Roopchan v. The Queen, 96 DTC 1338, [1995] 2 CTC 2415 (TCC)

Bowman J.T.C.C.:-These appeals are from reassessments for the appellant’s 1989 and 1990 taxation years and have to do with losses sustained by the appellant on two properties owned by her.

Mrs. Roopchan came to Canada from India in 1969. She was a widow. In 1973 she bought a house at 1094 Pharmacy Avenue in Scarborough in which she continues to reside. Shortly after the purchase she started to rent out the basement. The basement had a separate entrance, two bedrooms, a living room, a bathroom and a kitchen. Part of her reason for renting the basement was to help defray some of the costs of the house, but I do not think that this weighs particularly in the balance. The question is whether the rental of the basement was a commercial operation and whether the expenses which she attributed to that operation are reasonable.

In 1989 and 1990 the income and expense relating to 1094 Pharmacy Avenue was as follows:

The sum of Taxes, Insurance, and Light, Heat, and Water multiplied by 60%.

The Minister has aggregated these expenses with those relating to another property owned by Mrs. Roopchan in Whitby. For reasons that I shall set out later I do not think that the two properties should be linked together in this way.

Notwithstanding the substantial repairs done in 1989 the appellant realized an overall profit in 1989 from the Pharmacy Avenue property. It was not suggested that the profit of $515.57 which she realized was not taxable in her hands. The Minister’s reasoning is that when the income from 1094 Pharmacy Avenue is aggregated with the expenses of the Whitby property, the overall loss proves that there was "no reasonable expectation of profit", and, therefore no business. Had it not been for the Whitby property she would have had a profit in 1989. It seems unlikely that the Minister’s reasoning would have extended to refraining from taxing her on the profit on the basis that in 1989 she had no reasonable expectation of profit and therefore no business.

The concept of reasonable expectation of profit has been used by the Minister, with the benefit of hindsight, as a basis for denying losses from a commercial operation in years when there are losses but for taxing profits when profits are made on the apparent theory that a business exists only when there is a profit. I do not think that it is an appropriate application of the dictum of Dickson J. in Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213. Where there is a commercial operation, as we have here, and the expenses claimed do not fall within the definition of "personal and living expenses" in section 248, the question rather is whether the expenses claimed are reasonably attributable to the commercial enterprise carried on for the purposes of subsection 4(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") and whether they are reasonable within the meaning of section 67.

Here, the maintenance and repairs amounting to $2,114.82 carried on in the basement in 1989 were substantially for repairs to the kitchen floor in the basement, and to closets and cupboards in the family room, bedroom and kitchen and to mouldy dry wall. These expenses were occasioned in part by a drunken and careless tenant and in part by ordinary wear and tear. The basement had been continuously rented out since about 1973.

In 1990 a flood occurred as the result of a burst pipe, and about $6,500 was paid to repair the damage caused by it. The tenants left and as a result only $3,500 was received in 1990. A loss of $5,899.20 was claimed for 1990.

In computing her income or loss for 1989 and 1990, Mrs. Roopchan claimed 40 per cent of the taxes, insurance, heat and water and 100 per cent of the maintenance and repairs on the basement.

The 40 per cent of the running expenses of the house may be a little excessive but no argument or evidence was put forward to establish that a lesser percentage was reasonable and I am prepared to accept it.

So far as the maintenance and repairs to the basement are concerned I accept that the amounts were spent and I do not agree, as counsel for the respondent argued, that they were on capital account. These expenses did not involve a major structural upgrading of the house. They did no more than restore the property to its previous state. No purpose would be served by citing the voluminous jurisprudence that has been developed over the past century and a quarter in Canada and the United Kingdom on this question. The repairs were obviously on revenue account and they were all in connection with the portion of the house that was rented out.

I think, however, that a question of reasonableness arises. Where one rents out a part of one’s principal residence and affects extensive repairs those repairs may have a dual purpose depending upon the facts of the particular case. They may be necessary for the maintenance of the rental operation and to that extent they are properly deductible. They may be made with a view to enhancing the principal residence portion of the building. It is a question of fact whether it is reasonable to allocate all of the expenses to rental operation or whether some apportionment is appropriate. Here, I think the expenses would have been necessary as the result of the flooding in 1990 whether or not there had been tenants in the basement and I think that it is somewhat unreasonable to treat the entire expense of repairing the basement as a business expense. In the absence of any evidence justifying a different allocation an equal division seems reasonable.

I cannot, of course, direct that her income from the Pharmacy Avenue property be increased, but her loss from that property in 1990 should be reduced by 50 per cent of $7,286.90, or $3,643.45.

The second question arises in connection with the property she bought in Whitby. She had saved about $20,000 and wanted an additional investment. She consulted with her son and decided that since Whitby was growing rapidly it would be a good place in which to buy a rental property.

She bought the Whitby property in October 1989 for $284,000, having raised the money needed beyond the $20,000 she had saved by mortgaging it and the Pharmacy Avenue property for a total of $264,000. The house had four bedrooms and three bathrooms and had 2,639 square feet. She stated that she bought it to rent out. It was, in fact, never rented out notwithstanding her attempts to do so. It was sold in May 1990 for $254,000, giving rise to a loss of $30,000.

In 1989 and 1990 she claimed the following losses on the Whitby property:

The sum of Taxes, Insurance, and Light, Heat, and Water multiplied by 60%.

The basic assumption on which the disallowance of these losses was made was that she bought the house for her son. That assumption was shown to be erroneous at trial and the point was not pursued by counsel for the respondent. Clearly she bought the property only as an investment. I use the word investment in the broad sense of a commercial venture, either for rental purposes or as a speculation.

Her son, a chartered accountant, testified and put in evidence projections made before she bought the property that indicated that she could reasonably expect a profit in 3-4 years, depending upon certain assumptions as to interest rates and rentals charged. She expected, on the basis of advice from a rental agent, that she could obtain $2,500 per month but the projected rentals were conservatively estimated at $1,700 and $2,000 per month. To the extent that the expression is meaningful in the context of this case she clearly had a "reasonable expectation of profit". She is an astute and independent business woman who would not embark on a business venture expecting to lose money. She listed the property with different agents for rent and in fact paid one agent $1,700.

Counsel for the respondent criticized Mrs. Roopchan’s son for not taking into account in the projections a claim for capital cost allowance. He referred to the judgment of Dickson J. in Moldowan, supra, at C.T.C. pages 313-14 (D.T.C. 5215) where he said:

Although originally disputed, it is now accepted that in order to have a "source of income" the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business: Dorfman v. M.N.R., [1972] C.T.C. 151, 72 D.T.C. 6131. See also paragraph 139(l)(ae) of the Income Tax Act which includes as "personal and living expenses" and therefore not deductible for tax purposes, the expenses of properties maintained by the taxpayer for his own use and benefit, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit. If the taxpayer in operating his farm is merely indulging in a hobby, with no reasonable expectation of profit, he is disentitled to claim any deduction at all in respect of expenses incurred.

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer’s training, the taxpayer’s intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking: The Queen v. Matthews, [1974] C.T.C. 230, 74 D.T.C. 6193. One would not expect a farmer who purchased a productive going operation to suffer the same start-up losses as the man who begins a tree farm on raw land.

The reference to capital cost allowance must be considered in the context in which the statement was made. Dickson J. was discussing a "reasonable expectation of profit" in comparing the pursuit of a hobby with the conduct of a business. Where we have the purchase of a rental property intended purely as a source of income, with no element of either personal use and enjoyment or of a hobby, it is difficult to apply the observation. In the first place, the deduction of capital cost allowance, as opposed to accounting depreciation, is entirely within the discretion of the taxpayer. There is no requirement that it be deducted. In the second place the amount of capital cost allowance deductible on a rental property is, except in the case of a principal business corporation within subsection 1100(12) of the Income Tax Regulations, restricted, under subsection 1100(11) of the Regulations, essentially to the income otherwise determined without reference to paragraph 20(1 )(a) of the Income Tax Act. For many years after a positive cash flow is achieved the income from a rental property may be reduced to nil by the deduction of capital cost allowance. Indeed the very purpose of the restriction in subsection 1100(11) of the Regulations is to prevent taxpayers from using capital cost allowance on rental buildings to reduce income from other sources. This involves a legislative recognition that losses created by claiming capital cost allowance would otherwise be deductible, a concept that seems to be at variance with the idea that there can be no reasonable expectation of profit and therefore no business unless a profit is generated after taking into account capital cost allowance. If one were to apply the comment of Dickson J. in the manner in which counsel suggests it would mean that so long as the income before capital cost allowance did not exceed the capital cost allowance available there could be no "profit" in that period and, therefore, no reasonable expectation of profit. I cannot believe that Dickson J. could have intended his statement to be construed so as to achieve such a result.

The assumption that Mrs. Roopchan bought the house for her son turned out to be incorrect and counsel for the respondent brought out a further very relevant piece of evidence. In a very able cross-examination he established that Mrs. Roopchan had an alternative plan for the house. She planned not only to rent it but to turn it to account by sale at the earliest possible opportunity. He established that she had listed it for sale at $299,000 before she even took possession-indeed before the purchase transaction had closed. From this he argued that her stated intention to rent should not be accepted because she was engaged from the outset in an adventure in the nature of trade.

I accept counsel’s argument. Her listing of the property for sale before she even took possession marks the transaction clearly as a speculative one. Had she succeeded in selling the property at a profit, as she undoubtedly intended to do from the outset, it would have been impossible for her to escape taxation on the profit as income derived from an adventure in the nature of trade. If resale at a profit was not her primary motivation at the time of purchase-and I think it was-it was at least a secondary one. The cases are too well known to require citation. Since, instead, she sustained a loss on the venture she is entitled to deduct in computing her income not only the carrying costs which she claimed but also the loss on the sale of the house, the former being part of the costs of the venture and the latter being her loss therefrom.

I should add one further observation. Mr. Calabrese is to be commended for bringing out in evidence the fact that Mrs. Roopchan was clearly engaged in an adventure in the nature of trade. On behalf of the Attorney-General of Canada he brought to the Court’s attention an essential fact that would otherwise have gone undetected, (and which, I am sure, was unknown to counsel for the appellant) even though it was a fact that would rebound to the detriment of the respondent’s position. It is conduct of this type that contributes to the reputation of counsel representing the Attorney-General of Canada for fairness and openness.

The appeal is allowed with costs and the reassessments for 1989 and 1990 are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with these reasons.

Appeal allowed.