Date: 19980416
Docket: 97-3540-IT-I
BETWEEN:
CLIVE THOMSON,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Rip, J.T.C.C.
[1] Clive Thomson ("appellant") has appealed income
tax assessments for 1992, 1993 and 1994 so that in computing his
income for each year he be entitled to deduct expenses incurred
in the operation of a "Bed and Breakfast" in Sydenham,
Ontario, approximately 25 kilometres north of Kingston. The
appellant says he is permitted to deduct their expenses in
computing his income in accordance with paragraph 12(1)(a)
of the Income Tax Act ("Act") since they
were incurred for the purpose of earning income from a business
or property. The Minister of National Revenue
("Minister") disallowed the expenses since they were
personal or living expenses as defined by subsection 241(1) of
the Act and therefore not deductible (paragraph
18(1)(h)).
[2] Mr. Thomson and his partner, David Beecroft, purchased a
Victorian era four-bedroom house ("property") in 1985
for $130,000, of which they paid $30,000 or $40,000 in cash and
the balance was paid by loan secured on a mortgage on the
property. The appellant and his partner made extensive
renovations to their property. The property was also the
principal residence of the appellant and Mr. Beecroft.
[3] In 1986, the appellant and Mr. Beecroft began to rent out
rooms and serve breakfast ("Bed and Breakfast") on the
property under the name known as North Shore Bed and
Breakfast ("North Shore").
[4] The property was on a lakefront and offered both summer
and winter activities to guests of North Shore.
[5] The house, itself, was built in about 1862. The
neighbouring area offered many recreational and tourist
facilities and attractions.
[6] The area of the house was approximately 3,500 square feet;
this included a screened area of about 500 square feet used as a
sun room where breakfast was served during the summer. The house
contained four bedrooms, two of which were available to guests.
One guest-room had a double bed and the other guest-room
had three beds. The appellant and his partner had complete use of
all areas of the house, except for the use of guest-rooms when
they were rented.
[7] When the appellant and Mr. Beecroft purchased the
property, they intended to open a Bed and Breakfast and to retire
to the property, said Mr. Thomson. Their "approximate
idea", declared Mr. Thomson, was "aiming" to make
it profitable. They attended a seminar in Kingston on how to
advertise a Bed and Breakfast and consulted other Bed and
Breakfast operations in the area. They also advertised
extensively in leading magazines catering to people who would be
attracted to the type of property owned by the appellant. Local
newspapers featured articles on North Shore.
[8] Mr. Thomson stated that a typical profile of an owner of a
Bed and Breakfast operation is one who owns the property and also
has another occupation. In the case of the appellant, at all
relevant times he was a professor of French at Queen's
University; Mr. Beecroft was also employed.
[9] Two or three years after the North Shore commenced
operation Messrs. Thomson and Beecroft realized that for a
profit to be gained from the property the guest-rooms would have
to be rented for at least 100 nights a year. During the first
year of operation, the Bed and Breakfast generated approximately
$1,500 in income; Mr. Thomson believes that perhaps the rooms
were rented for 30 nights during that year. In 1993, he said, 200
couples rented the guest-rooms for approximately 100 nights;
there were twelve guests between January and April and ten
between October and December. He said his best year was 1989. Mr.
Thomson "started off" in the 1980’s renting the
room with three beds for $40 a night. In 1994 the North Shore
charged $54 for the guest-room with the double bed and $57
for the room with three beds. In none of the years did the North
Shore have a profit. Mr. Thomson believes no profit was earned
since "a Bed and Breakfast business requires several years
to show a profit ... to build up a clientele". He said at
the beginning he and Mr. Beecroft realized they would require
several years of operation before a profit would be made; he had
no idea what the "several" years were.
[10] With respect to 1989, Mr. Thomson said North Shore was
close to profitability but a recession took place and business in
the Kingston area declined. He believed in 1989, when the revenue
reached $7,000, that the next year would be profitable. However,
tourism fell in 1990. Mr. Thomson said that since 1993 losses
were declining. The losses from North Shore were:
Year Revenue (Loss)
1989 $8,400* ($
9,854)
1990 $4,400* ($15,996)
1991 $3,800* ($14,104)
1992 $3,387 ($11,695)
1993 $5,978 ($ 5,511)
1994 $ 745 ($ 5,705)
[11] The North Shore was only operated for six months in
1994.
[12] The above losses are before any capital cost allowance
was deducted. The bulk of the expenses was mortgage interest. For
the years under appeal, 1992, 1993 and 1994, the amounts of
interest paid on the mortgage on the property were $12,720,
$8,458 and $5,190 respectively.
[13] Mr. Thomson said that he and Mr. Beecroft made efforts to
reduce expenses. For example, they originally employed a student
during the months of May to September but in later years they did
not re-employ that person. Mr. Thomson also stated that he
and Mr. Beecroft refinanced the property in 1993 to increase the
mortgage to $145,000. However, they renewed the mortgage for
periods of six months during the years of appeal so as to obtain
lower interest rates. Mr. Thomson stated that improvements were
also made to the property: a boat house was built for $15,000, a
new bathroom was built for guests, a new furnace was installed,
insulation was added, limestone on the building was cleaned, and
all this required extra funds.
[14] When Mr. Thomson and his partner acquired the property in
1986, there were only two other Bed and Breakfast operations in
the Kingston area. The number increased to six and was again
reduced to two when the appellant and his partner sold the
property in 1994 to permit Mr. Thomson to accept a position at
University of Western Ontario in London. The North Shore was the
only Bed and Breakfast open throughout the year.
[15] During the years in appeal, the appellant's income
from Queen's University was:
Year Income
1992 $56,451
1993 $55,068
1994 $74,125
[16] In allocating expenses from the Bed and Breakfast
operation, the appellant allocated 50% to personal use by him and
his partner, and 50% was allocated to use by guests.
[17] Mr. Thomson testified that he and his partner tried to
sell the property in 1990 with a view of finding a larger
building for the Bed and Breakfast operation.
[18] Mr. Thomson realized it would be necessary to build up a
winter business to increase the number of guests. He was in touch
with the officials of nearby Frontenac Provincial Park to
"aggressively" promote winter activity in that area. He
contacted the manager of Frontenac Provincial Park to distribute
brochures for North Shore. Mr. Thomson thought the property would
be profitable with a year-round clientele. Crown counsel
suggested that he would have had to average 23-room nights
per month to show a profit in 1992. Mr. Thomson replied that he
thought the summer and winter clientele would increase over the
years. In 1992, rooms were rented to 35 guests for less than 100
room nights. There were almost 100 guests staying over 100 room
nights in 1993 and revenue increased in that year, Mr. Thomson
expected a further increase in 1994.
[19] Mr. Thomson testified that during the years 1986 to 1989,
he and Mr. Beecroft also operated an art gallery on the
property. The art gallery was not successful and was closed.
This, Mr. Thomson suggested, demonstrated the seriousness in
which North Shore was carried on.
[20] Mrs. Louise Tamblyn testified on behalf of the appellant.
She has known Mr. Beecroft for 35 years and the appellant for the
past 20 years. She and her daughters were visitors at North Shore
in 1993 and on about two other occasions. They did not pay the
appellant for lodgings during their stays.
[21] Mrs. Tamblyn was impressed with the operation of the
North Shore and stated it was "a pleasure to stay" on
the property. She indicated she had vacationed at Bed and
Breakfasts in England, Scotland and other parts of Canada and was
impressed by the professionalism of North Shore. There was a
serious commitment by the owners, she declared.
[22] It is only when a taxpayer loses money from property and
applies his or her losses to other income he or she earned or
received in the year that the Minister questions the losses. The
Minister queries whether the expenses of a property were
maintained by the taxpayer for the use of the taxpayer and not
maintained in connection with a business carried on for profit or
with a reasonable expectation of profit. If the property was not
maintained in connection with a business carried on for profit or
with a reasonable expectation of profit then the Act, at
subsection 248(1), provides that the expenses of that property
are personal or living expenses; personal or living expenses are
not deductible by a tax payable in computing income: paragraph
18(1)(h).
[23] In 1977 the Supreme Court of Canada[1] considered what is necessary for a
taxpayer to have a profit or reasonable expectation of profit so
that expenses of a property would not be categorized a personal
or living expense. Dickson, J. (as he then was) explained at page
5215:
Although originally disputed, it is now accepted that in order
to have a "source of income" the taxpayer must have a
profit or a reasonable expectation of profit. "source of
income", thus, is an equivalent term to business: Dorfman
v. M.N.R. [72 DTC 6131], [1972] C.T.C. 151. See also s.
139(1)(ae) of the Income Tax Act which includes as
"personal and living expenses" and therefore not
deductible for tax purposes, the expenses of properties
maintained by the taxpayer for his own use and benefit, and not
maintained in connection with a business carried on for profit or
with a reasonable expectation of profit. If the taxpayer in
operating his farm is merely indulging in a hobby, with no
reasonable expectation of profit, he is disentitled to claim any
deduction at all in respect of expenses incurred.
[24] Mr. Justice Dickson went on to explain the meaning of the
phrase "reasonable expectation of profit":
There is a vast case literature on what reasonable expectation
of profit means and it is by no means entirely consistent. In my
view, whether a taxpayer has a reasonable expectation of profit
is an objective determination to be made from all of the facts.
The following criteria should be considered: the profit and loss
experience in past years, the taxpayer’s training, the
taxpayer’s intended course of action, the capability of the
venture as capitalized to show a profit after charging capital
cost allowance. The list is not intended to be exhaustive. The
factors will differ with the nature and extent of the
undertaking: The Queen v. Matthews (1974), 28 DTC 6193.
One would not expect a farmer who purchased a productive going
operation to suffer the same start-up losses as the man who
begins a tree farm on raw land.
[25] Recently the Federal Court of Appeal has considered anew
in Tonn et al. v. M.N.R.[2], the relevancy of reasonable expectation
of profit to the deductibility of losses. In A.G. of Canada v.
Mastri et al.,[3] the Court held that where there is no personal element
involved in the making of expenses "the judge should apply
the reasonable expectation of profit test less assiduously than
he or she might do if such a factor were present".[4] Robertson, J.A. writing
for the Court, confirmed that Tonn cautioned against
"second guessing" the business decisions of a
taxpayer[5] whose
commercial venture turns out to be less profitable than
anticipated.[6]
[26] Soon after deciding Mastri, the Court of Appeal
released its reasons in Watt v. The Queen.[7]Décary, J.A.
writing for the Court, that a fair reading of Tonn and
Mastri allows the following conclusion[8] when considering reasonable
expectation of profit:
a) that a personal element may coexist with a profit motive;
b) that where a personal element exists, it will prompt the Court
to apply the reasonable expectation of profit test more
assiduously; and c) that where the personal element is "the
dominant, motivating force"[9] the taxpayer’s burden may be
considerably more onerous.
[27] It is not my intention to second guess the business
acumen of Mr. Thomson with respect to his decision to carry on
the Bed and Breakfast venture. He and Mr. Beecroft never made any
money from the venture; there were continuous losses. (I note
that in computing the income of North Shore, no capital cost
allowance was ever deducted.) The question before me is whether a
reasonable person could have foreseen these losses in 1985, when
Messrs. Thomson and Beecroft acquired the property.
[28] There is no evidence that before purchasing the property,
either Mr. Thomson or Mr. Beecroft considered how much money
they would have to earn from the North Shore so as to realize a
profit. In other words, they appear not to have considered annual
potential costs (for example, mortgage payments, repairs and
maintenance, food, taxes, insurance, advertising, cleaning,
hydro, heat, etc.) nor gross revenue. Other queries that seem to
have been absent are the number of guests the North Shore would
potentially attract in the year and the cost of improving the
property. It was two or three years after they commenced the
North Shore did the appellant and Mr. Beecroft begin to realize
how many guests they would require to garner a profit. And even
when, in 1993, they rented out the North Shore for over 100
nights - the number of nights they believed would make the North
Shore profitable - the North Shore still had a loss.
[29] It is obvious, of course, that it is the rare business
that has a profit in its first few years of operation. An
optimistic, but realistic, owner who does not see a change in
fortune within a reasonable time will close the business.
Mr. Thomson, however, had no idea when a "turn
around" would take place. "There comes a time in the
life of any business operating at a deficit", wrote Decary,
J.A., that “when the Minister must be able to determine
objectively after giving someone a head start for a number of
years, as the case may be, that a reasonable expectation of
profit has turned to an impossible dream”.[10]
[30] Pictures of the property, newspaper articles and the
testimony of Mr. Thomson and Mrs. Tamblyn all attest to the
fact that the property was historic and attractive. Leisure
activities were available for guests. The owners were attentive
to the needs of guests. Mr. Thomson, if I understood his
evidence, was of the view that owners of such high quality
property must be carrying on a business with a reasonable
expectation of profit by the very fact of operating such a high
end property. This is not necessarily so: Messrs. Thomson and
Beecroft had extra expenses due to the age of the property, for
example.
[31] A personal element also existed. The owners lived on the
premises and they had access to all of the property except when a
guest-room was rented. Guest-rooms were made available to friends
at no cost, at least when Mrs. Tamblyn and her daughters
visited. The fact that the partners considered the property their
principal residence creates the personal element as "the
dominant, motivating force" in acquisition of the property.
The lifestyle available to the appellant as an owner of the
property was prime factor in deciding to operate North Shore.
[32] Messrs. Thomson and Beecroft expended untold energy and
devotion to North Shore. They apparently built an excellent
reputation in operating a Bed and Breakfast. But these are not in
themselves sufficient to succeed in the appeals at bar.[11]
[33] The appeals are dismissed.
Signed at Ottawa, Canada this 16th day of April 1998.
“Gerald J. Rip”
J.T.C.C.
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