Citation: 2012 TCC 66
Date: 20120227
Docket: 2010-1454(IT)G
BETWEEN:
MARY KELLY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Sheridan J.
[1]
The Appellant, Mary Kelly, is a
registered nurse who in the late 1980’s purchased a studio apartment (“Unit”)
in a condominium building (“Condominium”) at a ski resort near Collingwood, Ontario. She is appealing the reassessments by the Minister
of National Revenue under the Income Tax Act of her 2005 and 2006
taxation years.
[2]
In each of those years, the
Minister disallowed her claims for rental losses of $8,555 and $10,702, respectively,
on the assumption that the Appellant acquired the Unit for her personal use.
Though not pleaded as an assumption, one of the grounds relied on in the Reply
was that the Appellant had not undertaken any activities relating to the Unit
in pursuit of profit.
[3]
The Minister’s alternative position was that, if the Unit
was a source of business income, the expenses claimed had not been proven
and/or were for capital expenditures.
[4]
The Minister’s assumptions regarding the Appellant’s
ownership of the Unit are set out
in subparagraphs 5(a) to (f) of the Reply
to the Notice of Appeal:
a)
the Appellant owned a studio
condominium (the “Unit”) in a building registered as Grey Condominium
Corporation No. 37 (the “Condominium”), located near Collingwood, Ontario;
b)
the Unit was maintained for the
Appellant’s personal use;
c)
unit owners of the Condominium could
contribute their units to a rental pool which operated under the name of
Mountain Springs Resort and Conference Centre (the “Resort”);
d)
the Resort provided short term rental
accommodation throughout the year to resort guests and groups;
e)
MSL Management Inc. (the “Management”),
a wholly owned subsidiary of the Condominium, operated the Resort on behalf of
the unit owners of the Condominium;
f)
Under a Lease Management Agreement (the
“Agreement”) between the Management and unit owners:
i)
all revenues and expenses of the Resort were
pooled and shared on a quarterly basis by unit owners who were a part of
the Resort on the basis of their respective ownership interests by
unit type;
ii)
the unit owners could opt out of the Resort each year but they were nonetheless
bound by all the rules in the Agreement for rental of their unit;
iii) the
unit owners who opted out of the Resort could not rent their units
for periods of less than thirty days; and
iv) the
unit owners who opted out of the Resort could not rent their unit
for more than three times in any calendar year;
v)
the unit owners were responsible for the payment of their
monthly condo fees and property taxes; and
vi) the
unit owners were responsible for owner staying charges in the event
they used their unit;
…
[5]
The Appellant was the only witness
to testify. She did not dispute that part of her motivation in purchasing the Unit
was her interest in skiing but contended that she was mainly attracted to its
income-producing potential. Though somewhat shaken by the rigourous
cross-examination of counsel for the Respondent, she nevertheless stood her
ground. Her inability, on occasion, to recall or explain fully the details of
each transaction underpinning her claims did not diminish her overall
credibility.
Analysis
1. Was there a Business?
[6]
Both counsel relied on the test in
Stewart v. R., [2002] 2 S.C.R. 645 to determine whether, given the personal
aspect to of the Appellant’s activity, there existed a source of income:
54 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.
55 The objective factors listed by
Dickson J. in Moldowan at p. 486 were (1) the profit and loss experience
in past years, (2) the taxpayer's training, (3) the taxpayer's intended course
of action, and (4) the capability of the venture to show a profit. As we
conclude below, it is not necessary for the purposes of this appeal to expand
on this list of factors. As such, we decline to do so; however, we would
reiterate Dickson J.'s caution that this list is not intended to be exhaustive,
and that the factors will differ with the nature and extent of the undertaking.
[…]
[7]
Of particular importance to the
present case is the Court’s caution in the second half of paragraph 55 that:
[…] although the reasonable expectation of profit is a
factor to be considered at this stage, it is not the only factor, nor is it
conclusive. The overall assessment to be made is whether or not the taxpayer is
carrying on the activity in a commercial manner. However, this assessment
should not be used to second-guess the business judgment of the taxpayer. It is
the commercial nature of the taxpayer's activity which must be evaluated, not
his or her business acumen.
[Emphasis added.]
[8]
In my view, in reassessing the
Appellant, the Minister encroached into the territory of second-guessing the
Appellant’s business acumen. Counsel for the Respondent submitted that because
of its self-serving quality, the Appellant’s testimony regarding her subjective
intentions when acquiring the Unit should be given little weight. However, this
concern is counterbalanced by the evidence of objective factors pointing to
commercial activity and also overlooks Stewart’s warning that, in each
case, such factors will “differ with the nature and the extent of the
undertaking”.
[9]
Turning first to the Appellant’s
subjective intentions, I accept her evidence that she saw the Unit as an
opportunity to combine earning extra income with her enjoyment of skiing. Like the
taxpayer in Stewart, the Appellant acquired her Unit as a “turnkey
operation” with management of the rental pooling agreement and financing
provided by the vendor. She did not, however, have Mr. Stewart’s business
acumen. The Appellant was a registered nurse who, for “a couple of years”, had rented out a basement
suite in her home. Mr. Stewart, on the other hand, had “held senior positions
with the Toronto Transit Commission”
and was “an experienced real estate investor [who] … in the past acquired and
disposed of several rental properties”.
As such, he was able to subject the vendor’s projections to a rigourous
analysis whereas the Appellant took at face value the promotional materials of
the Condominium vendors. She was influenced, in part, by the active involvement
in the Condominium promotion of Todd Brooker who, at that time, was one of Canada’s well-known
World Cup ski champions. Under the circumstances, I do not find unreasonable her
belief that the rental of her Unit would cover her carrying costs i.e., the
mortgage payments, property taxes and other fees, with some profit left over.
[10]
Counsel for the Respondent took
the Appellant to task for her failure to produce the Lease Rental Agreement to
show the profit/loss distribution between Management and the unit owners. However,
on cross-examination, the Appellant acknowledged that the Quarterly
Statement of Owner’s Account (Exhibit A-1, Tab 15) issued by
Management showed her Unit percentage share of profits/losses as .54593%. She distinguished
that percentage from the owners’ 58% share of the revenue and losses of the
Resort. This distinction and the correctness of the resulting calculations as
set out in Exhibit A-1, Index, Tab 14 and Tab 15 were conceded by the
Respondent, subject to the Court finding there was a business source. Furthermore,
given the detailed assumptions set out in paragraph 5(f) of the Reply, at some
stage, at least, the Minister seems to have had quite a good look at the Lease
Management Agreement. In the circumstances, I can see no justification for
drawing a negative inference from the Appellant’s failure to produce the Lease
Management Agreement at trial.
[11]
As for the Minister’s assumption
that the Appellant never contributed her Unit to the pool, I accept her
evidence to the contrary. Her evidence that she used the Unit personally “less
than 10%” of the 120 days it was available to her in each calendar year was
unshaken on cross-examination.
[12]
Counsel for the Respondent also
contended that the losses consistently incurred by the Appellant from 1987 to
2006 pointed to a lack of commerciality in the venture. He held up in contrast
the positive actions taken by the taxpayer in Stewart to render more
profitable his property rental business:
10 The appellant tried to reduce the amount
of financing on the units. In 1991, he increased the frequency of first
mortgage payments on the units from monthly to weekly, thereby reducing the
amortization period significantly. He sold one of the Park Woods units in 1991
and used the proceeds to pay down the debt on the other unit. By 1994, the
appellant had paid off the promissory notes on all of the units. The appellant
also exited the White Oaks rental pool arrangement in 1995 because of high
vacancies and poor management and set up his own management company. In 1996,
he changed management companies for the Park Woods unit.
[13]
First of all, it is interesting to
note that, notwithstanding the difference in their skill sets and degree of
direct involvement, both Mr. Stewart and the Appellant ultimately found
themselves on the losing end of what had initially seemed a promising venture.
In Stewart, the Court expressly rejected the notion that the mere fact
of losses having been incurred signifies that no business source exists. The
Court went on to cite the words of former Chief Justice Bowman in Bélec v.
The Queen, 95 D.T.C. 121 at page 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 now have such an expectation.’”
[14]
Secondly, holding the Appellant to
the same standard as Mr. Stewart overlooks the difference in the degree of
control each had over their respective undertakings. The Minister himself
assumed at subparagraph 5(e) of the Reply that the Management “… operated the
Resort on behalf of the unit owners of the Condominium”. By its very nature, the Unit
rental undertaking did not lend itself to the same level of active involvement
Mr. Stewart enjoyed in his business venture. It is against this factual
backdrop that the Appellant’s conduct in the face of losses must be considered.
At first, she simply accepted Management’s reassurance that things would
eventually turn around. When losses continued to accrue and she began to have
trouble making her mortgage payments, she tried to sell the Unit, the only real
“action” open to her. This proved unsuccessful. I found reasonable her
explanation that the recession which followed her 1989 purchase of the Unit
resulted in the devaluation of the Unit. Further complicating both the rental
and resale of the Unit was on-going litigation between Management and municipal
authorities over certain Condominium deficiencies. Finally, the development, in
the meantime, of similar resort properties in the area had reduced the demand
for units like the Appellant’s.
[15]
While the history of losses set
out in subparagraph 5(j) and paragraph 6 of the Reply is a relevant
consideration, I am satisfied that the Appellant has met her onus of rebutting
its force in light of the other considerations.
[16]
All in all, I am persuaded that
the Unit rental constituted a source of business income for the Appellant.
2. What Expenses are Properly
Deductible?
Concessions
[17]
At the hearing, the Respondent
conceded that in 2005 and 2006 the Appellant had rental income of $2,218.79 and
$304.67 and business expenses for realty taxes of $1,519.26 and $793.59,
respectively.
[18]
The only expenses remaining in
dispute were the amounts claimed in 2005 and 2006 for common area costs,
mortgage interest and in 2005 only, a special assessment.
Common Area Costs
[19]
In 2005 and 2006, the Appellant claimed
a total of $2,506.92 for common area costs. This works out to $208.91 per month.
At the hearing, she estimated the common area costs at approximately $223 per
month. In evidence was a copy of a letter from the current management of the
Condominium (Exhibit A-1, Tab 13) showing the monthly “common element fees” for
a unit like the Appellant’s to have been $223.53 in 2005 and 2006. Counsel for
the Respondent argued that no weight should be given to this document on the
basis that it was hearsay and other better evidence ought to have been
produced, for example, the Appellant’s banking records.
[20]
I agree with counsel for the
Respondent that banking records would have been more reliable than the letter
from the Condominium management. However, even leaving aside this document, I
have no reason to doubt the Appellant’s oral evidence. A review of the
“Statement of Adjustments” on the final closing for the Unit purchase (Exhibit
R-1) shows that when the Appellant first purchased the Unit in 1992, the monthly
common area fees were $99.20. It can reasonably be assumed that by 2005, this
amount would have increased. In these circumstances, it strikes me as reasonable
to average the initial $99.20 fee with the amount originally claimed by the
Appellant in her return, $208.91. This makes for a monthly common area cost of
$154.06 or annual common area costs for 2005 and 2006 of $1,848.72.
Mortgage Interest
[21]
When the Appellant originally
purchased her Unit, it was mortgaged through the vendor. Her evidence was that
by 2002, she was defaulting on her payments and was forced to mortgage her residence
to pay out the vendor’s mortgage on the Unit. In 2005 and 2006, she claimed
mortgage interest of $4,482 and $4,382.98, respectively.
[22]
The only documentation in support
of her claim was a print out of interest calculations from an online mortgage
calculator based on a principal amount of $79,200 with an interest rate of
6.05% amortized over 25 years with a 5-year term (Exhibit A-1, Tab 11).
However, no foundation was laid for the use of such variables in the
calculation. The Appellant did not testify to the terms of the mortgage.
Furthermore, there was nothing to corroborate her evidence that the proceeds
from the mortgage on her residence had been used to pay out the Unit mortgage.
In these circumstances, the Appellant has not succeeded in proving her entitlement
to the mortgage interest claimed.
Special Assessment
[23]
In 2005 only, the Appellant
claimed $2,191 in respect of a special assessment levied by the Condominium
corporation to pay for the removal and replacement of siding on the
Condominium. Counsel for the Appellant characterized this payment as covering a
shortfall in the Condominium corporation’s operating budget and argued that as
such, it ought to be deductible. However, I am persuaded by counsel for the
Respondent that it was, in fact, an expenditure on account of capital and is,
therefore, not deductible under subparagraph 18(1)(b) of the Act.
Conclusion
[24]
The appeals from the assessments
of the 2005 and 2006 taxation years are allowed and referred back to the
Minister of National Revenue for reconsideration and reassessment in accordance
with these Reasons for Judgment. In view of the mixed result, each party shall
bear its own costs.
Signed at Vancouver, British Columbia this 27th day of February, 2012.
“G. A. Sheridan”
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