REASONS
FOR JUDGMENT
Campbell J.
[1]
These appeals are from a decision of the Minister
of National Revenue (the “Minister”) which disallowed rental expenses
claimed in both the 2009 and 2010 taxation years.
Facts
[2]
The Appellant and his wife, Kit Morris, are
chartered accountants. They both worked at Deloitte when they married in
December, 2008. The Appellant retired in May, 2009 and started his own tax
service business from his home. In 2007, the Appellant agreed to purchase his
parents' principal residence located at 1350 Sinclair Street in West Vancouver (the “Sinclair property”).
[3]
The purchase was made pursuant to a verbal
agreement. The agreed purchase price in 2007 was $955,000. The Appellant was to
pay monthly instalments of $2,300. He testified that this property was his
principal residence commencing on July 1, 2007. However, legal title to the
Sinclair property was not transferred to the Appellant until March of 2009. The
Appellant introduced a notarized statement (Exhibit A-1) of his mother which
confirmed his testimony respecting the Sinclair property. The Respondent
objected to the introduction of Exhibit A-1 because the Appellant’s mother was
not present in Court to be cross‑examined. Even without this document,
and despite the Minister’s assumption of fact that the Appellant did not
purchase this property until March, 2009, I accept the Appellant’s evidence
that he actually purchased the property in 2007, although legal title was not
transferred until 2009.
[4]
Kit Morris moved into the Sinclair property in
December, 2008 after she and the Appellant were married. She testified that
this property became her principal residence. She listed her own property located
in Coquitlam for sale and it sold in June, 2009.
[5]
The Appellant and his wife eventually decided to
move to larger premises and purchased a property on Heywood Avenue (the
“Heywood property”). They moved from the Sinclair property to this
newly-purchased property on August 4, 2009. All of their belongings were
relocated to the new property with the exception of some tools, wood and some
odds and ends. After August, 2009, both the Appellant and his wife testified
that the Sinclair property was no longer their principal residence and was not
used for personal purposes. Ms. Morris testified that the insurance on the
Sinclair property was changed at this time to reflect that it was a vacant
property. The insurance policy at Exhibit A-5 confirms her evidence and it
references a vacancy permit in the description of the property.
[6]
At the time they relocated, Ms. Morris, after
consulting with her realtor, decided to purchase the Sinclair property from the
Appellant and to use it as an investment rental property. She purchased the
property from the Appellant for $900,000 on August 7, 2009. Exhibit A-4 from
the Land Registry Office confirms that the Application for Registration was
received on July 20, 2009 and registered on August 7, 2009. The document
indicated that the property was subject to a mortgage to the Bank of Montreal.
Ms. Morris testified that she obtained a mortgage for 80 percent of the agreed
price of $900,000. Exhibits A-8 and A-9 confirm her testimony respecting the
mortgage amount and the rate. Both the Appellant and Ms. Morris testified that,
contrary to the Respondent’s position, the purchase price that Ms. Morris paid
to the Appellant was not below fair market value and was based on the market in
the prior year plus advice obtained from their realtor.
[7]
The Appellant testified that, when the Sinclair
property was sold to Ms. Morris, they were both aware that repairs and
renovations were necessary prior to renting the property. They undertook to
complete the repair work themselves and, according to their testimony, they
began working on the property in September, 2009. The Appellant testified that,
although he was busy establishing his accounting business at his new residence,
he was at the Sinclair property three days per week and on weekends to attend
to these repairs. Although Ms. Morris was pregnant and still working full-time,
she also shared in the work, especially on weekends.
[8]
The repairs included painting the entire house,
replacing the kitchen flooring, fixing and painting the kitchen and bathroom
cabinets, replacing closets, repairing light fixtures, repairing a roof leak,
hiring a plumber to replace a kitchen faucet and landscaping, which included
fence repairs, renovating a bridge over a creek and attending to the gardens.
Ms. Morris stated that the work took much longer than they anticipated
initially.
[9]
Despite Ms. Morris’ intention to rent the
Sinclair property, it was never listed for rent. While the repairs remained unfinished,
the property was rented to a friend of Ms. Morris in December, 2010 for a
period of four months, until March, 2011. It was rented for $2,000 monthly,
slightly below the fair market value for rentals, because they continued to
require access to the property to continue the necessary repairs.
[10]
When this four-month tenancy ended, the Sinclair
property was listed for sale. Both witnesses testified that, during the
four-month rental, there was a change in the market in this area and their
realtor approached them about selling this property. It was listed for sale on
May 9, 2011 and sold on May 31, 2011. Ms. Morris made a profit of $350,000.
[11]
Receipts were not provided for any of the items
used in the repairs, although none of those are claimed and they are not in
issue before me. A Visa bill belonging to the Appellant shows several purchases
at Home Depot between August 23, 2009 and September 22, 2009. However, they do
not specifically state what the purchases were for, nor do they support that
they related to repairs at the Sinclair property and not their new residence at
the Heywood property. The expenses claimed by the Appellant related to mortgage
interest, property taxes, insurance and utilities.
The Reassessments
[12]
In 2009, there was no rental income in respect
to the Sinclair property, but the Appellant claimed rental losses of approximately
$13,071, comprised of mortgage interest of $10,872, insurance of $482,
utilities of $482 and property taxes of $1,235.
[13]
Total rental income in 2010 consisted of the
$2,000 paid for the month of December in that year. Claimed total rental losses
in this year totalled $26,014 and were comprised of mortgage interest of
$25,584 and maintenance of $430, leaving a claimed net rental loss of
$24,014.81. In both 2009 and 2010, all claimed expenses were denied with the
exception of one-twelfth of the mortgage interest ($2,132) in respect to the
December rental.
Issues
[14]
The first issue that must be addressed is
whether the Appellant had commenced a rental business between August, 2009 and
November, 2010. If there was a business, the second issue is whether the
Appellant can deduct the claimed rental expenses in 2009 and 2010.
The Position of the Parties
[15]
The Respondent’s position is that there was no
rental operation at the Sinclair property prior to December, 2010 because the
hallmarks of such an operation with sufficient commerciality did not exist
prior to that date. Therefore, expenses prior to December are not deductible.
Despite subjective intention that may have existed, significant activities in
this regard were not commenced until they started earning rental income in
December, 2010.
[16]
The Respondent submitted that it was unlikely
that repair work began on the property in 2009 as the Appellant contends. Also,
the duration of time that it took to complete the repairs was not reasonable.
The Appellant and his wife approached the repairs in a leisurely fashion and
there were no reasonable, continuous efforts to complete the repairs and rent
the property. Since there was no true intention, no business operation
commenced prior to December, 2010 and the expenses should be attributed to
basic upkeep rather than for the purpose of earning income from the property.
Since there were no receipts relating to the repairs, and no photos evidencing
the repairs, the expenses shown on the Appellant’s Visa statement (Exhibit A-7)
were instead related to their Heywood property.
[17]
In the alternative, the Respondent argued that,
if there was a finding of a rental operation prior to December, 2010, the
expenditures were capital in nature and not deductible.
[18]
The Appellant contended that, when his wife
purchased the Sinclair property from him, this was the first significant step
taken toward establishing a rental business. Although they did not devote all
their time to the repairs, continuous commitment to the work is not essential
under the relevant provisions.
Analysis
[19]
One of the assumptions of fact included in the
Reply to the Notice of Appeal was that from August, 2009 to November 30, 2010,
the property was a personal use property of Kit Morris (Assumption 14(i)).
Although the Respondent did not directly argue or rely on this assumption of
fact during the hearing, the evidence, of both the Appellant and Ms. Morris,
was that, after they relocated to their new residence on Heywood in August,
2009, the Sinclair property was essentially empty. Their testimony is supported
by Exhibit A-5 which shows that the insurance policy on the Sinclair property
was changed to reflect that it was vacant after their move in August, 2009.
Based on the testimony and the documentary evidence, this assumption of fact has
been demolished and, consequently, I reject the Respondent's contention that
the claimed deductions should be denied on the basis they were personal or
living expenses pursuant to paragraph 18(l)(h) of the Income Tax Act,
(the "Act").
[20]
The Respondent conceded in closing submissions
that there could be a rental operation as of November, 2010 since the rental
agreement that commenced in December, 2010 was signed in that month. The issue
is therefore whether there is sufficient evidence to conclude that a rental
operation existed between September, 2009 and October, 2010. The Respondent in
her submissions seemed to accept that Kit Morris had a subjective intention to
create a rental operation at the Sinclair property in 2009:
In the case at hand it was the evidence of both the appellant and
Ms. Morris that there was an intention to utilize the Sinclair property as part
of a rental operation.
It's
the respondent's position that the mere intention as of the date that they
indicate when they made the transfer of the property is not sufficient to begin
a rental operation. So we have to look at what was done.
(Transcript, page 121)
[21]
The Respondent has therefore focussed her
argument on the steps taken to establish a rental operation and argues that
there were insufficient steps undertaken to establish such an operation in this
period.
[22]
The Respondent contends that the work on the
Sinclair property did not commence until late 2010. This argument, however,
contradicts one of the Minister's own assumptions of fact contained in the
Reply to the Notice of Appeal. Paragraph 14(o) of the Reply, assumes the
following:
from August 2009 to November 30, 2010, the Appellant and Mrs. Morris
renovated the Property to make the Property suitable to rent;
[23]
The Reply contains no other assumptions
indicating that the work only commenced in 2010 and if the Reply had in fact
contained other such assumptions they would have been potentially contradictory.
Other than this one assumption, which agrees with the Appellant's position, the
Respondent did not introduce any evidence other than its contention in
submissions that the testimony of the Appellant and Ms. Morris was incorrect.
As a result, I have no alternative but to accept the evidence of the witnesses
and conclude that the work on the Sinclair property began in September, 2009.
[24]
The Respondent relied on the decision in Gartry
v. Canada, [1994] 2 CTC 2021, where J. Bowman (as he was then)
concluded that when a business operation commences is a question of fact and
that it begins somewhere between the time when the intention to start the
business forms and when it starts to earn income. In Gartry, the court
concluded that the fishing business had started because the taxpayer had
arranged to purchase a boat, make modifications on the boat, obtain licences, arrange
insurance, borrow money, arrange for a crew and make arrangements with other
boat owners to utilize his services. In the present appeal, Kit Morris
purchased the Sinclair property from the Appellant, arranged a mortgage of
$720,000 to finance the purchase and personally completed various repairs.
According to the evidence, the substantial repair work consisted of the
painting of the entire premises. The work spanned a period of September, 2009
to March, 2011 and, according to the Appellant and his wife, they were working
at the property several days per week and on weekends. Only one contractor, a
plumber, was hired to replace a kitchen faucet. I have difficulty accepting
that the work conducted at the property took this length of time in light of
the evidence respecting the type of repairs completed and the alleged amount of
time spent at the property. It is also unlikely that two chartered accountants
would neglect to retain the receipts that would support the actual repair work
and instead claim the obvious larger amounts that could easily be proved. I
also have difficulty believing that the Appellant's wife exposed herself to the
potential harmful effects of paint and so forth during this period when she was
pregnant, having difficulties with the pregnancy due to her age and having
concerns over the health of her baby. The steps taken in these appeals are in
no way comparable to the steps taken in Gartry.
[25]
While repairs may take a longer period of time
to complete than anticipated, findings on the reasonableness of the delays will
be dependent upon the facts in each case. In the case of Preiss v. Canada,
2009 TCC 488, [2010] 1 CTC 2164, J. D'Arcy did not find that a
four-year delay affected the taxpayer's intention to produce rental income. However,
in that case, there was evidence of legitimate delays relating to zoning delays
and health issues. Nevertheless, the testimony of the Appellant and his wife
was not impinged on cross-examination and I have no evidence to support my
suspicion that actual work may not have commenced until sometime in late 2010.
I also have the glaring assumption of fact at paragraph 14(o) stating that the
Respondent acknowledges that the Appellant and his wife were renovating the
property between August, 2009 and December, 2009. Consequently, I have no
alternative but to conclude that a rental operation was in existence between
August, 2009 and November, 2010.
[26]
In respect to the plumber's fee of $430 for
replacing a kitchen faucet, the Respondent conceded that, although the amount would
be non-deductible since it was a capital expense, it was a small expense and
could be allowed as a current expenditure (Transcript, page 136). I accept the
Respondent's concession and I will allow the plumbing expense, one of the
few actual receipts relating to repair work that the Appellant did retain,
which brought the sink back to its original functioning form.
[27]
Finally, in respect to the Respondent's
alternative argument, I conclude that the deductibility of claimed so called "soft
costs" is not precluded by subsection 18(3.1) of the Act. The
Respondent submitted that the deductibility of those expenses should be
disallowed on the basis that they were related to the construction, renovation
or alteration of the property. If the repairs do constitute construction,
renovation or alteration within the meaning of the Act, then it must be
determined whether the mortgage on the Sinclair property should be capitalized
pursuant to subsection 18(3.1). That is, if the mortgage proceeds are found to
be used to purchase the Sinclair property and not to finance its construction,
renovation or alteration, then the interest payable on the mortgage will remain
deductible pursuant to paragraph 20(1)(c) as a current expense. J. Margeson
in Magnowski v The Queen, 2000 DTC 2244, at paragraph 71, explained the
purpose of limiting the deductibility of soft costs under subsection 18(3.1) as
follows:
… to prevent taxpayers from using construction costs to create a
loss which would shelter income from other sources. The rules also appear to
assume that "soft costs" represent a disguised portion of the cost of
land and buildings.
[28]
The terms "construction, renovation or
alteration" are not expressly defined in the Act. However, J.
D'Arcy in Preiss indicates that the terms require more than simply
general repairs and cosmetic touch-ups. Although the expenses were allowed in Preiss,
the facts unfortunately did not outline the details of the repairs in that
case. I am, however, inclined to believe that, the tasks completed on the
Sinclair property, including painting, landscaping, minor plumbing and
cleaning, which constituted the majority of the work, are cosmetic touch-ups
rather than construction, renovation or alteration of the property.
[29]
Even if I had not concluded that the repairs at
the Sinclair property were merely cosmetic in nature, I had no evidence before
me that the mortgage proceeds were used to finance any of the repair work. The
Respondent on cross‑examination of the witnesses did not ask any questions
respecting the use of the mortgage proceeds. In addition, there were no
assumptions of fact made in this regard. Therefore, even if the Appellant did
engage in construction within the meaning of subsection 18(3.1) of the Act,
he would not necessarily be precluded from the deduction of the mortgage
interest since the Respondent did not establish that the funds were used to pay
for the construction. Consequently, the Respondent's alternative argument must
also fail.
[30]
In conclusion, based on the evidence, a rental
operation existed in 2009 and 2010 and the deductibility of the claimed costs
are not precluded by any of the relevant provisions in section 18 of the Act.
The appeals are allowed, without costs.
Signed at Ottawa, Canada, this 9th day of May 2014.
“Diane Campbell”
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