Date: 20010803
Docket: 2000-3791-IT-I
BETWEEN:
FRANK DELUCA,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1] These appeals are from assessments for the appellant's 1993 and 1994 taxation years. They involve the deduction of losses incurred by the appellant in those years from an investment that the appellant made in three condominium units in London, Ontario.
[2] The appellant is and, during the period was, a high school mathematics teacher.[1] In 1988 he and his spouse purchased three condominium townhouse units at 470 Second Street, London, Ontario. The units were part of a complex of 45 units promoted by a Mr. Wells among the high school teachers who were colleagues of the appellant. The units cost $72,300 each for a total of $216,900. The appellant put $2,000 of his own money into the purchase price of each unit. The remainder of the purchase price was provided by a 75% mortgage of about $54,000 and the rest through a line of credit with a trust company that had been arranged by the promoter Mr. Wells.
[3] The appellant believed the investment was a good one. He was influenced to some degree by the fact that his colleagues were investing in the project. Some of them taught business and others had had favourable experience in investing in real estate. He was given a projection of the cash flow by Mr. Wells that showed a projected positive cash flow in year six and a profit in year four. With the benefit of hindsight the projections seem unrealistic. I have no basis for believing that they were unrealistic in 1988.
[4] The appellant was also influenced by the fact that real estate prices were rising in the late 1980s. There was some argument by Mr. Deluca's representative that the appellant's intention was to realize a capital gain. One might reasonably consider that buying with a view of reselling and realizing a capital gain is an oxymoron, in that such a purpose, if it is a real motivating factor, would turn the project into an adventure in the nature of trade. However, I tend to be somewhat sceptical of belated assertions that the object was to flip the property at a profit. As was said in Donyina v. The Queen, file 2001-934(IT)I at page 10:
10. If what is ostensibly a rental property was acquired and held in the course of an adventure in the nature of trade and it was reasonable to expect a profit on the resale the losses (i.e. carrying costs net of rentals received) should not be disallowed on the basis of REOP (Roopchan). The court should however examine with some care an ex post facto declaration that property that was carried for some years at a loss is part of a speculative venture in which the motive was resale at a profit. This is not something that one would expect someone readily to admit if the property were sold at a profit.
[5] That was, in any event, not the basis on which the case was argued.
[6] In the late 1980s or early 1990s the builder went bankrupt and the participants in the project were unexpectedly saddled with large obligations before the project could be registered. The builder owed substantial sums of money to the original owner and they had to pay these off. They had to build a bern (a form of embankment) and a high fence along the railway line that ran behind the properties. Sewer charges and taxes were left unpaid by the builder and had to be paid. The result was that the appellant as well as the other participants had to obtain additional financing through their line of credit. The appellant had to put an additional mortgage on his home. The units were rented as early as 1988 but the rent was seized by the builder's creditors. The units were not registered in the appellant's name until 1991.
[7] The rather rosy cash flow projections made by Mr. Wells did not materialize. The reality was somewhat more sombre:
Gross Net
Rental Rental
Year Income Loss
1988 $16,335
1989 $14,070
1990 $32,677
1991 $16,368 $21,261
1992 $19,113 $37,188
1993 $28,125 $23,931
1994 $23,812 $30,258
1995 $20,012 $11,929
1996 $12,973 $16,273
1997 $ 9,612 $ 5,011
1998 $ 9,612 $ 3,022
1999 $ 9,612 $ 2,279
[8] In August of 1993 the appellant took over the management of the three units in an attempt to improve the return. This involved essentially two changes. Prior to that time the rents from all the units were pooled and the participants received a share based on the number of units they owned, regardless of whether their particular units were rented. After August the appellant assumed the responsibility of finding and dealing with the tenants and of doing the maintenance and repairs himself. Previously the cost of repairs had been pooled. Also, the appellant had to evict some tenants who had been allowed to go for a long period without paying rent. In 1994 as well he had to do extensive repairs to the unit where the tenants whom he had evicted had lived.
[9] In 1994 he sold one unit and later he sold another. At present he owns one unit and has raised the rent from $800 per month to $900 per month. Evidently this unit is turning a profit although he is still struggling with the debt load from the earlier refinancing.
[10] The detailed computation for 1993 and 1994 is as follows.
1993 1994
Gross Income $28,125.00 $23,812.00
Expenses
Advertising $ 15.00 $ 52.95
Insurance 69.00 326.90
Interest 33,078.00 28,573.80
Maintenance & repairs 1,546.00 7,316.80
Management & administration fees 3,135.00
Motor vehicle expenses 312.34
Office 198.00 182.90
Legal, accounting & other
professional fees 455.00 4,810.52
Property taxes 7,210.00 5,913.69
Salaries, wages & benefits 1,200.00
Travel 1,084.74
Utilities 315.00 878.42
Telephone 222.47
Bank charges 59.55
Other expenses* 9,170.00____________
Total Expenses $52,056.00 $54,070.08
Net Loss** $23,931.00 $30,258.08
* details of other expenses were not provided
** 100% of reported loss claimed by Appellant
[11] The Minister disallowed the losses and in support of his doing so now intones the ritual incantation "no reasonable expectation of profit".
[12] One of the most significant assumptions pleaded is that the disallowed rental expenses were
"personal or living expenses of the Appellant"
This expression is defined in section 248 of the Income Tax Act in part as follows.
"personal or living expenses" includes
(a) the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit.
[13] This point was not pursued in argument and was not mentioned in part C of the reply as one of the grounds relied on and in any event the notion that the expenses were personal or living expenses was thoroughly demolished. Neither the appellant nor any related person lived in the units.
[14] In determining whether the losses are deductible it requires something more than mechanically examining the losses, deciding that the interest and other expenses exceed the revenue and chanting the inevitable mantra REOP. This case is a very good example of REOP being used as a substitute for analysis, a practice that was criticized in Costello v. The Queen, 98 DTC 1362. Although the assessor's analysis was not put in evidence it seems that some examination was done but it was evidently not used as a basis of the assessment. One needs only to look at the expenses claimed to see that some of them cry out to be questioned. For example $7,316.80 for maintenance and repairs seems high and although counsel suggested in cross-examination of the appellant that only about one half of the amounts were supported by receipts, no evidence of this was put forward and the question of the quantum of the expenses or their authenticity was not raised in the pleadings. Similarly $1,084 for travel strikes me as somewhat odd, given the nature of the investment. Salaries of $1,200 were allegedly paid to the appellant's son for help in cleaning up one of the units from which the tenants had been evicted. This amount - a round figure - needed to be questioned.
[15] The only amount that is so patently wrong that it would be an error to allow it is the $4,810 that the appellant claimed for legal, accounting and professional fees. He admitted that this amount was substantially all for legal fees incurred in selling one of the units in 1994. Clearly such an expense cannot be deducted as a current expense of the rental operation. His representative suggested that part of it might be deductible in computing a terminal loss on the sale of the unit. That may be but no terminal loss was pleaded, claimed or proved.
[16] I come back to the question: did the appellant have a business? In my view he did and it is reasonable that he be allowed the losses, except for the $4,810.52 incurred in selling one of the condominium units. If REOP is relevant, and evidently it is, it is clear that his expectation of profit was reasonable. By the year 2000 he was it seems realizing a profit on the remaining unit. Had he kept the other two units it seems probable that "in the fullness of time" — to use the phrase used in Allen & Milewski v. The Queen, 99 DTC 968, aff'd 2000 DTC 6559 — he would have realized a profit as well.
[17] I think there has been a tendency to use the REOP principle excessively. The tax authorities appear to have learned nothing from the cases that I referred to in paragraphs eight and nine of Donyina and they seem to be applying it indiscriminately against a large number of businesses and investments just because the taxpayer's expectations have not been met. The present case is a good example. The taxpayer embarked on a business venture that for reasons beyond his control did not generate profits the way he reasonably hoped it would. Unexpectedly events over which Mr. Deluca had no control required that more capital be put into the project and he did so by putting a mortgage on his house. He made every effort to improve the situation by getting out of the rental pool and taking over the administration. Finally he decided to cut his losses by selling two of the three units. The CCRA, waving the REOP banner, and, against all the evidence and against all reason, disallowed the losses on the theory that the expenses were personal or living expenses.
[18] The appeals are allowed and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment to allow the deduction of losses of $23,931 and $25,447.56 in 1993 and 1994 respectively.
[19] The appellant is entitled to his costs, if any, in accordance with the tariff.
Signed at Ottawa, Canada, this 3rd day of August 2001.
"D.G.H. Bowman"
A.C.J.
COURT FILE NO.: 2000-3791(IT)I
STYLE OF CAUSE: Between Frank Deluca and
Her Majesty The Queen
PLACE OF HEARING: London, Ontario
DATE OF HEARING: July 25, 2001
REASONS FOR JUDGMENT BY: The Honourable D.G.H. Bowman
Associate Chief Judge
DATE OF JUDGMENT: August 3, 2001
APPEARANCES:
Agent for the Appellant: Bernard Linseman, C.A.
Counsel for the Respondent: J. Michelle Farrell
COUNSEL OF RECORD:
For the Appellant:
Name: --
Firm: --
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2000-3791(IT)I
BETWEEN:
FRANK DELUCA,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on July 25, 2001, at London, Ontario, by
The Honourable D.G.H. Bowman
Associate Chief Judge
Appearances
Agent for the Appellant: Bernard Linseman, C.A.
Counsel for the Respondent: J. Michelle Farrell
JUDGMENT
It is ordered that the appeals from assessments made under the Income Tax Act for the 1993 and 1994 taxation years be allowed and the assessments be referred back to the Minister of National Revenue for reconsideration and reassessment to allow the deduction of losses of $23,931 and $25,447.56 respectively.
The appellant is entitled to his costs, if any, in accordance with the tariff.
Signed at Ottawa, Canada, this 3rd day of August 2001.
|
"D.G.H. Bowman" |
A.C.J.
[1] The appellant's spouse was a 50% owner of the units but the appellant claimed 100% of the losses. This position was not challenged by the respondent nor was the point pleaded as an issue by the respondent and so the appellant had no onus to establish that he was entitled to 100% of the losses.