Date: 20010201
Docket: 1999-4986-IT-I; 1999-4985-IT-I
BETWEEN:
TRACEY L. JOHNSON,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1] These appeals were heard together. The appellants are married to each other. They appeal from assessments for the 1996 and 1997 taxation years.
[2] In 1995 they purchased a property at 8807 Findlay Creek Road, Canal Flats, British Columbia, in which they intended to carry on a bed and breakfast business. They sustained losses in 1996 and 1997 of $22,772.75 and $21,209.57, which they shared equally. The losses were denied on assessment.
[3] At that time both appellants worked for Syncrude Canada Ltd. at Fort McMurray. Tracey Johnson is a chemical engineer. They decided to make a career change. Tracey Johnson found the job stressful and her husband had health problems. They bought the Findlay Creek property with a view to carrying on a bed and breakfast operation. The property consists of a 4,000 square foot house and 20 acres.
[4] In preparation for the venture they took a business course at a local college and studied books on running a bed and breakfast. They looked for a suitable place and when they found the Findlay Creek property they decided to buy it because it was ideally located. It consisted of living area for the owners and also had space for four bedrooms with bathrooms, as well as a kitchen and seating area.
[5] They prepared a detailed business plan and took it to a firm of chartered accountants in Fort McMurray.
[6] At the outset they rented the property to Ms. Johnson's sister and her husband for $550 per month for 11 months. This figure was determined to be fair market value after checking what prices were being charged for comparable accommodation. In addition, they paid the appellant's sister's husband $200 per month to maintain the property.
[7] After Ms. Johnson's sister moved out they rented the property on a nightly basis for $75 per night to third parties and occasionally to Ms. Johnson's sister. I find as a fact that the rent charged to third parties and to Ms. Johnson's sister was fair market value and the amount paid to her husband was reasonable.
[8] In 1998 they closed the operation down and added three more bedrooms and enlarged the kitchen. To finance this the spouses sold their respective houses in Fort McMurray and took money out of their company savings plan. They did not borrow any further funds beyond the original mortgage when this property was bought. When they reopened in September 1998 they advertised the property extensively in Fort McMurray in posters and on bulletin boards.
[9] They did not charge the cost of the renovation as a current expense, nor did they claim capital cost allowance.
[10] They put the property in the hands of a management company who projected revenues of $400 per night from April to October for one half the time. This would have worked out to about $6,000 per month for seven months, or $42,000 annually. This projection did not in fact happen. The property was rented for only 32 days in the period April to October 1999 and the rent was only $200 per night. They had to close down in September 1999 because the water system was not working.
[11] In 2000 they put the property up for sale and have it rented out at $1,500 per month.
[12] The question is whether this is truly a business entitling them to deduct their losses.
[13] I reproduce in full paragraph 6 of the reply to the notice of appeal in the case of Tracey Johnson. Adrian D'Silva's reply is substantially the same, mutatis mutandis.
6. In so reassessing the Appellant, the Minister relied on the following assumptions:
a) the Appellant and Adrian D'Silva (the "Spouse") began a rental activity (the "Activity") in 1996;
b) the address at which the Activity took place is 8807 Findlay Creek Road, Canal Flats, British Columbia (the "Property");
c) the Appellant and her Spouse bought the Property for $299,000.00 and took possession of the Property in September 1995;
d) the Property's legal description is Lot 1, District lot 4596, Kootenay District Plan NEP 20894;
e) the Property consists of a 4,000 square feet house on 20 acres of land;
f) the Property has one open bedroom and one bathroom;
g) the Property was rented to David and Tammy Heard for $550.00 per month;
h) Tammy Heard is the Appellant's sister;
i) David and Tammy Heard rented the Property for 11 months of the 24 months under review;
j) the Appellant and her Spouse paid David Heard $200.00 per month for yard work;
k) the Appellant and her Spouse claimed the $200 paid to David Heard per month as yard work expense;
l) the net rent received from Tammy and David Heard was only $350.00 per month;
m) for the remaining 13 months of the 24 months under review, the Property was rented at various times on a nightly basis at $75.00 per night (see Schedule B);
n) the rental income was $4,700.00 for the 1996 taxation year in which $4,400.00 was received from Tammy and David Heard and $300.00 was received from third parties not related to the Appellant and her Spouse;
o) the rental income was $7,275.00 for the 1997 taxation year in which $1,650.00 was received from Tammy and David Heard and $5,625.00 was received from other relatives as well as third parties not related to the Appellant and her Spouse;
p) the rent charged included utilities and telephone;
q) the Losses were shared equally between the Appellant and her Spouse;
r) during the 24 months under review, the Appellant and her Spouse resided at 117 Brintnell Road, Fort McMurray, Alberta;
s) the Activity is undercapitalized;
t) the Appellant and her Spouse have no training in the Activity;
u) at all material times the Appellant was earning full time employment income from Syncrude Canada Ltd.;
v) before starting the Activity, the Appellant and her Spouse prepared no business plan to determine if it would be profitable;
w) the Appellant and her Spouse did not advertise the Activity;
x) the Activity was not a commercial venture;
y) the Appellant and her Spouse ended the Activity in 1998 when they made plans to renovate the Property to convert it into a bed and breakfast operation;
z) from 1996 to 1997 the Appellant and her Spouse reported the following income (losses) from the Activity:
Taxation Year Gross Income Expenses Net Income/(Loss)
1996 4,700.00 27,472.75* (11,386.27)**
1997 7,275.00 28,484.57* (10,604.79)**
* Expenses detailed in Schedule A
** Loss shared equally between the Appellant and her Spouse
aa) the Appellant and her Spouse did not have a reasonable expectation of profit from the Activity during the 1996 and 1997 taxation years; and
bb) the expenses claimed in relation to the Activity were personal or living expenses of the Appellant and her Spouse.
[14] Paragraph (l) is clearly wrong. The rent received was $550.00 per month. The $200.00 paid to David Heard was a necessary and reasonable maintenance cost.
[15] Paragraphs (s), (t), (v) and (w) are contrary to the evidence before the court and in fact contrary to the facts that were put before the CCRA. I find it wholly unacceptable that the persons in the CCRA who draft the replies to notices of appeal in the informal procedure simply push a button in a computer and spew forth pre-programmed boilerplate of the sort found in paragraphs (s), (t), (v) and (w). The "assumptions", so called, are supposed to be an accurate and honest disclosure of the particulars upon which the CCRA based its assessment. A blind and automatic recitation of this sort of stuff does not constitute a fulfilment of the respondent's obligations to this court or to an appellant.
[16] Moreover, pleaded assumptions which demonstrate, as they often do, that the Minister has recklessly and mindlessly pleaded "assumptions" that bear no relation to the facts form no basis on which to defend an assessment. This court will accord to boilerplate the respect and attention that it deserves.
[17] Paragraph (x) states that the activity was not a commercial venture. I do not see how it can be other than a commercial venture. They embarked upon it in an organized, businesslike way and put a substantial amount of their own time and resources into it. For reasons beyond their control the project was not a success but not because of any inherent lack of commerciality. Their projections were made with professional assistance.
[18] Paragraph (y) is clearly wrong on the evidence. The plan from the outset was to carry on a bed and breakfast operation.
[19] Four further points should be noted.
(a) The argument is that the activity did not have a reasonable expectation of profit in the years in question. The basis of this allegation is that since it did not have a profit in those years it necessarily could not have a reasonable expectation of profit. Obviously if this were the test no one with a loss could ever challenge the Minister's disallowance of that loss. The assertion begs the question and is logically fallacious.
(b) The fact that in 1996 the property was rented to Tracey Johnson's sister makes the expenses personal or living expenses. That is not what the definition in section 248 says. The property has to be maintained "for the use or benefit of the taxpayer or a person connected with the taxpayer ...". Where property is rented to a relative at fair market value at the same rental as would be charged a third party I do not see how that condition can be met.
(c) A substantial part of the losses were the result of mortgage interest. Since paragraph 20(1)(c) of the Income Tax Act permits the deduction of interest on moneys borrowed to acquire property to be used in carrying on a business, the Minister cannot rely upon the deductible interest as a basis for invoking the "no reasonable expectation of profit" mantra. This is clear from the decision of this court in Allen et al. v. The Queen, 99 DTC 968, aff'd 2000 DTC 6559.
(d) Finally, it was argued that the business did not start until 1998 and that the expenses in 1996 and 1997 were capital expenditures incurred prior to the commencement of the business.
Even if this point had merit — which I doubt, in light of Gartry v. The Queen, [1994] 2 C.T.C. 2021 — it was not the basis of the assessments and was not pleaded. It cannot now be put forward as a ground for upholding the assessments. Had it been the basis upon which the Minister proceeded it would have resulted in fundamentally different assessments, involving a capitalization of expenses, a resultant higher capital cost, and a terminal loss on the ultimate sale.
[20] The basis upon which the assessments were made has been thoroughly demolished. The appeals are allowed with costs and the assessments are referred back to the Minster of National Revenue for reconsideration and reassessment to allow the deduction of the losses claimed. The appellants are allowed only one set of counsel fees at trial.
Signed at Ottawa, Canada, this 1st day of February 2001.
"D.G.H. Bowman"
A.C.J.