular, the latter sets out a general prohibition which denies a deduction unless the amount is paid or incurred for the purpose of gaining or producing income. Paragraph 18(1)(h) specifically limits the deductibility of personal or living expenses which are defined in subsection 248(1) of the Act to exclude expenses in connection with a property unless it is maintained in connection with a business carried on for profit or with a reasonable expectation of profit.
[6] In Moldowan v. The Queen,[6] the following criteria for determining whether a reasonable expectation of profit existed were proposed by Dickson J. (as he then was):
There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. 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. The factors will differ with the nature and extent of the undertaking: The Queen v. Matthews (1974), 28 DTC 6193. One would not expect a farmer who purchased a productive going operation to suffer the same start-up losses as the man who begins a tree farm on raw land.
[7] Although the Appellant maintained that the Property was purchased solely for commercial purposes almost immediately after its acquisition, he and his partner moved into it and attempted to sell the Burnaby property. The Appellant said this had not been planned but was necessitated by their deteriorating financial circumstances. While it is inappropriate for a Court to second-guess or to substitute its business judgment for that of a taxpayer the circumstances here strongly suggest that a personal motivation existed. As well, the expectation of profit in this case was, on the facts, so unreasonable as to raise a suspicion. In such circumstances, an Appellant is required to demonstrate that there are sufficient of the indicia of commerciality to justify his position that a business is being conducted.[7]
[8] A number of factors lead me to conclude that the Appellant's position is not well-founded. He concedes that from 1981 to 1994, he incurred rental losses ranging from $5,621 to $17,572. During this same period, the Appellant personally occupied between 25% and 30% of the Property as his principal residence. He nonetheless maintains that the lack of profit was due almost entirely to the high cost of mortgage interest. This may be in some measure correct but the limited financial means of their prospective tenants is something that should have been taken into account at the time the Property was purchased. However, of greater significance is the fact that even if interest rates had been lower, the evidence strongly suggests that the maximum rents which could be charged would not have covered the expenses normally incurred in the course of a rental operation. As well, I must observe that although the Appellant maintained that he did make income and expense projections "in his head", no details beyond that bald statement were provided.
[9] It is also fair to say that at all relevant times the Appellant planned to and did target students as prospective tenants. He was aware that students had limited resources available for rental purposes and thus the amounts set by him were the going rate for that period and that type of tenant. He observed that not only was the Property located in an area which could not justify substantial rents but also that there were many units available for that purpose. As well, he was aware that renting to students had a further disadvantage in that there were no leases and that, as a general rule, the units would not be occupied for the full year. These facts were all known to him when the Property was purchased and it should have been apparent that profitability was improbable given the extent of the financing required and the limited amount of potential income available from their targeted tenants.
[10] In 1992, the Appellant reported gross rental income of $5,968. The expenses amounted to $13,800 with the mortgage interest component being $10,437. In 1993, the gross rental income was $8,674 while the expenses amounted to $20,195 of which $11,450 was attributable to mortgage interest.[8] In Mohammad v. The Queen,[9] Robertson J.A., speaking for the Court made the following observation:
... 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. 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. ...
The fact that the mortgage interest component is so large that a rental loss arises even before other permissible expenses are factored into the profit and loss statement is clearly inconsistent with an objectively reasonable profit motive. When one considers the Appellant's financial circumstances and his limited employment income with Canada Safeway, it is evident that there was absolutely no other source of income to enable him to significantly reduce the mortgage obligation on this Property.[10]
[11] All of the foregoing leads me to conclude that the Appellant in this case is unable to satisfy the reasonable expectation doctrine and accordingly, the appeals must be dismissed.
Signed at Ottawa, Canada, this 2nd day of August, 2000.
"A.A. Sarchuk"
J.T.C.C.
[1] Request to Admit – Exhibit R-1.
[2] Schedules "A" and "B" referred to herein are attached to these Reasons for Judgment.
[3] The Appellant testified that in addition to the main floor and basement suites, the upper or second floor level of the Property, although in poor condition, was utilized at least on occasion for rental purposes.
[4] In actual fact only one unit was available since the Appellant himself was residing in the other.
[5] The Appellant also made note of the fact that the Burnaby property was eventually lost to foreclosure. When this occurred is not known.
[6] 77 DTC 5213 (S.C.C.).
[7] A.G. of Canada v. Mastri et al, 97 DTC 5420 at 5423 (F.C.A.).
[8] The interest component referred to above represents 70% of the total, the remaining 30% having been accepted by the Appellant as personal expenses.
[9] 97 DTC 5503.
[10] In this context, it should be observed that in 1989, the Appellant became involved in the acquisition of property in Northern BC known as the Green Lake Property which acquisition required substantial down payments and which endeavour produced net rental losses in all years from 1989 to 1994 inclusive.