[OFFICIAL ENGLISH TRANSLATION]
Date: 19980916
Docket: 97-1661(IT)I
BETWEEN:
BENOÎT NADEAU,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
(Delivered orally at Montréal, Quebec, on
August 24, 1998, and subsequently revised at Ottawa, Ontario, on
September 16, 1998.)
Lamarre, J.T.C.C.
[1] The
appellant is appealing from the assessments issued for the 1992,
1993 and 1994 taxation years by which the Minister of National
Revenue ("Minister") denied him rental losses of
$7,482, $5,903 and $8,593 respectively.
[2] In
making the assessments, the Minister relied on the facts stated
as follows in paragraph 15 of the reply to the notice of
appeal:
[TRANSLATION]
(a) on June 30,
1989, the appellant acquired a property located at 9061 and
9063 Rue Bellerive in Montréal for the sum of
$208,000;
(b) to pay for the
purchase of that property, the appellant took out a mortgage of
$173,400 at a rate of interest of 11¾ percent;
(c) at the time the
appellant acquired the property, the building comprised three
leased apartments which generated a total monthly income of
$790;
(d) during the years
in issue, two apartments were rented and the appellant lived
in the main apartment;
(e) the property
constantly produced rental losses and those rental losses take
into account a personal portion of 33.33 percent:
(i)
1991 - $17 214
(ii)
1992 - $ 7,482
(iii)
1993 - $ 5,903
(iv)
1994 - $ 8,593;
(f) the gross
rental income from the property (two rented apartments) was
as follows for the years indicated:
(i)
1991 - $9,300
(ii)
1992 - $9,630
(iii)
1993 - $9,840
(iv)
1994 - $6,740;
(g) the gross annual
rental income from the property was always negative as a result
of the fixed costs corresponding to the years in issue:
TAXATION YEAR
1992
1993
1994
GROSS
INCOME
$ 9,630
$
9,840
$ 6,740
FIXED
COSTS
18,972
16,813
15,942
PERSONAL PORTION
6,324
5,604
5,314
DEFICIT
$ 3,018
$
1,369
$
3,888
(h) the appellant
did not show that he had taken concrete steps to improve the
situation with regard to the rental losses from the property on
Rue Bellerive in Montréal;
(i) the
appellant had no expectation of making a profit from the property
on Rue Bellerive in Montréal during the 1992, 1993
and 1994 taxation years;
(j) the rental
expenses claimed annually in respect of the property on
Rue Bellerive in Montréal were not incurred by the
appellant for the purpose of earning income from a business
or property.
[3] The agent for
the appellant admitted subparagraphs (a), (b) and (f) and
denied all the other facts set out. The appellant herself and
Élisabeth Roy, a Revenue Canada appeals officer,
testified.
[4] According to the
contract of sale whereby the appellant purchased the property in
question on June 30, 1989, the three apartments in the
property were rented and together generated monthly income of
$790, which would represent $9,480 a year if all three had been
rented throughout the year. This therefore confirms the facts
stated in subparagraph 15(c) of the reply to the notice of
appeal, which were initially denied.
[5] At the time he
bought the property, the appellant had been working for a number
of years as an operations technician for a petrochemical plant in
Varennes. His salary from that employment was $70,172 in 1989. It
had been $34,562 in 1981. In 1994, the appellant received $77,917
and worked an average of 42 hours a week.
[6] The appellant
purchased the property for $208,000, but the asking price had
been $235,000. The municipal assessment evaluated the property at
$190,365 for the 1987-1988 assessment roll.
[7] According to the
listing, the duplex that the appellant purchased had been built
in 1980; it had a view of the river and was located near a park
and a bicycle path. The property and school taxes amounted to
$4,000 and the electricity costs were $1,431 in 1988.
[8] To acquire the
property, the appellant invested $38,000 of his own money and
borrowed $173,400 from the Laurentian Trust of Canada at a rate
of 11.75 percent. The appellant says he spoke to two other
financial institutions before signing for that loan.
[9] On the basis of
his own projections, the appellant thought he could make the
property profitable by gradually increasing the rental income by
five percent a year, which, according to him, was
conservative since he had personally experienced rent increases
that ranged from eight to fifteen percent in the preceding
years.
[10] He anticipated maintenance
expenses of approximately $2,000 a year as the property was
relatively new. He also anticipated a very small increase in
property taxes.
[11] As for the interest
expense, he projected that it would decline from $19,434 in 1990
to $10,005 in 1994. He expected to bring this about by repaying
$6,000 to $8,000 a year on the principal of the loan; in
addition, he was counting on a drop in interest rates in future
years.
[12] Given these projections,
the appellant felt he could make a profit in 1994. In actual
fact, the appellant did not pay down the principal during the
years in issue other than through his regular payments. The
evidence revealed, however, that he invested a total of $12,350
in his RRSP during those same years.
[13] As to interest rates, the
appellant renewed his mortgage in 1991, paying a penalty of
approximately $6,500 in order to lower the interest rate to
8.5 percent. In 1993, he again renewed his mortgage,
bringing the rate down to 5.75 percent.
[14] If we disregard the
personal portion, the interest expenses were thus $17,412 in 1991
(higher because of the penalty), $9,398 in 1992, $7,885 in 1993
and $7,267 in 1994. Those expenses increased to $13,548 in 1995
and fell to $11,537 in 1996. In 1997, the appellant was able to
renegotiate a mortgage at 3.8 percent, and the interest for
that year was $6,921.
[15] Maintenance expenses turned
out to be higher than expected, ranging between $3,500 and $4,000
a year. The appellant said he had to replace countertops and
toilets, redo the ceramic work and so on.
[16] With respect to the rental
income, the appellant was not able to increase it by
five percent annually. Between 1990 and 1993, income
increased from $7,020 to $9,840, declining to $6,740 in 1994.
[17] The appellant gave as
explanations for this the exodus to the suburbs and supply and
demand. Furthermore, in 1994, the upper apartment, for which the
rental was highest, was vacant for nine months. Although the
appellant had been informed that the tenant was leaving the
premises on January 1, 1994, paying two months'
rent, the appellant was unable to find another tenant before
November of that year.
[18] The appellant did not see
fit to place advertisements in the newspapers because, he said,
that was not an effective method; he merely posted announcements
in convenience stores and other businesses and put a sign in the
window of the apartment.
[19] The appellant himself lived
in the ground floor apartment until January 1, 1995. He also
used the garage, the laundry room and the reading room in the
basement.
[20] The appellant tried
unsuccessfully to sell the property in question in 1992, when he
realized that it would take time before he could make a profit.
He ultimately sold it at a loss in 1998.
[21] From 1989 to 1996, the
appellant had nothing but losses, which declined from $15,101 in
1990 to $4,436 in 1996. In 1997, he made a profit of $848,
although that was without taking into account capital cost
allowance.
[22] Starting in 1995, the
rental income was appreciably higher since the appellant rented
the three apartments.
[23] Counsel for the respondent
argued that the appellant had no expectation of profit during the
years in issue and that there was accordingly no source of income
that could entitle him to claim losses.
[24] The burden is on the
appellant to prove objectively that he had a reasonable
expectation of making a profit during the years in issue and that
the rental activity constituted a business. The factors by which
"objective reasonability" might be demonstrated were
proposed by the Supreme Court of Canada in Moldowan v.
The Queen, [1978] 1 S.C.R. 480, and cited by the Federal
Court of Appeal in Enno Tonn v. The Queen,
[1996] 2 F.C. 73.
[25] Among the criteria are the
following: the profit and loss experience in past years, the
taxpayer's training, the taxpayer's intended course of
action and the capability of the venture as capitalized to show a
profit after charging capital cost allowance.
[26] These criteria must be
applied sparingly where personal motives are absent. It is my
view that here the appellant derived in part a personal benefit
from his investment.
[27] On analyzing these various
criteria, one sees that the property generated only losses for as
long as the appellant held it, except in 1997, when there was a
slight profit which did not take capital cost allowance into
account. The property was subsequently sold at a loss in
1998.
[28] The fact that the appellant
did not repay any principal amount greatly restricted his ability
to make the rental operation profitable. On this point I refer to
Zahid Mohammad v. The Queen, [1998]
1 F.C. 165, in which Robertson J.A. wrote as follows at
page 173:
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.
[29] I believe this is a case
where circumstances suggest that a personal or non-business
motivation existed, or that the expectation of profit was so
unreasonable as to raise a suspicion.
[30] I find on the evidence that
the appellant has not shown objectively that the activity in
question constituted a business. Indeed, from the very outset,
the rental income was such that no profit could be expected if
such high interest expenses were to be added to the property and
school taxes and the insurance and heating expenses.
[31] The appellant was counting
on factors beyond his control to make the property profitable,
those factors being: a significant decline in interest rates,
which were liable to fluctuate constantly; no increase in
property taxes, which in fact rose appreciably; a pay increase
over the years, which proved not to be as large as expected; and
a rise in rental income that did not occur.
[32] Having chosen to invest his
savings in an RRSP rather than in the reduction of the principal
amount of the loan, the appellant cannot objectively claim that
he hoped to make a profit from the property. In fact, he was
relying on other factors-much too risky and beyond his control-to
make his rental activity profitable.
[33] Accordingly, the appellant cannot claim
that during the years in issue he was carrying on a rental
business that might entitle him to deduct the rental losses. The
appeals are therefore dismissed.
Signed at Ottawa, Canada, this 16th day of September 1998.
J.T.C.C.
Translation certified true
on this 9th day of July 2003.
Erich Klein, Revisor
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