Gascho Farms Ltd. v. The Queen, 97 DTC 808, [1997] 1 CTC 2092 (TCC)

O’Connor J.T.C.C.: — These appeals were heard at London, Ontario, on October 1, 1996. Testimony was given by Daniel David Gascho, the president of the Appellant corporation and by Hélène Hébert, an appeals officer with Revenue Canada.

Issue

The only issue is whether a certain residential property acquired in 1990 by the Appellant was acquired for the purpose of gaining or producing income as contemplated in paragraph 1102(l)(c) of the Income Tax Regulations (“Regulations”). There are discrepancies in the figures in the Notice of Appeal and the Reply thereto but the Court was advised not to be concerned with these discrepancies. In other words, the Court was only to determine the issue without regard to the figures.

Facts

The following facts in the Notice of Appeal were admitted in the Reply to the Notice of Appeal:

I. The Appellant is a corporation incorporated pursuant to the laws of the Province of Ontario. Until November 26, 1990, the Appellant was primarily operating as a family farm corporation.

2. On or about the 27th day of October, 1990, the Appellant entered into an Agreement to sell its lands, buildings, equipment and inventory located at the West Half of Lot 8, Concession 2, Westerly Section, in the Township of Wellesley, being substantially all of the assets of the Appellant, hereinafter called “the Assets”, for a sale price of $500,000.00.

3. As consideration for the sale of the Assets, the purchaser gave back a first mortgage in the amount of $212,000.00, paid the sum of $150,000.00, subject to the usual adjustments, by certified cheque and conveyed the purchaser’s property located at 412 Carene Court, Waterloo, Ontario, hereinafter called “the Property”, to the Appellant. At all times the purchaser and the Appellant were dealing at arm’s length

4. The Property had been listed for sale by the purchaser for $244,900.00 and the price was subsequently reduced to $239,500.00. The Appellant and the purchaser attributed a price of $239,000.00 to the Property. The Property was also subject to a mortgage in the approximate amount of $101,000.00 bearing interest at the rate of 10.625% per annum, calculated semi-annually, not in advance, which mortgage matured March 1, 1992.

5. The Appellant completed the sale of the Assets on November 26, 1990, and at that time acquired the Property.

6. Immediately after entering into the Agreement to sell the Assets and acquire the Property, the Appellant attempted to [lease] the Property. On or about the 26th day of November, 1990, the Appellant entered into an Agreement to lease the Property to three individuals with whom the Appellant was dealing at arm’s length, hereinafter called “the Lease”.

7. The Lease commenced December 1, 1990, required the tenants to pay rent in the amount of $1,290.00 per month and was to terminate February 1, 1992. The Lease also contained the following provision:

The Lessees will pay rent in the sum of $700.00 per month until their property located at 50 Braun Street, Kitchener, Ontario, is sold or until May 1, 1991, whichever occurs first, at which time the Lessees will pay the difference between the rent of $1,299.00 and $700.00 per month, being $599.00 per month so that the rent as shown in the Lease will be paid by the Lessees.

8. The Appellant also agreed to sell the Property to its tenants for $240,000.00, conditional upon the tenants selling their property known municipally as 50 Braun Street, Kitchener, Ontario.

9. The tenants occupied the Property and paid rent commencing December 1, 1990.

10. By approximately July of 1991, it became apparent that the tenants were unable to sell their property. The Appellant therefore listed the Property for sale on July 29, 1991.

12. On or about December 1, 1991, the Appellant disposed of the Property for proceeds of sale in the amount of $189,500.00.

The following further facts were proven to the satisfaction of the Court.

13. In its income tax returns for its taxation year ending June 30, 1992, the Appellant claimed a terminal loss on the sale of the building comprised in the Property and attempted to carry that loss back against the Appellant’s income in its 1991 taxation year. The Minister, in his Re-Assessment dated November 10, 1994, disallowed the claim for a terminal loss and considered the Appellant’s loss a capital loss.

14. The amount of stated rent in the lease of the Property, namely $1,299, was the exact amount payable monthly in principal, interest and taxes under the mortgage on the Property. The tenants could not sell 50 Braun Street and never paid more than $700 per month. The tenants also defaulted on some rent.

15. Mr. Gascho had no experience in real estate but stated that he hoped to achieve profits similar to those attained on a rental operation by one of his friends. However, he also stated that he would have preferred cash than the swap of the Property.

16. With respect to paragraph 8, there was no writing related to the potential sale of the Property to its tenants for $240,000. The only evidence on this point is part of Exhibit R-l introduced by Hélène Hébert. It is in the form of a letter dated March 18, 1994 signed by one of the tenants, Kathe Akbar, indicating that she and Kon Akbar, another tenant, had made an agreement in November 1990 to purchase the Property for $240,000 conditional upon the Akbar’s selling their home at 50 Braun Street. The letter goes on to explain that at the end of November 1991, 50 Braun Street had still not been sold so that the Akbars had to back out of their agreement.

Submissions

Counsel for the Appellant submitted certain authorities and argued that, on the basis of the facts in these appeals, one must conclude that the Appellant acquired the Property for the purpose of gaining or producing income. Thus it was depreciable property as contemplated in the Regulations and he was entitled to claim a terminal loss. Counsel points out that the fact that the full rent of $1,299 was never paid and that only $700 per month (or less in certain instances) was paid is not that significant. One must look at the intention of the Appellant at the time of acquisition of the Property and not the ensuing events.

Counsel for the Respondent reviewed certain authorities and took the position that the Appellant did not acquire the Property for income purposes. The Appellant testified that he would have preferred cash rather than the swap of the property when he sold his farm. Counsel also points out that the Appellant did not truly try to rent the Property. The Property was not advertised for rent but rather was rented through “word of mouth” to acquaintances. He points to the short-holding period of the Property and the fact that there was an unwritten agreement between the tenants of the Property and the Appellant in November of 1990, that the tenants were to purchase the Property under certain conditions for $240,000. He argues that this is an indication that the Property was acquired to resell and the short rental period is not indicative of an intention to rent the Property but rather that the lease was an interim activity.

Law

Paragraph 1102(1)(c) of the Regulations provides in essence that depreciable property does not include property not acquired for the purpose of gaining or producing income.

Analysis

The issue in this appeal is clearly one of fact, as is clear from the authorities referred to. The following factors are significant.

1) When the Appellant sold its farm the Appellant would have preferred cash than the swap of the Property. To complete the sale however at the price of $500,000 he had to accept the swap. In my view that was the primary reason for the Appellant acquiring the Property.

2) The Appellant’s principal had no real estate experience. He had not examined the rental market and had not prepared any plan for renting the Property for a period of time.

3) When the tenants could not fulfill their obligations to pay full rent or purchase the Property, the Appellant did not attempt to rent the Property to anyone else but immediately decided to sell. As appears from Exhibit R-l and from the Notice of Appeal, a sale to the tenants was contemplated when the lease was entered into.

4) The amount of rent asked by the Appellant, $1,299, matched exactly the principal, interest and taxes payable on the mortgage on the Property. A small profit of approximately $200 per month, representing the principal component in the $1,299, less approximately $50 per month with respect to insurance may have been attainable had the full rent been paid. However, the Appellant gave generous terms by allowing less than full rent to be paid for six months (or until the Braun Street property sold) and, in fact, the Appellant never received more than $700 per month. Moreover, if one were to add a reasonable figure for repairs and maintenance, it is highly unlikely that a profit could have been realized not even taking into consideration capital cost allowance.

The Appellant has the burden of proof and, in my opinion, that burden has not been discharged. Based on all of the evidence submitted, and principally because of the factors stated above, I find, as a fact that the Appellant did not acquire the Property for the purposes of gaining or producing income as required by paragraph 1102(l)(c).

Consequently the appeals are dismissed, with costs.

Appeal dismissed.