Date: 20010709
Docket: 2001-934-IT-I
BETWEEN:
DAVID K. DONYINA,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1] These appeals are from assessments for 1997 and 1998.
[2] Two issues are raised:
(a) whether rental losses on an apartment in Winnipeg were deductible in computing the appellant's income in those years;
(b) whether losses incurred in connection with an alleged business called "Golden Seminars" are deductible.
[3] The assumptions pleaded are as follows.
Rental losses
(a) in November 1988, the Appellant purchased 40 Dalhousie Drive, Apartment 1105, Winnipeg, Manitoba ("40 Dalhousie"), a two bedroom condominium unit, for $87,900.00;
(b) the purchase of 40 Dalhousie was financed by a first mortgage of $48,750.00 from Household Trust, a second mortgage of $9,750.00 from Reicor Capital Corp., a third mortgage at $19,400.00 from Reicor Capital Corp. and an investment loan of $10,000.00 from the Bank of Nova Scotia;
(c) at all material times, the Manhatten Management Group charged the Appellant 36.6% of the gross rental fees received from 40 Dalhousie as a management fee;
(d) the Appellant began claiming rental losses in 1988, and from 1988 to 1999, the Appellant reported rental income and losses on 40 Dalhousie as follows:
Gross Income Net Loss
1988 $ 315.00 ($14,093.00)
1989 $ 7,560.00 ($13,484.00)
1990 $ 9,689.00 ($ 9,741.00)
1991 $ 16,345.00 ($32,316.00)
1992 $ 2,314.00 ($12,138.00)*
1993 $ 3,525.00 ($ 9,682.00)*
1994 $ 7,395.00 ($ 8,703.00)*
1995 Nil Nil
1996 $ 7,200.00 ($ 3,560.00)
1997 $ 7,200.00 ($13,525.00)
1998 $ 2,560.00 ($ 9,452.00)
1999 $ 6,400.00 ($ 2,323.00)
* - in the 1992, 1993 and 1994 taxation years, the Minister reassessed the Appellant to disallow the rental losses;
(e) in the 1997 and 1998 taxation years, the Appellant reported rental income, expenses and losses as per Schedule "A", attached;
(f) the rent charged was not sufficient to offset the mortgage interest and property taxes for 40 Dalhousie;
(g) in the 1997 taxation year, an amount claimed as H & R Developments was not an expense related to the purported rental operation, but was a down payment on a property located at 1011 Bancroft Drive, Mississauga, Ontario;
(h) the payment to H & R Developments in the 1997 taxation year was a capital expenditure;
(i) in the 1997 and 1998 taxation years, the Appellant's rental income/(losses) from the purported rental of 40 Dalhousie were not greater than $368.00 and ($5,161.00), respectively, as per Schedules "B" and "C", attached;
(j) the Appellant has not reported a profit from the purported rental operation since its commencement;
(k) in the 1997 and 1998 taxation years, the rental expenses were not made or incurred, or if made or incurred, were not made or incurred for the purpose of gaining or producing income;
(l) the Appellant had no reasonable expectation of profit from renting 40 Dalhousie during the 1997 and 1998 taxation years;
(m) in the 1997 and 1998 taxation years, the rental expenses were personal or living expenses of the Appellant.
Business Losses
[1]from which the Appellant deducted expenses of $34,789.00 and $25,224.00, respectively, resulting in losses of $17,117.00 and $8,795.00, respectively, arising out of a purported business known as Golden Seminars (the "Business");
(o) in the 1997 taxation year, of the aforesaid loss of $17,117.00, the Appellant claimed his 50% share which was $8,558.00;
(p) in the 1998 taxation year, of the aforesaid loss of $8,795.00, the Appellant claimed the entire amount of the loss, or $8,795.00;
(q) the Appellant commenced the Business in 1996;
(r) at all material times, the Appellant and his spouse were equal partners in the Business;
(s) the Appellant began claiming business losses in 1996, and from 1996 to 1998, the Appellant reported rental income, expenses and profits/(losses) from the Business as follows:
Gross Income Expenses Net Profit/(Loss)
1996 $ 2,340.00 $24,157.00 ($21,817.00)*
1997 $17,672.00 $34,789.00 ($17,117.00)*
1998 $16,429.00 $25,244.00 ($ 8,795.00)**
* - Appellant claimed 50% of net loss
** - Appellant claimed 100% of net loss;
(t) the Appellant has never reported a profit from the purported business activity since its inception;
(u) the Appellant ceased the operation of the Business in 1999;
(v) in the 1997 and 1998 taxation years, the Appellant's business income/(losses) from the purported business were not greater than ($2,569.00) and $1,635.00, respectively, of which his 50% share is ($1,284.00) and $817.00, respectively, as per Schedules "D" and "E", attached;
(w) in the 1997 and 1998 taxation years, the claimed business expenses were not made or incurred, or if made or incurred, were not made or incurred for the purpose of gaining or producing income from a business or property;
(x) in the 1997 and 1998 taxation years, the purported business did not have a reasonable expectation of profit;
(y) in the 1997 and 1998 taxation years, the claimed business expenses were personal or living expenses of the Appellant.
[4] The appellant is a professional engineer who worked for the Ontario Ministry of the Environment. He has a doctorate in metallurgical engineering from the University of Toronto.
[5] When the appellant bought the property from Imperial Anaheim in 1988 he had been provided with a brochure which described the property, its business prospects and its tax advantages in glowing terms. To demonstrate the kind of thing that was promised him I set out passages from the brochure.
Achieving your Income Producing
and Tax Saving Objectives
A Natural Opportunity
PRICELESS
That's a Fact! REAL ESTATE Income Producing Opportunities with Priceless Benefits.
A) The Reason I Chose Imperial Anaheim
Immediate Tax Relief up to $18,195 the initial year or ownership with ongoing Tax Benefits
Capital Gains Benefits
Ongoing Professional Property Management
Choice Condominium Revenue Producing Real Estate
No Collateral or Cash Required on Closing
A Hedge against inflation
6% Initial Term Mortgages
The Developers have created a unique program with no up front immediate down payment or closing costs. Imperial Anaheim have often provided their clients with the Secondary Financing Bank Payments until their Income Tax Source Exemption Income Tax Deductions were received.
B) The Imperial Anaheim Income Producing Formula
Arrange an appointment with an Account Executive
Our accountants will prepare a personal cash flow analysis
You select your Income Producing Condominium
We arrange "Total" Financing
You receive "title" to an Income Producing Condominium
A Chartered Accountant will prepare your initial Income Tax Returns
We provide on-going tax information for the preparation of your annual Income Tax Returns
Imperial Ahaheim will provide Ongoing Property Management Services, Revenue Protection, Maintenance including Immediate Income Tax Source Exemption Deduction Requests
C) Do I Qualify As An Imperial Anaheim Client?
Annual Income of $30,000 or more
A Fair Credit Rating
D) Benefits
Flat Fee Resale Assistance through a licensed Professional Real Estate Agent
Preferred Return on Equity
Cash Flow Warranty
Brokerage and Appraisals
Financial Assistance
7 Year "Fully Defined" Revenue Protection
"Fully Defined" 5% Annual Rent Increases
Positive Cash flows in 1988
Immediate Tax Refunds
100% Financing
7 Year on-going Maintenance Including "In Suite" Insurance Guarantee
5-10 year on-going Professional Property Management "At Your Option"
E) Members Club
Personal Use Benefits
A Membership to Sports Residence near the Gulf of Mexico in the Naples, Fort Myers region in Florida. A recently developed "Four Seasons" Resort was designed to assist in the needs both present and future for our property owners, guests and their families. Each client purchasing a "Canadian" Income Producing Condominium will enjoy "ongoing" Florida "Fully Defined" Members' Club Privileges. A Second Resort will be available shortly near Gray Rocks and Mont Tremblant in the Quebec Laurentians.
F) PRICELESS Benefits
7th Year Fully Defined Mortgage Assumption "Buy-Back" Provisions
Estate Protection
5-10 Year Life Insured Secondary Financing
G) SPORTS RESIDENCE PALM BEACH "POLO CLUB" Fitness Inspired Condominiums in Ottawa and Winnipeg.
AMENITIES
Sauna* Games Room*
Fitness Spa* Stove & Fridge*
Satellite Dish* Dishwasher*
Security Intercom System* Washer*
Outdoor Pool* Dryer*
Woodburning Fireplace*
Air Conditioner*
Canada's #1 No Fuss Real Estate Condominiums.
Imperial Anaheim is one of Canada's most innovative Real Estate Income Producing and Property Management Organizations.
* On selected models
_____________________________________________
PURCHASERS BENEFITS
AND HIGHIGHTS
A full range of services has been provided with each property opportunity.
1 The average vacancy rate for the ten (10) largest Ontario cities today is 0.8% compared with 1.9% in April, 1983.1
2 As added "Liquidity" the developer will provide "Flat Fee" Resale Assistance. THIS BENEFIT will be available on a "First Requested - First Repurchased" basis. Subject to the definitions.
3. Because each purchaser will own a specific condominium titled property, they will be provided with the "Flexibility" potential - to sell their condominium to other purchasers.
4. Purchasers are assured that their mortgages will bear interest at a favourable rate through an initial Guaranteed Mortgage BUY DOWN period. Please refer to Financial Schedule for details.
5 Through pre-arranged secondary financing qualified purchasers are provided with a UNIQUE 100% FINANCING OPPORTUNITY.
6 LIFE INSURANCE PROMISSORY NOTES will be provided on any advances made by the developer to assist in estate protection.
7 FURTHER ESTATE PROTECTION is provided by the developers commitment to purchase up to two units per year from owners estates up to seven years after turnover. Subject to certain conditions.
8 Each individual purchaser will have additional SECURITY VIA A RIGHT OF SET OFF in that all expenses may be CHARGED-UP for income tax purposes.
9 The Developer will continue to provide each client with a number of assurances and financial services in order to assist each property owner. The condominiums have been set up to maximize the purchasers' after tax position and to provide services in order to minimize personal involvement.
10 All initial start-up and marketing costs will be paid by Imperial Anaheim.
11 AN ADVANTAGEOUS LIQUIDITY POTENTIAL is achieved with two opportunities in order for the purchaser to achieve a Liquidity Position: ownership of an individual condominium suite; and a 7th year "Fully Defined Mortgage Assumption" buy-back provision commencing with the first year of ownership.
12 CAPITAL GAINS TREATMENT. A major government incentive has been established to encourage Canadians to invest in real estate income producing opportunities with the introduction of the cumulative tax exemption on capital gains. Capital gains on the sale of the property will be tax free up to $100,000.
13. A seven year fully defined cash flow protection program.
14 A seven year ongoing guaranteed flat fee insurance maintenance and repair warranty program.
15 A "prepaid fully defined" guaranteed preferred "cash flow" return on equity provided during the initial years of ownership.
1 Study prepared by Clayton Research Associates Ltd., Economic Consultants 1985.
2 Report of the Commission into Residential Tenancies, Volume 1, August, 1984.
WHO WE ARE
The Imperial Anaheim group is comprised of various divisions including Property Development, Land Acquisition, Property Management and Interior Decorating.
Each division has a different purpose with a common goal through the development and preparation of income production real estate condominium opportunities.
[6] The company Imperial Anaheim disappeared after the first year or so and the appellant, notwithstanding the guarantees, was left to fend for himself. He paid off the second and third mortgages. He did not borrow to do so. He maintained the first mortgage to Household Trust because he believed that if he simply walked away from the property he would be sued on his covenant. The only interest deducted in 1997 and 1998 was the interest on the first mortgage to Household Trust.
[7] From time to time he listed the property and finally he sold it for $45,000 in 2000. This barely covered the balance of the first mortgage.
[8] The REOP principle has been evolving. For a period of time after the Moldowan case assessors were zealously disallowing losses, that with the benefit of hindsight, they thought resulted from an activity with no REOP. Their fervour has been tempered substantially by such cases as Tonn et al. v. The Queen, 96 DTC 6001; A.G. of Canada v. Mastri et al., 97 DTC 5420; Mohammad v. The Queen, 97 DTC 5503; Kuhlmann et al. v. The Queen, 98 DTC 6652; Walls v. The Queen, 2000 DTC 6025 (under appeal to S.C.C.); Milewski v. The Queen, 99 DTC 968 (aff'd 2000 DTC 6559, F.C.A.); Kaye v. The Queen, 98 DTC 1659; Costello v. The Queen, 98 DTC 1362; Smith v. The Queen, 96 DTC 1886; Saunders v. R., [1998] 2 C.T.C. 3196, and Roopchan v. The Queen, 96 DTC 1338, as well as some earlier decisions of this court: Bélec v. The Queen, 95 DTC 121; Nichol v. The Queen, 93 DTC 1216, and N. Cipollone v. Canada, [1995] 1 C.T.C. 2598. The most recent pronouncement on this point is Keeping v. The Queen, 2001 F.C.A. 182.
[9] I shall not quote from these cases or analyse them at length. It is, I think, sufficient to summarize some of the principles that they appear to establish.
1. Where there is no personal element the REOP test should be applied sparingly (Tonn, Keeping, Bélec and Walls). The absence of a personal element does not establish conclusively that the REOP principle cannot be invoked but such an absence is a factor that carries a great deal of weight (Mastri).
2. The Minister or the court should not, with the benefit of hindsight, second-guess the business acumen of a taxpayer who embarks upon a business venture in good faith (Keeping, Tonn, Nichol, Kuhlmann, Bélec and Smith).
3. The fact that a business or property is 100% financed is not in itself a reason for applying the REOP principle (Milewski, Mohammad and Saunders).
4. A taxpayer should be allowed a reasonable period of time to get the business established (Keeping). Such a period will vary with the circumstances and may well be lengthy (Milewski).
5. The REOP principle should not be invoked as a substitute for analysis. Before invoking REOP the assessor should examine the expenses to determine whether they are reasonable or for any other reason not deductible (Smith, Costello and Cipollone).
6. For an expectation of profit to be reasonable it has to be not "irrational, absurd and ridiculous" (Kuhlmann).
7. The fact that an investment or a business is motivated in part by tax considerations is not relevant in determining whether there is a business, nor is tax motivation in itself relevant in determining the deductibility of expenses if a business exists (Stubart Investments Limited v. The Queen, 84 DTC 6305) unless of course the Minister chooses to invoke the general anti-avoidance rule in section 245, in which case we are into a fundamentally different ball-game.
8. The initial question where losses are claimed and denied is whether they are personal or living expenses, the statutory definition of which includes the REOP test. If they are not, the REOP test must be applied with extreme care and the question becomes "Is there a business?" The existence of REOP is only one factor in that determination (Kaye).
9. Reasonableness operates both in the context of the existence of a business, where section 67 disallows the deduction of expenses to the extent that they are unreasonable, and also at the liminal stage of determining whether there is a business (Kaye).
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.
11. If the taxpayer has several rental properties, some yielding a profit and some a loss, it is improper to apply REOP to the losing properties and ignore the profitable ones. The entire investment picture should be considered (Smith).
12. When to start a business and when to abandon it are business decisions in which neither the taxing authorities nor the court should intervene (Nichol). Nonetheless if losses go on being incurred year after year for an inordinate length of time sooner or later one has to apply what I shall call the "Enough is enough" principle and decide that what might have been a viable business has, with the effluxion of time, became hopeless and the best thing to do with it is to give it a decent burial. Nonetheless, a businessman's judgement to maintain a business must be treated with great respect.
[10] Applying these principles (or such of them as are germane) to this case it is obvious that the Minister erred in applying the REOP principle to Mr. Donyina's rental operation in Winnipeg. The property was purchased purely as an investment. There was no personal element. The expenses were not unreasonable. The appellant, an intelligent man, acted in good faith on the advice that he received from the promoter and he had no reason to doubt its correctness. Looked at with the benefit of 20/20 vision that we all have in hindsight it seems obvious that the appellant was sold a bill of goods, but it is not for me to second-guess his business judgement. He could not be responsible for the fact that the promoter disappeared and the guarantees became worthless. The appellant tried to sell the property sooner but it was because of his concern that he might be sued on the covenant in his first mortgage that he kept it as long as he did. The other mortgages and indebtedness were paid off relatively early out of his own funds.
[11] I see no basis for applying the REOP test to the appellant's rental operation in light of the jurisprudence I have referred to and summarized.
[12] Some of the expenses claimed by the appellant however have not been supported. Specifically, $10,000 paid to H & R Development in 1997 had nothing to do with the rental operation and is not allowable. Moreover, while I accept this in all probability some property taxes were paid on 40 Dalhousie I am in the dark as to how much. Therefore the claim to deduct property taxes in the computation of his rental loss is not allowed.
[13] So far as the claim to deduct losses from the operation Golden Seminars is concerned, it appears that after the appellant was laid off from his job he and his wife began putting on seminars in which he gave lectures on such topics as
(i) Real estate investments;
(ii) The destructive power of sex; and
(iii) Customer service.
[14] His qualifications to lecture on such things were not immediately apparent, although I daresay he must have learned something from his ill-fated investment in Winnipeg.
[15] He claimed his wife as an equal partner in 1996 and 1997 but not in 1998.
[16] He ceased the operation in 1999. Golden Seminars had some of the badges of trade. It generated some income and it had some expenses. I do not however think that it meets the test of a business that I stated in Kaye v. The Queen, 98 DTC 1659 at p. 1660:
[4] I do not find the ritual repetition of the phrase particularly helpful in cases of this type, and I prefer to put the matter on the basis "Is there or is there not truly a business?" This is a broader but, I believe, a more meaningful question and one that, for me at least, leads to a more fruitful line of enquiry. No doubt it subsumes the question of the objective reasonableness of the taxpayer's expectation of profit, but there is more to it than that. How can it be said that a driller of wildcat oil wells has a reasonable expectation of profit and is therefore conducting a business given the extremely low success rate? Yet no one questions that such companies are carrying on a business. It is the inherent commerciality of the enterprise, revealed in its organization, that makes it a business. Subjective intention to make money, while a factor, is not determinative, although its absence may militate against the assertion that an activity is a business.
[5] One cannot view the reasonableness of the expectation of profit in isolation. One must ask "Would a reasonable person, looking at a particular activity and applying ordinary standards of commercial common sense, say 'yes, this is a business'?" In answering this question the hypothetical reasonable person would look at such things as capitalization, knowledge of the participant and time spent. He or she would also consider whether the person claiming to be in business has gone about it in as orderly, businesslike way and in the way that a business person would normally be expected to do.
[6] This leads to a further consideration — that of reasonableness. The reasonableness of expenditures is dealt with specifically in section 67 of the Income Tax Act, but it does not exist in a watertight compartment. Section 67 operates within the context of a business and assumes the existence of a business. It is also a component in the question whether a particular activity is a business. For example, it cannot be said, in the absence of compelling reasons, that a person would spend $1,000,000 if all that could reasonably be expected to be earned was $1,000.
[7] Ultimately, it boils down to a common sense appreciation of all of the factors, in which each is assigned its appropriate weight in the overall context. One must of course not discount entrepreneurial vision and imagination, but they are hard to evaluate at the outset. Simply put, if you want to be treated as carrying on a business, you should act like a businessman.
[17] His expenses include mileage and automobile expenses, but these are only estimates. He essentially kept no records. He had no idea who attended his seminars or how much money was collected. Many of the expenses claimed were for capital items. Some, such as membership in a fitness club, were personal. He had only a few seminars, at least one of which was held in Pittsburgh.
[18] The reporting of income and expenses was haphazard. The expenses claimed were vastly disproportionate to the income reported.
[19] I might have been able to sift through the evidence and find which expenses were proved and deductible and which were not but I doubt that I would have arrived at a figure that was significantly different from that arrived at by the assessor (a loss of $2,569 in 1997 and a profit of $1,635 in 1998), of which 50% is attributable to the appellant and 50% to his spouse. However I think it is more appropriate to apply the reasoning that I used in Kaye and reject the appellant's claim for losses from the Golden Seminars operation.
[20] The appeals are allowed and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment to allow such portion of the rental losses as are allowed in the reasons for judgment.
[21] There will be no order for costs.
Signed at Ottawa, Canada, this 9th day of July 2001.
"D.G.H. Bowman"
A.C.J.
COURT FILE NO.: 2001-934(IT)I
STYLE OF CAUSE: Between David K. Donyina and
Her Majesty The Queen
PLACE OF HEARING: Toronto, Ontario
DATE OF HEARING: June 8, 2001
REASONS FOR JUDGMENT BY: The Honourable D.G.H. Bowman
Associate Chief Judge
DATE OF JUDGMENT: July 9, 2001
APPEARANCES:
Agent for the Appellant: Brian McFarlane, CA
Counsel for the Respondent: Sherry Darvish
COUNSEL OF RECORD:
For the Appellant:
Name: --
Firm: --
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2001-934(IT)I
BETWEEN:
DAVID K. DONYINA,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on June 8, 2001 at Toronto, Ontario, by
The Honourable D.G.H. Bowman, Associate Chief Judge
Appearances
Agent for the Appellant: Brian McFarlane, CA
Counsel for the Respondent: Sherry Darvish
JUDGMENT
It is ordered that the appeals from assessments made under the Income Tax Act for the 1997 and 1998 taxation years be allowed and the assessments be referred back to the Minister of National Revenue for reconsideration and reassessment to allow such portion of the rental losses as are allowed in the reasons for judgment.
There will be no order for costs.
Signed at Ottawa, Canada, this 9th day of July 2001.
|
"D.G.H. Bowman" |
A.C.J.