Date: 19980817
Docket: 96-256-IT-G
BETWEEN:
VIVIAN McGREGOR,
Appellant,
And
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
BOWIE J.T.C.C.
[1] These appeals are from reassessments for income tax for
the taxation years 1991, 1992 and 1993. The Minister of National
Revenue reassessed the Appellant for those years to disallow his
claim to be entitled, in computing his income under section 3 of
the Income Tax Act (the Act), to deduct from his
other income certain losses which he claims to have sustained in
the course of renting three houses owned by him. The losses
disallowed are $53,138 for 1991, $47,089 for 1992 and $37,791 for
1993.
[2] The Appellant first purchases a house for the purpose of
renting it in 1977 or 1978. He owned this house for about seven
years as a rental property before selling it. He next acquired a
rental property in 1988. Soon after, he acquired two more. The
Appellant apparently claimed a rental loss in reporting his
income for 1987, but the evidence does not reveal how this could
be so if in fact he did not own a rental property between 1985
and 1988. This is only one of the aberrations in the
Appellant’s evidence.
[3] The particulars of these purchases, so far as I can glean
them from the evidence, are these. In 1988 the Appellant
purchased 708 Mountain View Place, Newmarket. I shall refer to it
as property #1. He paid $159,000, of which $124,000 came from a
first mortgage at 12.5% per annum, and $24,000 from a second
mortgage. The interest rate on the second mortgage is unknown.
The Appellant paid some $15,000 from his own resources for the
balance of the purchase price, and the other closing costs.
[4] In 1989 he purchased 640 Mountain View Place for $205,000
and $153,650 came from a first mortgage at 13.75% per annum and
$25,000 from a second mortgage at 13.75% per annum. The Appellant
paid approximately $26,000 from his own funds. I shall call this
property #2.
[5] Also in 1989, he purchased 48 Seacliff Blvd., North York.
He paid $239,000 for it, of which $167,300 came from a first
mortgage at 12% per annum, and $31,000 came from a second
mortgage at 18% per annum. The Appellant’s equity therefore
was about $41,000 in this property. I shall call this property
#3.
[6] The Appellant’s evidence concerning the rents he was
able to charge for these properties was vague at best, as was his
evidence as to the precise time for which they were not fully
rented. It appears, however, that the monthly rental potential of
the properties was about $1,650 for property #1, $1,500 for
property #2, and about $1,600 for property #3 after the
Appellant had paid to have a second rental unit created in the
basement of it. The property taxes were about $1,500 per year for
each. From these figures it is clear that none of these
properties individually was capable of producing revenues
sufficient to pay even the mortgage interest and taxes at the
outset, even if the Appellant had been able to keep them rented
for the full 12 months throughout the year.
[7] In fact, between 1987 and 1997 the Appellant claimed to
have sustained losses totalling $425,235 from this so-called
rental business. The smallest loss was $12,826 in 1996, but the
following year it rose again to $29,738. I say that he claimed
these losses, because the Minister did not accept that they had
been satisfactorily established, and that was put in issue by the
pleadings. No evidence of these expenses, other than vague oral
assertions by the Appellant, was offered at the trial.
[8] The Appellant, throughout his evidence-in-chief, asserted
several times that he had a plan to make a profit from these
rental properties, and that according to that plan they would
become profitable after about five or six years. At one point he
testified that he had such a plan in writing, although,
inexplicably, he had not brought it with him, nor apparently had
he shown it to his counsel. I do not accept the Appellant’s
statement that he had a business plan. I consider all of the
Appellant’s evidence to be unsatisfactory in the extreme.
Not only was it vague and unsupported by the documents which
anyone carrying on a business would be expected to keep, but it
was at times contradictory. At its highest, it was
self-serving and uncorroborated in any way. On more than
one occasion it was apparent that it was simply incorrect, either
deliberately, or perhaps through carelessness. As a result I am
left with no clear picture of the expenses actually incurred by
him in connection with these properties. If they have been
overstated by him, and as a result the losses are exaggerated,
then he is the author of his own misfortune, because I have
concluded, at least in part on the basis of the long and unbroken
string of very large losses claimed by him, that the Appellant
could have had no reasonable expectation of profit in connection
with these properties, and that he consequently had no business,
and no source of income therefrom.
[9] Mr. McCool suggested in argument that I should consider
this case to be similar to Tonn v. Canada[1], wherein the Federal
Court of Appeal found that the Appellants did in fact have a
business, albeit an unprofitable one, and that their rental
business could have been expected to show a profit, and would
have done so but for unforeseen misfortunes. He asked me to
consider that similar unforeseen circumstances were all that
stood between this Appellant and a rosy financial future, and
that he too, to use Linden J.’s words, should not be
penalized for an honest error in judgment.
[10] In my view, there is no similarity between this case and
Tonn. In that case the Appellants were reassessed for the
years 1989, 1990 and 1991, in respect of a property which they
had acquired in 1989. The Court found that they had a plan,
although rudimentary. It also found that there were factors
beyond their control which led to the failure to make a profit.
In the present case I find that the Appellant had no plan by
which he was going to make a profit from this venture. He was
asked repeatedly by his own counsel to describe the plan, and
could say nothing more than that he intended to make $5,000 or
$6,000 per year after five years. He could say nothing about
how that would be done, other than that he would pay down the
mortgages and thus reduce his expenses. I shall return to this
shortly.
[11] The Appellant, unlike the Tonn Appellants, has
generated an unbroken string of losses for 11 years, according to
a summary accepted by him and by his counsel during the course of
the trial. Nor has he given any convincing evidence of unforeseen
events which derailed his plan for profitability. He spoke in the
vaguest possible terms of tenants leaving, and of having to have
some tenants removed for non-payment of their rent. These, of
course, are among the usual hazards of the property rental
business. The evidence does not convince me that the Appellant
was subject to these problems to any greater degree than is
normal.
[12] I return to the Appellant’s stated intention to pay
down the mortgages. First, there is no plan to indicate how much
he had intended to pay down, or what the source of the funds
would be. Second, there was no clear evidence as to how much was
in fact paid down, or when. It appears that he did make some
lump-sum payments on the mortgages from time to time, but the
evidence is unclear, imprecise, and unsupported by a single scrap
of paper. Third, the Appellant did indicate that at least some of
the lump-sum payments on the mortgages came from the very
substantial income tax refunds which the Appellant obtained as a
direct result of the losses he claimed to offset against his
income from a full-time factory job in the automobile industry.
It may be that some of these amounts did in fact come from his
paycheques, but it is a fair inference, I think, that the
payments would not have been made but for the tax refunds, or if
they were, they would have been of much smaller amounts.
[13] In Mohammad v. The Queen,[2] the Federal Court of
Appeal addressed the subject of rental properties purchased by
means of such high ratio financing as to render profit, at least
in the initial years, impossible. Robertson J., for a unanimous
court, said at pp 5505-6:
Frequently, taxpayers acquire a residential property for
rental purposes by financing the entire purchase price.
Typically, the taxpayer is engaged in unrelated full-time
employment. Too frequently, the amount of yearly interest payable
on the loan greatly exceeds the rental income that might
reasonably have been earned. This is true irrespective of any
unanticipated downturn in the rental market or the occurrence of
other events impacting negatively on the profitability of the
rental venture, e.g., maintenance and non-capital repairs. In
many cases, the interest component is so large that a rental loss
arises even before other permissible rental expenses are factored
into the profit and loss statement. The facts are such that one
does not have to possess the experience of a real estate market
analyst to grasp the reality that a profit cannot be realized
until such time as the interest expense is reduced by paying down
the principal amount of the indebtedness. Bluntly stated, these
are cases where the taxpayer is unable, prima facie, to satisfy
the reasonable expectation doctrine. These are not cases where
the Tax Court is being asked to second-guess the business acumen
of a taxpayer whose commercial or investment venture turns out to
be less profitable than anticipated. Rather these are cases
where, from the outset, taxpayers are aware that they are going
to realize a loss and that they will have to rely on other income
sources to meet their debt obligations relating to the rental
property.
After speaking of the specific facts relating to the financing
in that case he went on to say at pages 5506-7:
The above analysis is to the effect that there can be no
reasonable expectation of profit so long as no significant
payments are made against the principal amount of the
indebtedness. This inevitably leads to the question of whether a
rental loss can be claimed even though no such payment(s) were
made in the taxation years under review. I say yes, but not
without qualification. The taxpayer must establish to the
satisfaction of the Tax Court that he or she had a realistic plan
to reduce the principal amount of the borrowed monies. As every
homeowner soon learns, virtually all of the monthly mortgage
payment goes toward the payment of interest during the first five
years of a twenty to twenty-five year amortized mortgage loan. It
is simply unrealistic to expect the Canadian tax system to
subsidize the acquisition of rental properties for indefinite
periods. Taxpayers intent on financing the purchase of a rental
property to the extent that there can be no profit,
notwithstanding full realization of anticipated rental revenue,
should not expect favourable tax treatment in the absence of
convincing objective evidence of their intention and financial
ability to pay down a meaningful portion of the purchase-money
indebtedness within a few years of the property's
acquisition. If because of the level of financing a property is
unable to generate sufficient profits which can be applied
against the outstanding indebtedness then the taxpayer must look
to other sources of income in order to do so. If a taxpayer's
other sources of income, e.g., employment income, are
insufficient to permit him or her to pay down purchase-money
obligations then the taxpayer may well have to bear the full cost
of the rental loss. Certainly, vague expectations that an
infusion of cash was expected from Aunt Beatrice or Uncle Bernie
will not satisfy the taxpayer's burden of proof. In practice,
the taxpayer will discharge that burden by showing that
significant payments were in fact made against the principal
indebtedness in the taxation years closely following the year of
purchase.
...
I would also point out that it is difficult to accept that
interest being paid on money borrowed to acquire a capital
property can be characterized as a "start-up" cost of
the kind contemplated by this Court in Tonn, supra. This is not
to deny that in other circumstances non-capital start-up costs
may help explain, in part, why a taxpayer's rental venture
was unprofitable. The reality is that it is much easier for
taxpayers to satisfy the Moldowan test and claim a rental loss
where the property was acquired without high-ratio financing:
[14] The evidence in the present case falls far short of
discharging the burden of proof of which Robertson J. speaks
there. I infer from the Appellant’s evidence that the
primary source of funds to pay down the mortgages, to the extent
that they were paid down at all, was the tax refunds to which I
have referred. It is obvious that the Moldowan[3] burden of proving a
reasonable expectation of profit cannot be satisfied by a plan
which relies on the tax advantage of the losses in order to
achieve profitability. In any event, even with the advantage of
those losses for 11 years the Appellant has not been able to
achieve profitability, nor is there any objective sign that he
ever will.
[15] In addition to the history of profit and loss, and the
ability of the business to show a profit as structured, and the
ability and training of the taxpayer to engage in the business,
referred to by Dickson J. in Moldowan, the courts have
looked to such additional factors as the persistence of the
factors causing the losses, the presence or absence of planning,
and failure to adjust, when assessing whether or not an
enterprise has a reasonable expectation of profit.[4] In the present case
none of those factors can be invoked by the Appellant. I have
referred already to the absence of anything that could be called
a real plan. There is no evidence to suggest that the Appellant
took steps to adjust to the difficulties he had encountered,
other than the evidence to which I have alluded above about him
making lump-sum payments on the mortgage.
[16] In short, the Appellant may well have hoped that profits
would somehow materialize, but the assessment of the
reasonableness of the expectation of profit must be done on an
objective and not a subjective basis. No objective observer could
have concluded during the years under appeal that these rental
properties, or even any one of them, could be expected to show a
true profit, after capital cost allowance is taken into account,
in the foreseeable future.
[17] The appeals are dismissed, with costs.
Signed at Ottawa, Ontario, this 17th day of August, 1998.
"E.A. Bowie"
J.T.C.C.
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