[OFFICIAL ENGLISH TRANSLATION]
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Reference: 2004TCC437
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Date: 20030615
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Dockets: 2002-4491(IT)I
2002-4615(IT)I
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BETWEEN:
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GÉRARD BARRETTE,
DOMINIQUE BÉRARD,
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Appellants,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
(Delivered orally at the hearing of August 20,
2003, at Montréal, Quebec, and amended for greater
clarity.)
Archambault J.
[1] Mr. Dominique Bérard and
Mr. Gérard Barrette are appealing from the assessments
made by the Minister of National Revenue (the "Minister") for the
1998 taxation year. The Minister disallowed their claim for
deductible business investment losses within the meaning of
paragraph 38(c) of the Income Tax Act (the
"Act"). The amount of the deduction disallowed is $51,344
(75% of a $68,459 loss) for Mr. Bérard, and $42,098 (75%
of $56,131) for Mr. Barrette. The losses were incurred as a
result of investments in Groupe Immobilier Diese Inc.
("Diese").
[2] The Minister disallowed the
deductions because he considered the losses at issue to be
capital losses, given that Diese was not a "small business
corporation" within the meaning of subsection 248(1) of the
Act. The Minister maintains that Diese operated a
"specified investment business," according to the definition set
out in subsection 125(7) of the Act. All its income was
earned from property, and it did not employ more than five
employees on a full-time basis throughout the taxation year at
issue. The Appellants argue that Diese was a small business
corporation, because its operations consisted of buying and
selling real estate.
[3] At the outset of the hearing, the
Appellant admitted to all the facts set out in the Replies to the
Notice of Appeal prepared by the Respondent, except paragraph
4(i) of the Reply involving Mr. Barrette. The following are
each of the relevant paragraphs of the Reply involving Mr.
Bérard:
a) During the
years at issue, the Appellant was a shareholder in Groupe
Immobilier Diese Inc. (the "Corporation");
b) This
Corporation was incorporated on April 13, 1989;
c) The
Corporation's sole asset was a commercial building located at
2131 Sainte-Hélène Street, in the municipality of
Longueuil;
d) The
Corporation acquired this building on July 13, 1989, for the sum
of $258,000;
e) The
Corporation's sole income consisted of rental income;
f) The
Corporation had no employees;
g) The
Corporation was not associated with any other corporation;
h) The
Corporation declared bankruptcy on February 3, 1999;
i)
Between 1989 and 1998, the Appellant invested a total of $68,459
in this Corporation.
The following are the relevant paragraphs of the Reply
involving Mr. Barrette:
a) During the
years at issue, the Appellant was a shareholder in Groupe
Immobilier Diese Inc. (the "Corporation");
b) This
Corporation was incorporated on April 13, 1989;
c) The
Corporation's sole asset was a commercial building located at
2131 Sainte-Hélène Street, in the municipality of
Longueuil;
d) The
Corporation acquired this building on July 13, 1989, for the sum
of $258,000;
e) The
Corporation's sole income consisted of rental income;
f) The
Corporation had no employees;
g) The
Corporation was not associated with any other corporation;
h) The
Corporation declared bankruptcy on February 3, 1999;
i)
Between 1989 and 1998, the Appellant invested a total of $39,605
in this Corporation.
Facts
[4] The Respondent submitted income
tax returns for Diese for the 1992 to 1997 taxation years; each
of the returns shows that the principal activity of this
corporation is real estate rental. The real estate held by
Diese is treated as a capital property in these returns and the
attached financial statements. Moreover, capital cost
allowances totalling $25,514 were claimed for the period of 1992
to 1994.
[5] The analysis of these income tax
returns and financial statements shows that Diese incurred a tax
loss and an accounting loss for each year from 1991[1] to 1997. The
accounting losses are as follows:
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1991
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$23,589
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1992
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$18,537
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1993
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$13,386
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1994
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$14,218
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1995
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$9,857
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1996
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$4,510
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1997
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$1,035
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$85,132
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[6] The Appellants explained the
circumstances in which they invested in this corporation.
Mr. Barrette's sister-in-law, Diane Beaudry, a residential and
commercial real estate agent, identified a group of four
individuals who were interested in investing in this
corporation. She located the building that Diese acquired,
and she negotiated its purchase. The building, located on
Sainte-Hélène Street in Longueuil, was in good
repair and did not need any renovation work, even though Mr.
Bérard acknowledged that it had not been inspected by
experts. At the time of purchase, the building was occupied
by three tenants: a television and electronics repair business
that paid a monthly rent of $1,100; a karate school that paid a
monthly rent of $700; and, a non-profit organization that paid a
monthly rent of $800.
[7] The promise to purchase proposed
by Diese was accepted by the vendor on April 10, 1989. The
agreed on price was $258,000. The purchase agreement was
signed before a notary on July 12, 1989. The sum of
$223,000 was paid (in part with a mortgage loan) and the balance
of $35,000 was payable one year later, on July 12, 1990,
and bore interest at a rate of 10%.
[8] Diese was incorporated three days
after the promise to purchase was accepted, on April 13,
1989. The four shareholders, who each held 25% of the stock
in Diese, were the Appellants, Ms. Beaudry, and a Mr.
Roussel. The three men were all inspectors for the
Régie du bâtiment. Each of the four
shareholders' initial investment was $3,000.
[9] Diese filed a financial statement,
dated June 6, 1989, and signed by Ms. Beaudry, with the Inspector
General of Financial Institutions ("IGIF"). Ms. Beaudry
described the nature of Diese's activities as buying, renovating
and reselling real estate. During his testimony, Mr.
Bérard confirmed that the intention of Diese and its
shareholders was to purchase the Longueuil building and resell it
at a profit in one year. At the end of the 1980s, the real
estate industry was healthy; the market was fairly brisk.
Real estate values were constantly on the rise, and, according to
Ms. Beaudry, this building was expected to appreciate in value by
$15,000 to $20,000. Mr. Bérard explained that
Diese's financial statements had been prepared by an accountant-a
CGA-who had also completed the income tax returns for
Diese. This person described the principal activity of
Diese as the rental of real estate.
[10] In 1990, the shareholders visited
another building that Diese was considering purchasing.
However, no offer had been made to the vendor because of the
extensive renovations that would have been necessary in this
building; this was not appealing to them.
[11] During his testimony, Mr. Bérard
described the problems with the building at issue and Diese's
unsuccessful attempts to sell it. Six months after the
acquisition of the building in 1989, the non-profit organization
vacated its premises, and despite all its efforts, Diese was
unable to find another tenant before 1995. Moreover, Ms.
Beaudry experienced financial difficulties in 1990, and she
declared bankruptcy. She was unable to pay her share of the
balance owing to the vendor of the building. According to
Mr. Bérard, Ms. Beaudry attempted to sell the building at
that time, with no success. The Appellants assumed her
share of the debt, and the three remaining shareholders paid the
outstanding $35,000 in July 1990.
[12] A second effort to sell the building
was made on January 25, 1991. This one-year mandate was
given to Ms. Verreault, another real estate agent. The
mandate included an "MLS" listing, and the commission to be paid
was 5%. The asking price for the building was
$298,000. According to the listing, the balance owing on
the mortgage was $188,850, the interest rate was 15½%, and
the loan came due during the year.
[13] Over the two years that followed, the
karate school changed ownership, and it paid its rent every other
month only.
[14] The building was listed with a new
agent on March 9, 1993. The property listing was valid
until September 1993. The asking price was reduced to
$240,000, then it was reduced again on March 28, 1993, to
$235,000. The commission agreement was also changed: the 7%
commission on the selling price that the vendor initially agreed
to pay was changed to a $10,000 lump-sum payment. A 7%
commission on a selling price of $235,000 would be $16,450.
Obviously, where the building was to be sold for less than
$142,857, the percentage to be paid would be greater than 7%.
[15] In July 1994, a rental mandate, valid
until January 1995, was entrusted to La Capitale. Diese
agreed to pay a 5% commission on rent payments.
[16] In 1994 or 1995, a leaky roof required
Diese to pay $5,000 to $6,000 to replace it.
[17] Diese was finally successful in finding
a new tenant in 1995 to replace the non-profit
organization. The tenant signed a one-year lease, which, in
fact, would only be renewed once. Given the difficult
market conditions at the time, Diese was able to collect only
$400 per month, or half the amount of the rent that the
non-profit organization had paid. According to Mr.
Bérard, this amount of rent was better than none at
all. In order to have this lease signed, the shareholders
had to fit-up the space themselves by removing some walls and
repainting. The cost of the materials was approximately
$1,000.
[18] A new rental mandate was signed with La
Capitale in February 1996. This mandate was valid until
August 1996, and the commission remained at 5%.
[19] According to Mr. Bérard, Diese
lost its three tenants in 1997. Plans were made to convert
the property from a commercial building to a residential
building. However, because of the high cost of the
conversion and the bank's refusal to finance the work required,
the project was abandoned. Diese declared bankruptcy in
February 1999. The building was sold for a derisory
sum.
[20] Mr. Barrette acknowledged that he could
not support a sum of $56,131 for his investment in Diese; the
Minister determined that his investment was $39,605.
Analysis
[21] The only issue at bar in these appeals
is whether Diese was a "small business corporation," and more
specifically, whether its business was an "active business" or a
"specified investment business." The expression "active business"
is defined at subsection 248(1) of the Act as follows:
"active business", in relation to any business
carried on by a taxpayer resident in Canada, means any business
carried on by the taxpayer other than a specified investment
business or a personal services business;
[22] According to the same section, the
definition of a "specified investment business" is defined at
subsection 125(7) of the Act, as follows:
"specified investment business" carried on by a
corporation in a taxation year means a business (other
than a business carried on by a credit union or a business of
leasing property other than real property) the principal
purpose of which is to derive income (including interest,
dividends, rents and royalties) from property but,
except where the corporation was a prescribed labour-sponsored
venture capital corporation at any time in the year, does not
include a business carried on by the corporation in the year
where
(a) the corporation employs in the business throughout
the year more than 5 full-time employees, or
[...]
[Emphasis mine.]
[23] The Respondent's position is,
essentially, as follows. Because the only income declared
by Diese was rental income, it was a specified investment
business. It should also be noted that the Respondent's
Reply to the Notices of Appeal does not indicate that the
Minister considered that Diese's principal purpose was to
earn income from property. Because the "principal
purpose" of earning an income from property constitutes, in
my opinion, an essential element to conclude that a specified
investment business existed, and that the Minister did not
consider this element, I informed counsel for the Respondent at
the outset of this hearing that it was incumbent upon her to
establish this fact. I have addressed this issue in
Stein v. Canada, [1996] T. C. J. No. 685 (Q.L.),
paragraphs 12 to 15, 96 DTC 1526, at page 1529, in
which I cite important decisions with respect to burden of
proof. More specifically, I cite the decision in M.N.R.
v. Pillsbury Holdings Ltd., 64 DTC 5184, at page 5188,
in which Cattanach J. of the Exchequer Court of Canada explains
how a taxpayer must proceed to successfully challenge a tax
assessment:
[. . .]
The respondent could have met the Minister's pleading
that, in assessing the respondent, he assumed the facts set out
in paragraph 6 of the Notice of Appeal by::
(a) challenging the Minister's allegation that he did
assume those facts,
(b) assuming the onus of showing that one or more of the
assumptions was wrong, or
(c) contending that, even if the assumptions were
justified, they do not of themselves support the
assessment.
(The Minister could, of course, as an alternative to
relying on the facts he found or assumed in assessing the
respondent, have alleged by his Notice of Appeal
further or other facts that would support or help in
supporting the assessment. If he had alleged such further or
other facts, the onus would presumably have been on him to
establish them.)
[. . .]
[Emphasis mine.]
[24] I added the following, at paragraph 15
page (Q.L.), 1529 (DTC):
[TRANSLATION]
More recently, the Federal Court of Appeal, in Pollock
v. The Queen, 94 DTC 6050, described the onus on
the Minister to defend his assessment where a taxpayer has
successfully refuted some of the Minister's assumptions. At
page 6053, Hugessen J. said the following:
Where, however, the Minister has pleaded no assumptions, or
where some or all of the pleaded assumptions have been
successfully rebutted, it remains open to the Minister, as
defendant, to establish the correctness of his assessment if he
can. In undertaking this task, the Minister bears the
ordinary burden of any party to a lawsuit , namely to prove
the facts which support his position unless those facts have
already been put in evidence by his opponent.
[Emphasis mine.]
[25] In this case, the principal
evidence-the only evidence-presented by the Respondent, is that
all the gross income reported by Diese was rental income and that
Diese had stated in its income tax returns that its principal
activity was the rental of real estate.
[26] In her arguments, counsel for the
Respondent cited a number of court decisions, namely
Boulanger v. R., 2002 CarswellNat 1556, 2002 DTC
2016, Prosperous Investments Ltd v. Canada, [1992]
T.C.J. No. 6 (Q.L.), Rogers v. Canada, [1997]
T.C.J. No. 2 (Q.L.), Mayon Investments Inc. v.
Canada, [1990] T.C.J. No. 1121 (Q.L.), Canadian
Marconi v. Canada, [1986] 2 S.C.R. 522, [1986] S.C.J.
No. 66 (Q.L.), Lee v. Canada, [1999] T.C.J. No. 249
(Q.L.), Martel v. Canada, [2002] T.C.J. No. 302
(Q.L.), and finally, Gascoigne v. Canada, [1996]
T.C.J. No. 24 (Q.L.).
[27] In order to resolve the issue raised by
these appeals, we must, in my opinion, rely on the wording of
subsection 125(7) of the Act (reproduced above), which defines a
specified investment business. The key words in this
definition are "the principal purpose of which is to derive
income...from property." I stress that the wording
does not say that a specified investment business is a business
for which income is earned mostly from property or in large part
or mainly from property.
[28] It is important, therefore, to
determine the principal purpose, which, obviously, depends on the
true intention of the taxpayer. Among the decisions cited
by counsel for the Respondent is Prosperous Investments,
supra, in which my colleague, Bowman J., currently Associate
Chief Justice, addressed this issue, as follows:
In determining the "principal purpose" of a business
carried on by a corporation the stated object of the person who
carries it on is not necessarily the only, or even the most
important, criterion. Of critical importance is what the
corporation in fact does and what its sources of income are.
[29] It is important to recall the facts of
this decision, as reported by Bell J. in Rogers,
supra, at paragraph 14:
Judge Bowman proceeded to analyze the taxpayer's financial
statements in which he noted that the mortgage receivables and
rent items made up well over fifty percent of the value of the
company's assets. Furthermore, the principal
portion of the revenues of the taxpayer was derived from rentals
and interest and by far the preponderant part of the
corporation's capital was devoted to rental properties and
mortgages.
[30] It is my opinion that the remarks of
Bowman J. essentially deal with the same principles as those
applied in case law, where it is necessary to determine whether a
property constitutes capital property or property that is part of
the inventory to decide whether the gain resulting from the sale
of this property is a capital gain or business income.
There is no doubt that the taxpayer's intention is important in
determining the nature of a property, but obviously the courts
cannot render their decisions based solely on the taxpayer's
statements. Case law has established indicators to verify
the credibility of a taxpayer and to determine the plausibility
of statements of intention made subsequent to the acquisition of
the property.
[31] Although not an exhaustive list, these
indicators include the nature of the property, the duration of
possession, the circumstances surrounding the sale of the
property, and the profession practiced by the taxpayer.
Where the property is a rental property that generates rental
income, this could be an indicator that it is a capital asset,
whereas the purchase of a large number of vehicles or a large
amount of soap would indicate that they are property that are
part of the inventory.
[32] Given the principles relevant to
interpreting the Act, and given the facts relevant to this case,
it must be concluded in this case that the Respondent did not
discharge its duty to establish that Diese's principal goal was
to earn income from rental properties. Conversely, the Appellants
established that Diese's principal goal was real estate
speculation. The facts in support of the conclusion that
the building on Sainte-Hélène Street in Longueuil
was acquired in the context of a real estate buying and selling
business are as follows. Diese purchased its building for
the purpose of reselling it quickly, at a profit. Moreover,
where a corporation owns a building, the courts tend to conclude
more easily that the activity of such a corporation constitutes
"a business carried on" rather than a "project involving a risk"
or an "adventure in the nature of trade." It should also be
noted that Diese had taken steps to acquire a second
building.
[33] It is my opinion that, clearly, the two
Appellants were led into an adventure in the nature of trade with
risk by a real estate agent, Mr. Barrette's sister-in-law.
Because of her profession and her experience, this person had the
knowledge required to speculate in real estate. Given their
professional experience as building inspectors, the Appellants
did not have the knowledge required for speculation, nor did they
have the knowledge required for commercial leasing. They
relied on Ms. Beaudry, who was the veritable instigator of this
project and the person who directed it, at least at the
outset. Her intention is significant for the purpose of
determining the intention of Diese in the pursuit of this
project. Thus, Ms. Beaudry's intention was made clear at
the very beginning, when she stated, in her financial statement
to the IGIF in June 1989, that the activities of Diese would
consist of buying, renovating, and selling real estate.
Given her profession as a real estate agent and her knowledge of
taxation,[2] Ms.
Beaudry was well aware of the consequences of this
statement. Given this statement, Diese could not have
treated gains in its real estate operations as capital
gains. Where the intention of Diese had been to acquire
long-term real estate investments, Ms. Beaudry would not have
provided this description of the business.
[34] It is a fact that the financial
statements of Diese indicate that its principal activity was real
estate rental, but obviously this indication does not correspond
with that expressed in the financial statement. It is
likely that Ms. Beaudry was no longer a shareholder of Diese when
the accountant prepared these financial statements, and I am not
persuaded that the Appellants understood the scope of this
indication and the impact it might have. I am persuaded
that if the accountant had been properly apprised of the true
intention of Diese, he would not have described its principal
activity as he did. He would not have entered the building
in the statement as a capital asset, and he would not have
claimed a capital cost allowance. It is my opinion that the
financial statement prepared by the joint shareholder who located
the building, negotiated its purchase, and played a leadership
role in Diese has a more significant probative value than the
simple description made by the accountant in the financial
statements.
[35] It should be recalled that the market
conditions in 1989 encouraged speculation, owing to the constant
increase in the value of real estate, a trend that had been
occurring for a number of years-nearly two decades. The fact that
Diese never made a profit from the rental of its building, and
that it accumulated a loss of more than $85,000 in seven years,
does not help the Respondent discharge its duty to demonstrate
that this corporation's principal goal was to earn income from
property.
[36] My conclusion is the same where I
analyze the actions of Diese. Did it act in a manner that
is consistent with the indications made in the financial
statements sent to the IGIF? Did it attempt to sell the
building in question quickly? The evidence showed that
there were a number of attempts to sell. Firstly, Ms.
Beaudry tried to sell it. Unfortunately, the details are
somewhat vague in this respect because the Appellants did not
have the relevant documents with them and because Ms. Beaudry did
not testify. In his testimony, Mr. Bérard stated
that Ms. Beaudry did attempt to sell the building before the
shareholders were obligated to pay the balance of the purchase
price, that is, in the first twelve months following the
purchase. This step is consistent with the schedule
anticipated at the outset.
[37] In January 1991, another attempt was
made to sell the building. Documents were filed to
establish the fact that a mandate had been assigned to sell the
building for $298,000, or $40,000 more than the initial purchase
price of the building. In 1993, the price was reduced
twice, and despite all of its efforts, Diese was unable to sell
the building. In this situation, the initial plan failed
because of economic conditions and real estate market
conditions. It is a known fact that the real estate market,
particularly in the Montréal area, collapsed in the
1990s. The loss of a tenant, resulting in a five- or
six-year vacancy of a unit, obviously did not help sell the
building.
[38] The evidence provided by the Respondent
did not show that Diese had changed its business. The
rental of real estate continued, in my opinion, while awaiting
improvements in the real estate market. The fact in this
appeal are similar to those in Stein, supra. The
following is a part of the summary of this decision, found at
page 1526 DTC:
The evidence clearly established that the taxpayer had not
acquired the condominium for the purpose of earning rental
income. He acquired it for speculative purposes, not intending to
resell it quickly at a profit. Any rental income received,
therefore, was only intended to mitigate his carrying charges,
since the taxpayer's intention to rent was only ancillary to
his overall purposes. Nor did the taxpayer ever have any
expectation of profit from renting. Accordingly the Minister was
correct in disallowing the taxpayer's attempt to deduct
rental losses in computing his income for 1986 and 1987. On the
facts, moreover, when the taxpayer acquired the condominium, he
did indeed have a reasonable expectation of profit on subsequent
resale. And even though such expectation was thwarted by the
recession, the taxpayer's intention throughout had always
been to resell. The property, therefore, was inventory, so that
the taxpayer was required to capitalize, rather than to deduct,
any running expenses incurred by him during 1986 and 1987.
[39] This was a case in which the Minister
had disallowed the deduction of losses on the basis-too often
wrongly claimed-that there was no reasonable expectation of
profit. It is my conclusion that the Minister drew the same
incorrect conclusion in this case. It cannot be concluded
that a taxpayer ceased to operate the type of business in
question simply because the business was not operated in the
manner planned and because a taxpayer is saddled with a
speculative property that he cannot sell.
[40] Before concluding, I would like to
mention that I have read the decisions presented to me by counsel
for the Respondent attentively. The issue in this case is
question of fact, or, at the very least, a combined question of
fact and of law. Each case must be considered on its own
merits. I do not feel it is useful to comment on each of
these decisions and distinguish them from this one. I will,
however, comment on Boulanger, in which Lamarre J. wrote,
at paragraph 28:
[. . .]
I therefore reject the appellants' argument that the mere
intention to operate a business is sufficient to qualify the
Corporation as a small business corporation for the purposes of
deducting a BIL.
[41] It is important to place this statement
in its context. Clearly, the mere intention to wish to
operate a business is not sufficient to operate a business.
Action is required. That case involved a project which, in
the opinion of Lamarre J., had not advanced past the stage
of preparing to establish a business. In paragraph 34, she
says:
I agree with counsel for the respondent that the elements
essential to the project's implementation collapsed even
before the project saw the light of day. The Corporation did not
obtain the necessary financing to start its project, and the
Corporation was unable to conduct any major transaction with
respect to the type of business it was supposed to carry on.
[42] In this case, the intent was to group a
number of automobile dealerships together at one single
site. Further in paragraph 34, she adds:
No sufficient organizational structure was established that
could enable the Corporation to commence activities relating to
the operation itself, such as looking for suppliers, developing
markets for products, and looking for the necessary labour. All
this simply did not exist and, in that sense, it is hard to
conceive, as stated in Samson et Frères Ltée,
supra, that a business had begun even before those essential
elements relating to the structure of such a business were
brought together.
[43] At paragraph 35,
in fine, she writes:
It is difficult to claim that the Corporation actively
operated an automotive centre in 1996, when the only building
constructed on the land purchased for that purpose did not even
belong to the Corporation (see on the subject Goren,
supra). In my view, the Corporation was, to all intents
and purposes, merely an inactive corporation without the capital
needed to implement the automotive services project it intended
one day to operate.
[44] It is my opinion that this decision
illustrates very well the fact that the words of a judge should
not be cited out of context; they must be connected to the facts
relevant to the decision.
[45] In this case, the operation of Diese's
business had obviously started. This corporation had
acquired a building for the purpose of reselling it at a profit;
it had secured a loan to fund the purchase, and, in the following
months and years, attempted to sell the building without
success.
[46] For all these reasons, the appeals of
the Appellants are allowed, and the assessments are referred back
to the Minister for reconsideration and reassessment, taking into
consideration the fact that the Appellants held investments in a
small business corporation. However, Mr. Barrette's
business investment loss must be calculated on the basis of the
$39,605 investment he made, as he was unable to demonstrate that
his investment exceeded this amount.
Signed at Ottawa, Canada, this 15th day of June
2004.
Archambault J.
Certified true translation
Colette Dupuis-Beaulne
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