Date: 19980406
Docket: 96-3437-IT-G
BETWEEN:
JOHN DOUGLAS HUBBERT,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Sarchuk, J.T.C.C.
[1] These are appeals by John Douglas Hubbert (the Appellant)
from assessments of tax with respect to his 1989, 1991 and 1992
taxation years. In computing income for the 1989 taxation year,
the Appellant failed to report the gain realized in the amount of
$90,893 from the disposition of a property located at 5 Concorde
Place, Unit 1601, North York, Ontario (the property). In
computing income for the 1991 and 1992 taxation years, the
Appellant deducted the amounts of $11,400 and $9,600,
respectively, as carrying charges and claimed rental losses in
the amounts of $2,092 and $1,377, respectively.
[2] In reassessing the Appellant for the 1989 taxation year,
the Minister of National Revenue (the Minister) treated the sale
of the property as being on income account and included the gain
realized in the Appellant’s income. With respect to 1991
and 1992, the amounts deducted as carrying charges and rental
losses were disallowed by the Minister.
The Concorde Property Sale
[3] In 1985, the Appellant, a mechanical engineer, was
approached by Teron Developments to act as consulting engineer
for the design of a residential condominium project. His company
tendered a proposal and was awarded the contract. In 1986, just
prior to the commencement of construction, the Appellant decided
to purchase one of the units. The purchase price was $179,107 of
which $159,107 was financed by way of a vendor take back
mortgage.
[4] The Appellant’s unit was to be ready for occupancy
in December 1988. In September of that year, the project was
substantially completed, the first occupants began to move in and
it became apparent to the him that they were predominately of
Asian origin. He says that following discussions with his wife,
it was decided they did not want to live there as part of a
“minority group”. As a result, he spoke to the
developer’s sales manager and sought a release from his
obligations under the Agreement of Purchase and Sale. When that
was not forthcoming, he immediately retained a Chinese real
estate agent recommended by the manager and listed his unit for
sale. On January 3, 1989, the Appellant received and accepted an
offer for the condominium with occupancy to be taken by the
purchasers on April 1, 1989 (Exhibits A-2 and A-3). The sale
price was $270,000 plus the accrued interest on the original
deposit of $15,000.
[5] The Appellant asserts that his sole purpose in acquiring
the property was as a principal residence. It was, he said, a
good area, close to the neighbourhood in which he grew up. It had
features he sought such as a pool, spa and exercise facilities.
As well, because of his relationship with the developer, he was
able to buy a second parking stall and have both located side by
side in a preferred location. He maintains that he did not have
resale in his mind at the time of acquisition.
[6] I am unable to accept the Appellant’s assertions. An
examination of the Appellant’s personal and business
circumstances at the time of acquisition discloses the following.
He had been previously involved in new condominium projects and
had contracts with at least three such large developers. He was
aware of their practice with respect to
“predevelopment” sales and understood the value of
such a purchase in a rising real estate market. Indeed, he made
reference to advice received from a Teron employee (Wyatt) to the
effect that the predevelopment price available to him was a good
deal and that “prices would probably go up”. It is
also logical to infer that given his relationship with the
developer, the Appellant was aware of how Teron’s sales had
gone and what the market value of the units was in December 1988.
Last, the Appellant knew that the high interest rates of the
early 1980s had come down and agreed that the real estate market
had “just started to go up about a year earlier”.
[7] On the other hand, the reasons advanced by the Appellant
for the eventual abandonment of his stated intention were not
convincing. He testified that he was so certain that he did not
want to live in this unit that he sought to extricate himself
from his obligation to the developer. In cross-examination, the
following exchange took place:
Q. Now, and you have suggested that you saw this as being a
big problem?
A. I went to the sales manager for the Concorde Court property
and asked him, this fellow’s name was Al Decastro, and
asked him if there was a way to get out of this particular deal
and let them sell it to somebody else.
Q. So you were willing to walk away from the unit and have
them take it over?
A. Absolutely, absolutely.
Q. I would suggest that that is a little bit hard to believe,
given the fact that you had an agreement to buy the unit for
170,000 and yet apparently its market price was 270,000, so you
had $100,000 of profit there, yet you were willing to just let
the developer take the unit and sell it for whatever they could
get for it?
A. Absolutely, “Give me my money back and let me
go”.
[8] I find his assertions most difficult to accept. The
Appellant’s explanation that he did not wish to burden
himself with additional carrying costs[1] of an empty unit is simply not
credible given the nature of the market at that time.
Furthermore, if he truly intended this unit to be his principal
residence, one could expect to hear some testimony regarding any
plans for his current residence, but there was not a tittle of
evidence adduced in this regard. It also strikes me that if such
an offer had been made to Teron Development, it is unlikely that
the sales manager (who undoubtedly was aware that the market
value of the unit was almost $100,000 more than the
pre-construction price) would have rejected an opportunity
to make an additional profit for his employer.
[9] On balance, I am unable to accept the Appellant’s
stated intention with respect to the property in issue. As was
observed in Racine v. M.N.R.,[2]
... Generally speaking, a decision that such a motivation
exists will have to be based on inferences flowing from
circumstances surrounding the transaction rather than on direct
evidence of what the purchaser had in mind.
The inferences which can be drawn from the evidence before me
all point to the conclusion that the primary, if not the sole,
intention of the Appellant in purchasing the property was for
resale at a profit.
[10] Had I concluded otherwise and found that the gain
realized upon the disposition of the property was on capital
account, I would have in any event found that the capital gain in
the amount of $90,893 was properly included in the computation of
the Appellant’s income for his 1989 taxation year.
Subsection 110.6(6) of the Income Tax Act (the
Act) provides in part:
110.6(6) Failure to report capital gain.
Notwithstanding subsections (2)(2.1) and (3), where an individual
has a capital gain for a taxation year from the disposition of a
capital property and knowingly or under circumstances amounting
to gross negligence
...
(b) fails to report the capital gain in his return of
income for the year required to be filed pursuant to section
150,
no amount may be deducted under this section in respect of the
capital gain in computing his taxable income for that or any
subsequent taxation year and the burden of establishing the facts
justifying the denial of such amount under this section is on the
Minister.
I am satisfied that the Minister has met the onus.
[11] The Appellant testified that he had no idea why the
capital gain had been “left off the tax return”. He
testified that he had discussions with his accountant, Alan Noss
(Noss), with respect to this transaction when “they were
preparing the return”. He was not certain what documents,
if any, he gave them but did recall that: “I told him I
sold the thing and I made some money and he said: ‘How much
did you make, was it under $100,000? and I said: Yes, and then he
said: ‘Well then, don’t worry about, it’s
capital gains’”. The Appellant also testified that at
best, he made a very cursory examination of his return before he
signed it and that he “really didn’t go over
it”.
[12] The Respondent adduced evidence from Allan Noss, a
chartered accountant, and Frank Scolaro, a certified general
accountant, both of whom acted for the Appellant at the relevant
time. Scolaro has been responsible for preparing the
Appellant’s tax returns since 1970. Both testified that
they had no recollection of any discussion with respect to the
sale of the condominium. Both also testified that no advice was
given to Hubbert to the effect that it was not necessary to
report it. Noss further testified that had he been aware of the
sale of this property “I would have told him there was a
paper trail and he would be stupid ... and would have advised him
that he would blow the election”. Scolaro maintained that
he did not and would never counsel a client not to report
income.
[13] Hubbert cross-examined both witnesses and suggested that
their evidence was untruthful and that they were motivated to lie
because he had terminated their services in 1992 for excessive
billing. Both denied the allegations.
[14] I have considered the testimony of Noss and Scolaro,
their relationship with the Appellant, their attitude, the manner
in which they testified, as well as the probability of the facts
they have sworn to and have concluded that where there is a
conflict, I accept their testimony over that of the Appellant.
The Appellant’s allegations of bias are, in my view,
unfounded.
[15] On the general issue of the Appellant’s
credibility, two further points should be made. First, I have
substantial reservations regarding the testimony given by him
with respect to the acquisition and disposition of the
condominium unit. Second, in cross-examination, the Appellant
conceded that to obtain some tax relief with respect to another
matter, certain trust agreements were back-dated and signed by
him. He explained that the numbered companies which owned the
strip malls “were losing money” and that he and his
partner backdated a trust agreement in an attempt to
“recoup some of the losses personally because we were
bleeding to death”. Although the Appellant maintains that
he acted on the basis of professional advice, I am satisfied that
he was aware that the steps being taken were, to say the least,
questionable.
[16] The issue is whether the Appellant knowingly or under
circumstances amounting to gross negligence failed to report the
capital gain in issue. I am satisfied that the Appellant did not
advise his accountants with respect to the gain. On the evidence,
it is reasonable to infer that he did not intend to disclose this
gain and that his assertion that he did so on the advice of his
accountants was designed simply to conceal that fact. This
taxpayer is well-educated, has a great deal of business acumen,
and is reasonably knowledgeable with respect to tax matters. This
was not just a question of failing to exercise the care of a
reasonable man to review his tax returns before signing them.
Rather, the failure to report the capital gain was
deliberate.
[17] The Respondent also took the position that if the gain
realized by the Appellant on the disposition of the property had
been on capital account, it would not be subject to the rules
respecting a principal residence as described in section 40
of the Act. I agree, since the evidence quite clearly
established that the property was never his principal residence
as defined in subsection 54(g) of the Act.
Deduction of Carrying Charges
[18] In 1989, the Appellant and an associate purchased two
commercial properties in Sault Ste. Marie (strip malls). The
Appellant incorporated two companies, 761112 Ontario Limited and
746535 Ontario Limited (the companies), to purchase and hold his
interest in these properties. Both properties were encumbered by
mortgages obtained by the respective companies and in each
instance, the Appellant acted as guarantor.
[19] The Appellant testified that at the time of acquisition,
both properties were fully rented with well-established
tenants. Shortly thereafter, a downturn in the economy led to
closures of several businesses creating vacancies. Although
tenants had been lost, the Appellant felt that they “could
wait it out”. At some point of time, the companies were
either in default or were about to default on their payments of
principal and interest and the bank invoked its right against the
Appellant under the guarantees. He then utilized a personal line
of credit at the Royal Bank to obtain the funds required by the
companies. According to the Appellant, the amounts claimed as
carrying charges, $11,400 and $9,600, reflected the interest on
the amounts so borrowed against his line of credit. It was the
Appellant’s recollection that the funds so borrowed were
advanced to the two companies to enable them to make the
necessary payments. None of the relevant documents were produced
by the Appellant.
[20] It is the Minister’s position that the amounts
claimed by the Appellant as carrying charges/interest expense
were not incurred or, if incurred, were not incurred for the
purpose of gaining or producing income from a business or
property.
[21] The issue in this case is whether the payments made by
the Appellant were deductible pursuant to subparagraph
20(1)(c)(i) of the Act. The relevant portions of
that provision read:
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:
...
(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),
...
[22] As I understood the Appellant, the reason the funds were
borrowed was to preserve what he hoped would become
income-producing assets for the companies and ultimately, for
him. He did not dispute that the payments reflected his liability
for the companies’ indebtedness which arose out of his
guarantees of the mortgages.
[23] I should first observe that the evidence adduced as to
the actual quantum of the interest which related directly to the
monies borrowed was most unsatisfactory. The Appellant claimed
$11,400 and $9,600 in the years in issue. However, documents he
tendered prepared by the Royal Bank indicate that substantially
smaller amounts were paid by him as interest on his line of
credit.[3] His
explanations, a bald statement that the Bank was wrong, was
neither surprising nor acceptable.
[24] In 74712 Alberta Limited v. The Queen,[4] the corporate
taxpayer attempted to deduct interest paid on a loan obtained by
it to enable it to meet its guarantee of a bank loan owing by its
parent corporation. The taxpayer’s appeal was dismissed.
The headnote thereto summarized the ratio decidendi as
follows:
Because interest payments are usually made to increase the
capital holdings of taxpayers, the interest payment deduction
allowed by subparagraph 20(1)(c)(i) of the Act has
been strictly applied by the Courts. In this case, therefore, the
trial judge did not err in denying the deduction being sought,
either because the preservation of income-producing assets was
the true purpose of the loan, or because its true purpose could
be traced back to the reason for which the guaranty had
originally been given (which was not to obtain a credit facility
as the taxpayer had argued). The trial judge was correct in
concluding that the true purpose for the taxpayer’s loan
was to enable it to honour its guaranty, and not to be used
directly for the purpose of earning income from business or
property. Hence, the trial judge made no palpable and overriding
error.
I see nothing in the evidence adduced to distinguish the
Appellant’s situation from that of 74712 Alberta
Limited.
Rental Losses
[25] From 1989 to 1992, the Appellant reported rental income,
expenses and losses as follows:
|
Taxation Year
|
Income
|
Expenses
|
Net Loss
|
Appellant’s Portion (50%)
|
|
1989
|
$9,460.57
|
$24,927.95
|
$15,467.38
|
$7,733.69
|
|
1990
|
9,118.55
|
13,386.63
|
4,268.08
|
2,134.04
|
|
1991
|
5,156.10
|
9,341.11
|
4,185.01
|
2,092.51
|
|
1992
|
4,937.00
|
7,691.00
|
2,754.00
|
1,377.00
|
These rental losses were claimed in respect of a condominium
located at 20,000 Gulf Blvd., Unit 503, Florida (the
property). This property was owned 50% by the Appellant and 50%
by his spouse. It is not disputed that it was also used by them
as a vacation property.
[26] The Minister’s position was that the expenses were
not incurred for the purpose of gaining or producing income from
a business or property, in that the Appellant had no reasonable
expectation of profit in the years in question. The
Appellant’s testimony consisted of a brief history of the
acquisition, use of, and ultimate disposition of the property to
a holding company, as well as an assertion that the property had
produced a net profit in taxation year 1993. No supporting
documents were tendered. Although this testimony was lacking in
detail and substance, Counsel for the Respondent chose not to
cross-examine the Appellant. The only other evidence available to
the Court was the reported rental incomes, expenses and losses
previously referred to. I do note that the net loss in 1989 was
in excess of $15,000 and had been reduced to $2,754 by 1992. How
this was achieved is not known. Nonetheless, albeit not without
some misgivings, I have concluded that the Appellant has made out
his case and the losses as claimed will be allowed.
[27] The appeal for the 1989 taxation year is dismissed, with
costs to the Respondent, and the rental losses claimed by the
Appellant for the 1991 and 1992 taxation years are allowed.
Signed at Ottawa, Canada, this 6th day of April, 1998.
"A.A. Sarchuk"
J.T.C.C.
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