Citation: 2011 TCC 404
Date: 20111109
Docket: 2009-2180(IT)G
BETWEEN:
TIMOTHY H. MAGNUS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
AMENDED REASONS FOR JUDGMENT
Woods J.
[1]
The appellant, Timothy Magnus, has
claimed deductions for interest and carrying charges relating to real property for
the 2004 and 2005 taxation years. In reassessments for these years, the amounts
claimed in the tax returns, $190,600 and $87,200, respectively, were disallowed
in their entirety.
[2]
The main reason that the deductions
were disallowed was the failure of the appellant to provide any supporting
documentation during the audit or objection stages. The appellant blames this
on the Canada Revenue Agency. Apparently, the CRA refused to review
documentation at the appellant’s premises and insisted that the appellant bring
the documentation to its offices.
[3]
This standoff about
production of documents was resolved during discoveries, when extensive documentation was provided by the appellant.
[4]
Based on its review of
documentation produced during discoveries, the respondent made certain concessions at the opening of trial. It is conceded
that $77,173.14 is deductible for the 2004 taxation year and $32,196.61 is
deductible for the 2005 taxation year. These amounts generally represent interest
and carrying charges that are supported by documentation and which relate to
properties on which rental income was reported by the appellant in his tax
returns for the relevant taxation years.
[5]
Before discussing
whether further deductions should be allowed, I would comment concerning a
notice of motion sent to the Court by the
appellant just one business day prior to the hearing.
[6]
The motion sought to have the
assessments vacated for reasons related to the conduct of the CRA during the
audit process. The conduct of the CRA is not a sufficient reason to vacate the
assessments. For this reason, and since the motion material was filed very
late, I declined to hear the motion.
Issues and burden of proof
[7]
In the Reply, the respondent
referred to paragraph 18(1)(a) of the Income Tax Act in support
of the assessments. There was no description of the provision in the Reply, but
a description was provided by the CRA in the Confirmation. The provision is
reproduced below.
18.(1)
In computing the income of a taxpayer from a business or property no deduction
shall be made in respect of
(a) an
outlay or expense except to the extent that it was made or incurred by the
taxpayer for the purpose of gaining or producing income from the business or
property;
[8]
At the opening of the hearing, I
suggested to counsel for the respondent that it should bear the burden to
establish that there was no income-earning purpose for purposes of para 18(1)(a)
because the assumptions stated in the Reply do not deal with it.
[9]
The relevant assumption as stated in
the Reply reads:
f) The Appellant did not incur interest or carrying charges of
$190,600 in the 2004 taxation year and $87,200 in the 2005 taxation year.
[10]
There is no reference at all to
the purpose of the expenses in the above assumption. It is well-established
that a taxpayer’s burden is only to disprove the assumptions as set out in the
Reply: LeCaine v The Queen, 2009 TCC 382, 2009 DTC 1246.
[11]
The respondent strongly objects to
assuming this burden, and submits that several of the properties were not being
used to earn income. He submits that the assumption in (f) is broad enough to
extend to the income-earning purpose test and that it would be unfair to impose
the burden on the respondent in circumstances where the appellant did not
provide any supporting material during the audit process.
[12]
I disagree with these submissions.
[13]
First, assumption (f) is not broad
enough to encompass the facts supporting the application of s. 18(1)(a).
The respondent could have avoided the unfairness of having to assume the burden
by making appropriate assumptions and stating them in the reply.
[14]
Second, the rules relating to
assumptions and burden of proof are well-established and are designed to enable
taxpayers to know the case that they have to meet in order to be successful at
trial. The ultimate question is one of fairness. It would be unfair for the
appellant to bear the burden of disproving this when it is not mentioned in the
Reply.
[15]
Third, there is nothing unusual in
this case. The Minister often has to make assumptions regarding business
expenses which have not been substantiated during the audit process. In these
cases, the Minister often makes multiple assumptions: that the purported expenses
were not incurred, that they were not incurred for the purpose of earning
income, and perhaps that they were not reasonable.
[16]
I see no reason to make an
exception in the burden of proof in this case.
[17]
I have concluded that the burden
of proof rests with the respondent with respect to facts to support the income-earning
requirement in para 18(1)(a).
Discussion
[18]
Testimony was provided at the
hearing by the appellant on his own behalf. As a general comment, I did not
find the testimony to be convincing overall. It was not sufficiently detailed
or cogent to be reliable and it appeared to be inconsistent with some of the
facts set out in the Notice of Appeal.
[19]
In addition to his oral testimony,
however, the appellant introduced a large number of source documents that clearly
establish that interest and carrying charges were incurred either by the
appellant or his wholly-owned corporation.
[20]
I would first make a preliminary
comment concerning expenses that may have been incurred by the corporation. The
appellant submits that this should not be a bar to his claiming the deductions.
There were two reasons offered for this, first, that the appellant became the
beneficial owner of all the real estate in 2003, and second that the appellant
earned income from the corporation in return for paying these expenses.
[21]
As it turns out, it is not
necessary that I consider whether the appellant became the beneficial owner of
all the properties. The reason for this is that none of the expenses which have
been allowed appear to relate to properties which the corporation may have
owned.
[22]
I will begin the discussion by
reproducing a portion of the appellant’s written statement, which he read
during his testimony (Ex. A-1). The extract below describes the real estate
properties that the deductions relate to.
Investment Properties
4) Real property included 4 units at 610-17th
Ave SW [units 302, 502, 600 & 602], 3 units at 317-14th Ave SW [units 701, 702
& 706], unit 601, 111-14th Ave SE. and 2 detached homes [2925 Signal Hill Hts and 434070 2nd St. E].
5) Condominium properties were acquired for rental and/or personal
use. Over the years, rental income has been generated by each and every
condominium property, even if no rental income was generated in 2004 and/or
2005. [see 2002/2003 rental revenue].
6) 434070 is a detached home that has been offered for rental but we
discovered that the market for this type of property is not viable. The
Corporation was been domiciled at 434070 in 2004 and 2005 and as such qualifies
as a business investment where ‘rental’ is a portion of the Schedule 4 income.
7) 2925 is a detached home that was purchased with the intent of
providing ‘rooms’ for rent. Though no rental income for this property was
generated in 2005 (the year of acquisition) it is currently a going concern
with rental income.
[23]
Before considering these properties
in more detail, I would make a few general observations.
[24]
First, according to the
appellant’s statement the condominiums were acquired for rental and/or personal
use. This statement is too vague to be useful and oral testimony did not
provide sufficient clarity. In addition, during discovery the appellant stated
that he had lived at the 2985 property from “2005, 2006 through current.” This
is not reflected in the above statement.
[25]
Second, the statement mentions
that rental revenue was earned for each condominium property. However, the
notice of appeal states:
Rental income
claimed by Tim Magnus is for the rent of personal property, not related to the
properties managed by the Corporation.
Although it may be possible to reconcile these
statements, the evidence did not satisfactorily do so.
[26]
Further, the statement refers to 2002
and 2003 rental revenues in support. However, the only documentation provided
for this was an untitled document which seems to list purported rental revenue
in 2002 and 2003 (Ex. A-2). I have not given this document any weight as I do
not view it to be reliable. In particular, the document was not in the
appellant’s list of documents and the respondent has not had sufficient
opportunity to consider its reliability.
[27]
Similarly, the above statement
mentions that the 2925 property is currently a going concern with rental
income. No supporting documentation for this assertion was provided.
[28]
I now turn to consider specific
groups of properties.
[29]
The first group mentioned in the
appellant’s statement is four condominium units at 610-17th Ave SW (the “610 properties”). The respondent has conceded interest,
condo fees and taxes for three of these properties. It is not clear to me why
expenses were not also conceded for the fourth property, Unit 502. This unit
was sold early in the relevant period and the interest and carrying charges are
modest.
[30]
I propose to allow interest and
carrying charges for all four units of the 610 properties.
[31]
The second group is three
condominium units at 317-14th
Ave SW (the “317
properties”). Expenditures with respect to these properties were not conceded by
the respondent because there was no rental income reported in the relevant tax
years with respect to these properties. In other words, the respondent suggests
that the properties were not used for the purpose of earning income.
[32]
The fact that rental
income was not reported in 2004 or 2005 is not a sufficient basis for denying
the interest and carrying charges. According to the respondent’s own witness,
rental income was reported by the appellant in 2002 and 2003. Unless the
respondent led evidence to show that this income did not relate to these
properties, I would conclude that the respondent has not satisfied the burden
to establish facts to support the application of s. 18(1)(a) with
respect to this group of properties.
[33]
It is also relevant to consider
that having a portfolio of a relatively large number of properties strongly
suggests commercial use. The respondent referred to evidence that the business
was in the course of liquidation and it was suggested that the source of income
had disappeared. I do not agree with this. If properties were originally
acquired for purposes of earning income, the use does not change during the
period of liquidation.
[34]
I propose to allow interest and
carrying charges relating to these properties, except for expenses related to
Unit 701 which the appellant himself has listed in Ex. A-3 as personal
expenditures.
[35]
The next group is a single property,
condominium unit 601 at 111-14th
Ave SE (the “601 property”).
[36]
The respondent has conceded interest,
condo fees and taxes relating to this property for 2004 and 2005 even though
the appellant submits that expenses after February 2005 are personal.
[37]
I propose to allow interest and carrying
charges related to the 601 property for 2004 and 2005. For expenses after
February 2005, the amount allowed will be the amount conceded by the respondent.
[38]
The next group of properties to be
considered is also a single property, a detached home at 2925 Signal Hill Heights. (the
“2925 property”). This property has a much greater value than the condominium
units and greater expenses were incurred with respect to it.
[39]
As mentioned above, the appellant
stated during discoveries that he has lived at this property since “2005, 2006”
and that he still lives there.
[40]
This evidence, which was
introduced by the respondent, is sufficient in my view for the respondent to
establish a prima facie case that the 2925 property was a personal use
property and was not acquired for the purpose of earning income.
[41]
The appellant stated in Ex. A-1 that
this property was purchased in 2005 with the intent of providing “rooms” for
rent and that rental income is now being earned. It should not have been
difficult for the appellant to provide supporting evidence of this, for example
from his tax returns. In the absence of any supporting documentation, I do not
accept the self-serving evidence that this property was acquired for an
income-earning purpose.
[42]
The expenses relating to the 2925
property will be disallowed.
[43]
The final property to be
considered is identified as 434070 2nd
St. E (the “Oka Toks property”).
[44]
There is very little reliable
evidence relating to this property. According to the appellant’s statement in
Ex. A-1, he tried to rent the property but was unsuccessful. I have given this
testimony little weight as it was too brief to be convincing.
[45]
The statement goes on to mention that
the appellant’s corporation was domiciled there in 2004 and 2005. However, on
cross-examination the appellant implied that no one actually occupied the
premises and they were used only to hold furniture and equipment.
[46]
Although there is no reliable
evidence from the appellant relating specifically to this property, I have
concluded that the interest and carrying charges should be allowed because the
burden was on the respondent to establish that there was no income-earning
purpose. Overall, the evidence led by the respondent, either in chief or in
cross-examination, was not sufficiently detailed for me to have any idea what
the Oka Toks property was intended to be used for, or what in fact it was used
for.
[47]
I would conclude that interest and
carrying charges with respect to the Oka Toks property should be allowed.
[48]
To summarize, interest and
carrying charges will be allowed with respect to all of the properties, except
Unit 701 of the 317 properties and the 2925 property (“Qualifying Properties”).
[49]
It remains to be determined the
appropriate amount of the interest and carrying charges. It is very difficult
to determine appropriate figures from the source documentation and from the
list of expenses Ex. A-3. As an example, the expenses in Ex. A-3 includes
principal repayments and no detailed calculation of these has been provided.
[50]
According to the appellant’s
statement (Ex. A-1), the following types of expenditures are being claimed as
deductions:
1)
mortgage interest and banking
charges,
2)
fees charged by condominium
corporations,
3)
municipal taxes and charges,
4)
closing costs for sales (broker
fees, legal fees, title insurance, banking fees, etc.), and
5)
legal expenses relating to
lawsuits concerning the properties and a computer business that had been
conducted by his corporation.
[51]
The first three items qualify as
interest or carrying charges and should be allowed with respect to the
Qualifying Properties.
[52]
These amounts should be determined
based on the list of expenses that was prepared by the appellant in the course
of the litigation and introduced into evidence as Exhibit A-3 (the “Ledger”).
[53]
I reviewed a relatively large number
of source documents to verify this list. Although I found the Ledger to correspond
quite closely to the source documents, I also found discrepancies that I could
not reconcile. Just to take an example, the appellant claimed mortgage payments
for the 2925 property for ten months whereas the mortgage source document only
lists nine monthly payments. I have decided that it is appropriate to discount
the otherwise allowable amounts by an arbitrary ten percent on account of
potential discrepancies.
[54]
Subject to the discount for
discrepancies, interest and carrying charges for the Qualifying Properties
should be determined based on expenses itemized in A-3 for mortgage payments
(less principal), condo payments and taxes.
[55]
The appellant also seeks to deduct
selling expenses. These expenses are neither interest nor carrying charges and
I do not propose to allow them.
[56]
The appellant submitted that these
expenses are ordinary deductible expenses. I disagree. These properties were
reported and accepted as capital property. Selling expenses are should be
deducted in computing capital gains and are not incurred in the regular course of
earning income. Subsection 9(3) of the Act makes this clear.
[57]
In deciding to disallow selling
expenses, I have also taken into account written agreements (Ex. A-4) which
state that the corporation will increase interest payments to the appellant in
return for his assuming obligations with respect to the properties (including
“legal/sales expenditures”).
[58]
These agreements suggest that the
selling expenses were incurred in order to earn interest income. However, I am
not satisfied as to the reliability of these agreements. There is no execution
date on the agreements and they appear to contradict the following statement in
the notice of appeal:
5. Each year,
the Corporation pays to Tim Magnus a return on the total shareholder loan and
reports tax deductible carrying charges claimable, ensuring that there will be
no “double deduction” for the carrying charges. These carrying charges are limited
to the interest and condominium fees paid by Tim Magnus.
(Emphasis added.)
[59]
I would also comment that the
agreements are self-serving documents and they have not been supported by up to
date financial records of the corporation. The corporation has not filed tax
returns since about 2001.
[60]
Finally, I am troubled that the
issue of selling expenses was not properly raised in the notice of appeal. It
would be unfair to the respondent for the appellant to now seek relief with
respect to these expenses.
[61]
The next category of expenditures
is legal fees. As far as I can determine, none of the legal expenses were
supported by invoices. It would not be appropriate to allow any of these
expenses without proper supporting documentation as to the amounts incurred.
[62]
Finally, I have rejected a
deduction claimed in the amount of $40,000 for two cheques paid to a
corporation identified as Rock Solid Investors Group. There is insufficient
supporting documentation to establish what these amounts relate to. The
appellant listed them in Ex. A-3 as broker fees and they are mentioned
obliquely in legal reporting letters as consultancy fees. I am not satisfied as
to what these items represent.
[63]
Where does that leave us? I have
attempted to compute the amounts that are deductible in accordance with the
above reasons. These amounts, which are based on the figures in the Ledger, are
set out below:
|
2004 taxation year
|
|
|
Interest and carrying charges
|
|
|
Total expenses
|
$252,268.23
|
|
Less - personal
use
|
18,112.64
|
|
- principal
repayments
|
36,303.92
|
|
- selling
expenses
|
16,436.97
|
|
- Rock Solid
payments
|
40,000.00
|
|
Subtotal
|
$141,414.70
|
|
Less - 10
percent discount
|
14,141.47
|
|
Final total
|
$127,273.23
|
|
|
|
|
2005 taxation year
|
|
|
Interest and carrying charges
|
|
|
Total expenses
|
$188,785.25
|
|
Less -
personal use
|
17,151.26
|
|
- principal
repayments
|
23,783.15
|
|
- selling
expenses
|
58,331.29
|
|
- 2925
property mort interest and taxes
|
16,262.46
|
|
Add - 601 property concession in excess of amount claimed in
Ledger (assumes one-third of mort payment is principal)
|
9,305.92
|
|
Subtotal
Less – 10 percent discount
Final total
|
$ 82,563.01
8,256.30
$ 74,306.71
|
[64]
The appeal will accordingly be
allowed in accordance with these reasons.
[65]
I would like to give an
opportunity for submissions on costs. Such submissions, if any, should be sent
to the Court, by letter in writing addressed to the Hearings Coordinator, with
a copy to the opposing party. Appellant’s submissions to be received within two
weeks of the release of this decision, from the respondent within a further two
weeks and with a five-day right of reply.
These Amended Reasons for Judgment are issued in
substitution for the Reasons for Judgment dated August 26, 2011.
Signed at Toronto, Ontario this 9th day of November
2011.
“J. M. Woods”
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