Tax Court of Canada Judgments

Date: 20020808

Docket: 2002-833-IT-I

BETWEEN:

PHILIP DURBER,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Rip, J.

[1]      Philip Durber appeals income tax assessments for the 1997, 1998 and 1999 taxation years, claiming that he is entitled to deduct expenses incurred by him in respect of a mobile home, boat and trailer (collectively referred to as the "Property") as well as a 1985 Buick Regal automobile ("Buick"). The Property and the Buick were owned by Mr. and Mrs. Durber and at all relevant times were, and are, located in Havasu, Arizona. The Canada Customs and Revenue Agency ("CCRA") assessed Mr. Durber primarily on the basis that he did not have a reasonable expectation of profit ("REOP") from the rental of the Property and the Buick and therefore denied the expenses. At trial I advised Mr. Durber that in view of the Supreme Court of Canada decisions in Stewart v. The Queen[1] and Walls v. The Queen,[2] I would not give much weight, if any, to whether or not he had a REOP from renting the Property and Buick and he need not unduly concern himself with the REOP question. The issue before me is whether Mr. Durber's activities with respect to the Property constituted a source of business or property income during the years in appeal for purposes of section 9 of the Income Tax Act ("Act").

[2]      Mr. Durber sought to deduct losses of $7,266, $7,929 and $5,678 in filing his tax returns for 1997, 1998 and 1999 respectively. Because he had greater income than Mrs. Durber, he claimed all the losses from the Property, notwithstanding that he and she have equal interests in the Property. I informed him that if he were successful in these appeals, the losses available to him would be reduced by one-half, subject to further decreases if the amounts of the losses were inaccurate, as alleged by the respondent.

[3]      Mr. Durber is a captain with the District of West Vancouver Fire Department. He has worked for the Fire Department for over 24 years. During the years in appeal Mrs. Durber worked as a legal secretary. The Durbers have one child who was born in 1988.

[4]      The Durbers had no experience in owning or operating rental property prior to November 1996, when they purchased the Property for US$20,000. They mortgaged their residence in Burnaby, B.C. for $27,000 in order to fully finance the purchase of the Property. The interest rate on the mortgage was 6.7 per cent; the blended payments of principal and interest were payable in monthly installments of $529.62. The mortgage was paid off in 2001. (In November 1996, the exchange rate was US$0.75 for C$1.00, according to Mr. Durber.)

[5]      Mr. Durber had visited or "passed through" the Lake Havasu area on holidays on about three occasions before 1996, and "realized how popular a vacation spot it was". Lake Havasu is located in the Arizona desert. It is a holiday resort. Mr. Durber understood that a mobile home on Lake Havasu could rent for as much as a house fixed to the land. The mobile home purchased by Mr. and Mrs. Durber is about 50 feet long and 12 feet wide. It contains a kitchen, two bedrooms, living room and bathroom. A 20-foot deck is attached to the home. The mobile home rests on a pad rented to the Durbers by Beachcomber Resort for US$320 per month. The rented area also includes a hedge on one side, a gravel driveway, a 144 square foot yard and a small garden. The mobile home was 25 years old at time of purchase. Mr. Durber described the interior as "clean but well used". The carpets and furniture were "well worn". The boat included with the purchase of the mobile home was a 21-foot pontoon, a boat slip was included with the rent of the pad. Mr. Durber anticipated renting the Buick to tenants who did not have an automobile available during their vacation at the resort. He also intended to rent the boat to his tenants. In fact, he has never rented either the boat or the automobile.

[6]      The US$320 rent paid to the Beachcomber Resort also includes laundry facilities, a swimming pool, security and office staff. Most of the tenants of the Beachcomber Resort stay for at least three months; according to Beachcomber Resort rules, the minimum sublease is for three months. The Beachcomber Resort also charged a tenant a US$50 monthly fee when a mobile home was subleased. There are some full-time residents at the resort. Most, if not all tenants, are retirees. There are activities for tenants throughout the year.

[7]      Mr. Durber's intention, he testified, at the time of acquisition of the Property was to rent the Property and supplement the family income. He anticipated renting the Property to Canadians during the winter months and to persons from the Los Angeles area who liked boating and water sports during the summer months. Mr. Durber explained that most of the subtenants at Beachcomber Resort were repeat renters so he hoped that once he rented the Property, the same tenant would continue renting the Property in future years as well.

[8]      The appellant did not have much success in renting the Property during the years in appeal. He canvassed other mobile home owners in the Beachcomber Resort and realized they also were experiencing difficulty in renting. He was told that "word of mouth" was the best advertising. He did not advertise for tenants in Los Angeles newspapers because of the high cost of doing so. He posted advertisements at the resort's office and in several traffic areas near the Beachcomber Resort such as the local Safeway store. The appellant acquired the Property in November 1996, too late, he said, to rent on the open market for the winter of 1996-1997. Therefore, in order to reduce his expenses, he rented the Property to his parents for part of December, 1996 and about three months in 1997.

[9]      Mr. Durber continued to rent the Property to his parents for four months in 1998 and 1999. His parents were unable to occupy the Property in 2001 but apparently paid him the rent for "six or seven months". His parents had used the Buick when occupying the mobile home. He and his family also visited the Property during spring break at the end of March during 1997, 1998 and 1999. Mrs. Durber and their daughter would stay about 10 days, Mr. Durber would remain at the Property for about four to six weeks each year. Mr. Durber testified in order to reduce expenses, he devoted time while at Beachcomber Resort to repairing and maintaining the Buick, the boat and the mobile home.

[10]     The respondent claims that Mr. Durber charged his parents rent that was less than market value. Mr. Durber testified that he was able to get the Beachcomber Resort to exempt the US$50 charge on the sublease to his parents; therefore he could charge them US$50 less than he would charge other sub-lessees. He explained that he was new in the rental business "in a market that was quite literally foreign to me". Also, the condition of the mobile home was a factor to consider to determining rent. He explained that he rather have a tenant paying something than no tenant paying nothing. His parents, Mr. Durber declared, were "a last resort".

[11]     Mr. Durber recalled his parents did not always pay their rent on time. Payments of rent were made in cash. They would pay when they had money available. Sometimes they would pay only a portion of the rent and the balance would be paid later. On the other hand, his parents would advance him money for expenses. Mr. Durber did not keep a record of rental payments. He "knew what my parents owed me".

[12]     The reason for increased costs in subleasing the Property, according to Mr. Durber, was due to the fall in the value of the Canadian dollar after he purchased the Property. "The dropping Canadian dollar greatly affected my rental market in Canada." He also is of the view that the market for American tenants decreased "over the next several years due to events out of my control, namely, poor economy, dropping stock market, which affected some retirees' pensions". Mr. Durber is referring to the period from 1997 on. [I take judicial notice that the values of major stock market indices did not fall from 1998 on but, on the contrary, started to rise in 1998 and had their greatest values in 2000 but, at time of trial, returned to 1997 values.]

[13]     In assessing, the CCRA revised Mr. Durber's rental income for 1997 from $2,000 to $2,400. The attached Schedule 'A', which was entered as Exhibit R-1, shows rental income and claimed expenses for 1996 to 2000 inclusive as well as gross rents and net loss claimed for 2001. Attached Schedule 'B', which was entered as Exhibit A-5, shows Mr. Durber's "Proposed Profit and Loss for 1997/1998/1999" which he prepared on the eve of trial from calculations he had made close to the time he acquired the Property.[3]

[14]     In 2001 Mr. Durber also received rental income from a Mr. Strasman, a non-arm's length subtenant, for three months. Mr. Durber charged Mr. Strasman US$650 a month plus the US$50 charge required by the Beachcomber Resort. Mr. Durber also obtained a tenant for the period starting the last week of December 2001 to March 15, 2002; the rent was US$750 per month. Mr. Durber did not know if this rent included the sublet fee of US$50. Other tenants were found to rent the Property during the period of April 20 to May 31, 2002 and from the end of June to Labour Day 2002.

[15]     The greatest expense claimed by the appellant was not the interest on the money borrowed to acquire the Property but the pad or trailer park rent paid to Beachcomber Resort. Interest and pad rent were claimed as follows:

                             1996             1997                       1998                       1999

Interest                   $210             $1,534                    $1,181                    $826

Trailer pad rent       $881             $5,755                    $6,713                    $6,723

[16]     Mr. Durber reported the following rental revenues:

1997             1998             1999

                                      $2,000          $3,680          $3,566

[17]     According to Schedule 'B', Mr. Durber's projected income from the mobile home was US$700 per month for 12 months. He also projected rental income of US$350 per month for three months for the car and boat, an aggregate of US$9,450. To this, he added a 25 per cent exchange rate to arrive at income in Canadian currency of $11,812.50 per year.

[18]     The bulk of the expenses projected by Mr. Durber was $6,355.44 in annual interest payments and $4,800 annual for pad rental (in Canadian funds), a total of $11,155.44; to this amount he added $360 for miscellaneous expenses. Until the mortgage was paid off, he projected a modest profit of $297.11. (Mr. Durber omitted to add another miscellaneous expense of $125, which would reduce his profit to $172.11.) However, he claimed interest expenses of only $210, $1,534 and $1,182 for 1997, 1998 and 1999 respectively. There is no explanation for the difference in the amounts of interest projected and due under the mortgage and the amounts actually claimed as expenses in calculating income. Indeed, during the trial Mr. Durber stated that his accountant prepared his income tax returns and he signed them. He declared that he relied on his accountant and that he, himself, could neither answer nor explain any amounts, or the reasons for the amounts, in his tax returns. The accountant was not a witness.

[19]     In Stewart,[4] the Supreme Court of Canada set down tests to determine whether a taxpayer's activities constitute a source of business or property income for the purpose of section 9 of the Act.[5]

[20]     The words and sections of the Act, state Iacobucci and Bastarache JJ., determine whether a taxpayer has a source of income.[6] Section 3 of the Act refers generally to at least four sources of income: office, employment, business and property. Section 9 refers to business and property income; to apply section 9 one must have a source that is either business or property income. One may have a source of income from property when a commercial activity falls short of being a business. And there may be "some taxpayer endeavours [that] are neither businesses, nor sources of property income, but are mere personal activities".[7] The Supreme Court proposed the use of the following two-stage approach with respect to the source question:

(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?

[21]     The first stage of the test, the Court says, assesses the general question of whether or not a source of income exists; the second stage categorizes the source as either business or property.

[22]     Iacobucci and Bastarache JJ., explain at paragraph 51, that:

. . . [e]quating "source of income" with an activity undertaken "in pursuit of profit" accords with the traditional common law definition of "business", i.e., "anything which occupies the time and attention and labour of a man for the purpose of profit": Smith, supra, at p. 258[8]; Terminal Dock, supra.[9] As well, business income is generally distinguished from property income on the basis that a business requires an additional level of taxpayer activity: see Krishna, supra, at p. 240.[10] As such, it is logical to conclude that an activity undertaken in pursuit of profit, regardless of the level of taxpayer activity, will be either a business or property source of income.

       The purpose of this first stage of the test is simply to distinguish between commercial and personal activities, . . . this may well have been the original intention of Dickson J.'s reference to "reasonable expectation of profit" in Moldowan.[11]

. . . [T]his "pursuit of profit" source test will only require analysis in situations where there is some personal or hobby element to the activity in question. Where the nature of an activity is clearly commercial, there is no need to analyze the taxpayer's business decisions. Such endeavours necessarily involve the pursuit of profit. As such, a source of income by definition exists, and there is no need to take the inquiry any further.

       It should also be noted that the source of income assessment is not a purely subjective inquiry. Although in order for an activity to be classified as commercial in nature, the taxpayer must have the subjective intention to profit, in addition, as stated in Moldowan, this determination should be made by looking at a variety of objective factors. Thus, in expanded form, the first stage of the above test can be restated as follows: "Does the taxpayer intend to carry on an activity for profit and is there evidence to support that intention?" This requires the taxpayer to establish that his or her predominant intention is to make a profit from the activity and that the activity has been carried out in accordance with objective standards of businesslike behaviour.

             [Footnotes added]

[23]     The REOP of a taxpayer's activity is only one of several factors to consider, and it is not a conclusive factor. The overall assessment to be made, caution Iacobucci and Bastarache JJ., is whether or not the taxpayer is carrying on the activity in a commercial manner. This assessment is not to second-guess a taxpayer's business judgment. A judge evaluates the commercial nature of the taxpayer's activity, not anyone's business acumen.[12]

[24]     The deductibility of an expense itself is a separate question from the existence of the underlying source of income. Thus a taxpayer may have income from a business but certain deductions may be disallowed because they are personal; the business itself is not affected and all other expenses may be deductible in computing the income from the business.

[25]     Their Lordships summarized their reasons at paragraph 60:

. . . [t]he issue of whether or not a taxpayer has a source of income is to be determined by looking at the commerciality of the activity in question. Where the activity contains no personal element and is clearly commercial, no further inquiry is necessary. Where the activity could be classified as a personal pursuit, then it must be determined whether or not the activity is being carried on in a sufficiently commercial manner to constitute a source of income. However, to deny the deduction of losses on the simple ground that the losses signify that no business (or property) source exists is contrary to the words and scheme of the Act. Whether or not a business exists is a separate question from the deductibility of expenses. . . . As well, unlike many statutory stop-loss rules, once deductions are disallowed under the REOP test, the taxpayer cannot carry forward such losses to apply to future income in the event the activity becomes profitable. As stated by Bowman J.T.C.C. in Bélec, supra, at p.123: "It would be ... unacceptable to permit the Minister [to say] to the taxpayer ... 'The fact that you lost money ... proves that you did not have a reasonable expectation of profit, but as soon as you earn some money, it proves that you have now such an expectation.'"[13]

[Footnote added]

[26]     There is no doubt that there is a personal element in Mr. Durber's activities. First, the Property was rented to his parents and second, he and his family used the Property. [I acknowledge that Mr. Durber worked on the Property in order to reduce expenses.] The payment of rent by his parents to Mr. Durber was dependent on the parents having the cash to pay the rent. Mr. Durber maintained no records of payments from his parents or how much rent was due at any particular time and when any amount due was eventually paid. The only other persons on the Property during the years in appeal were the appellant, his wife and daughter.

[27]     I am also disturbed by the fact Mr. Durber was unable to answer questions with respect to various items included in his income tax returns or on documents attached to the returns that were put to him by the respondent's counsel. There is no explanation as to why the interest expenses claimed in his tax returns are less than those actually incurred. His attitude was that his accountant prepared the material and he relied without hesitation on his accountant. It did not appear that Mr. Durber instructed or assisted his accountant in preparing the returns or the financial information attached to them. I assume that a taxpayer engaged in business would have at least some rudimentary knowledge of his or her business accounts, Mr. Durber appears to lack this knowledge.

[28]     Mr. Durber did not establish that his predominant intention on acquiring the Property in 1996 was to make a profit from the activity and that activity was carried out in accordance with objective standards of businesslike behaviour. That Mr. Durber did not have a net profit from the Property during the years in appeal does not lead me to conclude that the Property was not a source of income to him. In my view when he acquired the Property he was of two minds, one, to rent the Property and two, to make the Property available to his parents while they could enjoy it and to his family, and the latter was his motivating reason to purchase the Property. During the years in appeal, the Property was not a source of income to the appellant.

[29]     The appeals are dismissed.

Signed at Ottawa, Canada, this 8th day of August 2002.

"Gerald J. Rip"

J.T.C.C.

SCHEDULE 'A'

Durber, Philip	1996	1997	1998	1999	2000	2001
Revenue (Rental Income)	0	2,000	3679.92	3565.92	2673.36	7587
Expenses - Category
Advertising
Insurance	340.9	195.2	179.4	173.83	218.32
Interest	210.28	1533.74	1181.48	826.42
Maintenance and repairs			594.08		90.12
Management and Admin Fees
Motor Vehicle Expenses			1143.25	1737.14	850.31
Office Expenses		21.67	523.4	192.47	198.83
Legal, accounting & prof fees		187.25	187.25	261.8	267.5
Property Taxes		69.8	76.57	76.57	184.62
Salaries, wages and Benefits
Travel			515.01
Utilities	176.67	256.35	373.35	326.1	369.26
Other Expenses:
Cable	68.8	227.25	296.18	393.24	603.03
Telephone	140.69	120.3	316.36	217.14	230.29
Trailer Park Rent	881.18	5754.51	6713.4	6722.69	5284.1
Bookkeping to G. Durber (spouse)			500	600	600
Total Expenses	1818.52	8366.07	12599.73	11527.4	8896.38
Less Personal Portion Deduction (%)	0	0	20%	20%	0
Expenses Subtotal	1818.52	8366.07	10079.79	9244.28	8896.38
Less: Rental Revenue	0	2,000	3679.92	3565.92	2673.36
Less: Capital Cost Allowance	0	900	1530.00	0	1193.9
	(car)	(car)			(computer)
Total Net Loss	-1818.52	-7266.07	-7929.87	-5678.36	-7416.92	-5792

SCHEDULE 'B'

Proposed Profit and Loss for 1997/1998/1999

Mtg. Payment	Pad Rent	Misc. xpenses	Misc. xpenses	Rent Credits	Car/Boat Rent Cr.
529.62 x 12 mo.	$400.00 12 mo.	car/boat/house Insur.	$100.00	$700.00 12 mo.	350.00 x 3 mon.
6355.44 Can. $	4800.00 Can. $	360.00 Can. $	125.00 Can. $	$8400.00 U.S. $	$1050.00
6355.44 4800.00				$9450.00 U.S. $	x 25%
360.00 11,515.44	Can. $	11,812.50 11,515.44	Credit Debit	9450.00 2362.50	Exchange
		$    297.11	Credit	11,812.50

COURT FILE NO.:                             2002-833(IT)I

STYLE OF CAUSE:                           Philip Druber and Her Majesty The Queen

PLACE OF HEARING:                      Vancouver, B.C.

DATE OF HEARING:                        July 24, 2002

REASONS FOR JUDGMENT BY:     the Honourable Judge Gerald J. Rip

DATE OF JUDGMENT:                     August 8, 2002.

APPEARANCES:

For the Appellant:                      The appellant himself

Counsel for the Respondent:      Johanna Russell

COUNSEL OF RECORD:

For the Appellant:

Name:                

Firm:                 

For the Respondent:                  Morris Rosenberg

                                                Deputy Attorney General of Canada

                                                          Ottawa, Canada

2002-833(IT)I

BETWEEN:

PHILIP DURBER,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeals heard on July 24, 2002 at Vancouver, British Columbia, by

the Honourable Judge Gerald J. Rip

Appearances

For the Appellant:                                The Appellant himself

Counsel for the Respondent:                Johanna Russell

JUDGMENT

          The appeals from the assessments made under the Income Tax Act for the 1997, 1998 and 1999 taxation years are dismissed.

Signed at Ottawa, Canada this 8th day of August 2002.

"Gerald J. Rip"

J.T.C.C.