Date: 20010626
Docket: 2000-3998-IT-I
BETWEEN:
CLARITA JARQUIO,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Miller, J.T.C.C.
[1] Clarita Jarquio appeals the Minister's disallowance of the deduction of her rental losses for her 1996 and 1997 taxation years. The rental losses arise in connection with the property in which Ms. Jarquio resided and which she rented to several family members.
[2] The Appellant acquired the property in question at 111 Fishery Road in Scarborough, Ontario in May 1997 jointly with her sister Pilar Jarquio at a cost of $163,000.00. Both sisters are registered owners.
[3] The Appellant stated that the decision to acquire a residence was made deliberately with a view to earn rental income, as opposed to being someone paying rent, which she had done for many years prior to acquiring her home. Although the cost at the time seemed overwhelming to her, given her modest income, she expected profit over the long term. She referred to the period over which the mortgage would be paid down as a lengthy start-up period. In the early years of owning the property Ms. Jarquio acknowledged that the interest on the mortgage alone was twice the amount of the rent collected. In fact even in 1996 and 1997 the interest on the mortgage was still twice the rent.
[4] The rent and losses from the years 1987 to 1995 are as follows:
|
Year |
Gross Income |
Net Loss |
|
1987 |
$4,200 |
$7,083 |
|
1988 |
$4,500 |
$7,444 |
|
1989 |
$5,500 |
$14,233 |
|
1990 |
$5,500 |
$10,019 |
|
1991 |
$5,500 |
$8,287 |
|
1992 |
$5,500 |
$19,280 |
|
1993 |
$5,500 |
$9,746 |
|
1994 |
$5,500 |
$8,657 |
|
1995 |
$4,900 |
$11,114 |
[5] All the rental income for those years was earned from the Appellant's mother and a sister (not however the sister who was a co-owner who also lived on the premises). In 1996 and 1997 the rent and expenses were as follows:
|
1996 |
1997 |
|
|
Gross Income |
$2,400.00 |
$2,400.00 |
|
Expenses |
||
|
Advertising |
$ - |
$ - |
|
Insurance |
$1,338.86 |
$1,222.32 |
|
Interest |
$7,299.45 |
$5,037.55 |
|
Maintenance and repairs |
$3,231.81 |
$2,904.39 |
|
Property taxes |
$3,476.80 |
$3,506.16 |
|
Utilities |
$2,562.09 |
$2,069.06 |
|
Total Expenses |
$17,909.01 |
$14,739.48 |
|
Less Personal Portion of Expenses (33.3%) |
$5,969.67 |
$4,913.16 |
|
Net Expenses |
$11,939.34 |
$9,826.32 |
|
Net Loss |
$9,539.34 |
$7,426.32 |
[6] In these two years rent was less than prior years as Ms. Jarquio only had one tenant due to the death of her mother in late 1995. So, in 1996 and 1997 three family members lived in the house, one of whom paid rent. Ms. Jarquio indicated that although only one of three was a tenant, she only claimed 33 1/3% as personal use as she was away more than the others. However, she also maintained that she did not rent the other room, vacated upon the death of her mother, as she was not very well at this time. I found her evidence somewhat contradictory in this regard.
[7] Ms. Jarquio believed she will be in a profitable position by 2002, though her calculations to support that belief appear optimistic, as she forecasts rent of $7,500 when she has never had greater than $5,550. She did advise that she currently had a non related tenant, a mother and child renting one room at $3,900 a year. She also forecast expenses of $5,800 when expenses appear to have averaged around $14,000 a year, although in 1996 and 1997 expenses were only $12,000 and $10,000 respectively.
[8] I do not doubt that the Appellant has been extremely diligent in the upkeep and maintenance of the property, relying on her modest income to do so. She was dutiful in maintaining her financial records including records of expenses. She did not however advertise for tenants, which was clearly unnecessary as she had a ready market with her family. Given the relationship of the tenants, there was some question raised by the Respondent as to whether $200 a month represented fair market rental rates. Ms. Jarquio's answer was that her home was situated in a student area and she believed the rate was in fact market rate and was the same rate that she would have charged had the tenants been at arm's length.
[9] The Respondent framed the issues as follows:
1. Were the expenses disallowed by the Minister in respect of the property incurred by the Appellant for the purpose of gaining or producing income from a business or property or were they personal or living expenses?
2. Did the Appellant have a reasonable expectation of profit from renting part of the property in 1996 and 1997? and
3. In the alternative, were the disallowed expenses reasonable in the circumstances.
[10] In dealing with income from property cases which involve the personal element of the Appellant dwelling in the property, I suggest there are two possible approaches to follow. The first is to rely on the statutory reasonable expectation of profit test as set forth in paragraph 18(1)(h) and the definition of personal or living expenses in section 248 of the Act, which reads 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,
...
The second approach is to rely on the Moldowan reasonable expectation of profit test.
[11] The Federal Court of Appeal in Tonn v. The Queen, 96 DTC 6001 distinguished the reasonable expectation of profit test as pronounced in Moldowan v. The Queen [1978] 1 S.C.R. 480 from the statutory test of paragraph 18(1)(h).
... Dickson J. intended the reasonable expectation of profit test, which was similar to that set out specifically in paragraph 18(l)(h), as a general limitation on deductibility, precisely as he stated the test. The wording of the test was wisely made to harmonize with the statutory provision, thus avoiding potential conflict in the meaning of different phrases. Its application was not restricted to farming cases under section 31, to personal expenditure cases under paragraph 18(1)(h), or even to business expense cases under the business category of income source. This view of the Moldowan test respects the general tone of Dickson J.'s reference to the concept of "source of income", and also accords with the use made of the test in much of the case law. I am satisfied, therefore, that the scope originally contemplated for the Moldowan test by Dickson J. was broader than that suggested by paragraph 18(1)(h); that this section is not properly viewed as a statutory source for the Moldowan test; and that the section by itself does not, therefore, dictate a more restrictive reading of Moldowan.
However, I do not intend by this analysis of Moldowan to discount the concerns felt by the authors in their statements above about the expanding use of the test. It is necessary to be clear about the purpose of the test, both as it is derived from the original Moldowan decision and from its comparison to relevant statutory tests. The Moldowan test is stricter than the business purpose tests set out in subsection 9(1) and paragraph 18(1)(a). As mentioned above, these tests stipulate that a taxpayer be subjectively motivated by profit when incurring an expenditure. The Moldowan test, however, also requires the presence of a profit motive, but, in addition, it must be objectively reasonable. In reality, in most situations, the objective Moldowan test and the subjective statutory tests will not yield many different results. A subjective intention is often determined by what may be reasonably inferred from the circumstances.
...
Summarizing the above analysis, the Moldowan test, though similarly worded, does not derive from any of the deductibility provisions in sections 9, 18, and 20. The test is much like the business intention tests of subsection 9(1) and paragraph 18(1)(a), but it contemplates stricter application because of its objective nature. To be sure, the objective aspect of the Moldowan test is the most significant feature distinguishing it from the general deductibility tests in the Act.
[12] The Federal Court of Appeal makes it clear that the Moldowan reasonable expectation of profit test is a recognized separate independent fiscal principle, though as has been clarified in subsequent cases (notably Mastri, 97 DTC 5420) one to be applied sparingly, only when the facts warrant. The Federal Court of Appeal distinguishes the statutory paragraph 18(1)(h) test from the Moldowan test on the basis the former is a subjective and the latter an objective based test. It also recognizes however that in most situations the two tests will not yield different results. I would distinguish the tests further on the basis of the concept of "source of income". Relying on the Moldowan test and finding no reasonable expectation of profit is a finding of no source of income against which losses can be claimed. In effect, the taxpayer does not set foot past the gate of section 3 of the Income Tax Act. Relying on the definition of personal or living expenses, the statutory test, the taxpayer has entered past the gate-keeping section 3 and is subjected to the rules of deductibility as found in section 18. I find this is a logical approach in cases of income from property with a personal element, as it is difficult to deny there is a source, a property, in such cases.
[13] The Federal Court of Appeal alludes to this distinction in Mastri:
For the sake of doctrinal purity, I should also point out that a distinction must be drawn between the determination of whether a taxpayer's source of income is from a business as opposed to a property. I may own a rental property but whether I carry on a business in regard thereto is a distinct legal issue giving rise to other tax consequences not relevant to the cases under review. Thus, strictly speaking it is inappropriate to speak of business expenses incurred in relation to a rental property unless, of course, the taxpayer's endeavours are regarded in law as a business. In any event, it is helpful at this point to set out the specific findings of law articulated in Moldowan.
[14] This distinction referred to above becomes academic when dealing with a case such as Ms. Jarquio's where she derives some personal benefit. The Act, by defining "personal or living expenses" as it has, requires a finding that the activity generating income from property must constitute a business to avoid this definition.
[15] Therefore in connection with the disallowed expenses the Appellant must show either:
1. The disallowed expenses were not incurred for the use and benefit of the Appellant or her relatives; or,
2. The rental operation constituted a business carried on with a reasonable expectation of profit.
If she can satisfy me that either of these conditions has been met, then I cannot find the disallowed expenses to be personal or living expenses.
[16] Were the disallowed expenses incurred to maintain properties for the Appellant's and family's benefit and use. Clearly they were, as only family lived in the property in 1996 and 1997.
[17] Did Ms. Jarquio carry on a business with a reasonable expectation of profit in 1996 and 1997? I find she did not.
[18] Although Ms. Jarquio kept detailed records of her expenses, she provided no other evidence of the operation of a business. She gave no indication that much time was spent on the operation. Neither was there any evidence of a marketing plan, any advertising, any business cards or separate business phone line or separate business office. Frankly, I would not expect any of these business trappings in the circumstances of a sister having other family members staying in her home and charging them rent. Ms. Jarquio's behaviour smacked more of a woman providing some accommodation for her family than a businessperson actively seeking to enhance her business. Even when a room came available upon the death of her mother, she took no steps to rerent the room during 1996 or 1997. She simply was not behaving in the manner one would expect of someone engaged in an ordinary commercial enterprise.
[19] Did she have an expectation of profit? I believe Ms. Jarquio when she admits that over a long term she expected a profit. This however was not a reasonable expectation in the years at issue as borne out by her history of losses over a protracted period. Her motivation in 1996 and 1997 appears more in keeping with accommodating her sisters than seeking a profit.
[20] There may come a time as the mortgage is paid down and Ms. Jarquio successfully advertises for and obtains tenants paying a fair market rent, that her rental operation might be categorized as a business, one which indeed has a reasonable expectation of profit. For the years 1996 and 1997 however she has been unable to prove on balance that a business existed or that there was a reasonable expectation of profit. I find the expenses disallowed by the Minister
do represent personal or living expenses as defined in section 248 and therefore are not deductible. The appeals are dismissed.
Signed at Ottawa, Canada this 26th day of June 2001.
"Campbell J. Miller"
J.T.C.C.
COURT FILE NO.: 2000-3998(IT)I
STYLE OF CAUSE: Clarita Jarquio and The Queen
PLACE OF HEARING: Toronto, Ontario
DATE OF HEARING: June 18, 2001
REASONS FOR JUDGMENT BY: The Honourable Judge Campbell J. Miller
DATE OF JUDGMENT: June 26, 2001
APPEARANCES:
For the Appellant: The Appellant herself
Counsel for the Respondent: Brianna Caryll
COUNSEL OF RECORD:
For the Appellant:
Name:
Firm:
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2000-3998(IT)I
BETWEEN:
CLARITA JARQUIO,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on June 18, 2001 at Toronto, Ontario, by
the Honourable Judge Campbell J. Miller
Appearances
For the Appellant: The Appellant herself
Counsel for the Respondent: Brianna Caryll
JUDGMENT
The appeals from the reassessments made under the Income Tax Act for the 1996 and 1997 taxation years are dismissed in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada this 26th day of June, 2001.
|
"Campbell J. Miller" |
J.T.C.C.