Citation: 2008TCC662
Date: 20081203
Dockets: 2008-1301(IT)I
2008-1303(IT)I
BETWEEN:
CHRISTINE SANTAGAPITA,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent;
AND BETWEEN:
JOSEPH SANTAGAPITA,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Woods J.
[1]
The appellants, who are husband
and wife, appeal reassessments made under the Income Tax Act for the
2002 and 2003 taxation years. The appeals were heard together on common
evidence under the informal procedure of the Court.
Background
[2]
The appeals concern a commercial
rental building that the appellants have owned since 1986. It is located at 124 Dundas Street
in London, Ontario.
[3]
Prior to 2001, the premises were
leased by the appellants to 598537 Ontario Inc. This corporation was
wholly-owned by the appellants, and it used the main floor of the building to
operate a hardware store under the name Warner Pro Hardware. The second and
third floors of the building were blocked off and were not usable.
[4]
In January of 2001, a fire broke
out in the hardware store causing extensive damage. The store had to be shut
down for a period of time, although Mr. Santagapita was able to carry on a
locksmith business at the back of the premises.
[5]
Fortunately for the appellants,
they and 598537 Ontario Inc. were adequately covered by insurance for their
losses. There was one policy covering all the insured and it was with Gore
Mutual Insurance Company.
[6]
Not long after the damage was
incurred, extensive repair work was undertaken, first by a contractor selected
by the insurance company and then by Mr. Santagapita or persons hired by him.
[7]
At some point, the appellants
decided not to reopen the hardware store and they made efforts to lease the
building to a third party.
[8]
The main floor of the building was
leased to an arm’s length tenant in 2005 for use as office premises.
The issues
[9]
Unfortunately, the issues in these
appeals are a bit like shifting sand. I will start, then, with a description of
the issues as stated in the appellants’ amended notices of appeal dated October
17, 2008. The relevant excerpt from the pleadings is reproduced below.
40. Whether the Minister erred in determining that the Property
was not available for use until October 23, 2003 and therefore the Expenses
should be capitalized rather than allowed on a current basis.
41. Whether the Minister erred in increasing the Appellant’s
income by $12,500 in each of the 2002 and 2003 taxation years in respect of
insurance proceeds for loss of rental income.
42. In the alternative, if the Minister was correct in
increasing the Appellant’s income by $12,500 in each of the 2002 and 2003
taxation years in respect of insurance proceeds for loss of rent, whether the
Appellant is therefore entitled to deduct the Expenses to the extent of this
amount pursuant to Subsection 20(29) of the Act.
43.
Whether the Minister erred in his calculation of the Expenses.
Should insurance proceeds be included in income?
[10]
I will first consider the
insurance proceeds. Broadly speaking, the issue is whether the Minister erred
in increasing the income of each of the appellants by $12,500 in both the 2002 and
2003 taxation years, for a total income inclusion of $50,000. This amount
represents insurance proceeds received for loss of rent.
[11]
The factual background follows.
[12]
In a settlement with the insurance
company made in 2002, the insurer paid a lump sum amount of $121,500 (Ex. A-6).
The amount was paid by cheque to 598537 Ontario Inc., and it was inclusive of
all claims of either the appellants or 598537 Ontario Inc.
[13]
Included in the lump sum was an
amount of $50,000 on account of “loss of rent.”
[14]
Based on evidence led by the
respondent, which includes the testimony of the claims specialist at Gore
Mutual who dealt with this matter and includes a letter that the specialist
wrote to the appellants’ lawyer (Ex. R-3), I am satisfied that the $50,000
payment was in satisfaction of the appellants’ right to claim for damages for
loss of rent under the insurance policy. As such, it is to be included in their
income under subsection 9(1) of the Act.
[15]
The appellants suggest that this
amount is not income to them because it was their company, and not themselves
personally, that received the money.
[16]
This argument cannot succeed. The
appellants had the right to receive the funds pursuant to their insurance
policy. It is the right to the funds, and not the receipt, which is the taxable
event.
[17]
Also, the payment to 598535 Ontario
Inc. satisfied the appellants’ claim against the insurer.
[18]
The evidence does not indicate
why the insurance proceeds were paid in a lump sum to 598537 Ontario Inc. It is
possible that the appellants’ lawyer directed the insurer to pay the funds in
this manner. But that does not matter. The appellants had the right to receive
the money from the insurer, and from 598537 Ontario Inc. which was wholly‑owned
by them.
[19]
The appellants further submit that
the proper year to include the amount is 2001.
[20]
I do not agree with this
submission. Although the fire occurred in 2001, there is not sufficient
evidence that the amount payable for loss of rent was known or determinable at
this time.
[21]
There is evidence, however, that
the right to the loss of rent payment became known on February 27, 2002 when
the insurance company acknowledged it in a letter to the appellants’ lawyer
(Ex. R-3). Based on the evidence presented, I conclude that it is only at this
time did the $50,000 become receivable.
[22]
That is not the end of the matter,
however. The Minister did not include the entire $50,000 in income in 2002 when
the settlement was reached. Rather, the Minister divided the amount equally
between the 2002 and 2003 taxation years.
[23]
It appears that the Minister
divided the amount in this manner because he assumed that the $50,000 was paid
in two equal installments in 2002 and 2003 (Replies, para. 15(j)).
[24]
This assumption was wrong,
however. The full amount was paid in one lump sum in 2002.
[25]
The Minister erred in including
any of the insurance proceeds for loss of rent in the appellants’ income for
the 2003 taxation year. The entire amount should have been included in the 2002
taxation year when the settlement was reached.
[26]
In the result, the income for the
2003 taxation year should be adjusted to remove any insurance proceeds.
[27]
Finally, a further issue was
raised for the first time in the written submissions. It was not clearly raised
in the pleadings, and nor was it raised at the opening of the hearing when an
overview of the issues was presented. It appears that the parties subsequently
agreed that this issue would be considered.
[28]
The appellants submit that the
income inclusion for insurance proceeds is statute barred. They submit that it
was raised for the first time in reassessments issued outside the normal
reassessment period and that there was no negligence, carelessness or willful
blindness on the part of the appellants in excluding it from their income tax
returns.
[29]
I do not agree with the appellants
that there has been no negligence, carelessness or willful blindness. At the
very least, the appellants were careless in not reporting the $50,000 as income
in their tax returns for the 2002 taxation year. No good explanation was
provided for excluding this amount from any income tax returns, including those
filed for 598537 Ontario Inc.
[30]
Mr. Santagapita suggested that he
always intended to include this amount in an amendment to the tax return of
598537 Ontario Inc. This explanation is being provided six years after the year
in which the money was received, and no such amendment has yet been filed. I do
not find the explanation to be credible.
[31]
In the result, the assessments
will be upheld with respect to this issue for the 2002 taxation year, but the
insurance proceeds will be excluded from income for the 2003 taxation year.
What is the
date of completion of construction?
[32]
The second issue is whether
certain expenses related to the repair of the building are required to be capitalized
under subsection 18(3.1) of the Act.
[33]
Subsection 18(3.1) is intended to
require the capitalization, during a period of construction, of expenses that
relate to the construction and that otherwise would be deductible as current
expenses.
[34]
In the reassessments, the Minister
applied this provision to certain expenses incurred in the 2002 and 2003
taxation years. For purposes of the assessments, the Minister assumed that the
period of construction ended on October 29, 2003 when the front entrance to the
building was finished.
[35]
I would also note that the
Minister did not capitalize all of the construction‑related expenses that
were claimed by the appellants. Some of these amounts were disallowed in their
entirety pursuant to paragraph 18(1)(a). This issue will be discussed
later in these reasons.
[36]
It is the position of the
appellants that subsection 18(3.1) does not apply to either the 2002 or 2003
taxation years because the renovation of the building was complete by the end
of 2001.
[37]
The relevant statutory provisions
are subsections 18(3.1) and (3.3) of the Act which are reproduced below.
18(3.1) Cost relating to construction of
building or ownership of land. Notwithstanding any other provision of this
Act, in computing a taxpayer’s income for a taxation year,
(a) no
deduction shall be made in respect of any outlay or expense made or incurred by
the taxpayer (other than an amount deductible under paragraph 20(1)(a),
20(1)(aa) or 20(1)(qq) or subsection 20(29)) that can reasonably
be regarded as a cost attributable to the period of the construction,
renovation or alteration of a building by or on behalf of the taxpayer, a
person with whom the taxpayer does not deal at arm’s length, a corporation of
which the taxpayer is a specified shareholder or a partnership of which the
taxpayer’s share of any income or loss is 10% or more and relating to the
construction, renovation or alteration, or a cost attributable to that period
and relating to the ownership during that period of land
(i) that is subjacent
to the building, or
(ii) that
(A) is immediately
contiguous to the land subjacent to the building,
(B) is used, or is
intended to be used, for a parking area, driveway, yard, garden or any other
similar use, and
(C) is necessary for
the use or intended use of the building; and
(b) the amount
of such an outlay or expense shall, to the extent that it would otherwise be
deductible in computing the taxpayer’s income for the year, be included in
computing the cost or capital cost, as the case may be, of the building to the
taxpayer, to the person with whom the taxpayer does not deal at arm’s length,
to the corporation of which the taxpayer is a specified shareholder or to the
partnership of which the taxpayer’s share of any income or loss is 10% or more,
as the case may be.
…
(3.3) Completion. For the purposes of subsection
18(3.1), the construction, renovation or alteration of a building is completed
at the earlier of the day on which the construction, renovation or alteration
is actually completed and the day on which all or substantially all of the
building is used for the purpose for which it was constructed, renovated or
altered.
[38]
There is no debate about the
question to be decided. It is to determine when the renovation of the building
was complete.
[39]
The appellants submit that the
renovation project was complete when the contractor hired by the insurance
company finished his work at the end of 2001.
[40]
While I accept that the contractor
hired by the insurance company completed his part of the work at the end of 2001,
this does not mean that the renovation was complete at this point.
[41]
At the end of 2001, the building
was clearly not ready for occupation. The building was a bare shell inside and
the front entrance was to be redone.
[42]
The entrance was constructed by
Mr. Santagapita himself in 2003 and it was completed on October 29 of that
year. As for the inside, it appears that the building remained almost in a
shell state until 2005 when it was finished for an arm’s length tenant.
[43]
When the evidence as a whole is
considered, I cannot agree with the appellants’ position that the renovation
was complete by the end of 2001.
[44]
Parliament’s intent in enacting
subsection 18(3.1) was to prohibit construction-related expenses to be deducted
on current account while a property is still under construction. In this case,
the period of construction ended no earlier than the time that the front
entrance was completed, which was on October 29, 2003.
[45]
The appellants suggest that the
renovation work carried out in 2002 and 2003 was not necessary for the
completion of the building. I am not satisfied that this was the case for the
simple reason that the building was not habitable at the end of 2001 and more
renovation work was planned. In fact some of the construction work was carried
out in 2002 and 2003.
[46]
Mr. Santagapita testified that he
purposely held off finishing the inside of the building and the front entrance
until a tenant was found. He said that he later decided to put up the front
facade before it was rented because the entrance was an eyesore to the
neighbours.
[47]
Even if this testimony is
accepted, it does not establish that the period of construction ended at the
end of 2001. The construction project may have gone through delays, but that
does not mean that it was finished.
[48]
Further, I am not convinced by the
evidence as a whole that Mr. Santagapita held off finishing the building so
that it could be completed to the specifications of a tenant.
[49]
I would note that his testimony in
this regard is contrary to statements that the appellants made to the insurer
through their law firm, Harrison Pensa. On March 7, 2002, Harrison Pensa wrote
to the insurance company in attempts to settle the claim (Ex. R-2) as follows:
… I can
confirm that it is Mr. Santagapita’s intention to reopen this location as
Warner Pro Hardware. …
… you raised
the fact that some of the delays associated with the construction may be
attributable to Mr. Santagapita and specifically the store front. … You will
see in the fourth paragraph of that letter that Mr. Santagapita had made his
decision regarding the facade very early on – February of 2001. However, the
repairs could not proceed at that time because of ongoing problems with the
common wall. Therefore, Mr. Santagapita has informed me that he is not prepared
to accept responsibility for the delays associated with the construction. …
[50]
In his testimony, Mr. Santagapita
resiled from certain statements in the letter, stating that the letter was
written in the course of settlement negotiations.
[51]
The problem that I have with this
testimony is that I have no way of knowing which version of events is true. The
representations to the insurer made by Harrison Pensa were self-interested
statements, as was Mr. Santagapita’s testimony at the hearing.
[52]
In the result, I am not satisfied
that the period of construction ended at the end of 2001. When all the evidence
is considered, I conclude that the construction was complete no earlier than
the time assumed by the Minister, which was October 29, 2003.
[53]
Before leaving this issue, I would
also mention an incident that occurred during the period at issue which
involves a GST matter.
[54]
An officer with the Canada Revenue
Agency testified at the hearing in some detail concerning a false GST refund
claim that Mr. Santagapita had filed with the Canada Revenue Agency in January
of 2003.
[55]
According to the officer’s
testimony, which for the most part was not disputed, Mr. Santagapita had
perpetrated a scheme to claim false refunds of GST input tax credits. The
scheme was carefully planned and executed and involved the creation of false
invoices which were paid by way of deposits to a corporation that was under Mr.
Santagapita’s control.
[56]
This incident does not of course
prove that Mr. Santagapita’s testimony at this hearing was not credible, but it
does suggest that that one should be careful in accepting his testimony where
it could have been corroborated but was not.
[57]
The appellants’ counsel objected
to this evidence being introduced, but I think it was proper, and indeed
important, for the respondent to introduce it.
Does s. 18(3.1) apply to
interest expense?
[58]
In her written submissions,
counsel for the respondent raised an issue regarding interest expense. It was
not mentioned, or even hinted at, in the reply and it was not discussed in the
appellants’ submissions. This issue provides the appellants another possible
avenue to deduct interest on current account and counsel for the respondent is
to be commended for raising it in the written submissions.
[59]
In the assessments, the Minister
applied s. 18(3.1) and capitalized interest payable in 2002 on a mortgage on
the Dundas Street property. No interest was capitalized for the 2003
taxation year, however, because the Minister was not satisfied that any
interest had been incurred in that year because no documentation was provided.
[60]
The issue is described in paragraph
56 of the respondent’s written submissions which is reproduced below.
56. In
reassessing the Appellants in 2002, the Minister assumed that the interest paid
or payable by the Appellants could not be identified with the Property but
could reasonably be considered as interest on borrowed money used by the
taxpayer in respect of the construction, renovation or alteration of the
Property. Accordingly, the Minister assumed interest expense of $19,044 as
addition to Class 3 property, pursuant to subsections 18(3.1) and (3.2). In
order to defeat the Minister’s assumption, and successfully claim interest
expense deductions, the onus is on the Appellants to show that:
(i)
subsection 18(3.2) did not apply; and
(ii)
another provision in the Act applied to allow the deduction.
This can be
done if the Appellants provided evidence that the borrowed money pertained to
the Property, and the interest expense was deductible pursuant to paragraph
20(1)(c). In order for paragraph 20(1)(c) to apply, the borrowed money needs to
be used for the purpose of earning income from a business or property. On
cross-examination, Mr. Santagapita could not establish the current use of
borrowed money. Accordingly, the Appellants have not established the direct use
of borrowed money for 2002. The Minister was correct in his assumption that
subsection 18(3.1) applied to the 2002 interest expense.
[61]
As I understand the respondent’s
position, it is that interest payable in respect of the mortgage on the Dundas
Street property is not required to be capitalized under subsection 18(3.1)
unless the mortgage proceeds can reasonably be considered to be used for the
renovation project. If the borrowed money had been used to buy the property, on
the other hand, the interest would be deductible on a current basis under s. 20(1)(c).
[62]
I would first note that
the reply contains no mention of s. 18(3.2) or s. 20(1)(c) and no
assumption as to the use of the mortgage proceeds. In order to be fair to the
appellants, all of this should have been set out in the reply.
[63]
Turning to the merits, the
question that must be decided is the actual use of the mortgage proceeds. Mr.
Santagapita was cross-examined on this point by counsel for the respondent.
Although his answers were vague, I conclude that it is likely that the proceeds
of the mortgage were used by the appellants for the original purchase of the Dundas Street
property.
[64]
Accordingly, interest payable on
the mortgage can be deducted on a current basis under s. 20(1)(c). It
remains to be considered how much interest was incurred and this is discussed later
in these reasons.
Should capitalized amount
be reduced pursuant to s. 20(29)?
[65]
As an alternative argument, the
appellants submit that certain expenses that otherwise would have to be
capitalized under subsection 18(3.1) should be deducted on current account
pursuant to subsection 20(29) of the Act.
[66]
In general, subsection 20(29)
permits a deduction for expenses that otherwise would be capitalized under s.
18(3.1) to the extent of income from renting the property.
[67]
Subsection 20(29) provides:
20(29) Idem. Where, because of subsection
18(3.1), a deduction would, but for this subsection, not be allowed to a
taxpayer in respect of an outlay or expense in respect of a building, or part
thereof, and the outlay or expense would, but for that subsection and without
reference to this subsection, be deductible in computing the taxpayer’s income
for a taxation year, there may be deducted in respect of such outlays and
expenses in computing the taxpayer’s income for the year an amount equal to the
lesser of
(a) the total of all such
outlays or expenses, and
(b) the taxpayer’s income for the
year from renting the building or the part thereof computed without reference
to subsection 20(28) and this subsection.
[68]
The appellants submit that, if the
insurance proceeds for loss of rent are required to be included in their
income, they should be allowed a deduction up to this amount for expenses
otherwise capitalized under s. 18(3.1).
[69]
I agree with this submission.
[70]
For purposes of this issue, it is
necessary to interpret the phrase in s. 20(29) “income for the year from
renting the building.” Is it broad enough to include the insurance proceeds?
[71]
The above phrase is open to more
than one interpretation, I believe. Based on a purposive approach, I conclude that the
phrase can, and should, be interpreted to include income from a rental
operation, which would include insurance proceeds for loss of rent.
[72]
In the result, the expenses
incurred by the appellants that otherwise would have to be capitalized under s.
18(3.1) are deductible up to a maximum of $12,500 for each of the appellants in
the 2002 taxation year.
What expenditures have
been incurred?
[73]
In the reassessments, the Minister
took the view that certain expenditures should be disallowed in their entirety pursuant
to paragraph 18(1)(a) of the Act. This provision reads:
18(1) General limitations. In computing the income of a
taxpayer from a business or property no deduction shall be made in respect of
(a) General limitation - 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;
[74]
In paragraph 47 of the amended
notices of appeal, the appellants submit that the expenses as claimed in the
income tax returns are correct, with the exception of items for which the
Minister has accepted a higher amount.
[75]
Aside from the merits of this
submission, I admit some difficulty in figuring out exactly what relief is
being sought.
[76]
The first question is to determine
the items that the Minister agreed to increase beyond what was claimed in the
income tax returns. It is true that the Minister did agree to increase some expenses
but it is not clear that these items are the same as submitted by the
appellants in paragraph 47 of their brief.
[77]
To compound the problem, it appears from the appellants’ written submissions that
their position has shifted somewhat since filing the amended notices of appeal.
[78]
As best as I could piece things
together, the chart below summarises the final positions of the parties
concerning the various expenditures:
|
|
Apps’ position
in notices of appeal
|
Apps’ position
in trial memo
|
Resp’s position in replies
|
In
dispute?
|
|
2002
|
|
|
|
|
|
Insurance
|
$2,196
|
$2,196
|
$2,196
|
No
|
|
Interest
|
$22,614
|
$19,044
|
$19,044
|
No
|
|
Maintenance
and repairs
|
$12,518
|
|
$12,583
|
No
|
|
Property
taxes
|
$2,788
|
$2,788
|
$2,788
|
No
|
|
Utilities
|
$1,502
|
$1,502
|
nil
|
Yes
|
|
2003
|
|
|
|
|
|
Insurance
|
$2,621
|
$2,621
|
$2,621¹
|
No
|
|
Interest
|
$17,644
|
$19,218
|
nil
|
Yes
|
|
Maintenance and repairs
|
$13,098
|
$15,475
|
$3,144
|
Yes
|
|
Property
taxes
|
$2,673
|
$2,673
|
$2,673
|
No
|
|
Utilities
|
$500
|
$187
|
$187
|
No
|
¹ Replies,
para. 14 and 15(x).
[79]
I will consider each of the
disputed items in the order that they appear in the chart.
Utilities
[80]
The first item is utilities for
the 2002 taxation year. The appellants state in their written submissions that
the Minister has acknowledged that these expenses were incurred.
[81]
It is not clear to me that the
Minister did in fact acknowledge that these expenses were incurred. Certainly
the replies of the Minister suggest otherwise (para. 15(s)).
[82]
Nevertheless, I have decided to
accept the appellants’ submissions on this point, which is a relatively small point
in the context of these appeals.
[83]
The basis for my conclusion is
Schedule A to the amended notices of appeal. This document appears to be a CRA
schedule which suggests that the utilities’ expense should be accepted.
Interest
[84]
The second item to be considered is
interest expense for the 2003 taxation year.
[85]
For purposes of the assessments,
the Minister acknowledged that mortgage interest in the amount of $19,044 was
incurred in the 2002 taxation year but he did not accept that any interest was
incurred in the 2003 taxation year because no documentation was provided.
[86]
The appellants introduced the
necessary documentation at the hearing relating to the 2003 taxation year. It
consisted of a bank statement showing interest totaling $19,218. Based on this
and other evidence, my conclusion is that this amount was interest payable in
respect of the 2003 taxation year. I also conclude that the use of the borrowed
money was for the original purchase of the building.
Maintenance and
repairs
[87]
The last item in dispute is listed
under the heading “maintenance and repairs.”
[88]
The appellants submit that the
total of these expenditures is $15,475, whereas only $13,098 was claimed in the
income tax returns. After the audit and objection process, the Minister allowed
only $3,144.
[89]
At the hearing, the appellants
introduced into evidence copious receipts (17 separate bundles) from
several stores, most of which specialized in home improvements.
[90]
The receipts by themselves do not
establish that these items were purchased in connection with the repair and
maintenance of the Dundas Street property.
[91]
Accordingly, the question is an
evidentiary one. Is there sufficient evidence linking the receipts to the
renovation project at 124 Dundas Street?
[92]
There are some obvious problems in
making this link. First, most of the receipts appear to relate to building
materials and equipment, but not all of them do. Also, counsel for the
respondent pointed out that one of the receipts was for tiles that were to be
delivered to another property owned by the appellants. No satisfactory
explanation was provided for this.
[93]
Mr. Santagapita did provide some testimony
regarding these receipts but I did not find his testimony to be clear and
cogent enough to be convincing.
[94]
I would also note that many of the
receipts are for cash purchases. I agree with the respondent that it is
possible that many of these purchases were made by others and not the
appellants.
[95]
When the evidence is considered in
its entirety, I conclude that there is not sufficient reliable evidence that
ties the receipts to the construction project at 124 Dundas Street.
[96]
The essential problem for the
appellants is that they were not able to produce proper books of account that
were prepared on a timely basis.
[97]
I acknowledge that the appellants
may have incurred greater expenses than those allowed by the Minister but there
is not sufficient reliable evidence to establish what the proper amount should
be. In the circumstances, the assessments will be upheld on this issue.
Conclusion
[98]
Based on the above conclusions,
the appeals will be allowed and the assessments will be referred back to the
Minister for reconsideration and reassessment on the following basis:
(a)
as for the $50,000 insurance proceeds, $12,500 shall be
included in computing the income of each of the appellants for the 2002 taxation
year and no amount shall be included for the 2003 taxation year;
(b)
as for soft costs, subsection
18(3.1) of the Act should be applied in respect of the 2002 and 2003
taxation years on the basis that the renovation of the building was completed
on October 29, 2003;
(c)
as for soft costs in respect of
the 2002 taxation year, the amount limited by subsection 18(3.1) shall be
reduced pursuant to subsection 20(29) of the Act to a maximum of $12,500
for each appellant;
(d)
as for interest expense with
respect to the mortgage, each of the appellants is entitled to a deduction for
the 2002 and 2003 taxation years in the amount of 50 percent of $19,044 and
$19,218, respectively, pursuant to paragraph 20(1)(c) of the Act;
and
(e)
as for utilities, expenses in the
amount of $1,502 were incurred in the 2002 taxation year.
[99]
The appellants are
entitled to costs on the basis of one set of counsel fees.
Signed at Ottawa, Canada this 3rd
day of December 2008.
“J. Woods”
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