Date: 20020109
Docket: 2000-178-IT-G
BETWEEN:
KEVIN SHAUGHNESSY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasonsfor
Judgment
Bowman, A.C.J.
[1]
These appeals are from assessments for 1994 and 1995 by which the
Minister denied losses sustained by the appellant from the rental
of a condominium at Whistler, British Columbia. The allegation
that the 1994 appeal was invalid was abandoned.
[2]
The appellant, his brother Joseph Michael, William Oberton and
William James Stuckey bought the condominium in December 1988 for
$204,000. The property was mortgaged for $153,000 at an interest
rate of 12% per annum. Each of the four had an undivided ¼
interest.
[3]
The appellant testified that his object in buying the property
was to have a long-term income producing property and not to sell
it at a profit. This evidence is uncontradicted and is borne out
by his subsequent purchase of the interests of the other
participants. I accept his testimony.
[4]
Counsel for the respondent spent some time cross-examining the
appellant on two rental questionnaires in which he described his
original purpose in buying the property "as an
investment". I think counsel was trying to get the appellant
to admit that by the word "investment" he meant that he
bought it to sell at a profit and realize a capital gain, thereby
leaving it open to the respondent to argue that since
subsection 9(3) of the Income Tax Act provides that
income does not include a capital gain the expenses were not laid
out for the purpose of earning income within the meaning of
paragraph 18(1)(a). Of course, it is open to question
whether, if one buys property intending to sell it at a profit,
it really is a capital property.
[5] I
think three observations on this approach are warranted. In the
first place I accept Mr. Shaughnessy's testimony with
respect to his purpose in acquiring the property and increasing
his investment.
[6]
In the second place, the word "investment" is a
completely neutral term. It can refer to a long-term investment
in land and building or in corporate or government bonds —
plainly a capital purpose — or it can refer to an
investment in a commercial enterprise or in property that it is
intended to sell at a profit (an adventure in the nature of
trade). It could, depending on the context, refer to a purely
non-commercial purpose, such as a new home.
[7]
Third, even if counsel for the respondent had been successful in
cross-examining the appellant into admitting that his real and
predominant purpose was to sell the property at a profit, the
enterprise would have been an adventure in the nature of trade
and the expenses would have been deductible in any event
(Roopchan v. The Queen, 96 DTC 1338).
[8]
The matter was argued however on the basis of REOP and it is on
that footing that I shall deal with it.
[9]
The other participants may have had a different purpose from that
of Mr. Shaughnessy. They became dissatisfied with the rate
at which the property was appreciating in value and wanted out.
In December 1993 the appellant bought out the interests of
Oberton and Stuckey so that after that date the property was held
as to ¼ by the appellant's bother Joseph Michael and
as to ¾ by the appellant and his wife Shirley Anne
Shaughnessy.
[10] In
December 1996 the appellant's brother Joseph Michael sold his
¼ interest to the appellant and Shirley Anne Shaughnessy,
so that the appellant and his wife each owned a 50% undivided
interest. A new mortgage for $217,500 was taken out. In 1998 the
appellant and his wife sold the property for $353,000.
[11] I shall
quote paragraphs (f) to (o) of the so-called
"assumptions" pleaded by the respondent:
(f)
at all material times the Activity was undercapitalized;
(g)
at all material times the appellant did not plan or make any
material changes to the Activity;
(h)
the Appellant has no training in the Activity;
(i)
before starting the Activity, and in subsequent years, the
Appellant did not prepare a business plan to determine if it
would be profitable;
(j)
the Appellant did not report any rental income or expenses in
respect of the Property for the 1989, 1990, and 1991 taxation
years;
(k)
from 1992 to 1998 the Appellant reported the following losses
from the Activity as real estate rental losses:
Taxation
Gross
Net
Year
Income
Expenses
Loss
1992
3,007
9,471
6,464
1993
14,300
31,043
16,743
1994
11,025
29,063
18,038
1995
19,265
32,762
13,497
1996
17,021
31,648
14,627
1997
16,743
34,746
18,003
1998
16,065
32,885
16,820
Total
$97,426
$201,618
$104,192
(l)
the total amount of $161,104, which the Appellant deducted as
rental expenses for the 1994, 1995, 1996, 1997 and 1998 taxation
years, consists of various expenses which are set out in Schedule
"A";
(m) the
Appellant did not have a reasonable expectation of profit from
the Activity during the 1994 and 1995 taxation years;
(n)
the expenses claimed in relation to the Activity are not
reasonable in the circumstances; and
(o)
the expenses claimed in relation to the Activity were personal or
living expenses of the Appellant and the other owners of the
Property.
[12]
Paragraphs (f), (g), (h) and (i) contain the usual boiler
plate which is a familiar but essentially purposeless part of
most REOP appeals. One pushes the appropriate button in the
computer and it spews out paragraphs (f) to (i).
[13]
Paragraphs (m), (n) and (o) contain more of the same sort of
verbiage. Paragraph (m) is of course the mandatory ritual
incantation of the mantra REOP. Paragraphs (n) and (o) are simply
tossed in for good measure. They have no basis in the evidence
and were not argued. They are so far-fetched that they could not
possibly have been the basis of the assessments. I presume that
pushing a button on the computer to produce paragraphs (n) and
(o) requires approximately the same amount of reflection and
deliberation as were required to produce paragraphs (f) to (i).
The simple fact is that these identical paragraphs appear in
replies in virtually every REOP case that comes before this
court. It is unacceptable that this type of unthinking
regurgitation of stereotypical verbal formulae should appear in
all replies in REOP cases. The pleading of assumptions involves a
serious obligation on the part of the Crown to set out
honestly and fully the actual
assumptions upon which the Minister acted in making the
assessment, whether they support the assessment or not. Pleading
that the Minister assumed facts that he could not have assumed is
not a fulfilment of that obligation. The court and the appellant
should be entitled to rely upon the accuracy and completeness of
the assumptions pleaded. Sadly, this is becoming increasingly
difficult. The entire system developed in our courts relating to
assumptions and onus of proof is in jeopardy if the respondent
does not set out the actual assumptions on which the assessment
is based with complete candour, fairness and honesty.
[14] Although
the appellant and his wife were co-owners of the property the
appellant claimed all of the losses. It was not argued or pleaded
that if the losses were deductible only 50% were deductible by
the appellant. Therefore the appellant had no case to meet on the
point. If he had he might have been able to justify his claim of
the entire amount on the basis of the attribution rules in
section 74.1 of the Income Tax Act. I am therefore
dealing with the case on the basis that if the losses are
deductible they are fully deductible by the appellant.
[15] In
Donyina v. R., [2001] 3 C.T.C. 2741, I
summarized what appeared to be the principles that has been
established up to that point in the field of REOP. The appeals
from the decisions of the Federal Court of Appeal in Stewart
v. R., [2000] 2 C.T.C. 244, and Walls v. R.,
[2000] 1 C.T.C. 324, have recently been heard in the
Supreme Court of Canada and we can expect that some fresh light
will be shed on this somewhat murky area.
[16] The
summary in Donyina was as follows.
[8]
The REOP principle has been evolving. For a period of time after
the Moldowan case assessors were zealously disallowing
losses, that with the benefit of hindsight, they thought resulted
from an activity with no REOP. Their fervour has been tempered
substantially by such cases as Tonn et al. v. The Queen,
96 DTC 6001; A.G. of Canada v. Mastri et al.,
97 DTC 5420; Mohammad v. The Queen,
97 DTC 5503; Kuhlmann et al. v. The Queen,
98 DTC 6652; Walls v. The Queen,
2000 DTC 6025 (under appeal to S.C.C.); Milewski v.
The Queen, 99 DTC 968 (aff'd
2000 DTC 6559, F.C.A.); Kaye v. The Queen,
98 DTC 1659; Costello v. The Queen,
98 DTC 1362; Smith v. The Queen,
96 DTC 1886; Saunders v. R., [1998]
2 C.T.C. 3196, and Roopchan v. The Queen,
96 DTC 1338, as well as some earlier decisions of this
court: Bélec v. The Queen, 95 DTC 121;
Nichol v. The Queen, 93 DTC 1216, and N.
Cipollone v. Canada, [1995] 1 C.T.C. 2598. The most
recent pronouncement on this point is Keeping v. The
Queen, 2001 F.C.A. 182.
[9] I
shall not quote from these cases or analyse them at length. It
is, I think, sufficient to summarize some of the principles that
they appear to establish.
1.
Where there is no personal element the REOP test should be
applied sparingly (Tonn, Keeping,
Bélec and Walls). The absence of a personal
element does not establish conclusively that the REOP principle
cannot be invoked but such an absence is a factor that carries a
great deal of weight (Mastri).
2.
The Minister or the court should not, with the benefit of
hindsight, second-guess the business acumen of a taxpayer who
embarks upon a business venture in good faith (Keeping,
Tonn, Nichol, Kuhlmann, Bélec
and Smith).
3.
The fact that a business or property is 100% financed is not in
itself a reason for applying the REOP principle (Milewski,
Mohammad and Saunders).
4.
A taxpayer should be allowed a reasonable period of time to get
the business established (Keeping). Such a period will
vary with the circumstances and may well be lengthy
(Milewski).
5.
The REOP principle should not be invoked as a substitute for
analysis. Before invoking REOP the assessor should examine the
expenses to determine whether they are reasonable or for any
other reason not deductible (Smith, Costello and
Cipollone).
6.
For an expectation of profit to be reasonable it has to be not
"irrational, absurd and ridiculous"
(Kuhlmann).
7.
The fact that an investment or a business is motivated in part by
tax considerations is not relevant in determining whether there
is a business, nor is tax motivation in itself relevant in
determining the deductibility of expenses if a business exists
(Stubart Investments Limited v. The Queen,
84 DTC 6305) unless of course the Minister chooses to
invoke the general anti-avoidance rule in section 245, in
which case we are into a fundamentally different ball-game.
8.
The initial question where losses are claimed and denied is
whether they are personal or living expenses, the statutory
definition of which includes the REOP test. If they are not, the
REOP test must be applied with extreme care and the question
becomes "Is there a business?" The existence of REOP is
only one factor in that determination (Kaye).
9.
Reasonableness operates both in the context of the existence of a
business, where section 67 disallows the deduction of
expenses to the extent that they are unreasonable, and also at
the liminal stage of determining whether there is a business
(Kaye).
10.
If what is ostensibly a rental property was acquired and held in
the course of an adventure in the nature of trade and it was
reasonable to expect a profit on the resale the losses
(i.e. carrying costs net of rentals received) should not
be disallowed on the basis of REOP (Roopchan). The court
should however examine with some care an ex post facto
declaration that property that was carried for some years at a
loss is part of a speculative venture in which the motive was
resale at a profit. This is not something that one would expect
someone readily to admit if the property were sold at a
profit.
11.
If the taxpayer has several rental properties, some yielding a
profit and some a loss, it is improper to apply REOP to the
losing properties and ignore the profitable ones. The entire
investment picture should be considered (Smith).
12.
When to start a business and when to abandon it are business
decisions in which neither the taxing authorities nor the court
should intervene (Nichol). Nonetheless if losses go on
being incurred year after year for an inordinate length of time
sooner or later one has to apply what I shall call the
"Enough is enough" principle and decide that what might
have been a viable business has, with the effluxion of time,
became hopeless and the best thing to do with it is to give it a
decent burial. Nonetheless, a businessman's judgement to
maintain a business must be treated with great respect.
[17] Applying
each of these points to this case, the following conclusions are
warranted:
1.
There was no personal element. The appellant and his wife visited
the property two or three days per year for cleaning and
maintenance. Their friends and family did not use it.
2.
Second-guessing the appellant's business judgement is
precisely what the Minister is doing here. The appellant saw
Whistler as a recreational area that was likely to expand and
develop and their decision was based on rational research and
enquiry.
3.
The property was not fully financed. The appellant put a
substantial amount of his own money into it from RRSPs that he
cashed in. Even if it had been fully financed this would not have
been fatal.
4.
The appellant acquired most of his interest in the property in
1993 and in 1996 when he bought out the other participants. The
Minister pounced on the 1994 and 1995 taxation years, immediately
after the appellant had increased his interest in the property.
Had he not decided to sell the property as a result of the
assessing action of the CCRA he would have realized a profit in
subsequent years. The Minister in my view was altogether too
quick on the draw.
5.
I have seen no evidence of any analysis — merely the usual
chanting of REOP.
6.
There is certainly nothing irrational, absurd and ridiculous
about expecting a profit from renting property in one of the
hottest recreational properties in North America.
7.
There were no tax considerations in this investment.
8.
These expenses are certainly not personal or living expenses.
9.
There is no element of unreasonableness in the expenses. The
point was pleaded in the reply and then dropped.
10.
The property was not bought to resell.
11.
This point is inapplicable.
12.
The appellant over a ten-year period acquired an increasingly
larger interest in the property and sold it in 1998. It is his
decision and he cannot be faulted for it.
[18] Not one
of these principles was observed by the CCRA in this case.
[19] There is
one further nail that has recently been hammered into the REOP
coffin: Ludco Enterprises Ltd. et al. v. The Queen,
2001 DTC 5505. In virtually all of the REOP cases I
have heard the real killer has been the interest. Were it not for
the interest usually the loss would be eliminated or
substantially reduced. In 1994 and 1995 in this case the interest
paid was $14,599 and $17,436 respectively. The losses reported
were $18,038 and $13,497. The appellant stated that the gross
income for those two years was incorrectly reported and should
have been $18,000 and $22,000 respectively rather than $11,025
and $19,265. Using the revised figures for gross income, the loss
for 1994 would have been $11,063 and for 1995 $10,762. The
elimination of the interest charge would have erased the loss and
created a profit.
[20] The
denial of the losses is tantamount to a denial of the deduction
of the interest expense. This I believe is demonstrably contrary
to the decision in Ludco, where the interest expense was
allowed on the basis that the borrowed money was used to acquire
shares that produced dividend income. The following discussion by
Iacobucci J., speaking for the unanimous court, is
illuminating:
[58] In the
case at bar, both the Tax Court of Canada and the Federal Court -
Trial Division ostensibly applied this Court's decision in
Moldowan v. The Queen, [1978] 1 S.C.R. 480, in equating
"income" with "profit". However, that case
was concerned not with the meaning of the term "income"
as such, but with identifying the source of income in play and,
more specifically, with differentiating between business
activities as distinct from personal or hobby activities. It is
clear that Moldowan,supra, does not stand for the
absolute proposition that "income" necessarily means
"profit".
[59 ] Because
it is left undefined in the Act, this Court must apply the
principles of statutory interpretation to discern what is meant
by "income" in the context of s. 20(1)(c)(i).
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.
[60] As noted
by Létourneau J.A., Bowman J.T.C.C. (as he then was)
lucidly dealt with the argument that the word "income"
in s. 20(1)(c)(i) necessarily means "profit" in
Mark Resources Inc. v. The Queen, 93 D.T.C. 1004, at p.
1015. Most importantly, Bowman J.T.C.C. dismissed that argument
at p. 1015 in these terms:
Interest on money that is borrowed to invest in common shares,
or property, or a business or corporation is deductible because
it is laid out to earn amounts that must be included in the
computation of income. Amounts of income such as dividends which
must be included in income under paragraphs 12(1)(j) and
(k) do not cease to be income merely because they are
exceeded by the cost of their production.
[61] I agree.
Indeed, when one looks at the immediate context in which the term
"income" appears in s. 20(1)(c)(i), it is
significant that within the provision itself the concept of
"income" is used in contradistinction from the concept
of tax-exempt income. Viewed in this context, the term
"income" in s. 20(1)(c)(i) does not refer to net
income, but to income subject to tax. In this light, it is clear
that "income" in s. 20(1)(c)(i) refers to income
generally, that is an amount that would come into income for
taxation purposes, not just net income.
[62] I am
bolstered in this conclusion by the other evidence of
Parliamentary intention. If Parliament had intended interest to
be deductible only in circumstances where borrowed money was used
for the purpose of earning "net income", it could have
expressly said so. Indeed, as noted by Létourneau J.A., in
both 1981 and 1991, amendments to the Act that would have
restricted interest deductibility to circumstances where borrowed
money is used for the purpose of making a profit were proposed
but never enacted.
[21] The
losses here were disallowed on the basis of the Minister's
ceremonial chanting of the rubric identified by the acronym REOP,
a gloss on the statute that, as applied by the CCRA as a
free-standing test, cannot withstand rational scrutiny. Any
realistic analysis of what the CCRA was doing in this case makes
it crystal-clear that it was in essence disallowing the interest
because it did not result in the production of net income. This
is precisely the approach rejected by the Supreme Court of Canada
in Ludco.
[22] The
appeals are allowed with costs and the assessments are referred
back to the Minister of National Revenue for reconsideration and
reassessment to allow the deduction of losses in 1994 of $11,063
and in 1995 of $10,762. These are the losses resulting from the
appellant's revision of his gross rental income in those
years.
Signed at Toronto, Canada, this 9th day of January 2002.
"D.G.H. Bowman"
A.C.J.
COURT FILE
NO.:
2000-178(IT)G
STYLE OF
CAUSE:
Between Kevin Shaughnessy and
Her Majesty The Queen
PLACE OF
HEARING:
Vancouver, British Columbia
DATE OF
HEARING:
December 13, 2001
REASONS FOR JUDGMENT
BY:
The Honourable D.G.H. Bowman
Associate Chief Judge
DATE OF
JUDGMENT:
January 9, 2002
APPEARANCES:
Counsel for the
Appellant:
F. Timothy Williamson, Esq.
Counsel for the
Respondent:
Carl Januszczak, Esq.
COUNSEL OF RECORD:
For the
Appellant:
Name:
F. Timothy Williamson, Esq.
Firm:
Vancouver, British Columbia
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2000-178(IT)G
BETWEEN:
KEVIN SHAUGHNESSY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on December 13, 2001, at
Vancouver, British Columbia, by
The Honourable D.G.H. Bowman
Associate Chief Judge
Appearances
Counsel for the
Appellant: F.
Timothy Williamson, Esq.
Counsel for the Respondent: Carl
Januszczak, Esq.
JUDGMENT
It is
ordered that the appeals from assessments made under the
Income Tax Act for the 1994 and 1995 taxation years be
allowed with costs and the assessments be referred back to the
Minister of National Revenue for reconsideration and reassessment
to allow the deduction of losses in 1994 of $11,063 and in 1995
of $10,762.
Signed at Toronto, Canada, this 9th day of
January 2002.
A.C.J.
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