Date: 20000919
Docket: 98-2386-IT-G
BETWEEN:
KLAUS SUDBRACK,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1] These appeals are from assessments for the appellant's
1994 and 1995 taxation years.
[2] A number of issues are raised, as follows:
(a) Whether the Minister was justified in allowing the
appellant only 85% of the interest expenses claimed by him in
respect of money borrowed for the renovation of a house to be
used as a country inn.
(b) Whether the Minister was justified in restricting the
appellant's losses from the operation of the country inn on
the basis that the entire inn was a self-contained domestic
establishment within the meaning of subsection 18(12) and
section 248 of the Income Tax Act and the business
part of the property was a work space within that self-contained
domestic establishment.
(c) Whether the Minister was justified in disallowing the
appellant's claim for investment tax credits on the basis
that the kitchen that was added to the inn was not qualified
property for the purposes of subsection 127(9) of the
Act because it was not a building or machinery and
equipment to be used primarily for the purpose of manufacturing
or processing of goods for sale or lease.
(d) Whether the appellant is entitled to capital cost
allowance on the basis that his cost of renovating the house,
including the addition of the kitchen, comprising the building
(class 1) and the equipment (class 8) was as claimed
$200,473.63 or $170,402.59 as computed by the Minister, on the
basis that 85% of the use of the inn was for business purposes
and 15% was personal, for the purposes of
paragraph 13(7)(c) of the Act.
(e) Whether the losses claimed should be allocated to the
appellant and his spouse Petra on a 50:50 basis, on the ground
that the appellant and his spouse were partners.
[3] It is alleged in the notice of appeal that the appellant
purchased a large older home in 1991 and moved it to the edge of
Little Shemogue Harbour, New Brunswick. This allegation is
denied. The house was acquired and moved as stated but title was
held by the appellant's wife Petra. There is no suggestion
that she held it in trust for the appellant.
[4] Although there was conflicting evidence on this point I
find as a fact that the primary intention was to develop the
property into a tourist facility, specifically a guest home
(Gasthaus) or country house known as The Little Shemogue Country
Inn which would serve meals and provide sleeping
accommodation.
[5] Extensive renovations were made to the house. Five
bedrooms with adjoining bathrooms were installed for guests. A
new kitchen was added and three dining rooms. A private living
area was installed for Mr. and Mrs. Sudbrack consisting of a
bedroom, living area, bathroom and two bedrooms in an attic for
their daughters. It is accepted that this area made up about 15%
of the total area of the house.
[6] The construction of the kitchen, which was an addition to
the house and which was about 17% of the entire area, cost
$29,432. Mr. Sudbrack stated that of this amount over
$20,000 related to equipment (class 8). On cross-examination
however he admitted that a significantly greater portion was
attributable to the construction of the building
(class 1).
[7] I turn now to a consideration of each of the issues.
[8] The appellant borrowed $100,000 from the Bank of Montreal
to do the renovations. 15% of the entire area was the private
living area for Mr. and Mrs. Sudbrack. Counsel for the
appellant argued that for safety and security reasons Mr. and
Mrs. Sudbrack had to live on the premises. Moreover it was
apparently a requirement of provincial law that they do so.
[9] I accept that Mr. and Mrs. Sudbrack lived at The
Little Shemogue Country Inn as a matter of practical, economic
and legal necessity. Does it follow from this finding that all of
the cost of renovation, including the interest on borrowed money,
is attributable to the business that was carried on? It
frequently happens that a person may occupy a living space that
is contiguous to the area where that person's business is
carried on. A professional person for example, such as a doctor
or lawyer, may practice his or her profession in a portion of
their residence. In this case the necessity for living at the inn
is considerably more compelling than in the case of the doctor or
dentist who practices out of his or her home. Nonetheless, here
we have a separate living area for the family and, whatever may
have been the practical or legal considerations that compelled
the Sudbracks to live at the inn, they had to live somewhere and
I do not think that the Minister was unreasonable in allocating
15% of the interest expense to personal use. Subsection 4(1)
of the Act requires a reasonable allocation of deductions
to particular sources and an allocation based on the area of the
personal living space strikes me as reasonable. This disposes of
the factual issue.
[10] The legal issues raised by counsel for the appellant are
a little more complex. Counsel points to the words in
subparagraphs 20(1)(c)(i) and (ii):
(c) An amount paid in the year or payable in respect of
the year ... pursuant to a legal obligation to pay interest
on
(i) borrowed money used for the purpose of earning income from
a business or property ...,
(ii) an amount payable for property acquired for the purpose
of gaining or producing income from the property or for the
purpose of gaining or producing income from a business
...
[11] From these words he argues that as a matter of law no
allocation is permissible or, at all events, since the housing
accommodation in the inn was inextricably bound up with the
business, the entire amount of interest is deductible. I have
dealt with the latter argument above.
[12] So far as the pure legal matter of statutory
interpretation is concerned, the opening of section 20
contains the words
... or such part of the following amounts as may
reasonably be regarded as applicable thereto.
[13] Counsel compares paragraph 20(1)(c) with
paragraph 13(7)(c) and observes that the latter
explicitly requires an apportionment between business and
non-business use of depreciable property.
[14] The opening words of section 20 have, in my view,
precisely the same purpose and effect with respect to interest
expense.
[15] I have read the article by John R. Owen in the
Canadian Tax Journal (2000, Volume 48, Issue Number 2),
"Subparagraph 20(1)(c)(i): What Is Its
Purpose?" With respect, I do not agree that that article
supports the view that where borrowed money is used for both a
business and non-business purposes,
subparagraph 20(1)(c)(i) authorizes no apportionment
between the two.
[16] The Minister restricted the appellant's losses under
subsection 18(12). That provision reads:
Notwithstanding any other provision of this Act, in computing
an individual's income from a business for a taxation
year,
(a) no amount shall be deducted in respect of an
otherwise deductible amount for any part (in this subsection
referred to as the "work space") of a self-contained
domestic establishment in which the individual resides, except to
the extent that the work space is either
(i) the individual's principal place of business, or
(ii) used exclusively for the purpose of earning income from
business and used on a regular and continuous basis for meeting
clients, customers or patients of the individual in respect of
the business;
(b) where the conditions set out in subparagraph
(a)(i) or (ii) are met, the amount for the work space that
is deductible in computing the individual's income for the
year from the business shall not exceed the individual's
income for the year from the business, computed without reference
to the amount and sections 34.1 and 34.2; and
(c) any amount not deductible by reason only of
paragraph (b) in computing the individual's
income from the business for the immediately preceding taxation
year shall be deemed to be an amount otherwise deductible that,
subject to paragraphs (a) and (b), may be deducted
for the year for the work space in respect of the business.
Subsection (b) was amended applicable to 1995. Prior to
that it read:
(b) where the conditions set out in subparagraph
(a)(i) or (ii) are met, the amount for the work space that
is deductible in computing the individual's income from the
business for a taxation year shall not exceed the
individual's income from the business for the year, computed
without reference to the amount.
[17] "Self-contained domestic establishment" is
defined in section 248 as follows:
"self-contained domestic establishment" means a
dwelling-house, apartment or other similar place of residence in
which place a person as a general rule sleeps and eats.
The French version (établissement domestique autonome)
is as follows:
“ établissement domestique
autonome ” Habitation, appartement ou autre logement
de ce genre dans lequel, en règle générale,
une personne prend ses repas et couche.
[18] The first question is what is the self-contained domestic
establishment: the living quarters of Mr. and Mrs. Sudbrack
and their family or the inn as a whole?
[19] I think the better view, on the facts of this case, is
that the separate living quarters of the family, which are
essentially a separate apartment within the inn, constitute the
self-contained domestic establishment. This appears to be the
more reasonable approach and is, I believe, more consonant with
what subsection 18(12) is seeking to achieve. Counsel for
the Appellant referred to a decision of the Supreme Court of
Canada in Bell v. Ontario (Human Rights Commission),
[1971] S.C.R. 756. That case dealt with the meaning of
"self-contained dwelling". It is not of much assistance
in this case because here we are dealing with a statutory
definition.
[20] The Crown's position is that the inn as a whole is
the self-contained domestic establishment. Tab 17 of
Exhibit R-1 contains a detailed summary of the adjustments
made under subsection 18(12). It allocates between expenses
not related to the work area and the expenses related to the work
area. No challenge is made to the arithmetical calculation if the
fundamental assumption that the self-contained domestic
establishment is the inn as a whole and the "work
space" in that self-contained domestic establishment is the
inn as a whole as well is correct.
[21] In my view that basic assumption is wrong. The
self-contained domestic establishment is the family apartment.
Moreover, if the inn as a whole is the "work space"
that work space is "the individual's principal place of
business". Accordingly there is, in effect, excised from the
area to which the limitation in paragraph (a) applies
the 85% of the inn in which the family does not live.
[22] The work space within the "self-contained domestic
establishment" (the family apartment) would consist of the
kitchen which served the dual function as the family cooking
space and the restaurant cooking space and the small room where
Mr. Sudbrack kept his computer, records and other equipment
for the purposes of the business.
[23] The result of this is that the disallowances for 1994 and
1995 under subsection 18(12) of $15,767.39 and $13,302.71[1] (which the
respondent concedes may be carried forward to later years under
subsection 18(12)) will need to be reduced. I do not propose
to attempt this calculation, but the amounts disallowed would
need to be reduced by at least 85%. If the parties cannot agree
on the figures the amounts disallowed under
subsection 18(12) will have to be reduced by 85%.
[24] The third issue is the matter of the ITCs. In 1994 the
appellant claimed $4,414.77 as ITCs in respect of the cost of the
addition of the kitchen and the equipment relating thereto.
[25] The question is whether the kitchen and the kitchen
equipment are qualified property as defined in
subsection 127(9) which reads in part as follows.
"qualified property" of a taxpayer means property
(other than an approved project property or a certified property)
that is
(a) a prescribed building to the extent that it is
acquired by the taxpayer after June 23, 1975, or
(b) prescribed machinery and equipment acquired by the
taxpayer after June 23, 1975,
that has not been used, or acquired for use or lease, for any
purpose whatever before it was acquired by the taxpayer and that
is
(c) to be used by the taxpayer in Canada primarily for
the purpose of
(i) manufacturing or processing goods for sale or lease,
...
[26] Within that definition the only questions are:
(a) Whether the addition of the kitchen involves the
construction of "a ... building ... to be used by
the taxpayer in Canada primarily for the purpose of manufacturing
or processing goods for sale or lease".
(b) Whether the kitchen equipment is "machinery and
equipment to be used by the taxpayer in Canada primarily for the
purpose of manufacturing or processing goods for sale or
lease".
[27] It is, I believe, settled that preparation of food for
immediate consumption is manufacturing or processing goods for
sale — Burger King Restaurants of Canada Inc. v. R.,
[1997] 1 C.T.C. 2058; affirmed [2000]
2 C.T.C. 1.
[28] This does not however conclude the matter. The kitchen is
not a separate building. It is part of the inn and it takes up
about 17% of the space of the entire building. The Federal Court
of Appeal has decided in Burger King Restaurants as well
as Mother's Pizza Parlour (London) Ltd. et al. v. The
Queen, [1988] 2 C.T.C. 197, that in determining
whether a building is used primarily for a particular purpose one
must compare the percentage of space devoted to that purpose with
the area of the whole building. Since the kitchen space does not
come near 50% of the area of the entire inn the claim for ITCs in
respect of the structural part of the kitchen must be
rejected.
[29] The kitchen equipment is another matter. I find as a fact
that the cooking and refrigeration and other kitchen equipment
meet the tests in subsection 127(9) and the cost of this
equipment qualifies for the ITC. On reassessment the Minister can
determine the portion of the cost attributable to the
equipment.
[30] The appellant was allowed to claim capital cost allowance
on only 85% of the cost of the inn and the moveable property on
the same basis as the interest expense was reduced by 15%. The
same reasoning applies to the claim for capital cost allowance
under paragraph 13(7)(c).
[31] Finally, I come to the question whether the losses from
the business should be divided between the appellant and his
spouse, on the basis that they were partners. The conclusion that
they were partners is not difficult. They obviously were.
Mrs. Petra Sudbrack worked full time at the inn and devoted
a large part of her time to preparing gourmet meals. The property
was registered in her name and there is no suggestion that she
held it in trust for her husband. I think the finding of fact
that is most consonant with the evidence is that Mr. and
Mrs. Sudbrack carried on the business of the inn as partners
("the relation that subsists between persons carrying on a
business in common, with a view of profit") and that they
held the inn as partnership property.
[32] The more difficult question is whether the Crown can
raise the argument at this point, having assessed
Mr. Sudbrack as a sole proprietor. Ever since M.N.R. v.
Pillsbury Holdings Ltd., 64 DTC 5184, it has been
assumed that the Crown could raise alternative bases for
supporting an assessment even though they were not considered
when the assessment was made. The onus, of course, lay upon the
Minister to establish that alternative basis.
[33] Doubt was cast on this long-standing belief by the
decision of Bastarache J. in The Queen v. Continental
Bank of Canada, 98 DTC 6501 at 6504-5. In that case
the Crown in the Supreme Court of Canada sought to advance a new
argument in support of the assessment. Bastarache J. held
that it could not do so. This is I think simply a restatement of
the principle that new arguments cannot be raised at an appellate
level that were not raised at trial. Simple procedural fairness
requires that one party cannot raise at an appellate level an
argument in respect of which the other party had no opportunity
to call evidence at trial. Here the question of the partnership
between the appellant and his wife was raised in the reply to the
notice of appeal.
[34] I do not think that the Minister is precluded from
raising the point. In this I am in respectful agreement with the
reasoning of Bonner J. in Smith Kline Beecham Animal
Health Inc. v. The Queen, 2000 DTC 1526. At
page 1530 he said:
[14] In my view Continental Bank was never authority
for the proposition that the Minister is, when defending an
appeal from an assessment after the expiry of the
subsection 152(4) period, confined within a conceptual
prison called "basis of assessment" comprising only the
facts and statutory provisions relied upon by the assessor. In my
view Continental Bank is an application of the
long-standing rule governing litigation in appellate courts which
rule prevents litigants from raising points on appeal which were
not pleaded and argued in the trial court. Appellate courts
cannot be expected to deal with a new issue on appeal resting on
an evidentiary record which is deficient by reason of the failure
to plead and direct evidence to that issue. Here the Respondent
seeks leave to amend well before the commencement of the trial.
The situation is in no way analogous to Continental
Bank.
[15] Furthermore, nothing said in Continental Bank
suggests that subsection 152(4) has a bearing on the amendment
which the Respondent seeks. Subsection 152(4) restricts the right
of the Minister to "... reassess or make additional
assessments, or assess tax, interest or penalties ...".
The amendment now in question would not effect a reassessment of
tax. Rather it is an attempt to defend the existing assessment of
tax by asserting that, on the facts already pleaded, liability is
imposed by a provision of the Act other than that relied
on by the assessor.
[16] It is long-settled law that the validity of an assessment
depends on the application of the statute to the facts and not on
the assessor's analysis. It is, I believe, unlikely that it
was the intention of the Court in Continental Bank (supra)
to overrule decisions such as Minden (supra) and
Riendeau (supra) without referring to them. Accordingly, I
am of the opinion that nothing said in Continental Bank
can apply to prevent the Minister from relying on
section 245 in the present case.
[35] Judge Bonner's decision was affirmed by the Federal
Court of Appeal on the basis of subsection 152(9), but
without disapproving of his reasoning independently of
subsection 152(9).
[36] Even if I were wrong in restricting the reasoning in
Continental Bank to the ambit suggested by Bonner J.,
with whose reasons I agree, subsection 152(9) would permit
the respondent to raise the partnership argument.
[37] I think that the losses should be divided between the
appellant and Mrs. Sudbrack.
[38] The appeals are allowed and the assessments are referred
back to the Minister of National Revenue for reconsideration and
reassessment in accordance with these reasons.
[39] Success is divided and accordingly I make no order for
costs.
Signed at Ottawa, Canada, this 19th day of September 2000.
"D.G.H. Bowman"
A.C.J.
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