Date: 20000915
Docket: 1999-4021-IT-I
BETWEEN:
JEAN-ROCH MASSÉ,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasonsfor Judgment
Tardif, J.T.C.C.
[1] This is an appeal respecting the 1994, 1995, 1996 and 1997 taxation years.
[2] The questions at issue are the following:
[TRANSLATION]
(a) Did the appellant have a reasonable expectation of profit from property rental with respect to the condominium during the 1994, 1995, 1996 and 1997 taxation years?
(b) If the appellant did have a reasonable expectation of profit from property rental with respect to the condominium during the 1994, 1995, 1996 and 1997 taxation years, was the net rental income he reported correctly computed by him?
[3] In support of the reassessments, the Minister of National Revenue (the "Minister") made the following assumptions of fact:
[TRANSLATION]
(a) the appellant purchased a condominium in Florida in March 1992;
(b) the condominium purchased was Unit 161 in Building 28 located at Waterside Village in Palm Beach;
(c) according to the insurance contract effective March 20, 1992 obtained from the appellant, the condominium was insured for US$77,990;
(d) on the statements of real estate rentals (Waterside Village Florida) for the 1994, 1995 and 1996 taxation years (the 1997 statement was not available to the Minister as the appellant had filed an electronic return), amounts of $106,250 for the real property and $13,161 for the movable property are reported as the undepreciated capital cost on December 31;
(e) the appellant stated that to finance the purchase of his condominium in Florida he had remortgaged his personal residence in Ste-Foy and taken out a personal loan;
(f) the amounts borrowed in order to purchase the condominium in Florida were estimated at $88,900;
(g) for the 1993 to 1997 taxation years inclusive, the appellant reported the following gross and net rental income:
Year Gross income Net loss
1993 5,250 (11,654)
1994 2,926 (10,719)
1995 5,192 (10,793)
1996 3,719 (9,812)
1997 4,232 (6,972)
(h) the gross rental income reported for the 1994, 1995 and 1996 taxation years was less than the interest amounts, which were $8,340 in 1994, $8,001 in 1995 and $7,603 in 1996;
(i) according to information obtained from the appellant, the condominium was rented for four weeks in 1993, four weeks in 1994, five weeks in 1995, four weeks in 1996 and four weeks in 1997;
(j) the appellant stated that for his 1996 taxation year he had reported rental income from himself for two of the four weeks the property was rented;
(k) the appellant stated that he had used his condominium for personal purposes for two weeks in each of the years in issue;
(l) the appellant deducted nothing for his personal use of the condominium on the statements of real estate rentals which he submitted for the 1994, 1995 and 1996 taxation years;
(m) the appellant has not shown that the expenses claimed in respect of the condominium for the taxation years in issue were incurred by him with a reasonable expectation of earning a profit;
(n) on April 27, 1998, the appellant signed a T-2029 form entitled "WAIVER IN RESPECT OF THE NORMAL REASSESSMENT PERIOD" with regard to his rental income and expenses for the 1994 taxation year;
(o) the Minister issued reassessments to the appellant denying the rental losses claimed by him in respect of the Florida condominium for the taxation years in issue.
[4] The appellant admitted all the facts on which the respondent relied, with the exception of those set out in subparagraphs (d), (l) and (m).
[5] The evidence showed that the appellant was a prudent businessman, methodical and meticulous in the administration of his company. His representations before the Court were moreover articulate and supported by very well prepared charts.
[6] The appellant purchased a condominium ("condo") in Florida which was part of a vast complex built by a large Quebec concern, "Groupe Pomerleau". The purchase was made in March 1992.
[7] At the time of the purchase, the real estate developer informed all those concerned, including the appellant, that a rental service was available to handle the rental of the purchased unit if the purchaser so desired. The appellant testified that he found the project very attractive since he could hope to receive relatively satisfactory income in the short term in the order of US$11,000 a year.
[8] The appellant invested solely on that basis, not having conducted any research to determine whether the possibility of that kind of income was realistic. He soon realized that the situation was not so simple or promising. He in fact noticed that the person responsible for rentals, a former manager of a Florida hotel, was not very dynamic and demonstrated little enthusiasm about renting condo units that had already been sold.
[9] After his purchase in March 1992 and having observed that the income was very disappointing, the appellant decided nearly three years later, in 1995, to charge a neighbour, a Ms. Rioux, the owner of a condo on the same site, with the rental of his unit. He admitted that the purpose of his neighbour's initiatives was first of all to rent her own condo and that he benefited by receiving tenants that she could not accommodate. The appellant said that the arrangement was a very good one and had the additional advantage of not being costly.
[10] The appellant could not state or describe the steps his neighbour took to rent his condo, except to say that he believed she had posted advertisements at various locations.
[11] The appellant also contended that things improved considerably after he turned to his neighbour.
[12] In actual fact, as admitted in subparagraph (i), the condo was rented for four weeks in 1993, four weeks in 1994, five weeks in 1995, four weeks in 1996 and four weeks in 1997. The rental was set at $550 a week in the high season, that is, from the holiday period in December until the end of March. In the low season, which was the rest of the year, the rental was $350 week.
[13] For the years in issue, the appellant received rental income of $2,926 in 1994, $5,192 in 1995, $3,719 in 1996 and $4,232 in 1997. That income included the amount of the rent which he billed himself for his personal occupancy.
[14] From these facts, which are essentially arithmetical and in no way open to interpretation, it is hard to understand and especially to see how or in what manner the situation improved after Ms. Rioux was entrusted with renting the condo.
[15] Analysis of the income also shows that the rental rates were not firm and that the appellant was accommodating with certain tenants. He gave the following explanation: [TRANSLATION] "It was better to reduce the price and have the property rented than not to have it rented."
[16] The evidence also showed that most of the tenants were the appellant's friends or business acquaintances, or the appellant himself and his family. Very few strangers or third parties occupied the appellant's condo during the years in issue, a fact which also contradicts the appellant's assessment of the effectiveness of Ms. Rioux's services.
[17] For the 1994, 1995 and 1996 taxation years, the gross rental income was less than the interest amounts, which were $8,340 in 1994, $8,001 in 1995 and $7,603 in 1996. After 1996, no doubt following the audit of his file, the amount of interest declined as the appellant reduced the amount of the mortgage.
[18] The main facts revealed by the evidence were moreover communicated to the respondent through a questionnaire completed by the appellant, which it is appropriate to reproduce here:
[TRANSLATION]
Questionnaire
1. Please submit the aforementioned contract of purchase for the property
A photocopy of the American documentation concerning the contract of purchase for my condominium at Waterside is appended to this questionnaire.
Description of rented unit (e.g., duplex, basement apartment, cottage, etc.)
Condominium.
Area of rented unit:
Approximately 1,040 square feet.
Age of property at time of purchase:
The condominium was brand new at the time of purchase.
Number of rooms rented (where applicable):
The unit is a five-and-a-half room condominium, all of which is available for rent.
Number and nature of services provided:
The condominium has all the amenities usually found in a condominium residence, and there is access to Canadian television and all the usual services available to owners at the Waterside Village site (such as a community hall, two swimming pools, courts for games such as tennis, and a reception service).
If you rent part of your personal residence, please apportion its area according to the number of square feet of the rented portion and of the portion which you occupy:
The condominium is entirely occupied by the tenant when rented.
If a principal residence has been converted into a rental property, state the fair market value of the property at the time of the conversion:
This Florida residence has always been a property intended entirely for rental purposes.
2. For what purpose was the property originally purchased?
The initial and ultimate purpose of the purchase of this Florida condominium purchase was and still is rental of the unit.
At the time of purchase, the vendor even told me that I could earn annual rental income of $10,000 to $11,000 just by using the existing on-site services.
3. When did you begin to rent the property? Please state the month and year.
The condominium has been made available for rental from the start.
4. What financing arrangements were made in order to rent the property?
There were no financing arrangements apart from having the entire rental cost paid at the time a rental agreement was entered into.
Please submit the loan agreement and confirmation of the interest deducted[1] against your rental income for:
1994 : $8,340
1995 : $8,001
1996 : $7,603
There are two loan agreements for the financing of this condominium:
· There was an initial agreement for a mortgage on my condominium in Sainte-Foy to finance the Florida condominium.
The reason is that a Canadian lending institution may not extend mortgage financing for a property located outside the country.
· A second financing agreement to obtain the balance through an investment loan was entered into with the caisse populaire that had provided the original loan.
You will find those two documents appended to this questionnaire.
I would ask you to note that these financing arrangements are now no longer with the Caisse populaire Laurier, but rather are with the Caisse populaire de Sainte-Foy.
As for confirmation of interest paid, reference documentation is also appended hereto.
5. What improvements have been made to the property to facilitate its rental?
Please be precise as to the kind of repairs or improvements made to the rental unit concerned and state the costs and the years concerned.
First, the unit was originally completely furnished with a maximum of practical amenities and comfort for tenants: numerous items for the kitchen, laundry facilities, towels, sheets, toilet articles and so on.
And in 1996, all the walls and ceilings were painted.
6. On a monthly basis, where applicable, please provide the following details for the taxation years: 1993 to 1997 inclusive.
YEAR RENTAL NAME OF TENANT'S
AMOUNT TENANT RELATION
TO YOU
(Family, friend, etc.)
1992[2] US$1,100.00 - 2 wks Denis Malépart No relation
US$1,100.00 - 2 wks André Breton No relation
1994 C$1,400.00 - 2 wks Béco Inc. Business relationship
Yvan Leblanc
C$1,526.00 - 2 wks (No lease exists.) No relation
1995 C$1,400.00 - 2 wks Béco Inc. Business relationship
Gilles Huard
C$2,169.00 - 3 wks (No lease exists.) No relation
1996 C$1,400.00 - 2 wks Béco Inc. Business relationship
Yvan Leblanc
C$1,054.00 - 2 wks Jean-Roch Massé[3] N/A
1997 US$1,350.00 - 2 wks Jn-Philippe Jacquet No relation
US$1,100.00 - 2 wks Mr. William No relation
1998[4] US$1,600.00 - 4 wks Benoît Boivin No relation
US$ 785.00 - 1.5 wks Béco Inc. Business relationship
Yvan Leblanc
US$1,600.00[5] - 4 wks Jean-Guy Caron Friend
US$ 350.00[6] - 1 wk Daniel Morin, C.A. Accountant for my business, Béco Inc.
Please submit the leases concerned.
The only leases prepared for these rentals are appended hereto, except where my business leased my condominium directly for its business relations (in which case, it paid me directly).
7. How do you set the rent for each unit (e.g., based on market comparisons, with a view to attracting a specific type of tenant, etc.)?
The only factor guiding me in determining rental costs at Waterside Village is the policy of the condominium owners' association. The weekly cost stated in that policy is $550 in high season and $350 in low season. A person may rent for somewhat less than those rates but that should not be the rule.
8. If the unit was not rented for a given period of time, state whether it was available for rental. If it was not, explain why not.
My condominium was always available for rental.
9. If the unit was available for rental, what efforts did you make to find tenants? Specifically describe the advertising you did, providing supporting documents regarding advertisements placed, rental agencies used, etc.
Until recently, responsibility for renting my Florida condominium was in the hands of Nicole Côté, who, at the time I made my purchase, was responsible for administering Waterside Village and in charge of rentals there. Condominium ownership did and still does lend itself to direct rentals at the association office in Florida.
But, there is nothing preventing an owner from placing his own advertisements and following them up. However, as I am a systems development consultant and have a business (all my time must be devoted to the management of my business operations in Québec), I gave Ms. Côté a verbal mandate to rent my condominium in Florida.
Recently, however, I decided to proceed differently because I was convinced that the unit could be rented out more. Accordingly, before Christmas 1997, I charged a female friend in Quebec City, who also has a condominium in Florida which she rents through newspaper ads, with renting my condo, for a commission of 10 percent of gross income.
She accepted the contract and has already found me two rentals and, had it not been for a friend who reserved the condo for one month but postponed his stay because of the ice storm, then ultimately delayed it until next fall, I would have had another rental, for one month, through her.
I am finally quite pleased now because this woman works in a very organized manner, using follow-up cards, standard agreements, documentation with instructions for tenants, whom she sees before proceeding with the rental (in order to ensure that they are suitable), etc.
10. Is the property rented at this time? If not, please explain why not. If the property has been sold, please submit the contract of sale.
The property is currently rented and has not been sold because I am now more convinced that the person I have entrusted with its rental will be more effective than the first.
11. Do you yourself use the rental property that is not your personal residence, or is it used by members of your family or by friends for recreational purposes or vacations? If so, do you require payment of rent and what is the amount of that rent?
I alone use my Florida condominium without paying and I do so for the purpose of carrying out owner's visits during slow periods for rentals when renting it is definitely even more difficult (low season).
However, my business has occasionally rented it, and paid, with a view to providing a service to its clientele.
12. Please submit the statement of revenue and expenditure for 1997, if available.
That statement of revenue and expenditure is not available at this time. It will be available at the end of April of this year and will be forwarded to your department.
13. Describe in detail the reasons for the rental losses incurred in 1993 to 1996 inclusive. What measures did you take to reduce expenses or increase income?
One of the reasons was that I expected more from the person responsible for rentals, who was presented to me as a competent person in the field when I purchased my condominium in Florida.
However, a number of factors soon arose that were decisive and catastrophic with respect to rentals in Florida for small owners who do not have the networks of the Hilton, Holiday Inn and other chains.
In this regard, one must not forget the murders of tourists that were committed over a period of more than one year and caused the number of tourists visiting Florida to decline sharply.
In addition, and above all, there is the matter of the value of the Canadian dollar in relation to the US dollar, which fell further sometime after I purchased my condominium in Florida.
I remember in that regard that, upon finalization of my purchase agreement with the signing of the contract, within one week I had to pay $5,000 more than I had anticipated, precisely as a result of the exchange rate.
As matters now stand, there has been no improvement in this regard; things are worse. The exchange rate when buying US currency even exceeds 40 percent.
As for the measures that I have taken, I need not mention that I cannot do anything about the exchange rate. I also have to stay within the guidelines suggested by the condominium owners' association as regards the weekly rental (US$350 in the low season and US$550 in the high season). There may be some price cuts to compensate for the exchange rate, but they cannot be too great because that would entail too great a risk of bringing in an undesirable clientele with the consequences that would have for the site.
The decisive step that I have taken is essentially having handed over responsibility for renting my condominium to this friend I now have who owns a condominium on the same site. She has the time to attend fully to her condominium and achieves success. This arrangement began last fall and, for her, handling the rental of my condo does not entail any greater expense or effort than are involved in just renting her own condominium.
14. Describe your rental experience prior to the purchase of the property concerned.
I did not and still do not have a great deal of experience in this area. I believe that is true of most condominium owners who rent out their units at the Waterside Village site. However, I was previously a co-owner of a hotel/motel in Québec.
In addition, my activities as a management systems development consultant and in the administration of my business take up all my time and I must therefore rely on someone else to handle the rental.
15. How much time do you devote per day/week/month to the rental property? What specific tasks do you perform yourself (e.g., maintenance, rent collection, selecting tenants, etc.)?
The only tasks I perform myself are maintenance type tasks, which I do when I visit the condo as its owner, and doing painting, as I did in 1996. I look after collection of income and administration of expenses and communicate with the person who handles the rentals for me. Lastly, I solicit a few acquaintances in order to rent the condo.
It is very hard to evaluate the time all this represents on an annual basis. I would estimate between 75 and 100 hours a year.
16. Describe your plan for profitability when you began renting your property. Append any relevant documents.
I had no plan except to rely on the sales infrastructure in place at Waterside Village. In short, I felt a plan was not necessary for such a small undertaking. It was only a condominium unit, not a condominium complex.
17. Describe your present plan for profitability aimed at having your operation finally produce net income. Append any relevant documents.
I very much hope that my Florida condominium will produce net income.
I nevertheless believe that, for this to happen, it is not necessary to do anything more than use the services of someone who is already renting her own condominium on the same site (the aforementioned friend). That alone will cost me 10 percent of the gross revenue that will be generated.
I have a choice to make: either my business in Quebec with its employees or larger-scale rental operations. The choice I have made will be less costly and will generate more income, considering that I also have to manage my business, which requires a great deal of time.
[19] To determine that there is a reasonable expectation of earning a profit from the rental of a condo, it is essential that the owner be able to show that he had a business plan offering a realistic and reasonable hope of earning real income, having regard to all the factors associated with the investment.
[20] On this important and fundamental question, the appellant essentially stated that the real estate developer had held out to him the possibility of earning income of perhaps approximately $11,000 a year, which, in the appellant's view, constituted a profitable business.
[21] However, it took the appellant more than two years to realize that the rental service provided by the developer was ineffective and inadequate and that it produced no results. He then decided to rely on Ms. Rioux, a neighbour who was scarcely more active, judging by her results.
[22] Can it be concluded from the facts adduced in evidence that the appellant, a prudent and well-organized businessman, put in place a serious plan the ultimate purpose of which was to create a profitable operation? If he did, the evidence did not prove it.
[23] On the contrary, the preponderance of the evidence showed that the appellant was certainly interested in the business becoming viable, but his initiatives and efforts to this end were worse than marginal. I believe that the appellant's primary concern was much more enhanced personal well-being through ownership of a property in Florida than a fixed and firm intention to earn a profit from the property.
[24] If the plan had been carried out with a true intention to earn a profit, the appellant definitely could and should have shown that he had actually took every measure to ensure greater income than he actually received. There is a host of means available to rent a condo in Florida. All the appellant saw fit to do was to rely on the promoter, who no doubt had scores of other units to rent, and then on a neighbour who herself rented a similar condo.
[25] The appellant no doubt operated on the principle that his investment would theoretically be profitable from a tax standpoint, but he failed to understand that the actual facts had to support the theory. The establishment of a genuine business whose main objective is to make a profit must be preceded by an objectively realistic and reasonable business plan on which serious and appropriate action is taken.
[26] For an undertaking to constitute a source of income, a taxpayer must have profit in mind or have a reasonable expectation of profit. Where there is no reasonable expectation of profit, there is no source of income and no basis on which the taxpayer can calculate a rental loss in the case of a condominium.
[27] It was admitted that the amount of interest was greater than gross income for 1994, 1995 and 1996 (subparagraph (h) of the Reply). This is a decisive factor regarding which Robertson J.A. of the Federal Court of Appeal wrote as follows in Mohammad v. The Queen, [1998] 1 F.C. 165, 97 DTC 5503, at page 173:
. . . Too frequently, the amount of yearly interest payable on the loan greatly exceeds the rental income that might reasonably have been earned. This is true irrespective of any unanticipated downturn in the rental market or the occurrence of other events impacting negatively on the profitability of the rental venture, e.g. maintenance and non-capital repairs. In many cases, the interest component is so large that a rental loss arises even before other permissible rental expenses are factored into the profit and loss statement. The facts are such that one does not have to possess the experience of a real estate market analyst to grasp the reality that a profit cannot be realized until such time as the interest expense is reduced by paying down the principal amount of the indebtedness. Bluntly stated, these are cases where the taxpayer is unable, prima facie, to satisfy the reasonable expectation doctrine. Therese are not cases where the Tax Court is being asked to second-guess the business acumen of a taxpayer whose commercial or investment venture turns out to be less profitable than anticipated. Rather these are cases where, from the outset, taxpayers are aware that they are going to realize a loss and that they will have to rely on other income sources to meet their debt obligations relating to the rental property.
. . .
[28] The appellant indeed reduced the mortgage debt and consequently the amount of interest, but it would appear that Revenue Canada's intervention had something to do with this turnaround. There was however no change with regard to the energy devoted to increasing income, even though losses were heavy.
[29] The appellant consulted no one and prepared no business or recovery plan. He let things go and continued to rely on an arrangement which, over several years, had yield only highly disappointing results.
[30] There being a tax benefit involved, the appellant did not see fit to review the situation by questioning his methods or considering other methods in order to increase income, as he claimed that his business took up all his available time.
[31] Furthermore, this was not a purely commercial operation; the condo purchase was a real source of personal benefits for the appellant. Indeed, a portion of the rental income came from his personal use and from use by his family.
[32] It is normal for any business to experience difficulties in the beginning and to incur losses in its first years until it is able to make certain adjustments and get itself on track. However, this implies that everything has been done in accordance with a serious and objective business plan in which expenses and revenue are assessed regularly. It is not essential that the implementation be entirely in accordance with the initial plan. A number of unforeseen circumstances may arise, which call for reaction, questioning or the consideration of corrective action.
[33] In the instant case, the appellant invested in a project whose attractiveness had clearly been exaggerated by the vendor, without first checking to see whether the vendor's representations were reasonable and realistic. The appellant borrowed to finance the purchase, which meant that the losses would be large. Lastly, he entrusted the rental of his condo to persons who clearly had no interest, expertise or genuine desire when it came to maximizing revenue, a nonetheless fundamental aspect.
[34] There is therefore reason to believe that the appellant's main consideration was not profit at all costs but rather the personal benefit of owning a condo in Florida, a portion of the costs of which would be paid by the government.
[35] The whole of the evidence showed that profit was not the ultimate goal sought during the years in issue; the appellant's actions demonstrated that profit was not at all a priority.
[36] On a preponderance of evidence and based on the tests set out in the case law, I find that, following his purchase of a condo in Florida in 1992, the appellant had no reasonable expectation of profit in 1994, 1995, 1996 and 1997.
[37] Consequently, the appeal is dismissed.
Signed at Ottawa, Canada, this 15th day of September 2000.
"Alain Tardif"
J.T.C.C.
Translation certified true on this 29th day of November 2001.
[OFFICIAL ENGLISH TRANSLATION]
Erich Klein, Revisor
[OFFICIAL ENGLISH TRANSLATION]
1999-4021(IT)I
BETWEEN:
JEAN-ROCH MASSÉ,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on July 18, 2000, at Québec, Quebec, by
the Honourable Judge Alain Tardif
Appearances
For the Appellant: The Appellant himself
Counsel for the Respondent: Valérie Tardif
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1994, 1995, 1996 and 1997 taxation years are dismissed in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 15th day of September 2000.
|
"Alain Tardif" |
J.T.C.C.
Translation certified true
on this 29th day of November 2001.
Erich Klein, Revisor
[1] You will note that the interest deducted for income tax purposes is less than the actual amount of interest appearing on the notices issued by the lending institution. The reason is that there was a mortgage balance on my residence in Sainte-Foy at the time and the accountant used only the portion of interest related to the financing of the Florida condominium.
[2] I here submit the only leases I have.
[3] As 1996 was unfortunately also slow, the accountant suggested that I report rent from me myself for two periods of two weeks each. In short, the idea was to pay for my two stays (both in the low season, even though the cost of one of those stays is shown as though it had occurred in the high season). This was in addition to the rental income from my own business, Béco Inc.
[4] I decided to add 1998 to show that there was at last a progression toward profitability as a result of the change made regarding responsibility for renting the property. In addition, the annual decline in financing costs will also help the condominium soon become profitable.
[5] This was a four-week reservation for the fall of 1998. This rental was to take place in January 1998, but was postponed because of the ice storm.
[6] This was a reservation for one week at the end of July 1998.