Bowens v. The Queen, 94 DTC 1853, [1994] 2 CTC 2404 (TCC), aff'd 96 DTC 6128 (FCA)

Bowman J.T.C.C.:—This appeal is from an assessment for the appellant's 1983 taxation year. By that assessment the Minister of National Revenue included in the appellant's income $69,238 under subsection 245(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") as it read in that year. At trial the respondent relied upon subsection 7(1) and, alternatively, section 6.

The problem, briefly put, is this: the appellant was an employee, director, chief financial officer and a shareholder of an oil and gas company, DEB Petroleum (1980) Limited ("DEB"). He had received options to purchase 47,000 shares of DEB at $5.20 per share over five years subject to the provision that if over 50 per cent of the shares were acquired by another person he could exercise all of his options immediately.

An offer was made by Trilogy Resource Corp. ("Trilogy") to acquire all of the shares of DEB, including any outstanding stock options. The appellant believed that to sell the stock options directly to Trilogy could give rise to tax immediately under paragraph 7(1)(b) and so, on the advice of solicitors, he incorporated a numbered company, 287495 Alberta Inc., transferred the options to it and sold the shares of the numbered company to Trilogy for shares of Trilogy, and filed jointly with Trilogy an election under section 85.

He took the position that this was not a transfer or disposition of the stock option as contemplated by paragraph 7(1)(b) of the Act and that he was therefore not taxable on the transaction. The Tax Avoidance Section of the Department of National Revenue saw this stratagem, whichadmittedly had no commercial purpose other than the avoidance of tax, as unacceptable and levied tax on a deemed benefit under subsection 245(2) equal to what it assumed was the value of the Trilogy shares received, $69,238. On objection the assessment was confirmed under paragraph 7(1)(b) and it was that provision, rather than subsection 245(2), upon which the respondent relied principally at trial.

The question, of course, is whether the appellant's tax avoidance strategy was effective.

In the course of the trial a matter arose in respect of which I was required to rule. Since the correctness of my ruling may become an issue in the event of an appeal I should briefly set out the ruling and the basis for it.

The assessment as originally made was, as stated above, premised on the assumption that Trilogy had conferred a benefit on the appellant under subsection 245(2) as it read in 1983 and that this benefit was taxable.

In light of the exception in subsection 245(3), subsection 245(2) could only be applied if the appellant and Trilogy were not dealing at arm's length and in maxing the assessment the assessor proceeded on the assumption that they were not at arm's length. Subsection 7(1) was not considered applicable and, indeed, if the appellant and Trilogy were not at arm's length paragraph 7(1)(b), the section relied on at trial, could not have supported the assessment as the application of that section requires that the transferor and the transferee of the options be at arm's length.

An objection was filed and the appeals assessor considered that the provision that should be applied was paragraph 7(1 )(b). The notification of confirmation read as follows:

. . .a benefit equal to the amount of $69,238 conferred by Trilogy Resource Corp. in respect of an agreement to sell shares of DEB Petroleum (1980) Ltd. to you has been determined and deemed to have been received by you by virtue of your employment in the taxation year in accordance with the provisions of paragraph 7(1)(b) of the Act.

Obviously, if paragraph 7(1 )(b) is to apply, the appellant and Trilogy would have needed to deal at arm's length, contrary to the assumption made on assessing when subsection 245(2) was applied.

The reply to the notice of appeal sets out a number of factual assumptions which appear on the evidence to be substantially correct or which are at all events not challenged. The reply does not mention subsection 245(2) nor does it deal with the question whether the appellant was dealing at arm's length with Trilogy. Nor was an answer filed by the appellant tothe reply.

On discovery the appellant obtained copies of memoranda prepared by the departmental official who made the assessment. One memorandum, Exhibit A-15, sets out detailed reasons for concluding that the appellant and Trilogy were not dealing at arm's length. It was clearly one of the essential "assumptions" upon which the assessment under subsection 245(2) was based.

At the opening of trial counsel for the appellant advised the court that he would be adducing evidence of this unpleaded assumption, and that he would rely upon it in support of the position that even if the Crown's position that the transfer of the shares to the numbered company followed by the sale of the numbered company's shares to Trilogy was indeed a "transfer or disposition” of the options to Trilogy within the meaning of paragraph 7(1 )(b), it was not a transfer or disposition to a person with whom the appellant was dealing at arm's length. Therefore, counsel contended, if section 7 was relevant it was paragraph 7(1 )(c) or (d) that applied because in the case of a non-arm's length transfer of share options tax is not triggered until the non-arm's length transferee exercises the options or disposes of them in an arm's length transaction, neither of which events has ever occurred. Both counsel contended strenuously that they had been taken by surprise. Counsel for the respondent contended that if the appellant was going to rely on the unpleaded assumption that the appellant and Trilogy were not at arm's length he should have said so in his pleadings. Counsel for the appellant contended that if the respondent was going to take a position that was contrary to an assumption made on assessing the respondent should have so pleaded and assumed the onus of rebutting the assumption.

The ruling I made pleased no one. I ruled that it was not necessary for either party to amend the pleadings and that counsel for the respondent could cross- examine the appellant in an attempt to establish that he was in fact dealing at arm's length with Trilogy. To permit or require an amendment to the pleadings at this late stage would nave delayed the trial and would not have been in the interests of justice. Section 7 is not a complex section and in determining the manner of its application the question whether a transferor and transferee are or are not dealing at arm's length is an essential ingredient that could not have escaped the notice of the senior and experienced counsel who appeared in the case. Procedural and evidentiary skirmishes should not be allowed to impede the business of hearing and disposing of an appeal.

This interesting and somewhat unusual procedural wrangle does however put a novel twist on the role of assumptions in income tax litigation. We have an assessment under subsection 245(2) based upon a factual and essential assumption that the parties to the transaction, the appellant and Trilogy, were not dealing at arm's length. On objection and at trial the Crowndevelopeda new theory of the case that was based on a fundamentally different premise, that there was, in substance, and notwithstanding the interposition of the numbered company, an arm's length transfer of the options by the appellant to Trilogy, giving rise to an immediate inclusion under paragraph 7(1)(L>) in the appellant's income of an amount equal to the value of the Trilogy shares received.

The pleading of assumptions in income tax appeals can be traced to the statement of Rand J. in Johnston v. M.N.R., [1948] S.C.R. 486, [1948] C.T.C. 195, 3 D.T.C. 1182, at pages 489-90 (C.T.C. 202-03, D.T.C. 1183):

Notwithstanding that it is spoken of in section 63(2) as an action ready for trial or hearing, the proceeding is an appeal from the taxation; and since the taxation is on the basis of certain facts and certain provisions of law either those facts or the application of the law is challenged. Every such fact found or assumed by the assessor or the Minister must then be accepted as it was dealt with by these persons unless questioned by the appellant. If the taxpayer here intended to contest the fact that he supported his wife within the meaning of the Rules mentioned he should have raised that issue in his pleading, and the burden would have rested on him as on any appellant to show that the conclusion below was not warranted. For that purpose he might bring evidence before the Court notwithstanding that it had not been placed before the assessor or the Minister, but the onus was his to demolish the basic fact on which the taxation rested.

The allegations necessary to the appeal depend upon the construction of the statute and its application to the facts and the pleadings are to facilitate the determination of the

issues. It must, of course, be assumed that the Crown, as is its duty, has fully disclosed to the taxpayer the precise findings of facts and rulings of law which have given rise to the controversy.

[Emphasis added.]

The practice in the courts as it relates to the Minister’s assumptions has developed over the years. In M.N.R. v. Pillsbury Holdings Ltd., [1964] C.T.C. 294, 64 D.T.C. 5184 (Ex. Ct.), Cattanach J. at page 302 (D.T.C. 5188), after quoting from the reasons of Rand J. in Johnston stated:

The respondent could have met the Minister’s pleading that, in assessing the respondent, he assumed the facts set out in paragraph 6 of the notice of appeal by:

(a) challenging the Minister's allegation that he did assume those facts,

(b) assuming the onus of showing that one or more of the assumptions was wrong, or

(c) contending that, even if the assumptions were justified, they do not of themselves support the assessment.

(The Minister could, of course, as an alternative to relying on the facts he found or assumed in assessing the respondent, have alleged by his notice of appeal further or other facts that would support or help in supporting the assessment. If he had alleged such further or other facts, the onus would presumably have been on him to establish them. In any event, the Minister did not choose such alternative in this case and relied on the facts that he had assumed at the time of the assessment.)

A further refinement in the extensive body of jurisprudence relating to assumptions and onus in income tax appeals is found in the Federal Court of Appeal decision in Pollock v. Canada, [1994] 1 C.T.C. 3, [1993] 94 D.T.C. 6050 (F.C.T.D.). There the taxpayer contended that it was sufficient for him to demolish some of the assumptions made by the Minister (including some that were not even pleaded). The Court of Appeal said at pages 7-8 (D.T.C. 6053):

As I understand him, appellant's counsel takes the position that where some of the Minister’s assumptions are successfully demolished by a taxpayer, the Minister’s position must necessarily fail unless he can show that the assumption or assumptions that remain are in and of themselves enough to support the assessment.

In my view, this contention is wrong and is founded upon a misapprehension as to the respective roles of pleadings in general and the assumptions made by the Minister in taxation cases in particular.

It is, of course, the general rule that every party to litigation in this Court must plead the facts upon which he relies in such a way as to put his opponent fairly on notice of the case he has to meet. Where a party's pleadings are so inadequate as to disclose no case at all he runs the risk of having them struck out and of losing for that reason. That rule is quite irrelevant here. There is no question in the present case of the Minister’s pleadings being inadequate or of the appellant not knowing clearly and beyond any possibility of doubt the basis upon which he was reassessed. That basis was and is that the appellant's dealings in shares of the companies in question constituted for him an adventure in the nature of trade so as to make the profits therefrom taxable as income.

The special position of the assumptions made by the Minister in taxation litigation is another matter altogether. It is founded on the very nature of a self-reporting and selfassessing system in which the authorities are obliged to rely, as a rule,on the disclosures made to them by the taxpayer himself as to facts and matters which are peculiarly within his own knowledge. When assessing, the Minister may have to assume certain matters to be different from or additions to what the taxpayer has disclosed. While the Minister’s assumptions, if any, are generally made in the pleadings, that is not always the case and we have seen, in this very record, an example of the taxpayer taking pains to demolish assumptions which the Minister had not pleaded. Where pleaded, however, assumptions have the effect of reversing the burden of proof and of casting on the taxpayer the onus of disproving that which the Minister has assumed. Unpleaded assumptions, of course, cannot have that effect and are therefore, in my view, of no consequence to us here.

The burden cast on the taxpayer by assumptions made in the pleadings is by no means an unfair one: the taxpayer, as plaintiff, is contesting an assessment made in relation to his own affairs and he is the person in the best position to produce relevant evidence to show what the facts really were.

Where, however, the Minister has pleaded no assumptions, or where some or all of the pleaded assumptions have been successfully rebutted, it remains open to the Minister, as defendant, to establish the correctness of his assessment if he can. In undertaking this task, the Minister bears the ordinary burden of any party to a lawsuit, namely to prove the facts which support his position unless those facts have already been put in evidence by his opponent. This is settled law.

In no case of which I am aware, including the numerous cases to which the Federal Court of Appeal referred in a footnote to the passage which I have cited, has this specific issue arisen, which I shall endeavour to enunciate as follows:

Where the Minister bases an assessment on a particular assumption of fact (in this case, the non-arm's length relationship between the appellant and Trilogy as a necessary ingredient to the application of subsection 245(2)) and, in confirming the assessment and at trial abandons the original basis of assessment and advances a new reason for supporting the assessment (i.e., paragraph 7(1)(b)) in which an essential fact (i.e. that the appellant and Trilogy were at arm's length) is contrary to the original assumption:

(a) may the appellant rely upon the unpleaded assumption in his defence against the new basis; and

(b) must the Crown plead the new fact and does it have the onus of establishing

The answer to these questions, based on the principles established in Johnston and Pillsbury, is that the appellant may rely upon an unpleaded assumption in support of his case and unless the respondent establishes that the assumption is wrongand that there are new facts that support the assessment on a different basis, the appellant must succeed. The non-arm’s length relationship between the appellant and Trilogy (Johnston, supra):

found or assumed by the assessor or the Minister must then be accepted as it was dealt with by these persons unless questioned by the appellant.

Here the appellant, far from questioning the original unpleaded assumption, relies on it to destroy the very factual underpinning of the new basis advanced.

The only difference between assumptions that the Crown chooses to disclose in the reply and those that it does not is, as stated in Pollock, supra, that unpleaded assumptions cast no onus on the appellant. The pleading of assumptions is no more than the fulfilment of the Crown's obligation to disclose fully the basis of the assessment. Since pleaded assumptions are in the nature of particulars it is incumbent upon the Crown to plead honestly and fully all of the assumptions relevant to the assessment. If a new basis of upholding the assessment is conceived after the assessment is made and is advanced at trial and the original assumptions are inconsistent with that new basis they must nonetheless be disclosed in the reply and the Crown must undertake the task of establishing that the original assumptions were wrong. It would be inappropriate if the Crown were to obtain a tactical advantage by failing to disclose in its reply assumptions that are embarrassing or irrelevant to its new theory of the case or, as is the case here, inconsistent with that new theory.

Where the Minister bases an assessment on a particular assumption of fact and in the confirmation of that assessment after objection and at trial advances a new factual basis for the assessment that is the reverse of that assumption, although the respondent must plead and prove the new basis, counsel for the respondent need not necessarily call witnesses for that purpose. He or she can endeavour to establish the new fact in the cross-examination of the appellant’s witnesses. In the particular circumstances of this case and in light of the novelty of the point I did not require counsel for the respondent to amend his reply. In the normal course, however, a new factual basis for assessing should be pleaded.

Even if I am wrong in believing that the original assumptions survive their abandonment by the Crown and may be relied upon by the appellant to attack the assessment on the basis set forward in paragraph (c) in the passage from Pillsbury, supra, quoted above, the fact nonetheless remains that the Crown has the onus of establishing any new ground advanced to uphold the assessment. I do not think that it has met that onus. The evidence is more consistent with the position taken on assessing that Mr. Bowens was not dealing at arm's length with Trilogy. He was a partner in the Delta partnership which, with othercorporations, raised capital and promoted the acquisition by Trilogy of the shares of DEB and of other oil and gas interests. Mr. Bowens was, since 1982, an executive vice-president of Trilogy and was active, indeed instrumental, in formulating the exchange offer made by Trilogy for the shares and options. I need not repeat the detailed reasons set forth in Exhibit A-15. They were not rebutted by the respondent and they were supported by Mr. Bowens’ viva voce testimony.

It follows therefore that even if, as the respondent contends, Mr. Bowens, in transferring the options to the numbered company for shares and subsequently selling the shares to Trilogy, can be said to have "transferred or otherwise disposed of" the options to Trilogy, he did not do so to a person with whom he was dealing at arm's length and accordingly paragraph 7(1)(b) has no application.

The appellant also contended that, even if he were dealing at arm's length with Trilogy, in transferring the options to the numbered company and in subsequently selling its shares to Trilogy, he did not "transfer or otherwise dispose of" the options to Trilogy. If one looks solely at the form of the transaction the appellant's position is obviously correct. On the other hand the broad, "substance versus form" approach advocated by the Crown would involve essentially the erasure of the numbered company. The company, it is true, served no purpose other than that of a vehicle or repository for the options. Nonetheless it was not suggested that the transaction with 287495 Alberta Inc. was either a sham or legally ineffective. The company dealt with the options as its own and, in fact, subsequently agreed to their cancellation. While it might be tempting to excise what may be seen as an unnecessary proliferation of corporate entities, the principle that substance must prevail over form does not extend to the ignoring of legally effective relationships or properly constituted legal entities. Absent sham, the legally effective form of a transaction must, for income tax purposes, be respected.

In Canada v. Irving Oil Ltd., [1991] 1 C.T.C. 350, 91 D.T.C. 5106 (F.C.A.), the Federal Court of Appeal recognized the legal validity of relations with an offshore subsidiary whose sole raison d'être was to avoid tax. If anything, Irvcal’s ownership of the oil was far more tenuous and ephemeral than the numbered company's ownership of the options. Leave to appeal to the Supreme Court of Canada was denied.

The principle to be deduced from the authorities relating to substance versus form is simply this: the essential nature of a transaction cannot be altered for income tax purposes by calling it by a different name. It is the true legal relationship, not the nomenclature that governs. The Minister, conversely, may not say to the taxpayer "You used one legal structure but you achieved the same economic result as that which you would have had if you used a different one. Therefore I shall ignore thestructure you used and treat you as if you had used the other one”.

In light of these observations I cannot accept the respondent's position that the existence of and the legal relations with the numbered company can be ignored and the transaction treated as a direct sale of the options by the appellant to Trilogy.

The alternative position under section 6 was not pressed with vigour, and rightly so, in my view, in light of paragraph 7(3)(a). The grant by DEB of the options to the appellant was the type of agreement contemplated by subsection 7(3) and this fact alone displaces section 6. As it happens, however, paragraph 7(1)(b) was inapplicable. This in itself does not of course propel the taxpayer into section 6.

For all of the above reasons the appeal is allowed with costs and the assessment referred back to the Minister or National Revenue for reconsideration and reassessment to delete from the appellant's income for 1983 the sum of $69,238.

Appeal allowed.

Harvey A. McLachlin and Pearl-Anne Dick-McLachlin v. Her Majesty [Indexed as: McLachlin (H.A.) v. Canada]

Tax Court of Canada (O'Connor J.T.C.C.), August 5, 1993 (Court File Nos. 93-437, 93-505)

Income tax—Federal—Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

The appellants were husband and wife. During the 1987, 1988 and 1989 taxation years, the female appellant ("the wife") (a) in partnership with her husband owned until July 1989 a triplex ("the triplex"), two units being rented out and the third being occupied since sometime in 1984 until July 1987 as a principal residence; (b) also in partnership with her husband acquired land at Hurd's Lake, Ontario ("Hurd's Lake"), built a home thereon, apparently as a principal residence, then converted it to a duplex and rented out one storey, occupying since July 1987 the other storey as a principal residence; (c) operated a tax preparation business; and (d) was a real estate sales representative on a commission basis. In computing their income, the appellants claimed numerous deductions which were disallowed by the Minister. The items in dispute related to the disallowance of expenses generally, the calculation of a capital gain realized on the sale of one property, the capital cost of building a second property and whether interest on a loan was deductible.

HELD:

Although the decision related to numerous different items, many issues were resolved by agreement and others were of no particular interest. Those items of interest were as follows: (1) the appellants' expenditure of $4,670 in the 1987 taxation year for the replacement of carpeting and vinyl flooring with respect to the triplex was fully deductible in 1987 from the triplex rentals because the expenditure was in the nature of maintenance expense; (2) the appellants’ mileage expense of $1,062.92 with respect to Hurd's Lake was disallowed because of the lack receipts and the likelihood that the expenses were personal in nature; (3) the advertising and promotion expenses, the wage expense, and the office expenses claimed with respect to the wife's tax preparation business were not allowed because they were not supported by receipts; (4) the wife's claim with respect to the tax preparation business for capital cost allowance on the husband's car which the husband allegedly used to pick up tax returns was not allowed because the wife could not claim capital cost allowance on a vehicle owned by her husband;

(5) the wife was entitled to deduct $718.75 in 1987, $1,477.17 in 1988 and $945.13 in 1989 with respect to advertising and promotion expenses with respect to her real estate business because a deduction of five per cent of gross commissions was reasonable; (6) the wife was entitled to deduct 80 per cent of her automobile expenses for each of 1987, 1988 and 1989 with respect to her real estate business; and (7) the interest on the additional $26,905.56 by which the appellants increased their mortgage loan on the triplex was not deductible against the triplex because there was no evidence that it had been used for the purpose of earning income from a business or property; the interest was, however, deductible from the rentals at Hurd’s Lake. Appeal allowed in part.

Pearl-Anne Dick-McLachlin, agent for the appellants.

Heather Hemphill for the respondent.

O'Connor J.T.C.C.:—These matters were heard together and on common evidence by consent of the parties in Ottawa, Ontario, on July 12, 1993. They are appeals pursuant to the informal procedure of this Court and concern the appellants' 1987, 1988 and 1989 taxation years. The appellants are husband and wife.

During the whole or part of the years under review the appellant Pearl-Anne Dick-McLachlin ("Pearl"), (a) in partnership with her husband Harvey A. McLachlin ("Harvey") owned until July, 1989 a triplex at 98, 98A and 100 Graham Avenue, Renfrew, Ontario (“Graham Avenue"), two units being rented out and the third being occupied since sometime in 1984 until July 1987 as a principal residence; (b) also in partnership with Harvey acquired land at Hurd's Lake, Ontario ("Hurd's Lake’’), built a home thereon, apparently as a principal residence, then converted it to a duplex and rented out one storey, occupying since July 1987 the other storey as a principal residence; (c) operated a tax preparation business ("tax preparation business”); and (d) was a real estate broker on a commission basis ("real estate operation"). In filing income tax returns consider- able expenses have been claimed relating to the foregoing operations and many of those expenses have been challenged by the respondent. There were also disputes as to the calculation of the capital gain realized on the sale of Graham Avenue, the capital cost of the building at Hurd's Lake and whether interest on a certain loan was deductible from the rentals at Graham Avenue.

The sections of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") most relevant to the determination of the issues in this appeal are 18(1)(a), 18(1)(b), 18(1)(h), 20(1 )(a), 20(1)(c)(i) and 40(2)(b) which provide as follows:

18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part;

(h) personal or living expenses of the taxpayer, other than travelling expenses incurred by the taxpayer while away from home in the course of carrying on his business;

20(1) Notwithstanding paragraphs 18(1 )(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(a) such part of the capital cost to the taxpayer of property, or such amount in respect

of the capital cost to the taxpayer of property, if any, as is allowed by regulation;

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy),

40(2) Notwithstanding subsection (1),

(b) where the taxpayer is an individual, his gain for a taxation year from the disposition of a property that was his principal residence at any time after the date, (in this section referred to as the “acquisition date") that is the later of December 31, 1971 and the day on which he last acquired or reacquired it, as the case may be, is his gain therefore for the year otherwise determined minus that proportion thereof that

(i) one plus the number of taxation years ending after the acquisition date for which the property was his principal residence and during which he was resident in Canada,

is of

(ii) the number of taxation years ending after the acquisition date during which he

owned the property whether jointly with another person or otherwise;. . .

The issues are as follows. Some were resolved prior to and during the trial but all are mentioned so as to enable the Minister to make a complete reassessment.

1. With respect to Graham Avenue

(a) The parties disagree on the treatment of an expenditure by the appellants in the 1987 taxation year of $4,670 for the replacement of carpeting and vinyl flooring. The appellants desire to treat this as an expense deductible in 1987 and the respondent submits that it is a capital outlay principally because, in the respondent's submission, it was made to improve the property to make it more saleable. The property actually was sold in July 1989. The appellants have testified that the installation of the new carpeting and flooring was simply to replace the former items which had become worn and that the quality of the materials was equal rather than superior to that of the former items. They have also submitted as Exhibit A-1 a document signed by the installer, Mid-Town Flooring and Furnishings, supporting their testimony. The Court accepts the position of the appellants and, having reviewed the applicable authorities and jurisprudence, concludes that the expenditure of $4,670 was in the nature of a maintenance expense fully deductible in 1987 from Graham Avenue rentals.

(b) An earlier disagreement between the parties as to the fair market value of the lot remaining at Graham Avenue after the sale in 1989 has been resolved by both parties agreeing to an amount of $5,000.

(c) As to the calculation of the principal residence exemption in relation to the capital gain realized in 1989 on the sale of Graham Avenue the appellants submitted that they resided there for six months in 1987 and the respondent submits that it was only five months. The Court accepts the sworn testimony of Pearl that the period of residence was six months in 1987.

(d) A further disagreement as to the treatment of interest deductibility is dealt with in paragraph 5 below.

2. With respect to Hurd's Lake

(a) The respondent has allowed a previously disputed $400 expense for wood in 1987.

(b) The appellants and the respondent have agreed that the capital cost of the building at Hurd's Lake totals $62,642.86, one half, i.e., $31,321.43 for each of the two appellants.

(c) An additional maintenance expense of $93 raised at the hearing of this appeal has been allowed by the respondent.

(d) With respect to certain 1988 repair expenses at Hurd's Lake the difference between what the respondent would allow and what the appellants claimed was $296.34. The respondent was prepared to accept a figure of $148.17 and owing to the lack of receipts or indications of what the receipts represented the Court agrees that the correct figure be $148.17.

(e) Although not claimed on the appellants’ financial statements they have on the appeals claimed a mileage expense relative to Hurd's Lake of $1,062.92. This the respondent has refused and the Court, owing to lack of receipts and the likelihood that the expenses were personal in nature, agrees with the respondent.ip3. With respect to the taxation business carried on by Pearl:

(a) The respondent disallowed portions of "Advertising and Promotion" expenses claimed in the 1987, 1988 and 1989 years. The amounts disallowed were $269.35 in 1987; $1,169, $339.27 and $307.80 in 1988 and $931.09 in 1989. According to the evidence given by Ms. Christine Buck, auditor for the respondent who examined all available receipts and questioned Pearl on nonreceipted items, the amounts disallowed appeared to be of a personal as opposed to a business nature. The Court is prepared to accept the position of the respondent on all these expenses;

(b) The respondent disallowed a wage expense of $510 claimed in the 1987 year as no receipt or other evidence was submitted by Pearl; the latter main- tained that this item represented cash wages paid to a person who later moved abroad and could not be reached. It is the burden on the appellant to prove an expenditure and in the present instance this burden has not been discharged and consequently the disallowance of $510 is found to be correct;

(c) The respondent disallowed an amount of $1,000 claimed in each of the 1988 and 1989 years as capital cost allowance on Harvey's car which he allegedly used to pick up tax returns and other documents from clients of Pearl. This amount has been properly disallowed by the respondent because Pearl cannot claim capital cost allowance on a vehicle owned by her husband nor is she entitled to consider it a "freight" expense, as she suggested at trial, because no payment to the husband was made. Nor is Pearl entitled tothe additional mileage expense claims presented immediately prior to the trial of $1,152 for 1988 and $1,000 for 1989 because, in the Court's opinion, the respondent has properly allowed all claimable car expenses such as gas and oil bills and consequently the additional mileage expenses are not admissible;

(d) The respondent originally disallowed certain maintenance expenses claimed for 1988 but at trial reduced the total disallowed amount to $140. Owing to the fact that the receipts produced relative to this amount of $140 indicate they did not relate to the business, the disallowance of this amount of $140 is maintained;

(e) The respondent disallowed as office expenses an amount of $792.07 and a further claim of $386.13. The Court agrees with these disallowances owing to absence of receipts, or lack of indication on the receipts of details proving a business relationship or because it seems many items appear to be of a personal nature.

(f) A 1988 expense of $329 for a phone has been allowed by the respondent.

(g) A claim by Pearl for the capitalization of that portion of the Graham Ave. used as an office for the tax preparation business (i.e., '/3 of the unit occupied by the appellants as a principal residence) has been allowed by the respondent.

It must be noted that in agreeing with most of the respondent's disallowances, the Court has taken into consideration the relatively small gross revenues realized by Pearl's tax preparation business ($4,350 in 1987, $6,110 in 1988 and $7,185 in 1989) and the fact that the respondent has allowed numerous other deductions which were claimed.

4. With respect to the real estate operations carried on by Pearl

(a) The respondent has disallowed the following amounts claimed as "Advertising and Promotion", namely $1,041 in 1987 (of an amount claimed of $1,320.92), $2,516.16 in 1988 (of an amount claimed of $3,190.16) and $2,877 in 1989 (of an amount claimed of $2,877). The reasons for the disallowances are similar to those expressed above, namely the absence of receipts in some cases, lack of detail in others and a conclusion that the expenses were more of a personal than business nature in some cases.

In reviewing these items the Court recognizes that Pearl was essentially an independent real estate agent working strictly on a commission basis. She was responsible for her own advertising and promotion and she submits this involved entertaining clients, prospective clients and other contacts in the real estate field. In the circumstances the Court believes that some higher amount of the expenses claimed should be allowed in the circumstances. The Court observes that the gross commissions earned were $14,374.90 in 1987, $29,543.50 in 1988 and $18,902.70 in 1989. If a factor of five per cent of gross commissions, which the Court considers appropriate, were to be used the advertising and promotion expenses allowable would be $718.75 in 1987, $1,477.17 in 1988 and $945.13 in 1989. The Court considers this reasonable and so rules.

(b) The respondent has allowed 50 per cent of automobile expenses for each of 1987, 1988 and 1989 and Pearl claims 90 per cent. She points out that her car is indispensable to carry out her real estate duties and testified that she may have used it as much as 99 per cent for business purposes. The respondent points out that much of the travel relates to trips from Renfrew, where Pearl lived, to Ottawa and back and that a largeportion of those trips should be considered as personal driving to and from work as opposed to driving while working. Ottawa is not a major location for Pearl’s sales of real estate but she testified that she had to go there frequently to meet clients and contacts and arrange mortgage financing. The Court recognizes some validity in both positions and concludes that the proper percentage to be used is 80 per cent.

The Court also finds that the only individual items of car expense not allowed by the respondent of $750, $205.60 and $300 are to be allowed;

5. Deductibility of Interest

(a) In 1987 the appellants increased their mortgage loan on Graham Avenue from $43,094.44 to $70,000, an increase of $26,905.56 and they seek to deduct the interest on the said $26,905.56 from the rentals of Graham Avenue with respect to parts of 1987 and 1989 and all of 1988. The respondent has disallowed the deductions because they were not interest on money borrowed for the purpose of earning income from a business or property. What were the funds used for? Pearl testified that when the property was acquired in 1984 she alone out of her own available funds made the down payment of $15,375 and to that extent the additional funds borrowed were paid to her, i.e., not one half to her and one half to Harvey. In the Court's view this payment does not result in a conclusion that the interest on said amount constitutes interest on money borrowed to produce income. It would be different if she had originally borrowed the $15,375 with interest. In that event the $15,375 would be considered as replacement financing and the interest thereon would normally be deductible.

The balance of the $26,905.56, namely $11,530.56, the appellants submit was used to pay for repairs and maintenance, the acquisition of equipment and appliances and other miscellaneous items, all with regard to Graham Avenue. The respondent submits that most of the $26,905.56, and therefore, at the very least, the said $11,530.56 was used to construct the property at Hurd's Lake. This appears to be the case from an examination of withdrawals from the bank account into which the $26,905.56 was deposited. The respondent further argues that the rentals from Graham Avenue could easily have supported these expenses of $11,530.56 and that therefore there was no need to borrow. After considering the testimony and reviewing certain exhibits the Court concludes that the respondent is correct and that the interest on the $26,905.56 is not deductible from the Graham Avenue rents. The respondent agreed that such interest could be deducted from the rentals at Hurd's Lake.

(b) The respondent has attempted to allocate interest charged on two visa accounts and a checking account in each of the 1987, 1988 and 1989 years in varying percentages to the four operations discussed above. The amounts of interest (which are not great) have been agreed on but the respondent has assessed the said amounts as 25 per cent business and 75 per cent personal and based on the evidence submitted the Court finds the respondent's assessments correct.

Appeal allowed in part.