Valladolid v. The Queen, docket 98-1009-IT-G

Date: 20010531

Docket: 98-1009-IT-G

BETWEEN:

ROSALINA VALLADOLID,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Mogan J.

[1]            The Appellant has appealed from income tax assessments for her 1992 and 1994 taxation years. In each of those years, the Appellant deducted in computing income losses which she suffered from a property rental operation and a food operation. The Minister of National Revenue disallowed the deduction of the losses on the basis that the Appellant did not have a reasonable expectation of profit. The principal issue in these appeals is whether the Appellant is entitled to deduct her claimed losses in 1992 and 1994. The Appellant claimed a goods and services tax ("GST") credit in 1992 and 1994. She also claimed the child tax benefit in 1992, 1994 and 1996. The GST credit and child tax benefit depended in part on the Appellant's income. Accordingly, the Minister either reduced or disallowed entirely the amounts claimed as GST credit or child tax benefit. The secondary issues in these appeals is the amount of GST credit which the Appellant may claim in 1992 and 1994 and the amount of child tax benefit she may claim in 1992, 1994 and 1996.

[2]            The GST credit and the child tax benefit each depend in part on the quantum of a particular taxpayer's income. The principal issue in these appeals clearly affects the quantum of the Appellant's income for 1992 and 1994 because of the substantial losses which she deducted in each of those years. It is my understanding from both counsel that, if the deductibility of losses is finally determined, the Appellant's right to a GST credit and child tax benefit (and the amounts of such credit and benefit) will follow as a matter of course. Therefore, I will address only the principal issue in these reasons for judgment.

[3]            The Appellant was born in 1934 in the Philippines. She married there and had seven children. Her husband died in 1964 when her youngest child was only one year old. She received a university degree in the Philippines and became a school teacher. She moved to Canada in 1982 and brought all of her children with her even though most of them were young adults. The Appellant took up residence in the Toronto area and read local newspapers looking for a teaching job. She soon found employment as a qualified teacher. She later acquired a masters degree in language teaching and a PhD in linguistics. At the hearing of these appeals, the Appellant testified for more than three hours. She is intelligent, enterprising and hard-working with a high level of energy. The documents filed by the Appellant's counsel demonstrate that she is a meticulous record keeper. I found her to be a credible witness.

[4]            In the years 1992 through 1996, the Appellant reported good employment income, above $50,000, from her job as a qualified teacher. It is from this employment income that she sought to deduct the losses from her various enterprises. Although only 1992 and 1994 are under appeal, I shall set out in the table below the losses deducted by the Appellant in the five-year period from 1992 to 1996 inclusive. In the column headed "Activity" I have identified the source of the respective losses. The words "Meals and Fresh Food" will need further explanation because the product changed from 1992 to 1993.

Activity	1992	1993	1994	1995	1996
Rental	$25,304.08	$12,100.15	$13,896.37	$1,236.83	$10,570.19
T-shirt	392.63
Meals and Fresh Food	1,931.30	11,105.98	8,860.49	5,791.03	5,171.18

Rental

[5]            I will consider first the rental operation because it is more substantial and longer lasting. The Appellant purchased her first house in June 1987 on Truscott Drive in Mississauga at a cost of $168,000. It was a relatively small house with only three bedrooms. In 1988, she rented out the basement and two rooms on the second floor. In 1989, she sold the Truscott Drive house for $220,000 and purchased her second house at 4859 Guildwood Way in Mississauga, close to the corner of Mavis Road and Eglinton Avenue.

[6]            The second house on Guildwood Way was renumbered from 4859 to 5199 and was still owned and occupied by the Appellant at the time of the hearing of this appeal in the year 2000. Her cost in 1989 was $344,990 financed mainly by a first mortgage to the Bank of Nova Scotia for $289,680 and proceeds of approximately $30,000 from the sale of her first house. When the Bank knew that she was planning to rent parts of her house to some of her children in order to help pay down the mortgage, the Bank insisted that the children who would be tenants go on title as co-owners and co-mortgagors. The deed and the mortgage which are part of the documents in Exhibit A-4, Book I, show the co-owners to be:

                                                Rosalina Valladolid                               94%

                                                Mildred Valladolid                                2%

                                                Alex Valladolid                                      1%

                                                Edna Valladolid                                     1%

                                                Omar Valladolid                                     1%

                                                Pamela Valladolid                                  1%

Mildred is the Appellant's daughter; Alex and Omar are her sons; Edna is Alex's wife; and Pamela is Omar's wife.

[7]            The Appellant regarded herself as the real owner of the house at 5199 Guildwood Way. So did her children. Therefore, they signed a Co-tenancy Agreement in October 1989 (part of Exhibit A-4) which allocated ownership interests in accordance with the percentage beside each name in the above table. The purpose of the Co-tenancy Agreement was to pay lip service to the Bank's insistence that the "children-tenants" be on title and on the mortgage while confirming that, within the family, the Appellant was the true owner of the house. In 1989, the three children (Mildred, Alex and Omar) and the two daughters-in-law did in fact become tenants in the house. On July 27,1992, the five family members who were on title signed a document (part of Exhibit A-4) stating that they had "no interest whatsoever" in the house at 5199 Guildwood Way. This document simply confirmed what had been a fact from July 1989 when the house was first purchased.

[8]            I stated in paragraph 3 that the Appellant is a meticulous record keeper. Exhibits A-6 to A-9, Book II are records of all of her rental revenues and expenses for 1992 and 1994. Exhibit A-6 shows that her tenants in 1992 and the rent they paid were as follows:

Alex (son) and Edna plus 3 children	$600/month	12 months	$7,200
Omar (son) and Pamela plus 2 children	$550/month	12 months	$6,600
Ulysses Valladolid (son of Appellant)	$300/month	12 months	$3,600
Felisa Hernando (Edna's mother)	$300/month	6 months	$1,800
Omar	$200/month	12 months	$2,400
Total Rent reported in 1992			$21,600

The gross annual rent of $21,600 is the amount shown on the Appellant's 1992 income tax return but it is misleading with respect to the $200/month which Omar is shown as paying. Omar did not pay and the Appellant did not receive the $200/month. Each month, the Appellant issued to Omar a receipt for $200 stating that it was the value of snow shovelling or lawn maintenance (depending on the season) services which he provided "in exchange for accommodation for his kids". If this exchange was a real contra, it seems to me that the Appellant should have shown both sides of the transaction; the revenue and the expense as if Omar had paid her an extra $200/month in rent and she had paid him $200/month for ground maintenance. By showing only the revenue, the Appellant has reduced her reported loss by $2,400.

[9]            One can see from the table in paragraph 8 that all of the Appellant's tenants in 1992 were either direct family (sons, daughters-in-law and grandchildren) or in the case of Felisa Hernando, her son's mother-in-law. The Appellant testified that she followed the ads in the Toronto Star to find out what the fair rent was for comparable accommodation (basement apartment and single room) and that she charged her tenants the fair rent whether they were family or not. In 1994, many of her tenants were strangers (non-family) and she used Exhibit A-8, Book II to prove that the rent she charged to family was the same as rent charged to strangers. There were a number of tenants moving in and out during 1994 but, from Exhibit A-6, I shall attempt to list the tenants and rent.

Alex and Edna plus 3 children	$600/month	12 months	$7,200
Priscilla Almarinez	$250/month $100/ month	10 months 1 month	$2,500 $100
Tess Cuadra	$350/month	10 months	$3,500
Nancy Naboya	$350/month	2 months	$700
Ulysses Valladolid	$300/month	8 months	$2,400
Marcelino Syjueco	$375/month	3 months	$1,125
Rosemarie Bartolome	$350/month	6 months	$2,100
	$175/month	1 month	$175
Total Rent reported in 1994			$19,800

[10]          Among the above seven tenants, only Alex and Ulysses (both sons) were related to the Appellant. The other five (Priscilla, Tess, Nancy, Marcelino and Rosemarie) were not related. The gross rent in 1994 was approximately the same as the gross rent in 1992; particularly if the notional rent of $2,400 from Omar in 1992 is subtracted from the total rent of $21,600. On the evidence, I am satisfied that the Appellant was attempting to charge the market value rent to both her family and strangers. Also, subject to the allocation of expenses discussed below, I am satisfied that she was attempting to earn a profit from her rental operation.

[11]          Set out below is a condensed version of the way in which the Appellant computed her rental loss in each of the two years under appeal (1992 and 1994) and the year in between. The Appellant regarded only one-thirteenth (1/13) of her house and adjoining land as referable to her personal use. Accordingly, she allocated twelve-thirteenths (12/13) or 92.3% of all expenses to her rental operation:

	1992	1993	1994
Gross Rents	$21,600	$21,000	$19,800
Total Expenses	50,800	35,862	36,483
Personal Portion (1/13)	3,896	2,762	2,787
Rental Portion	46,904	33,100	33,696
Reported Loss	$25,304	$12,100	$13,896

The Appellant adopted the 1/3 ratio for personal use in 1989 or 1990 when she had the following thirteen persons living in her house:

Residing at 5199 Guildwood Way	Number
The Appellant	1
Alex Sr. (son) and Edna plus 3 children	5
Omar (son) and Pamela plus 2 children	4
Felisa Hernando (Edna's mother)	1
Ulysses (son)	1
Alex Jr. (adopted son)	1
	13

The Appellant saw that she was only one of thirteen persons residing in the house and so she decided that only 1/13 of all expenses was referable to her personal use. Because all of the other twelve were tenants paying rent, she deducted 12/13 of all expenses when computing rental income or loss. The Appellant maintained this 1/13 ratio for personal use in succeeding years (up to 1995 and 1996; see Exhibits R-9 and R-10) even when the number of persons residing in the house was less than 13.

[12]          If the 1/13 personal use ratio were reasonable, then the 12/13 portion of expenses applied against rental revenue would produce consistent losses and the Appellant would not have a reasonable expectation of profit with respect to her rental operation. Under section 67 of the Income Tax Act, a taxpayer may deduct an expense only to the extent that it was "reasonable in the circumstances". I find that the 1/13 ratio never was reasonable and it certainly was not reasonable in the years under appeal. The Appellant assumed that every individual residing in her house had equal needs and opportunity with respect to the use of the house and adjoining land. This is patently not true. For example, the three children of Alex and Edna and the two children of Omar and Pamela (in 1992) were not on the same footing as the adults. Not all adults had the same needs with respect to space because Alex and Edna were married as were Omar and Pamela. And finally, the Appellant herself had absolute control as to who would occupy which rooms; who would share certain common facilities like kitchen, living room, laundry and washrooms; how the yard would be used and who would maintain it.

[13]          In my opinion, it would be reasonable to allocate 1/3 of the total expenses to the Appellant having regard to her ownership, control, management and use of the house. The remaining 2/3 of the total expenses could reasonably be allocated to the rental operation. This revised allocation of expenses may be somewhat arbitrary but it gives to the rental operation a reasonable expectation of profit which it did not otherwise have, and it recognizes the reality of the Appellant's position as owner of the house and adjoining land. I have taken the trouble to revise the allocation of expenses because I am satisfied that the Appellant has a true entrepreneurial spirit. I am impressed with the size of the house she purchased; her diligent perusal of the Toronto Star to find out what a fair rent would be; her record keeping; and her efforts to recruit new tenants in 1994. This is not like the situation seen in many cases where a person is simply renting out one or two rooms in order to raise additional cash to help pay down the mortgage. The Appellant knew that she would need a significant rental operation when she purchased the larger house in 1989. Relying on the revised allocation of expenses, the Appellant is entitled to deduct the following adjusted losses in 1992 and 1994:

	1992	1994
Gross Rents	$21,600	$19,800
Total Expenses	50,800	36,483
Personal Portion 1/3	16,933	12,161
Rental Portion	33,867	24,322
Adjusted Loss	$12,267	$4,522

T-shirts

[14]          The Appellant and a friend, Mary Calanglang, had decided around 1990 that they could import T-shirts from the Philippines and sell them for profit. It was a modest operation. They did not realize at the time that they would have to pay duties when they imported the T-shirts. It was the kind of mistake that any inexperienced person could make, particularly if she was not born and raised in Canada. Costs were higher than expected and they (the Appellant and Mary Calanglang) lost $785.26 in 1992. The Appellant's one-half share of that loss was $392.63. There was no suggestion that the T-shirt sales were within the family. There were no "suspicious circumstances" to use the words of Linden J.A. in Tonn et al v. The Queen, 96 DTC 6001. In my view, the T-shirt operation was another example of the Appellant's enterprising nature. I would allow her to deduct in 1992 the amount of $392.63 as her one-half of the loss from the T-shirt operation.

Meals and Fresh Food

[15]          The third activity in which the Appellant suffered losses I have identified as "meals and fresh food". The meals operation was only in 1992. The fresh food was in 1993 and subsequent years. The Appellant knew that she was a good cook and so she decided to prepare meals in her kitchen at 5199 Guildwood Way for her tenants and others from the local Philippine community. According to the statement of business income attached to her 1992 income tax return (Exhibit R-1), the financial results of the Appellant's meals enterprise may be summarized as follows:

Gross Revenue	$4,459.65
Less Purchases	2,973.10
Gross Profit	1,486.55
Less Expenses	3,417.85
Net Loss	$1,931.30

[16]          The list of tenants in paragraph 8 above shows that all tenants in 1992 were either directly related to the Appellant or related by marriage. These were the persons for whom the Appellant primarily prepared meals in 1992. There is no evidence that a significant number of meals was sold to persons other than the Appellant's family. Again adopting the words of Linden J.A. in Tonn, there were "suspicious circumstances" in the Appellant's claim that her preparation and sale of meals in 1992 was a business. Paragraph 9 of the Notice of Appeal states:

9.              In 1992, the taxpayer again tried to supplement her income, this time by providing meals to her renters at a price. However, again it did not go as expected, she suffered a loss, and she discontinued this business.

[17]          I do not regard the meal activity as a "business". It is too closely tied to the idea of the Appellant feeding her extended family who were tenants in her house in 1992. The rent they paid as tenants can be compared with the rent paid by strangers (as in 1994) to prove that they were paying market value rent but there is no similar comparison for the amounts they paid to the Appellant for meals in 1992. Having regard to the computation in paragraph 15 above, I conclude that the Appellant was providing subsidized meals to part of her family in 1992. Her preparation and sale of meals did not have a reasonable expectation of profit. The Appellant's reported loss of $1,931.30 is not deductible in 1992.

[18]          The Appellant's evidence is that she got tired of preparing meals at the end of 1992 and decided that she would sell fresh fruits and vegetables. This activity is described in her 1993 income tax return as the sale of "fresh fruits, vegetables and frozen fish". The same words appear in her 1994 return. For 1995 and 1996 (Exhibits R-9 and R-10), the Appellant's returns show the product as "frozen foods". The Appellant seems to have regarded this as one continuous activity because the closing inventory from one year was carried forward into the opening inventory of the following year from 1993 through to 1996. See Exhibits R-2, R-3, R-9 and R-10.

[19]          At all relevant times, the Appellant was a full-time teacher. She would get up at 5:00 a.m. and be at the Ontario Food Terminal (west end of Metro Toronto) by 5:30 a.m. She would make her purchases. Her son would then take her to school for 8:30 a.m. and return to the house to store the food in a refrigerator or freezer. She would attempt to sell the food after she came home from school and on Saturdays. I will concentrate on the activity as reflected in the Appellant's income tax returns for 1993 and 1994 even though only 1994 is under appeal. The financial statements attached to the Appellant's returns for 1993 and 1994 may be summarized as follows:

Fresh Fruit & Vegetables	1993	1994
Gross Revenue	$12,162.00	$11,383.32
Cost of Goods Sold	9,817.94	9,354.05
Gross Profit	2,344.06	2,029.27
Expenses	13,450.04	10,889.76
Net Loss	$11,105.98	$8,860.49

[20]          The amounts shown as "expenses" in the above loss calculation can be divided as follows:

	1993	1994
Motor vehicle expenses	$3,337.32	$3,432.22
Other amounts paid out	1,584.22	1,462.74
Capital cost allowance (CCA)	8,528.50	5,994.80
	$13,450.04	$10,889.76

In both years, the motor vehicle expenses exceed the gross profit by about 50%. Other expenses and CCA simply increase a loss already established. According to the CCA schedule attached to the Appellant's 1993 income tax return (Exhibit R-2), CCA is deducted with respect to two freezers and refrigeration equipment having a cost of $1,242.53 and a van costing $27,600. The Appellant showed that 20% of the van was for personal use but she deducted CCA as if the van were 100% for business use.

[21]          The CCA with respect to the van is like the 1/13 personal use ratio which the Appellant applied to her house expenses in her rental operation. See paragraphs 11 and 12 above. If the van was used 80% or 100% for business purposes, the operating expenses and CCA will leave the Appellant with no reasonable expectation of profit; and the loss will not be deductible in 1994. I am satisfied that the van was not used more than 50% of the time for business because the Appellant was a full-time teacher; the food business was a sideline activity; and there was no evidence that any other member of the Appellant's family worked at the food business. If the van was used not more than 50% for business purposes, the Appellant's loss computations for 1993-1994 would be approximately as follows:

	1993	1994
Gross Profit	$2,344.06	$2,029.27
Motor Vehicle expenses	1,668.66	1,716.11
Other expenses	1,584.22	1,462.74
CCA	4,388.50	3,717.80
Total expenses	7,641.38	6,896.65
Net Loss	$5,297.32	$4,867.38

[22]          If the van was used not more than 50% for business purposes, I would allow the Appellant to deduct a loss of not more than $4,800 in 1994 with respect to her sale of fresh fruits and vegetables. If the van was used more than 50% for business purposes, I would conclude that the Appellant's activity of selling fresh fruits and vegetables did not have a reasonable expectation of profit and no loss would be deductible.

[23]          Referring back briefly to the Appellant's rental operation, and having regard to the Appellant's great energy in her meals activity in 1992 and sales of fruits and vegetables in 1993 and 1994, one can see why it was not reasonable for the Appellant to claim that she used only 1/13 of her house!

[24]          The Appellant had signed a waiver with respect to her 1992 taxation year so that it could be kept open for reassessment. She later claimed that she had signed the waiver under some pressure; that she believed she had no option but to sign; that the waiver should be set aside; and that 1992 should be regarded as statute-barred. There was no evidence on which I would set aside the waiver.

[25]          In conclusion, I grant certain relief to the Appellant. In her rental activity, she may deduct losses of $12,267 and $4,522 in 1992 and 1994, respectively. In her T-shirt activity, she may deduct a loss of $392.63 in 1992. And in her sale of fruits and vegetables, she may deduct a loss of not more than $4,800 in 1994. I place a limit of $4,800 on the fruit and vegetable loss in 1994 because I am not certain that a careful audit would determine the same amount of CCA which I have computed. Because the Appellant obtained substantial relief, she is entitled to her costs to be taxed. In particular, I would allow a disbursement for the costs of the binders containing Exhibits A-1 to A-25 because those exhibits were important to the Appellant's partial success.

Signed at Ottawa, Canada, this 31st day of May, 2001.

"M.A. Mogan"

J.T.C.C.