Date: 20020722
Docket: 1999-5028-IT-G
BETWEEN:
ALAIN FECTEAU,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Lamarre Proulx, J.T.C.C.
[1] These appeals are for the 1995 to 1997 taxation years.
[2] With respect to the principal argument, the points at issue are: (1) whether, in 1991, the appellant converted personal-use property, that is, his principal residence, to inventory; and (2) whether the appellant may deduct the rental losses for the three years, 1995 to 1997, as expenses relating to an adventure in the nature of trade. As to the alternative argument, the question is whether the appellant carried on a rental business with or without a personal interest and whether he may deduct the losses from that rental business.
[3] At the start of the hearing, counsel for the appellant informed the Court that he was withdrawing the first argument from the Notice of Appeal concerning the reasonable expectation of rental profit and replacing it with the alternative argument put forward in the Notice of Appeal respecting the adventure in the nature of trade. He added that, since the appellant was a joint owner with his spouse, he was seeking only half the losses. He also informed the Court that all the information stated in paragraph 20 of the Notice of Appeal had been admitted by the respondent party, which counsel for the respondent confirmed.
[4] Paragraph 20 reads as follows:
[TRANSLATION]
PROJECT INVOLVING A RISK OR AN ADVENTURE IN THE NATURE OF TRADE
20. In the alternative, to the extent the Court concludes that there was no reasonable expectation of profit, it is the appellant's view that a business loss of $125,441, computed in the manner hereunder, must be deducted from his income for 1997, in view of the fact that the appellant was involved in a project involving a risk or an adventure in the nature of trade:
|
Proceeds of disposition of the real property, land and building
Less disposition expenses |
$317,000
(11,441) |
|
|
Net proceeds of disposition from the real property, land and building |
$305,559 |
$305,559 |
|
Less:
Cost of inventory property
Opening cost of inventory (FMV of real property in 1991) Net rental loss - 1995 Net rental loss - 1996 Net rental loss 1997 |
$413,000 6,934 6,733 4,333 |
|
|
|
$431,000 |
$431,000 |
|
Business loss on disposition of real property |
|
($125,441) |
[5] According to the appellant, he converted his principal residence to inventory in the year in which he ceased to occupy it and from the time he tried to sell the house at a profit. Counsel for the respondent does not admit that there was a conversion to an adventure in the nature of trade because he relies on the appellant's intention at the time he acquired his principal residence. Otherwise, if there was a conversion, he admits the different values in paragraph 20 above, including the fair market value of the capital property in 1991.
[6] Since the Supreme Court of Canada rendered its decision in Stewart v. Canada, [2002] S.C.J. No. 46 (Q.L.) before I made a decision in this case, I asked counsel for the appellant whether he wanted to make representations on the matter. He retained the adventure in the nature of trade as his first point and argued in the alternative that the rental of the house constituted a rental business without personal interest and that the appellant was thus entitled to the rental expenses.
[7] The appellant and France Vigneault, an officer of the Minister of National Revenue (the "Minister"), testified at the request of counsel for the appellant.
[8] The appellant explained that he was an administrative employee with AT & T in Montréal in 1989. That company offered him the position of vice-president for marketing and managing director of the business in Toronto. He and his wife sold their house in St-Lazare, near Montréal. His wife visited some 60 houses and he about 15, employing the services of three real estate agents. They chose a property in Newmarket, an area in Toronto not far from where the high technology industry was located. The house was at 963 Creebridge Crescent.
[9] According to the appellant, Toronto was anticipating a wave of Asian immigrants following the hand-over of Hong Kong to China in 1997, and real estate agents advised him on the important features sought by those immigrants when buying a house. The house he purchased had those characteristics. The real estate agents had advised the appellant on the subject, as described in subparagraph 19(d) of the Notice of Appeal:
[TRANSLATION]
. . .
(d) Moreover, the appellant, who was advised at the time by specialists on the subject, had ensured that the property purchased had characteristics highly sought after in a residence by the Asians, such as:
- not situated on a street corner to avoid automobile headlights shining directly into the residence (the "eyes of the tiger" phenomenon);
- not having number 4 in the street address (since the number "4" has the same sound in Chinese as the word for "death");
- not having a stairway opposite the main entrance (Scarlett O'Hara stairway - because the "good spirits" could escape through the main entrance); and
- big enough so that a separate dwelling could be built to house relatives or a nanny.
[10] The appellant and his spouse expected the prices of houses to continue rising since Hong Kong would be handed over to China in 1997. The real estate market was booming at the time. The person who sold him the house had purchased it six months earlier for $385,000 and resold it for $450,000.
[11] In August 1991, he and his family left Toronto. He explained that AT & T had acquired another business called NCR and that a number of positions, including his own, had had to be abolished. Since neither he nor his family wanted to move to the United States, they returned to Québec. They rented at first, and then in June 1992, they purchased a property at Lac Delage.
[12] Exhibit A-2 is a listing for the sale of the Toronto property made on October 31, 1991. The asking price was $454,900. The expiry date was December 20, 1991. Exhibit A-3 is another listing dated January 29, 1992, either for sale or for rent. The expiry date was April 7, 1992. The asking price was $444,900, and the asking rent was $3,200 a month. Exhibit A-4 is a photocopy of a real estate advertising newspaper dated May 27, 1992, containing a photograph of the Newmarket property. This time the asking price was $414,900.
[13] Exhibit A-10 is the report of the Minister's officer. Question 9 reads as follows:
[TRANSLATION]
(9) Personal Benefit
(i) What personal benefit can the taxpayer derive from his business or property?
He initially purchased the residence in order to live in it, and subsequently to resell it at a considerable profit.
Question 4 reads as follows:
[TRANSLATION]
(4) Intentions and Action Plan:
(i) Does the taxpayer have a specific action plan to make his rental property or business profitable?
Decline in interest rates, increase in frequency of mortgage payments and downward reassessment of the building. Every year, Mr. Fecteau reviewed the market value and rental value of the property by consulting statistics on the transactions so as to have rental comparables and to accurately determine the time to put the property up for sale.
[14] The taxpayer's accountant wrote as follows in the Notice of Objection (Exhibit A-8):
[TRANSLATION]
. . .
To reduce the carrying charges, Mr. Fecteau renegotiated his mortgage, lowering the interest rate from 11.75 percent to 7.50 percent, and had to pay a penalty of $33,629 in 1992. Those penalty costs were never claimed as expenses for the purpose of determining rental losses for the years concerned. That mortgage renegotiation resulted in a reduction in interest expense from $36,660 in 1992 to $24,161 in 1993. . . .
. . .
. . . Mr. Fecteau finally managed to rent the property to Mr. Aubry in August 1992 for $2,000 a month. That amount was far lower than what he had expected. Subsequently, Mr. Fecteau tried to increase the rent each year until August 1994, when he managed to raise it to $2,200 a month. It should be noted that the tenant took admirable care of the house and kept Mr. Fecteau informed of the necessary repairs and maintenance (e.g., repairs to the patio/porch damaged by freezing, water leaking into the basement as a result of the poorly configured gutters and French drain). Moreover, in five years, he never had any difficulty cashing the rent cheques.
[15] In 1997, the tenant left the premises. The insurance company informed the appellant that the policy premiums would increase or that it would refuse to insure an uninhabited house. The appellant then asked the company that held the mortgage whether it wanted to acquire the property for the balance of the mortgage, and this was done at a price of $317,000.
Arguments
[16] Counsel for the appellant referred to newspaper articles, which had appeared in 1991, describing the wealth of Hong Kong immigrants and stating that their preferred cities were Toronto and Vancouver. He referred to an article published in 1992, which stated that the Ontario economy had been hit very hard by the recession and that the housing markets had not yet recovered from the shock. The article also mentioned that the influx of immigrants was one of the rare factors that helped stimulate housing demand.
[17] Counsel for the appellant argued that, when the appellant left his Toronto home, he changed its use. There was a deemed disposition of the property at its fair market value of $413,000. That value was not disputed by counsel for the respondent. From principal residence, the house became inventory.
[18] Counsel for the appellant referred to the decision of Judge McArthur of this Court in Stremler v. Canada, [2000] T.C.J. No. 13 (Q.L.), and to the decision of the Supreme Court of Canada in Friesen v. Canada, [1995] 3 S.C.R. 103. He cited the following paragraphs in Stremler:
2 The Appellants purchased the properties through Reemark Properties Ltd. which was in the business of selling residential condominiums. The Appellants' position is that their sole purpose in acquiring the properties was for resale at a profit and therefore, they were real estate traders. The Minister of National Revenue denies this and states that the properties were capital assets, the Appellants had no reasonable expectation of profit, and they were estopped from characterizing the units as inventory because they had reported them as capital assets in their income tax returns and claimed rental losses from their rental operations. There are other issues which I shall deal with later.
. . .
6 Both Appellants testified that they purchased their units to sell them. They were intent on cashing in on the real estate boom of the late 1980s as they saw it, living in the Toronto area. . . .
. . .
9 The question is how to characterize the properties on the day of purchase by the taxpayers having regard to all the circumstances. It is unique to each individual. Each case must be looked at individually to determine if, on the date of purchase, the taxpayer intended keeping the property for the long term to earn rental income, taking into account probable tax deductions, or did he intend to sell it within a reasonably short period of time.
10 The determination of whether or not the Appellants acquired the properties as adventures in the nature of trade is a question of fact. I find as a fact that both Appellants had as their primary motive in purchasing the properties, the intention to sell. They did not purchase with the intention of earning income from the rental business. They were opportunists, speculators in real estate following the trend of buying in the rising market with the intention of selling at a profit in a few years. In the meantime, the rents would offset some of the costs of holding the units and by taking advantage of the Reemark plan, there would be very little cash expenditures from their pockets and no effort to manage the units. Their acquisition was about 95% financed through a first mortgage and promissory notes all arranged by Reemark. Even vacancies were of limited concern because they entered into a rental pooling arrangement wherein the impact was shared by most owners.
. . .
13 The Appellants have satisfied the Court, upon reviewing all of the evidence, that their primary intention was to sell as quickly as possible and realize a profit. . . .
. . .
28 In following the reasoning of Justice Iacobucci in Canderel, I find that the carrying costs associated with the properties should be deducted in the years in which the costs were incurred. In Canderel, the proper manner in which to calculate profit is to follow that calculation which best depicts the reality of the taxpayer's income losses. . . .
[19] From the decision in Friesen, supra, he cited the following paragraphs in particular:
. . .
(1) Is the Appellant's Venture a Business?
13 The definition of "business" in s. 248(1) specifically includes an adventure in the nature of trade:
"business", includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), an adventure or concern in the nature of trade but does not include an office or employment; [Emphasis added.]
An "adventure in the nature of trade" is not defined in the Act but is a term which has a meaning established by the common law.
. . .
15 The concept of an adventure in the nature of trade is a judicial creation designed to determine which purchase and sale transactions are of a business nature and which are of a capital nature. . . .
16 The first requirement for an adventure in the nature of trade is that it involve a "scheme for profit-making". The taxpayer must have a legitimate intention of gaining a profit from the transaction. . . .
17 IT-218R, which replaced IT-218 in 1986, lists a number of factors which have been used by the courts to determine whether a transaction involving real estate is an adventure in the nature of trade creating business income or a capital transaction involving the sale of an investment. Particular attention is paid to:
(i) The taxpayer's intention with respect to the real estate at the time of purchase and the feasibility of that intention and the extent to which it was carried out. An intention to sell the property for a profit will make it more likely to be characterized as an adventure in the nature of trade.
(ii) The nature of the business, profession, calling or trade of the taxpayer and associates. The more closely a taxpayer's business or occupation is related to real estate transactions, the more likely it is that the income will be considered business income rather than capital gain.
(iii) The nature of the property and the use made of it by the taxpayer.
(iv) The extent to which borrowed money was used to finance the transaction and the length of time that the real estate was held by the taxpayer. Transactions involving borrowed money and rapid resale are more likely to be adventures in the nature of trade.
. . .
19 I agree with Iacobucci J. that the appellant meets the tests which have been established in the common law for an adventure of trade. The speculative venture in which the appellant was involved was clearly an adventure of a business nature rather than an investment of a capital nature. . . .
. . .
31 The basic scheme of dividing property into one of two broad classes under the Income Tax Act is further assisted by ss. 13(7) and 45(1). These sections make specific provision for the conversion of real estate from capital property to inventory and vice versa in particular circumstances. As IT-218R explains, these circumstances arise only when the taxpayer's intention and use of the property change subsequent to the initial purchase. Sections 13(7) and 45(1) provide for the transfer to be made by means of a deemed disposition and reacquisition at fair market value. The deemed reacquisition at the time when the taxpayer's intention with respect to the property is materially changed reflects the fact that the category of the property is determined according to the taxpayer's intention at the time of acquisition.
[20] Counsel for the appellant referred to paragraph 10 of Interpretation Bulletin IT-218R:
. . . However, where real estate is converted from capital property to inventory as discussed in 12 and 13 below, the results will be as follows:
(a) for real estate that is personal-use property its conversion to inventory will constitute a change in use for the purposes of subsections 13(7) and 45(1) with the attendant deemed disposition and acquisition as explained in 11 below; and
. . .
[21] Counsel for the respondent referred to a decision of this Court in Isaaks v. Canada, [2001] T.C.J. No. 312 (Q.L.), and to the following paragraph:
14 The courts have consistently emphasized that in determining whether a transaction was intended as an adventure in the nature of trade, regard must be had to the surrounding circumstances: Happy Valley Farms Ltd. v. The Queen, 86 D.T.C. 6421 at 6424. The significance of intention as one of the factors to be considered was emphasized by the Supreme Court of Canada in Friesen v. Canada, [1995] 3 S.C.R. 103. In that case Major J. summarized certain important factors to be considered in determining whether a transaction in real estate is an adventure in the nature of trade. He listed the following at paragraph 17:
(i) The taxpayer's intention with respect to the real estate at the time of purchase and the feasibility of that intention and the extent to which it was carried out. An intention to sell the property for a profit will make it more likely to be characterized as an adventure in the nature of trade.
(ii) The nature of the business, profession, calling or trade of the taxpayer and associates. The more closely a taxpayer's business or occupation is related to real estate transactions, the more likely it is that the income will be considered business income rather than capital gain.
(iii) The nature of the property and the use made of it by the taxpayer.
(iv) The extent to which borrowed money was used to finance the transaction and the length of time that the real estate was held by the taxpayer. Transactions involving borrowed money and rapid resale are more likely to be adventures in the nature of trade.
[22] Counsel for the respondent argued that, based on the case law principles used to determine whether a property has been acquired with an intention to trade or on account of capital, the property did not become inventory.
[23] Is the recent decision of the Supreme Court of Canada in Stewart, supra, favourable to the appellant? Counsel for the respondent made the following written representations on that point:
[TRANSLATION]
. . . With deference to the contrary view, the respondent's position is that Mr. Fecteau did indeed have a personal interest in the property located at 963 Creebridge Crescent, if only because his family had made it its principal residence, as is established by the evidence.
If the Court were to conclude that there was indeed a personal element, it would then be possible for it to consider how the appellant carried out his rental activity in light of the tests established by the Supreme Court of Canada in Moldowan: (1) the profit and loss experience in past years; (2) the taxpayer's training; (3) the taxpayer's intended course of action; and (4) the capability of the venture as capitalized to show a profit after charging capital cost allowance.
Thus, considering the appellant's lack of experience in this type of activity, the constant annual losses, the absence of any real action plan and the high fixed costs, the respondent claims that the appellant was not carrying on a commercial rental activity in the years in issue. The rental expenses incurred during those years are therefore not deductible.
[24] The representations in rebuttal of counsel for the appellant were as follows:
[TRANSLATION]
. . .
With respect to the alternative argument as to the existence of a reasonable expectation of profit, the appellant would like to point out that, contrary to what counsel for the respondent states, there was no element of personal benefit at the time the Toronto property was rented. In fact, when the property located at 963 Creebridge Crescent in Toronto was rented, the appellant and his family no longer lived there and had moved to the Québec area a few months earlier. From the moment the appellant put the property up for sale or rent, neither the appellant nor his family lived there, given that the property was always rented. From the principal residence it was when the appellant and his family lived there, the Toronto property became a rental property when the appellant moved to Québec and when the property was offered for rent. It is therefore wrong to claim that there were any elements of personal use and benefit in the rental property following the move to Québec.
With respect to the application of the principle of reasonable expectation of profit and the determination as to whether there was a personal element, that test must be limited to situations in which there are clearly elements of personal use or benefit. Take, for example, the situation in which a taxpayer owns a condo in Florida or in a well-known ski resort and, while renting the said condo, occupies or uses the property a few weekends during the year. Based on the various tests established by the Supreme Court of Canada in Moldowan, the taxpayer would have to prove his right to deduct expenses since there is a personal element in that type of situation.
We submit that, since there was no element of personal use in Mr. Fecteau's case, those various tests do not have to be applied, as the Supreme Court recently held in Bryan J. Stewart and Walls et al.
Conclusion
[25] The strategy proposed by counsel for the appellant to convert the principal residence to inventory is tempting at first glance. However, the intention to trade that must exist in respect of inventory is proven on the basis of certain characteristics. Upon analysis, the circumstances of the purchase, the offering for sale and the renting of the appellant's family residence do not reflect an intention to trade. They are those of many taxpayers who want to acquire and protect an investment. A taxpayer may be concerned with the resale value of his principal residence. Depending on the market circumstances, he may also wait a few years before reselling the main residence he has ceased to occupy. All this is normal and does not convert the gain from the sale of his house to a business gain, particularly in the appellant's case, in which his principal residences were actually acquired and sold in order to house him following a change in work location.
[26] There was no evidence of previous trading transactions by the appellant. Neither the appellant's previous conduct nor the circumstances in which the property was purchased give any indication of an intention to trade. The principal residence was therefore not converted to inventory. In my view, to decide otherwise would be to go against the principles developed in the case law to distinguish between purchase and sale transactions of a commercial nature and those which are of a capital nature, as restated in Friesen, supra.
[27] What of the appellant's rental activities? I refer to paragraphs 50, 52 and 62 to 65 of Stewart:
50 It is clear that in order to apply s. 9, the taxpayer must first determine whether he or she has a source of either business or property income. As has been pointed out, a commercial activity which falls short of being a business, may nevertheless be a source of property income. As well, it is clear that some taxpayer endeavours are neither businesses, nor sources of property income, but are mere personal activities. As such, the following two-stage approach with respect to the source question can be employed:
(i) Is the activity of the taxpayer undertaken in pursuit of profit, or is it a personal endeavour?
(ii) If it is not a personal endeavour, is the source of the income a business or property?
The first stage of the test assesses the general question of whether or not a source of income exists; the second stage categorizes the source as either business or property.
. . .
52 The purpose of this first stage of the test is simply to distinguish between commercial and personal activities, and, as discussed above, it has been pointed out that this may well have been the original intention of Dickson J.'s reference to "reasonable expectation of profit" in Moldowan. Viewed in this light, the criteria listed by Dickson J. are an attempt to provide an objective list of factors for determining whether the activity in question is of a commercial or personal nature. These factors are what Bowman J.T.C.C. has referred to as "indicia of commerciality" or "badges of trade": Nichol, supra, at p. 1218. Thus, where the nature of a taxpayer's venture contains elements which suggest that it could be considered a hobby or other personal pursuit, but the venture is undertaken in a sufficiently commercial manner, the venture will be considered a source of income for the purposes of the Act.
. . .
62 In this case, the appellant was engaged in property rental activities. He owned four rental condominium units from which he earned rental income. The fact that there was no personal element to these properties was never questioned. The units were all rented to arm's length parties and there was no evidence that the appellant intended to make use of any of the properties for his personal benefit. In our view, a property rental activity which lacks any element of personal use or benefit to the taxpayer is clearly a commercial activity. For what purpose would the taxpayer have spent his time and money in this activity if not for profit? As a result, the appellant satisfies the test for source of income. Although this is sufficient to dispose of the appeal, in our view a few additional remarks are warranted.
63 Even if the appellant had made use of one or more of the properties for his personal benefit, the Minister would not be entitled to conclude that no business existed without further analysis. A taxpayer in such circumstances would have the opportunity to establish that his or her predominant intention was to make a profit from the activity and that the activity was carried out in accordance with objective standards of businesslike behaviour. Whether a reasonable expectation of profit existed may be a factor that is taken into consideration in that analysis.
64 The Minister and the courts below made much of the fact that the appellant anticipated a capital gain from the eventual sale of the properties. It was argued that it was this anticipated gain, and not rental profits, which motivated the taxpayer. As well, the Minister argued that an anticipated capital gain should not be included in assessing whether the taxpayer had a reasonable expectation of profit. As such, it was the Minister's submission that the appellant should not have been allowed to deduct his interest payments under s. 20(1)(c)(i) as amounts paid in respect of borrowed money used to produce income from a business or property. The application of the REOP test by the Minister was motivated by the policy concern that Canadian taxpayers should not have to subsidize mortgage payments made in respect of properties where the primary motivation is a long-term capital gain.
65 In response to this argument, it must be remembered that s. 20(1)(c)(i) is not a tax avoidance mechanism, and it has been established that, in light of the specific anti-avoidance provisions in the Act, courts should not be quick to embellish provisions of the Act in response to tax avoidance concerns: Ludco, supra, at para. 39; Neuman v. M.N.R., [1998] 1 S.C.R. 770, at para. 63. In addition, in Walls v. Canada, 2002 S.C.C. 47 the companion to this case, we point out at para. 22 that a tax motivation does not affect the validity of transactions for tax purposes. As such, the appellant's hope of realizing an eventual capital gain, and expectation of deducting interest expenses do not detract from the commercial nature of his rental operation or its characterization as a source of income. Moreover, in Ludco, supra, at para. 59, this Court specifically stated that s. 20(1)(c)(i) does not require the taxpayer to earn a net profit in order for interest to be deductible:
The plain meaning of s. 20(1)(c)(i) does not support an interpretation of "income" as the equivalent of "profit" or "net income". Nowhere in the language of the provision is a quantitative test suggested. Nor is there any support in the text of the Act for an interpretation of "income" that involves a judicial assessment of sufficiency of income. Such an approach would be too subjective and certainty is to be preferred in the area of tax law. Therefore, absent a sham or window dressing or similar vitiating circumstances, courts should not be concerned with the sufficiency of the income expected or received. [Emphasis added.]
[28] Like counsel for the appellant, I believe that the appellant's rental activities could not be considered as a hobby or other personal activity. The appellant no longer had any personal interest in the property from the moment he ceased to occupy it without any intention of returning to live in it again. His activity was carried on with a view to earning a profit and was not a personal activity. What the appellant sought was to obtain the best possible price for his house. According to the decision in Stewart, supra, that does not vitiate the business nature of his rental activity, which was carried on for the purpose of realizing a profit in the most serious and commercial manner possible, as proven by the comments of his accountant reproduced in paragraph 14 of these reasons.
[29] The appeals are allowed for the amounts admitted by counsel at the start of the hearing, with costs to the appellant.
Signed at Ottawa, Canada, this 22nd day of July 2002.
|
"Louise Lamarre Proulx" |
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]
1999-5028(IT)G
BETWEEN:
ALAIN FECTEAU,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on January 30, 2002, at Québec, Quebec, and
last written submissions received at Ottawa, Ontario, on June 27, 2002
by the Honourable Judge Louise Lamarre Proulx
Appearances
Counsel for the Appellant: Daniel Bourgeois
Counsel for the Respondent: Alain Gareau
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1995, 1996 and 1997 taxation years are allowed, with costs to the Appellant, for the amounts admitted by counsel at the start of the hearing, in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 22nd day of July 2002.
|
"Louise Lamarre Proulx" |
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]