Citation: 2008TCC24
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Date: 20080114
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Dockets: 2007-2616(IT)I
2007-2617(IT)I
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BETWEEN:
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FAROUK A. ALBAYATE,
LORETTA ALBAYATE,
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Appellants,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Little J.
A. FACTS
[1] The Appellants are husband
and wife.
[2] The appeals were
heard in Vancouver, British Columbia on
common evidence.
[3] In May 2003 the
Appellants each purchased a one-half interest in a property located at 396
South Fletcher, in the town of Gibsons, British Columbia. The purchase price was $145,000. (The property
located in Gibsons is hereinafter referred to as the “Property”.)
[4] It is agreed by the
parties that at the time of the purchase the Property was in very bad shape.
The Property was uninhabitable and had been used as a “grow-op” for the
production of drugs for a period of time and at other times by numerous
transient tenants.
[5] The Property is a
two storey home containing 1300 square feet on level one and 1300 square feet
on level two.
[6] The parties also
agree that the Appellants originally purchased the Property as their personal
residence but due to financial constraints they decided to rent out level one of
the Property.
[7] Subsequent to the
purchase, the Appellants spent a substantial sum of money carrying out
extensive repairs to the Property.
[8] In filing their
income tax returns for the 2003 and 2004 taxation years, the Appellants
reported the following rental losses:
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2003
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2004
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Farouk A. Albayate
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$8,973
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$11,669
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Loretta Albayate
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$8,973
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$15,327
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[9] By Notices of
Assessment dated April 1, 2004 and March 30, 2005, the Minister of National
Revenue (the “Minister”) initially assessed the 2003 and 2004 tax returns of
the Appellants as filed.
[10] By Notices of
Reassessment dated July 27, 2006, the Minister revised the rental losses
claimed by the Appellants in 2003 and 2004. The following adjustments were made
by the Minister:
Farouk A. Albayate
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2003 Taxation Year
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2004 Taxation Year
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Per Appellant
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Audit
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Adjustment
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Per Appellant
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Audit
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Adjustment
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Gross Rent
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$4,200
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$4,200
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nil
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$8,400
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$8,400
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nil
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Expenses
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-$22,147
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-$5,782
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$16,365
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-$35,396
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$7,899
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$27,497
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Net Income (loss)
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-$17,947
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-$1,582
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-$26,996
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$501
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50/50 split
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-$8,973
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-$791
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-$13,498
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$251
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Reported by Appellant
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-$8,973
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-$791
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$8,182
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-$11,669
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$251
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$11,920
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Loretta Albayate
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2003 Taxation Year
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2004 Taxation Year
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Per Appellant
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Audit
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Adjustment
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Per Appellant
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Audit
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Adjustment
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Gross Rent
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$4,200
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$4,200
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nil
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$8,400
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$8,400
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nil
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Expenses
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-$22,147
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-$5,782
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$16,365
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-$35,396
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$7,899
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$27,497
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Net Income (loss)
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-$17,947
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-$1,582
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-$26,996
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$501
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50/50 split
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-$8,973
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-$791
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-$13,498
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$251
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Reported by Appellant
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-$8,973
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-$791
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$8,182
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-$15,327
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$251
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$15,577
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[11] In revising the
rental losses claimed by the Appellants for the 2003 and 2004 taxation years,
the Minister adjusted the following expenses:
Farouk A. Albayate:
2003 Taxation Year
(a)
disallowed
insurance expense - $2,066;
(b)
disallowed
repairs and maintenance - $13,999; and
(c)
disallowed
interest expense - $300.
2004 Taxation Year
Disallowed
repairs and maintenance - $28,830.
Loretta Albayate:
2003 Taxation Year
(a)
disallowed
insurance expense - $2,066;
(b)
disallowed
repairs and maintenance - $13,988; and
(c)
disallowed
interest expense - $300.
2004 Taxation Year
Disallowed
repairs and maintenance - $28,830.
B. ISSUE
[12] The issue to be
determined is whether the Appellants are entitled to deduct rental expenses in
excess of the amounts already allowed by the Minister in determining rental
income for the 2003 and 2004 taxation years.
C. ANALYSIS AND
DECISION
(A) Disallowed
Insurance Expense
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2003
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Farouk A. Albayate
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$2,066
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Loretta Albayate
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$2,066
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[13] The insurance
expense claimed by the Appellants relates to a guarantee fee paid to the Canada
Mortgage and Housing Corporation with respect to a mortgage on the Property
with a term of five years.
[14] The Minister determined
that this fee should be allowed over a five year period. The Minister allowed
the Appellants to deduct 20% of the fee in 2003 and 20% of the fee in 2004.
[15] Because the fee
claimed related to a mortgage with a term of five years, I believe that the
position adopted by the Minister of allowing a deduction of 20% per year was
correct. The appeal on this issue is dismissed.
(B) Disallowed
Repairs and Maintenance
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2003
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2004
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Farouk A. Albayate
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$13,999
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$28,830
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Loretta Albayate
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$13,988
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$28,830
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[16] The Appellants claim
that the expenses spent on the Property in 2003 and 2004 were ordinary repairs
that should be deductible in the year that the expenses were incurred. Counsel
for the Respondent maintains that the expenses that were claimed were capital
in nature and not deductible because of the prohibitions contained in paragraph
18(1)(b) of the Income Tax Act (the “Act”).
[17] Paragraph 18(1)(b) of
the Act reads as follows:
18.(1) In computing the income of a
taxpayer from a business or property no deduction shall be made in respect of
…
(b) an
outlay, loss or replacement of capital, a payment on account of capital or an
allowance in respect of depreciation, obsolescence or depletion except as
expressly permitted by this Part;
[18] The repairs in question made by
the Appellants included the following items to level one of the Property:
·
a
new refrigerator;
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a
new stove and microwave;
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a
new washer and dryer;
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a
new fireplace;
·
new
doors and windows and new locks on the doors and windows;
·
new
electric wiring and light fixtures
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new
plumbing and a new bathroom;
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new
furniture;
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a
new deck;
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a
new fence;
·
new
flooring;
·
a
new kitchen;
and
related labour costs.
(Note – During
the hearing Loretta Albayate conceded that the new stove, the new refrigerator
and the new furniture should not be treated as repairs but as capital outlays.)
[19] In support of the
Minister’s position, that the amounts claimed as repairs were capital outlays, counsel
for the Respondent referred to the decision of the Supreme Court of Canada in M.N.R.
v. Haddon Hall Realty Inc., 62 DTC 1001.
[20] The facts and issue
in that case may be summarized as follows:
1.
The
Respondent owned and operated a large apartment building in Montreal.
2.
Each
year the Respondent incurred expenses for the replacement of stoves,
refrigerators and window blinds which had become worn out, obsolete or
unsatisfactory to the tenants.
[21] In the Haddon
Hall decision at pages 1001 and 1002, Justice Abbott said:
…The sole matter
in issue here is whether such expenditures were an income expense incurred to
earn the income of the year 1955 and allowable as a deduction from gross income
in that year under s. 12(1)(a) of the Income Tax Act, or a
capital outlay to be amortized or written off over a period of years under the
capital cost allowance regulations made under s. 11(1)(b) of the said
Act.
The general
principles to be applied in determining whether a given expenditure is of a
capital nature are fairly well established: Montreal Light Heat and Power Consolidated v. Minister of
National Revenue; British
Columbia Electric Railway Company Limited v. Minister of National Revenue.
Among the tests which may be used in order to determine whether an expenditure
is an income expense or a capital outlay, it has been held that an expenditure
made once and for all with a view to bringing into existence an asset or an
advantage for the enduring benefit of a trade is of a capital nature.
Expenditures to
replace capital assets which have become worn out or obsolete are something
quite different from those ordinary annual expenditures for repairs which fall
naturally into the category of income disbursements. Applying the test to which
I have referred to the facts of the present case, the expenditures totalling
$11,675.95, made by respondent in the year 1955 for replacing refrigerators,
stoves and blinds in its apartment building were, in my opinion, clearly
capital outlays within the provisions of s. 12(1)(b) of the Act.
The appeal should
be allowed, the judgments of the Exchequer Court and
the Income Tax Appeal Board set aside and the assessment restored.
Appeal allowed.
[22] Counsel for the
Respondent also referred to the decision of the Federal Court of Appeal in Fiore
et al. v. The Queen, 93 DTC 5215.
[23] The facts in the Fiore
case indicate that the Appellants purchased two properties in 1984 for the
price of $107,000. The facts also indicate that at the date of purchase the
properties were in poor condition and the Appellants at once set about
renovating the properties.
[24] In the Fiore
decision at page 5216, Justice Létourneau said:
Where, as in the
instant case, property is bought for a price ($107,000) below its ordinary
capital value at the time of the purchase ($263,380 in 1983) and the expenses
are necessary because of the condition of the buildings and are incurred to
restore them to their ordinary value, we consider that those expenses are
capital in nature.
Further, the
evidence in the record disclosed that the work done by the applicants
considerably exceeded that of maintenance and repair done to preserve a capital
asset, and in fact involved a significant improvement to that asset. Whereas
the ordinary capital value of the buildings purchased was $263,380 in 1983,
that of the renovated buildings had risen to $437,453 in 1988. The scope of the
improvements made can be seen from the 1983 and 1988 valuation reports. Accordingly,
there are now poured concrete foundations that did not exist before. Hardwood
floors replaced plywood floors. Ceramic tile took the place of vinyl tile and
linoleum. A low-amperage, obsolete electrical system (60 amperes) was replaced
by a modern and more powerful system (125 amperes). Walls and ceilings
were improved by using gypsum plaster board to replace prefit, plaster and
plywood.
These are only a
few examples of the improvements which led the Tax Court of Canada judge to
conclude that the property in question had become new property and that the
expenses amounting to $174,150 were capital expenses. In the circumstances,
this Court cannot find that this conclusion was arbitrary or unreasonable.
[25] In this situation
Loretta Albayate gave the following information concerning the Property:
Assessed Value in July 2002
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$162,800
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Our Purchase Price May
2003
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$145,000
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Assessed Value in July 2003
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$189,000
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Assessed Value in July 2004
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$267,000
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Assessed Value in July 2005
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$332,000
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(see
Exhibit R-3)
[26] During the hearing
the Appellant, Loretta Albayate, said that in 2005 she and her husband fixed up
the exterior of the Property. The work carried out on the Property in 2005 included
a new roof, new vinyl siding, new soffits and new eavestroughing.
[27] After considering
the nature of the Property at the time of purchase and the extensive
renovations to the Property carried out in 2003, 2004 and 2005, I have
concluded that the expenses claimed in 2003 and 2004 were capital expenses and
that the deduction of these expenses is prohibited by paragraph 18(1)(b) of the
Act.
[28] In reaching my
conclusion, I also note that the assessed value of the Property at the time of
the purchase in 2003 was $162,800 and the purchase price of $145,000 was lower
than the assessed value. After the renovations made by the Appellants to the
Property the assessed value of the Property in July 2005 was $332,000. This
increase in the value of the Property after the renovations is similar to the situation
referred to by Justice Létourneau in Fiore.
(C) Disallowed
Interest Expense
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2003
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Farouk A. Albayate
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$300
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Loretta Albayate
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$300
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[29] The interest expense
claimed was interest paid on credit cards.
[30] The evidence is that
the credit cards were used by the Appellants to pay for the renovations.
[31] Since I have
concluded that the repairs that were claimed were non‑deductible capital
expenses, the interest that has been claimed is not deductible.
[32] The appeals are
dismissed, without costs.
Signed at Vancouver, British Columbia, this 14th day of January 2008.
“L.M. Little”